-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F+Vn1dy2zwV+qpa86cYElvDoPKwyAlCU0vLtSL83lNTAKrPrgrEsoNWIbBeUC7ED 0l07A0Kd0/90pz+QNWHZkQ== 0000950134-98-007277.txt : 19980901 0000950134-98-007277.hdr.sgml : 19980901 ACCESSION NUMBER: 0000950134-98-007277 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 12 FILED AS OF DATE: 19980831 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERNET AMERICA INC CENTRAL INDEX KEY: 0001001279 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 860778979 STATE OF INCORPORATION: TX FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: SEC FILE NUMBER: 333-59527 FILM NUMBER: 98700980 BUSINESS ADDRESS: STREET 1: 350 N ST PAUL STE 200 CITY: DALLAS STATE: TX ZIP: 75201 MAIL ADDRESS: STREET 1: ONE DALLAS CENTRE 350 N. ST. PAUL STREET 2: SUITE 3000 CITY: DALLAS STATE: TX ZIP: 75201 SB-2/A 1 AMENDMENT NO. 1 TO FORM SB-2 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 31, 1998 REGISTRATION NO. 333-59527 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- PRE-EFFECTIVE AMENDMENT NO. 1 TO FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 INTERNET AMERICA, INC. (Name of small business issuer in its charter) TEXAS 7372 86-0778979 (State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or Organization) Classification Code Number) Identification No.)
MICHAEL T. MAPLES ONE DALLAS CENTRE ONE DALLAS CENTRE 350 N. ST. PAUL, SUITE 3000 350 N. ST. PAUL, SUITE 3000 DALLAS, TEXAS 75201 DALLAS, TEXAS 75201 (214) 861-2500 (214) 861-2500 (Address and telephone of registrant's (Name, address and telephone number of agent principal executive offices) for service)
Copies of communications to: RICHARD F. DAHLSON JOHN B. MCKNIGHT JACKSON WALKER L.L.P. LOCKE PURNELL RAIN HARRELL 901 MAIN STREET, SUITE 6000 (A PROFESSIONAL CORPORATION) DALLAS, TEXAS 75202-3797 2200 ROSS AVENUE, SUITE 2200 TELEPHONE: (214) 953-6000 DALLAS, TEXAS 75201 TELECOPIER: (214) 953-5822 TELEPHONE: (214) 740-8000 TELECOPIER: (214) 740-8800
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If this Form is filed to register additional Common Stock for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED AUGUST 28, 1998 2,300,000 SHARES Internet America Logo COMMON STOCK --------------------- Of the 2,300,000 shares of Common Stock offered hereby, 1,700,000 shares are being sold by the Company and 600,000 shares are being sold by the Selling Shareholders. The Company will not receive any of the proceeds from the sale of shares by the Selling Shareholders. See "Principal and Selling Shareholders." Prior to this offering (the "Offering"), there has been no public market for the Common Stock. It is currently estimated that the initial public offering price will be between $9.00 and $11.00 per share of Common Stock. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price. The Company has applied to have the Common Stock approved for quotation on the Nasdaq National Market under the symbol "GEEK." --------------------- THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 7. --------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- -------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------- PROCEEDS TO PRICE TO UNDERWRITING PROCEEDS TO SELLING PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS - -------------------------------------------------------------------------------------------------------------- Per Share................. $ $ $ $ - -------------------------------------------------------------------------------------------------------------- Total(3).................. $ $ $ $ - -------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------
(1) The Company and the Selling Shareholders have agreed to indemnify the Underwriters against certain liabilities under the Securities Act of 1933, as amended. See "Underwriting." (2) Before deducting estimated expenses of this Offering of $450,000 payable by the Company. (3) The Selling Shareholders have granted to the Underwriters a 30-day option to purchase up to an aggregate of 345,000 additional shares of Common Stock, solely to cover over-allotments, if any. If such option is exercised in full, the total Price to Public will be $ , the total Underwriting Discount will be $ and the total Proceeds to Selling Shareholders will be $ . See "Underwriting." --------------------- The Common Stock is offered by the Underwriters as stated herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. Delivery of such shares will be made through the offices of Hoak Breedlove Wesneski & Co., Dallas, Texas, or its agent on or about , 1998. HOAK BREEDLOVE WESNESKI & CO. FERRIS, BAKER WATTS INCORPORATED The date of this Prospectus is , 1998. 3 [GRAPHICS] - Inside front cover will contain a color map of Texas, designating the counties and cities with populations greater than 50,000 and highlighting the locations of the Company's POPs. Under the map will be the following text: Internet America has dial-up customers in almost half of the 254 counties in Texas. The Company's strategy for growth involves building a critical mass of customers in a given market to take advantage of marketing, network and operating efficiencies. - Inside back cover will contain screen shots of television and billboard advertising and the following text: Internet America combines direct-response television commercials with billboards to attract new customers and position itself as "The Best Route Along the Information Highway." CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING THE ENTRY OF STABILIZING BIDS, EFFECTING SYNDICATE COVERING TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." Internet America(R), 1-800-BE-A-GEEK(R), Airnews.net, Airmail.net, Airweb.net and their respective logos are trademarks, trade names and service marks of the Company. This Prospectus also includes trademarks, trade names and service marks of companies other than the Company, which are the property of their respective owners. 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and Financial Statements, including Notes thereto, appearing elsewhere in this Prospectus. Except as otherwise indicated, the information contained in this Prospectus assumes (i) a 2.25-for-1.00 stock split of the Common Stock effected in the form of a dividend on July 13, 1998, (ii) the automatic conversion of all outstanding shares of the Company's preferred stock into shares of Common Stock on a 2.25-for-1.00 basis 30 days after the completion of the Offering, (iii) an initial public offering price of $10.00 per share, the mid-point of the range on the cover of this Prospectus and (iv) the Underwriters' over-allotment option is not exercised. See "Description of Securities -- Preferred Stock" and "Underwriting." Except where the context otherwise requires, all references to the "Company" or "Internet America" include Internet America, Inc., a Texas corporation, and its predecessor. References to fiscal years by date refer to the fiscal year ended June 30 of that year. This Prospectus contains certain forward-looking statements that involve risks and uncertainties. In addition to the other information in this Prospectus, prospective investors should carefully consider the information set forth under the heading "Risk Factors." The "Glossary of Technical Terms" appearing elsewhere in this Prospectus contains definitions of certain technical terms used herein. THE COMPANY Internet America is a leading Internet service provider ("ISP") in the southwestern United States. The Company provides a wide array of Internet services tailored to meet the needs of individual and business customers, including customers with little or no online experience. With approximately 50,000 customers, primarily in the North Texas area, the Company believes that it has achieved one of the highest user densities per point of presence ("POP") of any ISP in the United States. This user density has enabled the Company to realize substantial marketing, network and operating efficiencies, which have resulted in net profit margins in recent periods that are substantially higher than those of the publicly traded ISPs. The Company realized a net profit margin for the year ended June 30, 1998 of 9.5%, with net profit margins for the quarters within fiscal 1998 of 13.0% for the first quarter, 8.5% for the second quarter, 8.6% for the third quarter, and 8.2% for the fourth quarter. As part of its user density business model, the Company uses television advertising as its primary marketing tool. The Company's experience is that television, reinforced with billboard advertising, is substantially more effective and efficient than radio, print or direct mail in rapidly building a customer base and creating brand awareness. Through its 1-800-BE-A-GEEK(R) television campaigns, which emphasize the speed and quality of the Company's Internet services and its commitment to customer care, the Company has succeeded in building the brand awareness of Internet America in its existing markets. This brand awareness, combined with the Company's deep penetration of the North Texas market, has also resulted in a substantial number of customer referrals. Internet America's most popular service package includes unlimited dial-up Internet access for $19.95 a month. The Company also offers value-added services for additional fees, including multiple e-mail boxes, personalized e-mail addresses and personal Web sites. The Company's Airnews.net provides access to Internet America's news services for customers of other Internet services and on a wholesale basis to other businesses and ISPs. The Company also provides business customers with a full range of services, including dedicated high-speed access, Web hosting, server co-location and domain name registration and hosting. Although the Company's customers are primarily individuals, these business services represent approximately 10% of the Company's fiscal 1998 total revenue. Outstanding service and customer care are crucial to customer acquisition and retention in the ISP industry. The Company's goal of 100% customer satisfaction begins with providing superior systems and network performance, and emphasizes high quality customer service and technical support. The Company's customer care department is available to customers 24-hours-a-day, 7-days-a-week, and is structured to provide effective, friendly support to each customer, whether a novice or an experienced Internet user. 3 5 The Company's systems and network infrastructure, which can be expanded rapidly to accommodate customer growth, is designed to provide fast, highly reliable performance. The Company's primary operations center and largest POP is located in Dallas. Additional physical POPs, incorporating modems, terminal servers and routers are located in four other Texas cities. To expand its geographic coverage and upgrade to new technology, the Company has also implemented a "Virtual POP" architecture with various telecommunications providers. Through its Virtual POP architecture, the Company can provide local access services without deploying physical infrastructure. The benefits of this architecture include substantially reduced capital expenditures, lower operating costs and reduced exposure to technological obsolescence. At June 30, 1998, approximately 50% of the Company's customers were serviced by Virtual POPs. Unlike many other ISPs, the Company believes that at the current stage of the ISP industry's development, the highest priority should be to rapidly build profitable market share, not to deploy a large network infrastructure with a substantial number of underutilized POPs. Therefore, the Company's growth strategy is focused on (i) acquiring additional customers in its existing markets and (ii) deploying its user density business model in other selected markets. The aim of the user density business model is to quickly build in a given market a "critical mass" of customers that will support profitable operations. Elements of the Company's growth strategy include: Aggressive Use of Advertising to Rapidly Acquire a Critical Mass of Customers and Build the Internet America Brand. The Company intensively uses two of the more effective and efficient advertising media -- television and outdoor billboard displays -- to acquire customers quickly and build brand awareness. Strategic and Add-On Acquisitions. The Company intends to pursue strategic acquisitions that will jump-start its entry into new markets, as well as add-on acquisitions in its existing markets that it believes will be accretive to earnings. The Company completed a strategic acquisition in fiscal 1997 and an add-on acquisition in fiscal 1998, but is not currently negotiating any acquisitions. The completed acquisitions were purchases of customer bases and did not constitute business combinations requiring financial statements of the acquirees to be included herein. Cost-Effective Development of Network Infrastructure. In deploying physical infrastructure, the Company will continue to apply its disciplined approach, which is premised upon the achievement of substantial economies of scope and scale. The Virtual POP architecture enables the Company to serve existing markets more efficiently and enter certain new markets more quickly. Development of Value-Added Revenue Streams. In addition to growing value-added revenue streams from its existing services, such as dedicated high-speed access, news access and Web hosting, the Company continues to evaluate and develop other value-added service opportunities, such as xDSL connectivity. The Company believes that a user dense, regionally focused customer base provides an excellent platform for the introduction of new value-added services that can take advantage of brand awareness and economies of scope and scale, potentially including Internet telephony. Maintenance of a First-Rate Customer Care Operation. The Company's sophisticated, high quality customer care operation is designed to assist both novice and experienced Internet users, to ensure that every customer's Internet experience is efficient, productive and enjoyable. The Company believes that this operation is a substantial competitive advantage. The Company was formed in 1994 and reincorporated in Texas in 1995. The Company's principal executive office is located at One Dallas Centre, 350 N. St. Paul, Suite 3000, Dallas, Texas 75201, and its telephone number at that office is (214) 861-2500. The Company's World Wide Web home page is at http://www.airmail.net. Information contained in the Company's Web site does not constitute, and shall not be deemed to constitute, part of this Prospectus. 4 6 THE OFFERING Common Stock offered by the Company.......................... 1,700,000 shares Common Stock offered by the Selling Shareholders............. 600,000 shares Common Stock to be outstanding after the Offering(1)............ 6,285,957 shares Estimated net proceeds to the Company(2)..................... $15.4 million Use of proceeds.................. The Company intends to use the net proceeds of the Offering as follows: (i) approximately $6.0 million to fund potential acquisitions of unaffiliated persons or entities, (ii) approximately $5.0 million to fund increased marketing expenses and incremental capital equipment and infrastructure expenditures related to the Company's anticipated growth, (iii) approximately $2.7 million to repay certain indebtedness, of which approximately $2.2 million is debt owed to affiliates; and (iv) the remaining amount for general corporate purposes. Proposed Nasdaq National Market symbol........................... GEEK SUMMARY FINANCIAL AND OPERATING DATA (In thousands, except per share and customer data)
YEAR ENDED JUNE 30, ----------------------------- 1996 1997 1998 ------- ------- ------- STATEMENT OF OPERATIONS DATA: Total revenue............................................. $ 3,777 $ 9,471 $10,643 Total operating expenses.................................. 7,129 12,814 9,042 ------- ------- ------- Income (loss) from operations............................. (3,352) (3,343) 1,601 Interest expense.......................................... 77 481 571 Income tax expense........................................ -- -- 24 ------- ------- ------- Net income (loss)......................................... $(3,429) $(3,824) $ 1,006 ======= ======= ======= Net income (loss) per share(3): Basic..................................................... $ (1.15) $ (1.12) $ 0.28 Diluted................................................... $ (1.15) $ (1.12) $ 0.21 Weighted average shares(3): Basic..................................................... 2,981 3,418 3,532 Diluted................................................... 2,981 3,418 4,783 OTHER DATA: Approximate number of customers at end of period.......... 27,900 39,900 48,600 EBITDA(4)................................................. $(2,804) $(1,725) $ 3,075 EBITDA margin(4).......................................... (74.2)% (18.2)% 28.9% Cash flow provided (used) by: Operating activities................................... $ 390 $(1,430) $ 1,797 Investing activities................................... (2,981) (1,513) (407) Financing activities................................... 2,615 2,864 (826)
See notes on following page 5 7
THREE MONTHS ENDED --------------------------------------------------- SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, 1997 1997 1998 1998 ------------- ------------ --------- -------- QUARTERLY STATEMENT OF OPERATIONS DATA: Total revenue.................................. $2,412 $2,534 $2,810 $2,887 Total operating expenses....................... 1,957 2,159 2,397 2,529 ------ ------ ------ ------ Income (loss) from operations.................. $ 455 $ 375 $ 413 $ 358 ====== ====== ====== ====== Net income (loss).............................. $ 320 $ 220 $ 248 $ 242 ====== ====== ====== ====== OTHER QUARTERLY DATA: Approximate number of customers at end of period...................................... 39,800 44,600 47,600 48,600 EBITDA(4)...................................... $ 818 $ 738 $ 802 $ 717 EBITDA margin(4)............................... 33.9% 29.1% 28.5% 24.8%
JUNE 30, 1998 ------------------------ ACTUAL AS ADJUSTED(5) ------- -------------- BALANCE SHEET DATA: Cash and cash equivalents................................. $ 565 $13,250 Working capital (deficit)................................. (5,962) 9,398 Total assets.............................................. 3,150 15,835 Long-term debt, net of current portion.................... 31 31 Total shareholders' equity (deficit)...................... (3,767) 11,593
- --------------- (1) Includes 33,750 shares of Common Stock subject to a warrant granted on March 31, 1996 to M.J. Capital Partners, L.P. (the "Warrant") at an exercise price of $1.67 per share that the warrant holder has indicated it intends to exercise contemporaneously with the Offering, and assumes the automatic conversion of all outstanding shares of the Company's preferred stock into shares of Common Stock on a 2.25-for-1.00 basis 30 days after completion of the Offering. Excludes as of June 30, 1998 (i) 225,000 shares of Common Stock reserved for issuance under the 1996 Incentive Stock Option Plan (the "1996 Option Plan"), of which options to purchase 61,756 shares were outstanding at a weighted average exercise price of $1.67 per share, (ii) 400,000 shares of Common Stock reserved for issuance under the 1998 Nonqualified Stock Option Plan (the "1998 Option Plan"), of which no options were outstanding and (iii) 1,184,657 shares of Common Stock issuable upon exercise of other outstanding options at a weighted average exercise price of $1.55 per share. See "Management -- 1996 Incentive Stock Option Plan," "-- Nonqualified Stock Options Issued to Officers and Directors," and "-- 1998 Nonqualified Stock Option Plan." (2) After deducting the underwriting discount and other estimated expenses of the Offering. (3) See Notes 1 and 11 of Notes to Financial Statements for information concerning the calculation of basic and diluted net income (loss) per share. (4) EBITDA (earnings before interest, taxes, depreciation and amortization) consists of total revenue less connectivity and operations expense, sales and marketing expense, general and administrative expense and impairment of equipment expense. EBITDA is provided because it is a measure commonly used by investors to analyze and compare companies on the basis of operating performance. EBITDA is presented to enhance an understanding of the Company's operating results and is not intended to represent cash flows or results of operations in accordance with generally accepted accounting principles ("GAAP") for the periods indicated. EBITDA is not a measurement under GAAP and is not necessarily comparable with similarly titled measures for other companies. EBITDA margin represents EBITDA as a percentage of total revenue. (5) Adjusted to give effect to the sale of 1,700,000 shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $10.00 per share (the mid-point of the range set forth on the cover of this Prospectus), after deducting the underwriting discount and estimated expenses of the Offering payable by the Company, the application of the net proceeds therefrom, the exercise of the Warrant and the conversion of all of the outstanding shares of preferred stock to Common Stock. See "Use of Proceeds" and "Capitalization." 6 8 RISK FACTORS The shares offered hereby involve a high degree of risk. The factors set forth below, along with the other information contained herein, should be considered carefully in evaluating an investment in the shares of Common Stock offered hereby. Further, this Prospectus contains certain forward-looking statements that involve risks and uncertainties, such as statements of the Company's plans, goals, objectives, expectations and intentions. The cautionary statements made in this Prospectus apply to all related forward-looking statements wherever they appear in this Prospectus. Prospective investors in the shares of Common Stock offered hereby are cautioned that, while the forward-looking statements reflect the Company's good faith beliefs, they are not guarantees of future performance, and involve known and unknown risks and uncertainties. In addition, the Company's actual results could differ materially from those discussed herein. Some of the factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this Prospectus. LIMITED OPERATING HISTORY; OPERATING LOSSES The Company was incorporated in December 1994 and commenced offering Internet access in January 1995. Accordingly, the Company has only a limited operating history upon which an evaluation of its prospects can be made. Such prospects must be considered in light of the substantial risks, expenses and difficulties encountered by new entrants into the Internet services industry. Moreover, the Company's current management, a number of whom joined the Company as recently as the first and second quarters of 1997, is relatively new. Although the Company had net profits for each of its last three fiscal quarters, the Company had net losses in every preceding quarter since it commenced operations. As of June 30, 1998, the Company had an accumulated deficit of approximately $6.6 million. The Company's ability to maintain profitability and positive cash flow is dependent upon a number of factors, including the Company's ability to increase revenues while reducing costs per subscriber and achieving economies of scale. There can be no assurance that the Company will be successful in increasing or maintaining revenues or achieving or sustaining economies of scale or positive cash flow in the future, and any such failure could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Factors Affecting Operating Results; Potential Fluctuations in Quarterly Results," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview" and "-- Selected Quarterly Results of Operations," "Business -- Competition" and "Management -- Executive Officers and Directors." FACTORS AFFECTING OPERATING RESULTS; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS The Company's future success depends on a number of factors, many of which are beyond the Company's control. These factors include the rates of and costs associated with new customer acquisition, customer retention, capital expenditures and other costs relating to the expansion of operations, the timing of new product and service announcements, changes in the Company's pricing policies and those of its competitors, market acceptance of new and enhanced versions of the Company's services, changes in operating expenses, changes in the Company's strategy, personnel changes, the introduction of alternative technologies, the effect of potential acquisitions, increased competition in the Company's current and prospective markets and other general economic factors. The Company's operating results, cash flows and liquidity may fluctuate significantly in the future. The Company's revenues depend on its ability to attract and retain subscribers. Internet America's monthly customers, who account for a majority of the Company's revenues, have the option of discontinuing their service at the end of any given month for any reason. The percentage of customers discontinuing service on a monthly or other basis is immaterial. The Company's expense levels are based, in part, on its expectations as to future revenues. Moreover, the Company's operations often require up-front expenses, but result in trailing revenues. To the extent that revenues are below expectations, the Company may be unable or unwilling to reduce expenses proportionately, and operating results, cash flow and liquidity are likely to be adversely affected. In addition, the Company has in recent periods experienced increasing customer utilization rates, which increases the Company's expenses. To remain competitive from a pricing standpoint, the Company may not be able to increase customer fees to match these increasing expenses and therefore could experience 7 9 deteriorating profit margins or losses. Due to these and other factors, in some future quarter the Company's operating results and/or growth rate may be below the expectations of analysts, management and investors, which could materially adversely affect the value of the Common Stock. RISKS OF TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS The market for Internet access is characterized by rapidly changing technology, evolving industry standards, changes in customer needs and frequent new service introductions. The Company's future success will depend, in part, on its ability to use leading technologies effectively, to continue to develop its technical expertise and to enhance its existing services and develop new services to meet changing customer needs on a timely and cost-effective basis. There can be no assurance that the Company will be successful in using new technologies effectively, developing new services or enhancing existing services on a timely basis or that such new technologies or enhancements will achieve market acceptance. The Company believes that its ability to compete successfully is also dependent upon the continued compatibility and interoperability of its services with products and architectures offered by various vendors. Although the Company intends to support emerging standards in the market for Internet services, there can be no assurance that industry standards will be established or, if they become established, that the Company will be able to conform to these new standards in a timely fashion and maintain a competitive position in the market. In addition, there can be no assurance that services or technologies developed by others will not render the Company's services or technology uncompetitive or obsolete. The Company is also at risk to fundamental changes in the way Internet access is delivered. Currently, Internet services are accessed primarily by computers connected by telephone lines. There are currently available or under development a number of alternative methods for users to access the Internet, including cable television modems, high speed dedicated access, screen based telephones, satellite technologies, wireless telecommunications technologies and other consumer electronic devices. The methods have the ability to transmit data at substantially faster speeds than the modems the Company currently uses. As the Internet becomes more accessible through these alternative methods, or as customer requirements change the way Internet access is provided, the Company will face additional competitive pressures and will have to develop or use new technology or modify its existing technology, either internally or through arrangements with third parties, to accommodate these changes. See "Competition." Adjusting to such technological advances may require substantial time and expense, and there can be no assurance that the Company will succeed in addressing these competitive pressures or adapting its business to alternative access methods. DEPENDENCE ON NETWORK INFRASTRUCTURE; CAPACITY; RISK OF SYSTEM FAILURE The future success of the Company's business will depend to a large extent on the capacity, reliability and security of its network infrastructure. The Company will be required to expand and adapt its network infrastructure as the number of customers and the amount and type of information they wish to transfer increase. Such expansion and adaptation of the Company's network infrastructure will require substantial financial, operational and management resources. In order to address anticipated growth in its existing markets, the Company believes that it will require up to $500,000 for capital expenditures on network infrastructure during the next twelve months and expects the source of these funds to be drawn from the proceeds of the Offering. However, there can be no assurance that the Company will be able to expand or adapt its network infrastructure to meet additional demand or changing customer requirements on a timely basis and at a commercially reasonable cost, or at all. See "Use of Proceeds." Capacity constraints have occurred and may occur in the future, both at the level of particular POPs (affecting only customers attempting to use the particular POP) and in connection with system wide services (such as e-mail and newsgroup services). From time to time, the Company has experienced delayed delivery from suppliers of new telephone lines, modems, terminal servers and other equipment. If delays of this nature are severe, all incoming modem lines may become full during peak times, resulting in busy signals for customers who are trying to connect to the Internet through the Company. Further, if the Company does not maintain sufficient bandwidth capacity in its network connections, customers will perceive a general slowdown of all services on the Internet. Similar problems can occur if the Company is unable to expand the capacity of 8 10 its information servers (for e-mail, news and the World Wide Web) fast enough to keep up with demand from an expanding subscriber base with increasing utilization rates. If the capacity of such servers is exceeded, customers will experience delays when trying to use a particular service. As the majority of the Company's information traffic flows through the Dallas POP, a capacity constraint, supplier delay or other slowdown at the Dallas POP or operations infrastructure would affect a majority of the Company's customers and operations. Any of these events could cause customers to terminate use of the Company's services. Accordingly, while the Company's objective is to maintain excess capacity, any failure of the Company to expand or enhance its network infrastructure on a timely basis or to adapt it to an expanding subscriber base, changing customer requirements or evolving industry standards could materially adversely affect the Company's business, financial condition and results of operations. The Company's operations and services are dependent on the extent to which the equipment of the Company is protected against damage from fire, earthquakes, power loss, telecommunications failures and similar events. A significant portion of the Company's equipment, including critical equipment dedicated to its Internet access services, is located at a single facility in Dallas, Texas. Despite precautions taken by the Company, the occurrence of a natural disaster or other unanticipated problems at the Company's headquarters, network hub or a POP could cause interruptions in the services provided by the Company. The Company does not currently maintain fully redundant or back-up Internet services, backbone facilities or other computing and telecommunications facilities. See "Business -- Systems Infrastructure." Any accident, incident or system failure that causes interruptions in the Company's operations could have a material adverse effect on the Company's ability to provide Internet services to its customers and, in turn, on the Company's business, financial condition and results of operations. See "-- Dependence on Telecommunications Carriers and Other Suppliers" and "-- Security Risks." The Company's billing and management information systems are also dependent on the extent to which the computer equipment and attendant software of the Company is protected against damage, malfunction or other loss. The Company bills the majority of its customers by automatic charges to customers' credit cards or bank accounts each month in advance, while some customers are invoiced. Any damage to or system failure of the Company's billing and management information systems could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Security Risks." DEPENDENCE ON TELECOMMUNICATIONS CARRIERS AND OTHER SUPPLIERS The Company relies on local telephone companies and other companies to provide data communications capacity via local telecommunications lines and leased long-distance lines, usually through contracts effective for terms of one to three years. The Company has experienced and is subject to disruptions or capacity constraints in these telecommunications services and may have no means of replacing these services, on a timely basis or at all, in the event of such disruption or capacity constraints. The Company has in the past temporarily lost service in a market area, although these problems are usually cured within 24 hours. In addition, local phone service is sometimes available only from the local monopoly telephone company in each of the markets served by the Company. In addition, the Company provides Internet access exclusively through Virtual POPs in some markets. See "Business -- Infrastructure." The inability or unwillingness of any third-party to provide POP access to the Company's customers or the Company's inability to secure alternative POP arrangements upon partial or complete termination of a third-party network provider agreement or other loss of access to such POPs could significantly limit the Company's ability to provide Internet access to its customers and could limit the Company's ability to expand in new markets, which could, in turn, have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that, if access to one or more Virtual POPs is lost, any alternative arrangements will be available or, if available, that such arrangements will be on terms acceptable to the Company. The Company does not currently have any plans or commitments with respect to such alternative POP arrangements. Moreover, while the third-party providers are contractually obligated to provide commercially reliable service to the Company's customers with a significant assurance of accessibility to the Internet, there can be no assurance that such services or Internet 9 11 access will meet the Company's requirements, which could materially adversely affect the Company's business, financial condition and results of operations. The Company's operations and services are dependent on the extent to which the equipment of its third-party network providers (over which the Company has no control) is protected against damage from fire, earthquakes, power loss, telecommunications failures and similar events. Any accident, incident, system failure or discontinuance of operations involving a third-party network that causes interruptions in the Company's operations could have a material adverse effect on the Company's ability to provide Internet services to its customers and, in turn, on the Company's business, financial condition and results of operations. In addition, failure of the Company's telecommunications providers to provide the required data communications capacity as a result of a natural disaster, operational disruption or for any other reason could cause interruptions in the services provided by the Company. The Company is dependent on certain third-party suppliers of hardware components. Expansion of network infrastructure by the Company and others is placing, and will continue to place, a significant demand on the Company's suppliers, some of which have limited resources and production capacity. Failure of the Company's suppliers to adjust to meet such increasing demand may prevent them from continuing to supply components and products in the quantities, at the quality levels and at the times required by the Company, or at all. The Company's inability to develop alternative sources of supply, if required, could result in delays and increased costs in expanding the Company's network infrastructure, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's telecommunications carriers and suppliers also sell, lease or make available products and services to the Company's competitors and may be, or in the future may become, competitors of the Company themselves. There can be no assurance that the Company's telecommunications carriers and suppliers will not enter into exclusive arrangements with the Company's competitors or stop selling, leasing or making available their products or services to the Company at commercially reasonable prices, or at all. See "-- Competition." RISKS ASSOCIATED WITH GROWTH STRATEGY AND ACQUISITIONS Although the Company has tested each component of its growth strategy in its existing markets, the Company has not attempted to introduce its user density business model to other markets. There can be no assurance that the Company will be successful in implementing its growth strategy, and any failure could have a material adverse effect on the Company's business, financial condition and results of operations. One component of its growth strategy, the strategic acquisition of businesses and subscriber accounts, involves certain risks, including, among others, the following: the difficulty of assimilating the acquired operations and personnel; the potential disruption of the Company's ongoing business; the possible inability of management to maximize the financial and strategic position of the Company by the successful incorporation of acquired technology and rights into the Company's service offerings and to maintain uniform standards, controls, procedures and policies; the risks of entering markets in which the Company has little or no direct prior experience; and the potential impairment of relationships with employees and customers as a result of changes in management. There can be no assurance that the Company will be successful in overcoming these risks or any other problems encountered in connection with future transactions. In addition, any such transaction could materially adversely affect the Company's operating results due to dilutive issuances of equity securities, the incurrence of additional debt and the amortization of expenses related to goodwill and other intangible assets, if any. COMPETITION The market for the provision of Internet access to individuals and small businesses is extremely competitive and highly fragmented. There are no substantial barriers to entry, and the Company expects that competition will continue to intensify. The Company believes that the primary competitive factors determining success in this market are a reputation for reliability and service, effective customer support, pricing, creative marketing, easy-to-use software and geographic coverage. Other important factors include the timing of introductions of new services and industry and general economic trends. There can be no assurance that the 10 12 Company will be able to compete successfully against current or future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations. The Company's current and prospective competitors include many large companies that have substantially greater market presence and financial, technical, marketing and other resources than the Company. The Company currently competes or expects to compete with the following types of Internet services providers: (i) national commercial providers, such as Verio, Inc., Mindspring Enterprises, Inc. and EarthLink Network, Inc.; (ii) numerous regional and local commercial providers, which vary widely in quality, service offerings and pricing, such as Websight Services, Inc. and PDQ Net, Inc.; (iii) established online commercial information service providers, such as America Online, Inc.; (iv) computer hardware and software and other technology companies, such as International Business Machines Corporation, Microsoft Corp. and Gateway, Inc.; (v) national telecommunications providers, such as AT&T Corp. ("AT&T"), MCI Communications Corporation ("MCI"), WorldCom, Inc., Sprint Corporation ("Sprint") and WindStar Communications, Inc.; (vi) regional telecommunications providers, such as SBC Communications and IXC Communications; (vii) cable operators, such as Tele-Communications, Inc., Time Warner, Inc., TCA Cable, Inc. and Marcus Cable, Inc.; (viii) wireless communications companies; (ix) satellite companies; and (x) nonprofit or educational Internet access providers. The Company believes that new competitors, including large computer hardware and software, media and telecommunications companies, will continue to enter the Internet services market, resulting in even greater competition for the Company. In particular, the Company expects to face increased competition in the future from companies that provide connections to consumers' homes, including local and long distance telephone companies, cable companies, electric utility companies and wireless communications companies. Technologies have been developed that enable cable television operators to offer Internet access through their cable facilities at significantly faster rates than existing modem speeds. Such companies include Internet access in their basic bundle of services or offer such access for a nominal additional charge, and could prevent the Company from delivering Internet access through the wire and cable connections that such companies own. In addition, as consumer awareness of the Internet grows, existing competitors are likely to further increase their emphasis on Internet access services, resulting in even greater competition for the Company. Any such developments could materially adversely affect the Company's business, financial condition and results of operations. See "Business -- Competition." As a result of increased competition in the industry, the Company expects to encounter significant pricing pressure. Reductions in rates charged by the Company's competitors could require the Company to reduce prices charged to its customers, which could cause a decrease in total revenues and revenue per customer and reduce the likelihood of the Company maintaining positive cash flow or profitability in the future. Any such reductions in prices could materially adversely affect the Company's business, financial condition and results of operations. In addition, telecommunications companies may be able to offer customers reduced communications costs in connection with their Internet access services, reducing the overall cost of such services and significantly increasing price pressures on the Company. Competition could also result in increased selling and marketing expenses, related customer acquisition costs and customer attrition, all of which could materially adversely affect the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to offset the effects of any such increased costs or reductions in the Company's prices through an increase in the number of its customers, higher revenues from enhanced services, cost reductions or otherwise, or that the Company will have the resources to continue to compete successfully. DEPENDENCE ON AND ABILITY TO ATTRACT KEY PERSONNEL The Company's success depends upon the continued efforts of its senior management team and its technical, marketing and sales personnel. Such employees may voluntarily terminate their employment with the Company at any time, as the Company has no employment agreements with any of its employees. The Company's success also depends on its ability to attract and retain additional highly qualified management, technical, marketing and sales personnel. The process of hiring employees with the combination of skills and attributes required to carry out the Company's strategy is extremely competitive and time-consuming. There 11 13 can be no assurance that the Company will be able to retain or integrate existing personnel or identify and hire additional qualified personnel. The loss of the services of key personnel, or the inability to attract additional qualified personnel, could materially adversely affect the Company's business, financial condition and results of operations. SECURITY RISKS Despite the implementation of security measures, the Company's network infrastructure may be vulnerable to computer viruses, hacking or similar disruptive problems caused by customers, customers of other ISPs, other connected Internet sites, the interconnecting networks and the various telephone networks. Computer viruses or problems caused by third parties could lead to interruptions, delays or cessation in service to the Company's customers. Inappropriate use of the Internet by third parties could also potentially jeopardize the security of confidential information stored in the computer systems of the Company or its customers, which may cause losses to the Company or its customers or deter certain persons from subscribing to the Company's services. Such inappropriate use of the Internet includes attempting to gain unauthorized access to information or systems, which is commonly known as "cracking" or "hacking." Although the Company intends to continue to implement security measures, such measures have been circumvented in the past, and there can be no assurance that measures implemented by the Company will not be circumvented in the future. Alleviating problems caused by computer viruses or other inappropriate uses or security breaches may require interruptions, delays or cessation in service to the Company's customers, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company expects that its customers will increasingly use the Internet for commercial transactions in the future. Any network malfunction or security breach could cause these transactions to be delayed, not completed at all or completed with compromised security. There can be no assurance that customers or others will not assert claims of liability against the Company as a result of any such failure. Further, until more comprehensive security technologies are developed, the security and privacy concerns of existing and potential customers may inhibit the growth of the Internet service industry in general and Internet America's customer base and revenues in particular. MANAGEMENT AND RISKS OF GROWTH The rapid execution necessary for the Company to fully exploit the market for its services requires an effective planning and management process. The Company's growth has in the past placed, and may in the future place, a significant strain on the Company's managerial, operational and financial resources. In order to effectively manage its operations, the Company will be required to continue to implement and improve its operational, financial and management information systems and to identify, attract, train, integrate and retain qualified personnel. These demands will require the addition of new management personnel and the development of additional expertise by existing management. In particular, the successful integration of acquired businesses or assets and the implementation of an expansion strategy will require close monitoring of quality of service (particularly through Virtual POPs) and, to the extent management deems necessary, identification and acquisition of physical sites, acquisition and installation of necessary equipment and telecommunications facilities, implementation of marketing efforts in new as well as existing markets, employment of qualified personnel to provide technical and marketing support for such sites and continued expansion of the Company's managerial, operational and financial resources to support such development. The demands on the Company's customer service and technical support resources will grow as the Company's customer base expands. There can be no assurance that the Company's customer service and technical support or other resources will be sufficient to manage any future growth in the Company's business or that the Company will be able to implement its expansion program in whole or in part. NEW AND UNCERTAIN MARKET; UNCERTAIN ACCEPTANCE OF THE INTERNET AS A MEDIUM OF COMMERCE AND COMMUNICATION The market for Internet access and related products is in an early stage of growth. The Company's success will depend upon the continuing development and expansion of the Internet and the market for 12 14 Internet access. Critical issues concerning commercial and personal use of the Internet (including practice standards and protocol, security, reliability, cost, ease of use, access and quality of service) remain uncertain and may affect the growth of Internet use. See "-- Potential Liability." The acceptance of the Internet for commerce and communications, particularly by those individuals and enterprises that have historically relied upon alternative means of commerce and communication, generally requires that such users accept a new way of conducting business and exchanging information, that industry participants continue to provide new and compelling content and applications and that the Internet provide a reliable and secure computer platform. It is difficult to predict with any assurance the rate at which the market will grow, if at all, or at which new or increased competition will result in market saturation. The novelty of the market for Internet services may also adversely affect the Company's ability to retain new customers, as customers unfamiliar with the Internet may be more likely to discontinue the Company's services after an initial trial period than other customers. If demand for Internet services fails to continue to grow, grows more slowly than anticipated or becomes saturated with competitors, the Company's business, operating results and financial condition will be materially adversely affected. Conversely, to the extent that the Internet continues to experience significant growth in the number of users and level of use, there can be no assurance that the Internet infrastructure will be able to support the demands placed on it by such growth. POTENTIAL LIABILITY The Company has limited control over its customers' online practices and the information passed through and stored on its systems by its customers. The law relating to the liability of Internet access providers and online services companies for incorrect use of the Internet and information carried on or disseminated through their networks is unsettled. On June 22, 1998, the United States Supreme Court declined to review a Fourth Circuit Court of Appeals decision in which a negligence action was brought against an ISP for allegedly delaying the removal of defamatory messages posted by an Internet user, refusing to post retractions of those messages and failing to screen for similar postings thereafter. The Fourth Circuit Court of Appeals affirmed the lower court's decision that the Communications Decency Act of 1996 bars the claims against the ISP. Although no such claims or lawsuits have been asserted against the Company to date, there can be no assurance that such claims will not be asserted in the future, or if asserted, will not be successful. As the law in this area develops, the potential imposition of liability upon the Company for information carried on and disseminated through its network could require the Company to implement measures to reduce its exposure to such liability, which may require the expenditure of substantial resources or the discontinuation of certain service offerings. Any costs that are incurred as a result of contesting any such asserted claims or the consequent imposition of liability could materially adversely affect the Company's business, financial condition and results of operations. In addition, the Communications Decency Act of 1996 imposes fines on any entity that: (i) by means of a telecommunications device, knowingly sends indecent or obscene material to a minor; (ii) by means of an interactive computer service sends or displays indecent material to a minor; or (iii) permits any telecommunications facility under such entity's control to be used for the purposes detailed above. The standard for determining whether an entity acted knowingly has not yet been established. Certain defenses to liability under the statute are available but may not apply. Although the Company does not actively monitor the content of its customers' Internet transmissions, there can be no assurance that the Company would not be considered to have knowledge of such content. Although no such claims or lawsuits have been asserted against the Company to date, there can be no assurance that if the Company were prosecuted that any defenses to liability would be applicable. PROPRIETARY RIGHTS; INFRINGEMENT CLAIMS The Company's success depends in part upon its technology. The Company relies upon a combination of copyright, trademark and trade secret laws, and contractual restrictions to establish and protect its proprietary technology. There can be no assurance that the steps taken by the Company will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. 13 15 The Company has obtained permission and, in certain cases, licenses from each manufacturer of software that the Company bundles in its front-end software product for customers. Although the Company does not believe that the software or the trademarks it uses infringe on the proprietary rights of any third parties, and no such claims or lawsuits have been asserted against the Company to date, there can be no assurance that third parties will not assert such claims against the Company in the future or that such claims will not be successful. The Company could incur substantial costs and diversion of management resources with respect to the defense of any claims relating to proprietary rights, which could materially adversely affect the Company's business, financial condition and results of operations. In the event a claim relating to the proprietary technology or information is asserted against the Company, the Company may seek licenses to such intellectual property. There can be no assurance, however, that licenses could be extended or obtained on commercially reasonable terms, if at all, or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain the necessary licenses or other rights could materially adversely affect the Company's business, financial condition and results of operations. See "Business -- Proprietary Rights." THE YEAR 2000 ISSUE The Year 2000 issue is the result of computer programs using two digits rather than four to define the applicable year. Date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations, causing disruptions of operations, including, among others, a temporary inability to process transactions, send invoices or engage in similar normal business activities. The Company does not believe that the Year 2000 issue will have a material effect on its network, computer systems or operations, however, it will continue to assess the potential impact of the Year 2000 issue. Any failure of the Company to become Year 2000 compliant on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations, including, without limitation, a complete failure or degradation of the performance of the Company's network or other systems. To the extent that the Company relies on external vendors and network providers with Year 2000 exposure, any failure by such third-party providers to resolve any Year 2000 issues on a timely basis or in a manner that is compatible with the Company's systems could have a material adverse effect on the Company. Most of the Company's critical third-party providers have made representations to the effect that they are, or will be, Year 2000 compliant. The Company, however, has not undertaken an in-depth evaluation of such providers in relation to the Year 2000 issue, and furthermore the Company has no control over whether its third-party providers are, or will be, Year 2000 compliant. Any failure on the part of such third-party providers to become Year 2000 compliant on a timely basis or in a manner that is compatible with the Company's systems could have a material adverse effect on the Company. In the event the Company encounters Year 2000 problems, it would expect to take all necessary measures to address such problems. GOVERNMENT REGULATION The Company provides Internet access, in part, through transmissions over public telephone lines. These transmissions are governed by regulatory policies establishing charges and terms for communications. The Company, as an Internet access provider, is not currently subject to direct regulation by the Federal Communications Commission (the "FCC") or any other agency, other than regulations applicable to businesses generally. In a report to Congress adopted on April 10, 1998, the FCC reaffirmed that Internet access providers should be classified as unregulated "information service providers" rather than regulated "telecommunications providers" under the terms of the 1996 Telecommunications Act. The consequence of this finding is that the Company is not subject to regulations applicable to telephone companies and similar carriers merely because the Company provides its services via telecommunications networks. The Company also is not required to contribute to the universal service fund, which subsidizes phone service for rural and low income consumers and supports Internet access among schools and libraries. The FCC action may also discourage states from regulating Internet access providers as telecommunications carriers or imposing similar subsidy obligations. Nevertheless, Internet-related regulatory policies are continuing to develop, and it is possible that the Company could be exposed to regulation in the future. For example, in the same report to Congress, the FCC 14 16 stated its intention to consider whether to regulate voice and fax telephony services provided over the Internet as "telecommunications" even though Internet access itself would not be regulated. The FCC is also considering whether such Internet-based telephone services should be subject to the universal service support obligations discussed above, or should pay carrier access charges on the same basis as traditional telecommunications companies. Access charges are assessed by local telephone companies to long distance companies for the use of the local telephone network to originate and terminate long distance calls, generally on a per-minute basis. Access charges have been a matter of continuing dispute, with long distance companies complaining that the rates are substantially in excess of cost and local telephone companies arguing that access rates are justified to subsidize lower local rates for end users and other purposes. Both local and long distance companies, however, contend that Internet-based telephony should be subject to these charges. The Company currently does not offer telephony, and so is not directly affected by these developments, however, should the Company offer telephony in the future, it may be affected by these issues. Additionally, the Company cannot predict whether these debates will cause the FCC to reconsider its current policy of not regulating Internet access providers. In a notice of proposed rulemaking adopted on August 6, 1998, the FCC proposed that if an incumbent LEC established a separate affiliate to pursue the deployment of advanced telecommunications services such as xDSL and that affiliate interconnected with the LEC's network on the same terms and conditions as the LEC's competitors did, then the affiliate would not be subject to the unbundling requirement that applied to the LEC. If the FCC ultimately adopted this proposal or similar proposals, the Company's access to xDSL and other high-speed data transmission methods could be curtailed. Such curtailment could have a material adverse effect on the Company's business, financial condition and results of operations. Due to the increasing popularity and use of the Internet, it is possible that additional federal, state or other laws and regulations may be adopted with respect to the Internet, covering issues such as content, privacy, pricing, encryption standards, consumer protection, electronic commerce, taxation, copyright infringement and other intellectual property issues. See "-- Potential Liability." The Company cannot predict the impact, if any, that any future regulatory changes or development may have on its business, financial condition and results of operations. Changes in the regulatory environment relating to the Internet access industry, including regulatory changes that directly or indirectly affect telecommunication costs or increase the likelihood or scope of competition from regional telephone companies or others, could have a material adverse effect on the Company's business, financial condition and results of operations. NEED FOR ADDITIONAL CAPITAL Although the Company believes that the net proceeds of the Offering will be sufficient to enable the Company to implement its business strategies for at least the next twelve months, there can be no assurance that the net proceeds will be sufficient for such purposes, either in the near term or thereafter. Additionally, the Company may have insufficient capital to respond to unanticipated technological developments or competitive pressures or to take advantage of unanticipated opportunities, such as special marketing opportunities, the development of new services or larger than anticipated acquisitions of complementary businesses or assets. As a result, the Company may need to raise additional funds through equity or debt financings. There can be no assurance that such additional financings will be available on terms acceptable to the Company or at all. Further, any such financings may be upon terms that are dilutive or potentially dilutive to the Company's shareholders. If alternative sources of financing are required, but are insufficient or unavailable, the Company will be required to modify its growth and operating plans in accordance with the extent of available funding, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition -- Liquidity and Capital Resources." CONTROL OF COMPANY After completion of the Offering, the Company's officers, directors and 10% shareholders will beneficially own, directly or indirectly, approximately 48.8% of the outstanding voting stock of the Company, (assuming the exercise of all derivative securities currently outstanding, such persons would beneficially own, directly or 15 17 indirectly, approximately 44.7% of the outstanding voting stock of the Company). As a result, these shareholders, acting together, would be able to exercise control over substantially all matters requiring approval by the shareholders of the Company, including the election of directors and certain change-of-control transactions. See also "-- Anti-Takeover Matters." ABSENCE OF A PRIOR PUBLIC MARKET Prior to the Offering, there has been no public market for the Common Stock, and there can be no assurance that an active trading market will develop or be sustained. The initial public offering price of the Common Stock will be determined through negotiations among the Company, the Selling Shareholders and the Underwriters and may not be indicative of the market price for the Common Stock after the Offering. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. STOCK PRICE VOLATILITY The trading price of the Common Stock may be subject to wide fluctuations in response to factors such as actual or anticipated variations in the Company's operating results; announcements of technological innovations by the Company or its competitors; new services or contracts; developments with respect to patents, copyrights or proprietary rights; changes in recommendations or financial estimates by securities analysts; conditions and trends in the Internet services and technology industries; adoption of new accounting standards affecting the Company's industry; general market conditions and other factors. Further, the stock market has experienced in recent months and may continue in the future to experience extreme price and volume fluctuations that particularly affect the market prices of equity securities of Internet services and technology companies and that often are unrelated or disproportionate to the operating performance of such companies. The trading prices of many Internet services and technology companies' stocks have recently been at or near historical highs and reflect price to earnings ratios that are substantially above historical levels. There can be no assurance that these trading price to earnings ratios will be sustained. These broad market price fluctuations, as well as general economic, political and market conditions, may adversely affect the market price of the Company's Common Stock. In the past, following periods of volatility in the market price of a company's stock, securities class action litigation has often been instituted against the issuing company. There can be no assurance that such litigation will not occur in the future with respect to the Company. Such litigation could result in substantial costs and would at a minimum divert management's attention and resources, which could have a material adverse effect on the Company's business, financial condition and results of operations. Any adverse determination in such litigation could also subject the Company to significant liabilities. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, the Company will have an aggregate of 6,285,957 shares of Common Stock outstanding. Of these shares, all of the shares sold in the Offering will be freely transferable without restriction or limitation under the Securities Act of 1933, as amended (the "Securities Act"), except for any shares purchased by "affiliates" of the Company, as such term is defined in Rule 144 under the Securities Act. The remaining 3,985,957 shares constitute "restricted securities" within the meaning of Rule 144. Of these "restricted securities," 1,886,333 shares have been held for the required one-year period and will be freely tradable upon completion of the Offering, subject to the 180-day lock-up period described below and subject to the 90-day information requirement of Rule 144 for shares held by affiliates or for less than the required two-year period. The holders of 1,660,769 outstanding shares have certain rights to have shares registered under the Securities Act pursuant to the terms of agreements between such holders and the Company. See "Description of Securities -- Registration Rights." Of those 1,660,769 shares, 769,149 shares are freely tradeable upon completion of the Offering, subject to the 180-day lock-up period described below and subject to the 90-day information requirement of Rule 144 for shares held by affiliates or for less than the required two-year period. The Company, and its executive officers, directors and certain shareholders (including all those with registration rights) who will hold, collectively, 3,066,017 outstanding shares of Common Stock after the Offering, have agreed not to offer or sell any shares of Common Stock for a period of 180 days 16 18 following the date of this Prospectus without the prior written consent of Hoak Breedlove Wesneski & Co., except under limited circumstances. If this 180-day lock-up period is waived by Hoak Breedlove Wesneski & Co., then 2,459,284 of the 3,066,017 shares would be freely tradeable subject to the 90-day information requirement of Rule 144 for shares held by affiliates or for less than the required two-year period. The Company intends to file a Registration Statement on Form S-8 to register 800,000 shares of Common Stock, which is the aggregate of all shares reserved for issuance pursuant to the 1996 Option Plan and 1998 Option Plan and shares underlying certain nonqualified options granted to officers and directors. Accordingly, shares issued upon exercise of such options will be freely tradeable by holders who are not affiliates of the Company and, subject to volume and other limitations of Rule 144, by holders who are affiliates of the Company. Sales of substantial amounts of shares of Common Stock in the public market after the Offering, or the perception that such sales could occur, may adversely affect the market price of the Common Stock. See "Shares Eligible for Future Sale." ANTI-TAKEOVER MATTERS The Company's Articles of Incorporation, as amended (the "Articles"), and Bylaws, as amended ("Bylaws"), contain provisions that may have the effect of delaying, deterring or preventing a potential takeover of the Company that shareholders purchasing shares in the Offering may consider to be in their best interests. The Articles and Bylaws prevent shareholders from calling a special meeting of shareholders, prevent shareholders from amending the Bylaws and prohibit shareholder action by written consent. The Articles also authorize only the Board of Directors to fill vacancies, including newly-created directorships, and state that directors of the Company may be removed only for cause and only by the affirmative vote of holders of at least two-thirds of the outstanding shares of the voting stock, voting together as a single class. Article XIII of the Texas Business Corporation Act, which is applicable to the Company, contains provisions that restrict certain business combinations with interested shareholders, which may have the effect of inhibiting a non-negotiated merger or other business combination involving the Company. See "Description of Securities -- Texas Anti-Takeover Law and Certain Provisions." IMMEDIATE AND SUBSTANTIAL DILUTION Investors purchasing shares of Common Stock in this Offering will incur immediate and substantial dilution in net tangible book value of the Common Stock of $8.23 per share on a pro forma basis assuming an initial public offering price of $10.00 per share. If all currently exercisable derivative securities are exercised, investors will incur total dilution in net tangible book value of the Common Stock of $8.25 per share on a pro forma basis assuming an initial public offering price of $10.00 per share. See "Dilution." 17 19 USE OF PROCEEDS The net proceeds to the Company from the sale of 1,700,000 shares of Common Stock offered hereby by the Company at an assumed initial public offering price of $10.00 per share are estimated to be approximately $15.4 million, after deducting the underwriting discount and estimated offering expenses payable by the Company. The Company will not receive any of the proceeds from the sale of shares of Common Stock by the Selling Shareholders. The principal purposes of the Offering are to increase the Company's equity capital, to create a public market for the Common Stock, to facilitate the future access by the Company to public equity markets, to facilitate acquisitions funded through the issuance of Common Stock, to provide liquidity for certain of the Company's existing shareholders and to provide increased visibility of the Company in the marketplace. The Company anticipates that the net proceeds of the Offering will be applied as follows, subject to the qualifications set forth further below:
APPROXIMATE USE OF PROCEEDS DOLLAR AMOUNT PERCENT --------------- ------------- ------- Possible acquisitions of complementary businesses or expansion in existing and new markets..................... $ 6,000,000 39.0% Marketing expenses and capital equipment and infrastructure expenditures related to anticipated growth................ 5,000,000 32.5 Repayment of indebtedness(1)................................ 2,700,000 17.5 General corporate purposes(2)............................... 1,700,000 11.0 ----------- ---- Total............................................. $15,400,000 100% =========== ====
- --------------- (1) Specifically the following: (a) indebtedness owing to Jack T. Smith, a director of the Company, in the aggregate approximate amount of $307,000, and indebtedness owing to Carl Westcott, a principal shareholder of the Company, in the aggregate approximate amount of $1.7 million (collectively, the "Affiliate Debt"); (b) indebtedness owing to a commercial bank in the aggregate approximate amount of $225,000 (the "Bank Debt"); (c) indebtedness owing to Webstar, Inc. in connection with the acquisition of subscribers in the aggregate approximate amount of $352,000 (the "Webstar Debt"); and (d) indebtedness owing to M.J. Capital Partners, L.P. in connection with a loan for general working capital in the aggregate approximate amount of $80,000 (the "MJ Debt"). The Affiliate Debt and Bank Debt both accrue interest at the prime rate. The Webstar Debt accrues interest at 14% per year, and the MJ Debt accrues interest at 16.5% per year. The Affiliate Debt and the Bank Debt mature two days after the Company receives the proceeds of this Offering, while the Webstar Debt matures on June 30, 1999 and the MJ Debt matures on January 1, 1999. The Bank Debt is secured by the personal guaranty of William O. Hunt, a director of the Company, and the pledge of all assets of the Company. See "Certain Transactions" and Notes 4, 5 and 6 of Notes to Financial Statements. (2) Such funds could be used for a variety of general corporate purposes, including, without limitation, further marketing efforts and infrastructure improvements. The Company continues to evaluate potential acquisitions, and to identify and have preliminary discussions with potential acquisition candidates, although there are, as of the date of this Prospectus, no agreements, arrangements or understandings between the Company and any party relating thereto. 18 20 Pending the above uses of proceeds, the Company intends to invest the net proceeds of this Offering in short-term bank deposits or investment-grade securities. The foregoing represents the Company's current intentions with respect to the allocation of the proceeds of this Offering based upon its present plans and business conditions. However, changed business conditions and various other factors could result in the application of the proceeds of this Offering in a manner other than as described in this Prospectus. DIVIDEND POLICY To date, the Company has neither declared nor paid any dividends on its Common Stock nor does the Company anticipate that dividends will be declared or paid in the foreseeable future. Rather, the Company intends to retain any earnings to finance the growth and development of its business. Any payment of cash dividends on its Common Stock in the future will be dependent, among other things, upon the Company's earnings, financial condition, capital requirements and other factors which the Board of Directors deems relevant. 19 21 CAPITALIZATION The following table sets forth at June 30, 1998, the short term debt and capitalization of the Company: (i) on a historical basis and (ii) as adjusted to reflect the sale of shares of Common Stock offered hereby at an assumed initial public offering price of $10.00 per share and the application of the estimated net proceeds therefrom, the automatic conversion of all outstanding shares of preferred stock into shares of Common Stock on a 2.25-for-1.00 basis, which will occur 30 days after completion of the Offering, the exercise of the Warrant and repayment of substantially all current indebtedness contemporaneously with the Offering and the cancellation of Common Stock in treasury. See "Use of Proceeds" and "Description of Securities -- Preferred Stock." This table should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Company's Financial Statements and Notes thereto and other financial and operating data included elsewhere in this Prospectus.
JUNE 30, 1998 ------------------------ ACTUAL AS ADJUSTED ---------- ----------- (IN THOUSANDS, EXCEPT SHARE DATA) Short-term debt (notes payable, shareholder loan, line of credit and current portion of capital lease obligations and long-term debt)....................................... $ 3,008 $ 333 ------- ------- Long-term debt (capital lease obligations).................. $ 31 $ 31 Shareholders' equity (deficit): Preferred Stock, $0.01 par value; 5,000,000 shares authorized Series A Preferred Stock, $0.01 par value; 400,000 shares authorized; 379,672 shares issued and outstanding; no shares issued and outstanding, as adjusted.............................................. 4 -- Series B Preferred Stock, $0.01 par value; 300,000 shares authorized; 73,667 shares issued and outstanding; no shares issued and outstanding, as adjusted.............................................. 1 -- Common Stock, $0.01 par value; 40,000,000 shares authorized; 3,532,205 shares issued and outstanding; 6,285,957 shares issued and outstanding, as adjusted(1)(2)......................................... 35 63 Additional paid-in capital................................ 2,816 18,153 Accumulated deficit....................................... (6,623) (6,623) ------- ------- Total shareholders' equity (deficit).............. (3,767) 11,593 ------- ------- Total capitalization.............................. $(3,736) $11,624 ======= =======
- --------------- (1) Excludes (i) 225,000 shares reserved for issuance under the 1996 Option Plan, of which options to purchase 61,756 shares were outstanding at a weighted average exercise price of $1.67 per share, (ii) 400,000 shares reserved for issuance under the 1998 Option Plan, of which no options were outstanding and (iii) 1,184,657 shares of Common Stock issuable upon exercise of other outstanding options at a weighted average exercise price of $1.55 per share. See "Management -- 1996 Incentive Stock Option Plan," "-- Nonqualified Stock Options Issued to Officers and Directors" and "-- 1998 Nonqualified Stock Option Plan." (2) Reflects the amendment of the Company's Articles of Incorporation in July 1998 to increase the authorized Common Stock from 15,000,000 shares to 40,000,000 shares. 20 22 DILUTION The deficit in net tangible book value of the Common Stock as of June 30, 1998 was approximately $4.2 million, or $.92 per share, on a pro forma basis after giving effect to conversion of all outstanding shares of preferred stock into shares of Common Stock and exercise of the Warrant. Dilution is determined by subtracting net tangible book value per share after the Offering from the amount of cash paid by investors for the shares of Common Stock. Net tangible book value per share represents the book value of the Company's total tangible assets less total liabilities, divided by the number of outstanding shares of Common Stock. After giving effect to the sale of the 1,700,000 shares of Common Stock offered by the Company hereby (at an assumed initial public offering price of $10.00 per share), and after deducting the underwriting discount and estimated expenses of the Offering payable by the Company and the application of the net proceeds therefrom, and assuming no other changes in the net tangible book value after June 30, 1998, the Company's pro forma net tangible book value as adjusted at June 30, 1998 would have been approximately $11.1 million, or $1.77 per share. This represents an immediate increase in net tangible book value of $2.69 per share to existing shareholders and an immediate decrease in net tangible book value to new investors of $8.23 per share. The following table illustrates the per share dilution: Assumed initial public offering price per share............. $10.00 Deficit in pro forma net tangible book value per share at June 30, 1998.......................................... $(0.92) Increase per share attributable to new investors.......... 2.69 ------ Pro forma net tangible book value per share after this Offering.................................................. 1.77 ------ Dilution per share to new investors......................... $ 8.23 ====== Percentage dilution......................................... 82.3% ======
The following table sets forth on a pro forma basis the differences between the existing shareholders and the investors in this Offering with respect to the total consideration paid or payable and the average price per share paid or payable:
SHARES PURCHASED TOTAL CONSIDERATION(1) ------------------- ----------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------- ------- ------------ -------- ------------- Existing Shareholders(2)(3)..... 4,585,957 73.0% $ 2,634,776 13.4% $ 0.57 New Investors(2)................ 1,700,000 27.0% 17,000,000 86.6% 10.00 --------- ----- ----------- ----- Total................. 6,285,957 100.0% $19,634,776 100.0% ========= ===== =========== =====
- --------------- (1) These amounts reflect total consideration paid by shareholders and do not reflect net amounts received by the Company. (2) Sales by the Selling Shareholders in the Offering will reduce the number of shares held by existing shareholders to 3,985,957 shares, or 63.4% of the total shares of Common Stock outstanding after the Offering, and will increase the number of shares held by new investors to 2,300,000 shares, or 36.6% of the total shares of Common Stock outstanding after the Offering. If the Underwriters' over-allotment option is exercised in full, the number of shares held by existing shareholders will further decrease to 3,640,957 shares, or 57.9% of the total shares of Common Stock outstanding after the Offering, and the number of shares held by new investors will further increase to 2,645,000 shares, or 42.1% of the total shares of Common Stock outstanding after the Offering. See "Principal and Selling Shareholders." (3) Assumes the exercise of the Warrant and conversion of all outstanding shares of preferred stock into shares of Common Stock. The foregoing computations assume no exercise of outstanding stock options. Options to purchase 61,756 shares of Common Stock were outstanding under the 1996 Option Plan at a weighted average exercise price of $1.67 per share as of June 30, 1998. Additional options to purchase 1,184,657 shares of Common Stock were outstanding as of June 30, 1998 at a weighted average exercise price of $1.55 per share. If all currently exercisable options are exercised, investors purchasing shares in the Offering will incur total dilution of $8.25 per share of Common Stock on a pro forma basis assuming an initial public offering price of $10.00 per share. See "Management -- 1996 Incentive Stock Option Plan," "-- Nonqualified Stock Options Issued to Officers and Directors" and "-- 1998 Nonqualified Stock Option Plan." 21 23 SELECTED FINANCIAL AND OPERATING DATA The following selected historical financial data for the years ended and as of June 30, 1997 and 1998 have been derived from the Company's financial statements included elsewhere herein and audited by Deloitte & Touche LLP, independent auditors as set forth in their report thereon also included herein. The selected historical financial data of the Company for the year ended June 30, 1996 is derived from the Company's audited financial statements not included herein. The following selected financial data should be read in conjunction with, and is qualified in its entirety by, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and Notes thereto included elsewhere in this Prospectus.
YEAR ENDED JUNE 30, ------------------------------------- 1996 1997 1998 --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE AND CUSTOMER DATA) STATEMENT OF OPERATIONS DATA: Total revenue Access................................................. $ 3,052 $ 8,177 $ 9,566 Business services...................................... 411 1,045 1,036 Other.................................................. 314 249 41 ------- ------- ------- Total revenue..................................... 3,777 9,471 10,643 Operating expenses Connectivity and operations............................ 2,187 6,185 4,509 Sales and marketing.................................... 1,597 1,912 1,140 General and administrative............................. 2,797 2,748 1,919 Depreciation and amortization.......................... 548 1,618 1,474 Impairment of equipment................................ -- 351 -- ------- ------- ------- Total operating expenses.......................... 7,129 12,814 9,042 ------- ------- ------- Income (loss) from operations............................... (3,352) (3,343) 1,601 Interest expense............................................ 77 481 571 Income tax expense.......................................... -- -- 24 ------- ------- ------- Net income (loss)........................................... $(3,429) $(3,824) $ 1,006 ======= ======= ======= Earnings (loss) per share(1): Basic..................................................... $ (1.15) $ (1.12) $ 0.28 Diluted................................................... $ (1.15) $ (1.12) $ 0.21 Weighted average shares(1): Basic..................................................... 2,981 3,418 3,532 Diluted................................................... 2,981 3,418 4,783 OTHER DATA: Approximate number of customers at end of period.......... 27,900 39,900 48,600 EBITDA(2)................................................. $(2,804) $(1,725) $ 3,075 EBITDA margin(2).......................................... (74.2)% (18.2)% 28.9% Cash flow provided (used) by: Operating activities................................... $ 390 $(1,430) $ 1,797 Investing activities................................... (2,981) (1,513) (407) Financing activities................................... 2,615 2,864 (826)
JUNE 30, ------------------------------- 1996 1997 1998 ------- ------- ------- BALANCE SHEET DATA: Cash...................................................... $ 79 $ -- $ 565 Working capital (deficit)................................. (3,462) (6,834) (5,962) Total assets.............................................. 3,127 3,114 3,150 Long-term debt, net of current portion.................... 373 684 31 Total shareholders' equity (deficit)...................... (1,063) (4,681) (3,767)
See notes on following page 22 24 - --------------- (1) See Notes 1 and 11 of Notes to Financial Statements for information concerning the calculation of basic and diluted net income (loss) per share. (2) EBITDA (earnings before interest, taxes, depreciation and amortization) consists of revenue less connectivity and operating expense, sales and marketing expense, general and administrative expense and impairment of equipment expense. EBITDA is provided because it is a measure commonly used by investors to analyze and compare companies on the basis of operating performance. EBITDA is presented to enhance an understanding of the Company's operating results and is not intended to represent cash flows or results of operations in accordance with GAAP for the periods indicated. EBITDA is not a measurement under GAAP and is not necessarily comparable with similarly titled measures for other companies. EBITDA margin represents EBITDA as a percentage of total revenue. (3) Adjusted to give effect to the sale of 1,700,000 shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $10.00 per share (the mid-point of the range set forth on the cover of this Prospectus), after deducting the underwriting discount and estimated offering expenses payable by the Company, the application of the net proceeds therefrom, the exercise of the Warrant and the conversion of all of the outstanding shares of preferred stock to Common Stock. See "Use of Proceeds" and "Capitalization." 23 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed in the forward-looking statements as a result of certain factors including those set forth under "Risk Factors" and elsewhere in this Prospectus. The following discussion and analysis should be read in conjunction with "Selected Financial and Operating Data" and the Financial Statements and Notes thereto appearing elsewhere in this Prospectus. OVERVIEW Internet America is a leading ISP in the southwestern United States with approximately 50,000 customers, primarily in the North Texas area. From inception through fiscal 1997, the Company incurred substantial operating losses while building its infrastructure and rapidly increasing market share. In response to these losses, the Company moved to reorganize its management and operations personnel and implement a comprehensive cost control program. At the end of the third quarter of fiscal 1997, the Company's Board of Directors accepted the resignation of the President and Chief Executive Officer of the Company. The Company's new Chief Executive Officer continued the reorganization of the Company. The primary elements of the cost control program involved: (i) selective reduction in customer care, administrative and marketing personnel (reducing Company personnel from 220 to 80); (ii) elimination of ineffective marketing programs and (iii) improved cost efficiencies in the Company's network infrastructure. As a result of the implementation of the Company's cost control program, management was able to apply positive cash flow to the orderly reduction of a substantial amount of past due trade payables, thus allowing the Company to thereafter direct available cash to marketing efforts. By the end of the first quarter of fiscal 1998, the Company had completed its reorganization and implementation of the cost control program, and the Company achieved sustained profitability for the first time. The reorganization and cost controls implemented by management were carefully designed not to compromise quality of customer service or customer care. In fact, in several key ways, management believes that the changes improved the Company's overall level of service quality, principally through reorganization of the Company's customer care operations, improved browser software and enhanced network performance. The Company's customer base remained stable from the third quarter of fiscal 1997, when the changes began, through the second quarter of fiscal 1998, after the changes were substantially implemented, even though the Company had suspended virtually all advertising during this period. The Company has continued to apply its disciplined approach to strict cost controls, proven marketing tools and network operating efficiencies. Management believes that the Company's experience in implementing and maintaining the above changes validated important elements of its user density business model, and also believes that this model can be effectively applied in other markets. The Company's user density business model focuses on the rapid development of a profitable base of customers in selected markets. Upon entry into a new market, the Company will make a strategic acquisition and/or engage in substantial direct response marketing to quickly gain a critical mass of customers. The early phases of entering new markets will involve substantial initial expenditures on advertising, customer care and other operating needs. The Company believes that it will be able to control its infrastructure costs upon entry into new markets through use of its Virtual POP architecture or other scalable technologies that will enable it to more closely match the capacity needs of its customers with actual sales in those markets. The initial expenses associated with entering new markets will offset the positive EBITDA achieved in established markets. The Company believes that this offset effect will decrease as its new markets mature and the Company realizes the marketing, network and operating efficiencies created by user density in those markets. The Company expects that the overall significance of the offset effect will diminish as the Company's customer base and revenues increase. Through application of its user density business model in selected new markets, the Company believes it will be able to achieve economies of scope and scale similar to those achieved in the Company's existing markets. 24 26 The Company's access revenues are derived primarily from individual dial-up Internet access, whether analog or ISDN, and revenues derived from value-added services. Airnews.net as a subscription service also contributes to access revenues. Both types of access revenues are principally derived from monthly subscription fees and are therefore primarily determined by the number of customers. The Company derives business services revenues primarily from dedicated connectivity, bulk dial-up access and Web services. Business services revenues are also generated from the sale of Airnews.net to other ISPs on a wholesale basis. While monthly subscriptions are an important component of business services revenues, these revenues fluctuate because of the wide range of setup fees associated with different business services and the mix thereof in any given period. Other revenues are derived from advertising fees and other miscellaneous sources. A brief description of each element of the Company's operating expenses follows: Connectivity and operations expenses consist primarily of the setup costs for new customers, telecommunication costs and wages of network operations and customer support personnel. Setup expenses include one-time license fees for the right to bundle other software into the Company's software, cost of diskettes and other media, manuals, packaging and delivery costs. The Company does not defer customer setup expenses, but expenses such items as incurred. Telecommunications costs include (i) the costs of providing local telephone lines into each POP (or fees for Virtual POP connectivity), (ii) leased lines connecting each POP to the Company's internal network and (iii) connectivity from the internal network to the Internet. Sales and marketing expenses consist primarily of creative, media and production costs, as well as call center employee wages. These expenses include the cost of the Company's television and billboard advertising campaigns, as well as other advertising. The Company does not defer any advertising costs, but expenses such items as incurred. General and administrative expenses consist primarily of accounting and administrative personnel wages, professional services, rent and non-Internet related telephone costs. Depreciation is computed using the straight line method over the estimated useful life of the assets. The Company's data communications equipment, computers, data server and office equipment are depreciated over a three-year life. The Company depreciates its furniture, fixtures and leasehold improvements over a five-year life. The acquisition of customer accounts is amortized over three years. Management anticipates that further expansion using the Virtual POP technology will cause depreciation as a percentage of revenue to decrease, with a corresponding increase in connectivity and operations expenses, as network equipment that would have been purchased by the Company will now be provided by selected telecommunications providers. 25 27 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items from the Company's Statement of Operations as a percentage of total revenue. Operating results for any period are not necessarily indicative of results for any future period.
YEAR ENDED JUNE 30, ----------------------- 1996 1997 1998 ----- ----- ----- Revenue: Access.................................................... 80.8% 86.3% 89.9% Business services......................................... 10.9 11.1 9.7 Other..................................................... 8.3 2.6 0.4 ----- ----- ----- Total revenue..................................... 100% 100% 100% ----- ----- ----- Operating Expenses: Connectivity and operations............................... 57.9 65.3 42.4 Sales and marketing....................................... 42.3 20.2 10.7 General and administrative................................ 74.1 29.0 18.0 Depreciation and amortization............................. 14.5 17.1 13.8 Impairment of equipment................................... -- 3.7 -- ----- ----- ----- Total operating expenses.......................... 188.8 135.3 84.9 ----- ----- ----- Income (loss) from operations............................... (88.8) (35.3) 15.1 Interest income (expense), net.............................. (2.0) (5.1) (5.4) Income tax expense.......................................... -- -- (0.2) ----- ----- ----- Net income (loss)........................................... (90.8)% (40.4)% 9.5% ===== ===== =====
YEAR ENDED JUNE 30, 1998 COMPARED TO YEAR ENDED JUNE 30, 1997 Total Revenue. Total revenue increased by $1.2 million, or 12.4%, to $10.6 million for fiscal 1998 from $9.5 million for fiscal 1997. Access revenue increased by $1.4 million, or 17.0%, to $9.6 million for fiscal 1998 from $8.2 million for fiscal 1997. The increase in access revenue is primarily attributable to increased subscription fees derived from an increased number of dial-up access customers which totaled 48,600 at June 30, 1998, as compared to 39,900 at June 30, 1997. Business services revenue declined by $9,000, or 1.0%, to $1,036,000 for fiscal 1998 from $1,045,000 for fiscal 1997. Other revenue decreased by $208,000, or 83.4%, to $41,000 for fiscal 1998 from $249,000 for fiscal 1997. The decrease in other revenue is primarily attributable to the termination of a contract to provide customer care services to another ISP and the termination of charges for browser software provided to customers. Connectivity and operations. Connectivity and operations expenses decreased by $1.7 million, or 27.1%, to $4.5 million for fiscal 1998 from $6.2 million for fiscal 1997. The majority of the reduction in these expenses is associated with the cost control program which commenced in the fourth quarter of fiscal 1997, including (i) a decrease in wages of approximately $1.4 million resulting from reduced staffing, (ii) a decrease in software costs of $169,000 and (iii) a decrease in Internet and telephone connectivity costs of $118,000 due to improved cost efficiencies in the Company's network infrastructure. Sales and marketing. Sales and marketing expenses decreased by $772,000, or 40.4%, to $1.1 million for fiscal 1998 from $1.9 million for fiscal 1997. For fiscal 1998, the Company suspended virtually all advertising until a new television advertising campaign began in January 1998. For fiscal 1998, marketing payroll and consulting fees declined by $558,000, or 57.3%, and advertising and promotional costs declined by $202,000, or 21.5%. General and administrative. General and administrative expenses decreased by $828,000, or 30.1%, to $1.9 million for fiscal 1998 from $2.7 million for the same period in the prior year. The decrease in general and 26 28 administrative expenses was primarily due to decreased staffing, and decreases in telephone expenses, professional services and equipment leases in connection with the Company's cost control program. Depreciation and amortization. Depreciation and amortization decreased by $144,000, or 8.9%, to $1.5 million for fiscal 1998 from $1.6 million for fiscal 1997. Interest expense. Interest expense increased by $90,000, or 18.7%, to $571,000 for fiscal 1998 from $481,000 for fiscal 1997. This increase in interest expense relates primarily to interest on certain indebtedness accruing at a default rate of 18%. See "Certain Transactions." YEAR ENDED JUNE 30, 1997 COMPARED TO YEAR ENDED JUNE 30, 1996 Total Revenue. Total revenue increased by $5.7 million, or 151%, to $9.5 million for fiscal 1997 from $3.8 million for fiscal 1996. Access revenue increased by $5.1 million, or 168%, to $8.2 million for fiscal 1997 from $3.1 million for fiscal 1996. The increase in access revenue is primarily attributable to increased subscription fees derived from an increased number of dial-up access customers, which totaled 39,900 at June 30, 1997 as compared to 27,900 at June 30, 1996. During fiscal 1997, the Company introduced its Airnews.net service, which resulted in an increase in access revenue of approximately $141,000. Business services revenue increased by $634,000, or 154%, to approximately $1.0 million in fiscal 1997 from $411,000 in fiscal 1996. In fiscal 1997 business services revenue increased as a result of the addition of new business customers and price increases. Other revenue decreased by $65,000, or 20.7%, to $249,000 in fiscal 1997 from $314,000 in fiscal 1996. The decrease in other revenue is primarily attributable to a decline in fees charged under a contract to provide customer services to another ISP. Connectivity and operations. Connectivity and operations expenses increased by $4.0 million, or 183%, to approximately $6.2 million in fiscal 1997 from $2.2 million in fiscal 1996. These expenses increased as a result of increased customer support wages and increased connectivity expenses related to the increase in the number of customers and excessive staffing during fiscal 1997 prior to the Company's reorganization and implementation of its cost control program. Sales and marketing. Sales and marketing expenses increased by $315,000, or 19.7%, to $1.9 million for fiscal 1997 from $1.6 million for fiscal 1996. This increase was primarily a result of increased staffing in sales and marketing and the cost of providing promotional kits to customers. General and administrative. General and administrative expenses of $2.7 million remained relatively constant from fiscal 1996 to fiscal 1997. Depreciation and amortization. Depreciation and amortization expenses increased by $1.1 million, or 195%, to $1.6 million in fiscal 1997 from $548,000 in fiscal 1996 as the Company's fixed assets continued to grow with subscriber growth. In fiscal 1997, the Company also recognized amortization expenses related to the acquisition of an ISP located in San Angelo, Texas. Impairment of equipment. Operating expenses for fiscal 1997 include an impairment loss recognized for certain modem and telecommunication equipment. Due to the emergence of a new standard in modem speeds, management deemed these assets to be fully impaired by the fourth quarter of fiscal 1997, and the Company recognized an impairment loss of $351,000. Interest expense. Interest expense increased by $404,000, or 528%, to $481,000 for fiscal 1997 from $77,000 in fiscal 1996. The increase was due to the issuance of promissory notes in fiscal 1997 to shareholders for working capital and notes issued in connection with the acquisition of an ISP located in San Angelo, Texas. See "Certain Transactions." 27 29 SELECTED QUARTERLY RESULTS OF OPERATIONS The following table sets forth certain quarterly financial information of the Company for each quarter of fiscal 1997 and 1998. The information has been derived from the quarterly financial statements of the Company which are unaudited but which, in the opinion of management, have been prepared on the same basis as the audited Financial Statements and Notes thereto included herein and include all adjustments (consisting only of normal recurring items) necessary for a fair presentation of the financial results for such periods. This information should be read in conjunction with the Company's Financial Statements and Notes thereto and the other financial and operating information appearing elsewhere in this Prospectus. The operating results for any quarter are not necessarily indicative of results for any future period.
THREE MONTHS ENDED -------------------------------------------------------------------------------------- FISCAL 1997 FISCAL 1998 ------------------------------------------ ----------------------------------------- SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30 DEC. 31, MAR. 31, JUNE 30, 1996 1996 1997 1997 1997 1997 1998 1998 --------- -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS) Total Revenue: Access.......................... $ 1,762 $ 2,185 $2,098 $2,132 $2,150 $2,242 $2,566 $2,608 Business services............... 194 304 299 248 259 289 229 259 Other........................... 93 85 31 40 3 3 15 20 ------- ------- ------ ------ ------ ------ ------ ------ Total revenue............. 2,049 2,574 2,428 2,420 2,412 2,534 2,810 2,887 ------- ------- ------ ------ ------ ------ ------ ------ Operating expenses: Connectivity and operations..... 1,696 1,796 1,555 1,138 1,108 1,151 1,112 1,138 Sales and marketing............. 909 648 233 122 86 199 388 467 General and administrative...... 733 848 648 519 400 446 508 565 Depreciation and amortization... 351 430 426 411 363 363 389 359 Impairment of equipment......... -- -- -- 351 -- -- -- -- ------- ------- ------ ------ ------ ------ ------ ------ Total operating expenses................ 3,689 3,722 2,862 2,541 1,957 2,159 2,397 2,529 ------- ------- ------ ------ ------ ------ ------ ------ Income (loss) from operations..... (1,640) (1,148) (434) (121) 455 375 413 358 Interest income (expense), net.... (47) (121) (136) (177) (135) (155) (165) (116) ------- ------- ------ ------ ------ ------ ------ ------ Income tax expense................ -- -- -- -- (6) (6) (6) (6) Net income (loss)................. $(1,687) $(1,269) $ (570) $ (298) $ 314 $ 214 $ 242 $ 236 ======= ======= ====== ====== ====== ====== ====== ======
THREE MONTHS ENDED -------------------------------------------------------------------------------------- FISCAL 1997 FISCAL 1998 ------------------------------------------ ----------------------------------------- SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30 DEC. 31, MAR. 31, JUNE 30, 1996 1996 1997 1997 1997 1997 1998 1998 --------- -------- -------- -------- -------- -------- -------- -------- (AS A PERCENTAGE OF TOTAL REVENUE) Total Revenue: Access.......................... 86.0% 84.9% 86.4% 88.1% 89.1% 88.5% 91.3% 90.3% Business services............... 9.5 11.8 12.3 10.2 10.8 11.4 8.2 9.0 Other........................... 4.5 3.3 1.3 1.7 0.1 0.1 0.5 0.7 ------- ------- ------- ------- ------- ------ ------ ------ Total revenue............. 100% 100% 100% 100% 100% 100% 100% 100% ------- ------- ------- ------- ------- ------ ------ ------ Operating expenses: Connectivity and operations..... 82.8 69.8 64.0 47.0 45.9 45.4 39.6 39.4 Sales and marketing............. 44.4 25.2 9.6 5.0 3.6 7.9 13.8 16.2 General and administrative...... 35.8 32.9 26.7 21.4 16.7 17.6 18.1 19.6 Depreciation and amortization... 17.1 16.7 17.5 17.0 15.0 14.3 13.8 12.4 Impairment of equipment......... -- -- -- 14.5 -- -- -- -- ------- ------- ------- ------- ------- ------ ------ ------ Total operating expenses................ 180.1 144.6 117.8 104.9 81.2 85.2 85.3 87.6 ------- ------- ------- ------- ------- ------ ------ ------ Income (loss) from operations..... (80.1) (44.6) (17.8) (4.9) 18.8 14.8 14.7 12.4 Interest income (expense), net.... (2.3) (4.7) (5.6) (7.3) (5.6) (6.1) (5.9) (4.0) Income tax expense................ -- -- -- -- (0.2) (0.2) (0.2) (0.2) ------- ------- ------- ------- ------- ------ ------ ------ Net income (loss)................. (82.4)% (49.3)% (23.4)% (12.2)% 13.0% 8.5% 8.6% 8.2% ======= ======= ======= ======= ======= ====== ====== ======
28 30 From the last quarter of fiscal 1997 through the first quarter of fiscal 1998, the Company was in the process of reorganizing its management and operations personnel and implementing a comprehensive cost control program. See "-- Overview." The Company's business is not subject to any significant seasonal influences. Sales during the third fiscal quarter of a given year, however, have historically been slightly higher due to new users who get personal computers during the holiday season of the prior year. LIQUIDITY AND CAPITAL RESOURCES The Company's principal capital and liquidity needs have historically consisted of funds required for (i) customer care and sales personnel, (ii) marketing expenditures and (iii) telecommunication costs incurred in connecting customers to the Internet. These outflows have been funded through a combination of cash generated from existing operations, shareholder loans and other credit facilities from various third parties. Cash used in operating activities of $1.4 million during fiscal year 1997 was primarily attributable to marketing expenditures, the building of the customer care operations and the expansion of the Company's network infrastructure, partially offset by increases in deferred revenue. For the year ended June 30, 1998, cash provided by operations was $1.8 million, which resulted largely from cost controls implemented just prior to and during this period. See "-- Overview." Cash used in investing activities during fiscal 1997 was $1.5 million, and was primarily related to the purchase of customers from a regional ISP in San Angelo, Texas and purchases of property and equipment. Cash used in investing activities for the year ended June 30, 1998 was $407,000, and was primarily related to the acquisition of an ISP's customer base located in the Dallas-Fort Worth area and purchases of property and equipment. During fiscal 1997, cash provided by financing activities was $2.9 million, which consisted primarily of $2.0 million of Affiliate Debt, $225,000 of Bank Debt and $106,000 of MJ Debt. During fiscal 1998, cash used in financing activities was $826,000, which consisted primarily of $420,000 of payments under capital leases and $314,000 of payments on long term debt. The Company intends to repay the Affiliate Debt, the Bank Debt and the MJ Debt with the net proceeds of this Offering. See "Use of the Proceeds" and "Certain Transactions." Following the Offering, the Company intends to seek a new line of credit. The Company expects to spend approximately $6.0 million for possible acquisitions of complementary businesses, approximately $5.0 million to fund the growth strategy in new and existing markets, primarily for marketing expenses and incremental capital equipment and infrastructure expenditures, and, as indicated above, approximately $2.7 million to repay substantially all current indebtedness. See "Use of Proceeds." The Company believes that the net proceeds of the Offering, together with existing cash resources, cash flows from operations and any financing obtained through a new line of credit, will be sufficient to fund the Company's operations for at least the next twelve months. After such period, depending on its financial condition and results of operations, the Company may require additional equity or debt financing. There can be no assurance that additional financing will be available when required. YEAR 2000 COMPLIANCE The Company recognizes the need to ensure its operations will not be adversely impacted by Year 2000 software failures. The Company does not believe that the Year 2000 issue will have a material effect on its internal network, computer systems or operations. However, it will continue to assess the potential impact of the Year 2000 issue. Any failure of the Company to become Year 2000 compliant on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations, including, without limitation, a complete failure or degradation of the performance of the Company's network or other systems. To the extent that the Company relies on external vendors and network providers with Year 2000 exposure, any failure by such third-party providers to resolve any Year 2000 issues on a timely basis or in a manner that is compatible with the Company's systems could have a material adverse effect on the Company. Most of the Company's critical third-party providers have made representations to the effect that they are, or 29 31 will be, Year 2000 compliant. The Company, however, has not undertaken an in-depth evaluation of such providers in relation to the Year 2000 issue, and furthermore the Company has no control over whether its third-party providers are Year 2000 compliant. Any failure on the part of such third-party providers are, or will be, Year 2000 compliant on a timely basis or in a manner that is compatible with the Company's systems could have a material adverse effect on the Company, including, without limitation, a complete failure or degradation of the performance of the Company's network or other systems. In the event the Company encounters significant Year 2000 problems, it would expect to take all necessary measures to address such problems. See "Risk Factors -- Year 2000 Compliance." CHANGE IN INDEPENDENT AUDITORS On June 1, 1998, the Company's Board of Directors made the decision to replace Farmer, Fuqua, Hunt & Munselle, P.C., Accountants and Consultants ("FFHM"), with Deloitte & Touche LLP as its independent auditor. The report of FFHM on the financial statements of the Company as of and for the fiscal year ended June 30, 1997 contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. In connection with FFHM's audit for the fiscal year ended June 30, 1997, there were no disagreements with FFHM on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which, if not resolved to the satisfaction of FFHM, would have caused it to make reference thereto in its report on the Company's financial statements for such year. During the same period, the Company did not consult Deloitte & Touche LLP regarding the application of accounting principles to a specified transaction or the type of audit opinion that might be rendered on the Company's financial statements. RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 129, "Disclosure of Information about Capital Structure," which establishes standards for disclosing information about an entity's capital structure and is effective for financial statements for periods ending after December 15, 1997. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components in the financial statements for fiscal years beginning after December 15, 1997. The FASB also issued, in June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for the way public companies disclose information about operating segments, products and services, geographic areas and major customers. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. The Company has determined that the impact on its financial statements of adopting SFAS Nos. 129, 130 and 131 is not material. In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," which is effective for fiscal quarters endings after June 15, 1999. The Company does not expect the adoption of SFAS No. 133 to have a material impact on its financial statements. 30 32 BUSINESS GENERAL Internet America is a leading ISP in the southwestern United States. The Company provides a wide array of Internet services tailored to meet the needs of individual and business customers, including customers with little or no online experience. With approximately 50,000 customers, primarily in the North Texas area, the Company believes that it has achieved one of the highest user densities per POP of any ISP in the United States. This user density has enabled the Company to realize substantial marketing, network and operating efficiencies, which have resulted in profit margins in recent periods that are substantially higher than those of the publicly traded ISPs. INDUSTRY OVERVIEW Internet access and related value-added services ("Internet services") represent one of the fastest growing segments of the telecommunications services marketplace. According to industry estimates, the number of Internet users in the United States who access the World Wide Web reached approximately 29.2 million in 1997 and is projected to grow to approximately 72.1 million by the year 2000. In addition, total ISP revenues in the United States are projected to grow from $4.6 billion in 1997 to $18.3 billion in 2000. Declining prices in the PC market, continuing improvements in Internet connectivity, advancements in Internet navigation technology, and the proliferation of services, applications, information and other content on the Internet have attracted a rapidly growing number of users. Numerous companies have moved to enter the Internet services market, such as (i) telecommunications services providers, including national and regional interexchange carriers, incumbent local exchange carriers ("LECs") and competitive LECs, (ii) online commercial information service providers, (iii) computer hardware and software providers, (iv) cable television operators and (v) national, regional and local companies that focus primarily on providing Internet services. These companies pursue a wide variety of business strategies. For example, cable television operators, who are not required to grant third party ISPs access to their local networks, are deploying high-speed cable modems among their subscribers. Incumbent and competitive LECs, which generally provide third party ISPs access to their local networks, are deploying high-speed data transmission technologies such as xDSL to support the provision of Internet services. There are more than 4,000 national, regional and local ISPs. Some of these ISPs have chosen to focus on business customers, others on individual customers. Most national ISPs have made a major investment in network infrastructure in anticipation of future high subscriber growth. As a result, the average national ISP has been experiencing an extended period of losses as it works to build a profitable base of customers in each of the many markets it serves. In addition to these losses, national ISPs are exposed to a high level of technological obsolescence risk as Internet access technology continues to evolve. At the other end of the spectrum, many regional and local ISPs, which have a much lower investment in network infrastructure, lack the marketing skills and resources to build a critical mass of customers. STRATEGY Unlike many other ISPs, the Company believes that at the current stage of the ISP industry's development, the highest priority should be to rapidly build profitable market share, not to deploy a large network infrastructure with a substantial number of underutilized owned or leased POPs. Therefore, the Company's growth strategy is focused on (i) acquiring additional customers in its existing markets and (ii) deploying its user density business model in other selected markets. The aim of the user density business model is to quickly build in a given market a critical mass of customers that will support profitable operations. Elements of the Company's growth strategy include: Aggressive Use of Advertising to Rapidly Acquire a Critical Mass of Customers and Build the Internet America Brand. The Company extensively uses two of the more effective and efficient advertising media -- television and outdoor billboard displays -- to highlight its high-speed, quality 31 33 services and strong customer care. The Company believes these media are particularly effective in quickly acquiring customers, particularly new Internet users, and building brand awareness. The Company is currently preparing aggressive advertising campaigns for new target markets. See "-- Marketing and Sales." Strategic and Add-On Acquisitions. Because of the fragmented nature of the ISP industry and the difficulty that many ISPs have encountered in growing to a size where they can realize economies of scale and achieve profitability, the Company expects to be able to make a significant number of acquisitions in new and existing markets. The Company is currently investigating strategic acquisition opportunities that would jump-start the Company's entry into new markets, enabling the Company to more quickly achieve the critical mass necessary to support profitable operations. The Company also continues to evaluate add-on acquisitions in existing markets that it believes would be accretive to earnings. The Company has already made add-on acquisitions, successfully transitioning two smaller ISPs' customers to the Internet America infrastructure and brand while eliminating duplicative facilities and operations. Cost-Effective Development of Network Infrastructure. The Company seeks to ensure that its deployment of physical infrastructure, particularly POPs, is accompanied with the rapid development of a substantial customer base. Through this disciplined approach, the Company has been able to achieve economies of scope and scale more quickly than most other ISPs. The Virtual POP architecture that the Company is now deploying with the participation of various telecommunications providers enables the Company to enter new markets more quickly with a smaller commitment of long-term capital resources, lower operating costs and less exposure to technological obsolescence. See "-- Network Infrastructure." Development of Value-Added Revenue Streams. The Company provides a number of value-added services, such as dedicated high-speed access, news access, Web hosting and server co-location. The Company continues to evaluate and develop potential new value-added services, seeking to leverage its current sales, marketing and network capabilities to create additional revenue opportunities. These revenue streams may arise from technological changes, such as the introduction of high-speed xDSL connectivity technology, or other factors. The Company believes that a user dense, regionally focused customer base provides an excellent platform for the introduction of new value-added services that can take advantage of brand awareness and economies of scope and scale, potentially including Internet telephony and video and audio programming distribution. Maintenance of a First-Rate Customer Care Operation. The Company's sophisticated, high-quality customer care operation is designed to make every customer's Internet experience efficient, productive and enjoyable, whether that customer is a novice or an experienced Internet user. The Company believes that this operation is a substantial competitive advantage. See "-- Customer Care." SERVICES The Company offers Internet services tailored to meet the needs of both its individual and business customers. The Company's primary service offering is dial-up Internet access and value-added services for its individual customers. The Company's business customers take advantage of dedicated high speed Internet access, Web hosting and other services. The Company's services are offered in various prices and packages so that customers may customize their subscription with services that meet their particular requirements. The majority of the Company's customers have month-to-month subscriptions. The Company offers a 30-day money-back satisfaction guarantee for new customers. Customers can subscribe by calling the 1-800-BE-A-GEEK phone number, e-mailing the Company or enrolling through the Company's Web site. The majority of customers are billed through automatic charges to their credit cards or bank account, although some customers are invoiced. The Company offers discounts ranging from 10% to 20% on most of its services for customers who prepay. Internet Access. The Company's primary service is a dial-up Internet access package, which includes unlimited Internet access and various Internet applications such as World Wide Web, e-mail, Internet relay chat ("IRC"), file transfer protocol ("FTP") and Usenet news access. The package costs $19.95 per month 32 34 plus a $29.95 activation fee. Value-added services available for an additional fee include multiple e-mail mailboxes, personalized e-mail addresses and personal Web sites. The Company also offers individual dedicated analog connections for $79 a month plus a $79 setup fee. Airnews.net. The Company's Airnews.net, provides access to Internet America's news services for customers of other Internet services and on a wholesale basis to other businesses or ISPs. The service has approximately 3,800 customers in 35 countries and provides access to millions of articles. The service is included in the Company's dial-up access package and costs $10 per month for other retail customers. High Speed Connectivity. In addition to offering dial-up and dedicated analog access, the Company also offers its business customers dedicated ISDN access and full T-1 connectivity, which can service hundreds of users at once. Internet America offers numerous services related to a customer's T-1 connection, including hardware configuration and local loop installation. In addition, the Company provides 24-hour network monitoring to alert customers of any circuit trouble. T-1 connections have a setup fee of $995 and monthly fees ranging from $470 to $1295, depending on the type of services purchased. Fees for dedicated ISDN access are $540 for setup and $300 to $400 per month depending on the speed of the circuit. Web Services. The Company offers Web hosting through its Airweb.net service for businesses and other organizations that wish to create their own World Wide Web sites without maintaining their own Web servers and high-speed Internet connections. With this "virtual Web server" service, Web hosting customers can use their own domain names in their World Wide Web addresses. Web hosting customers are responsible for building their own Web sites and then uploading the pages to an Internet America Web server. The Company's Web hosting service features state-of-the-art Web servers for high speed and reliability, a high- quality connection to the Internet, specialized customer support and advanced services features, such as secure transactions and site usage reports. The Company currently offers various price plans for Web hosting customers beginning at $20 per month. Internet America had approximately 270 Web hosting customers as of June 30, 1998. The Company offers Web server co-location services at its headquarters in Dallas for customers who want to maintain their own Web servers in Internet America's state-of-the-art data telecommunications environment and receive a high-speed, full-time connection to the Internet. Internet America's co-location services include 24-hour security monitoring, uninterruptible power (battery and generator), climate control and after-hours access for the customer. The Company also offers domain name registration and hosting to protect the use of the name of a customers's Web site address. CUSTOMER CARE The Company's goal of 100% customer satisfaction begins with providing superior systems and network performance. The Company focuses on scalability, reliability and speed in the technical design and maintenance of its systems. See "-- Systems Infrastructure." In addition to the provision of superior systems and network performance, the Company emphasizes high quality customer care and technical support. The Company strives to retain its customers by prioritizing fast response to customer problems. Individuals accessing the Internet have many different hardware configurations and varying levels of computer sophistication. Consequently, Internet America's customer care department must be able to efficiently and effectively address (i) problems affecting a variety of hardware systems, (ii) start-up or other basic problems of new customers or new Internet users and (iii) more technical issues that sophisticated users may encounter. Internet America is committed to providing the best technical support in the industry, especially for new users, while maintaining the ability to resolve the most difficult problems that a sophisticated user may present. The Company's customer care department includes approximately one-half of all employees, or approximately 48 employees as of June 30, 1998. Customer care is available to subscribers 24-hours-a-day, 7-days-a-week. The department is organized in three-tiers designed to respond to varying types of support needs. The three tiers are staffed with knowledgeable and experienced support technicians able to diagnose customer problems and prescribe corrective measures. Each call is routed to the appropriate tier of the department for response. Internet America's customer care department answers approximately 5,000 calls per week. The average "hold" time is less than 45 seconds, and approximately 65% of all calls are resolved within 33 35 four minutes of the caller's initial contact with the technician. In addition to diagnosing and resolving customers' technical problems, Internet America's customer care department answers customer account questions, responds to software requests and provides configuration information. Customers can access customer support services through a local telephone number or e-mail. The Company maintains on its Web site a comprehensive description of its customer care services, as well as troubleshooting tips and configuration information. Additionally, the Company offers to its customers free educational classes, which are held weekly at the Company's Dallas location. Customers can also obtain recorded system and network status reports at any time and review extensive system and network performance via the World Wide Web. MARKETING The Company's marketing approach is designed to further its user density business model, which focuses on rapid penetration of a given market to acquire a critical mass of customers to support profitable operations. The Company's approach combines direct response with brand building advertising. Unlike most other ISPs, the Company makes extensive use of television and outdoor billboard displays, rather than print, radio or direct mail. The Company continually evaluates the effectiveness of its marketing methods, primarily by analyzing sales statistics such as call volumes, sales volumes, media mix and incentive offer response, so that it can refine its marketing campaign. The Company also uses input from focus groups and other customer contacts to determine what marketing methods and incentives will be most effective. The Company reinforces the customer's purchase decision and stimulates referral business by sending the customer a welcome letter with the start-up package. The Company also sends all customers quarterly e-mail newsletters containing information and updates on the Company services, as well as reminders about the Company's referral incentive programs. Since the Company's inception, its marketing message has evolved substantially. Its early television campaigns were directed at early technology adopters, who wanted to join the Internet power users on the World Wide Web. The Company's current advertising campaign focuses on young, middle and upper income families that are seeking the "best route" to the information highway and access to the Web's increasingly diverse information, entertainment, educational, product and service resources. Once the Company's advertising has saturated a given market and the Company has acquired a critical mass of customers, it begins to reap the benefits of word of mouth communication about the quality and reliability of its services. Such communication not only results in a significant number of referrals, but also reinforces brand awareness of Internet America. At this point, the Company's advertising expense per acquired customer drops significantly. The Company's integrated marketing and sales approach includes the following elements: Direct Response Television Advertising. The Company believes that television is the most effective and efficient way of reaching potential customers, particularly first-time Internet users whose numbers are growing as personal computers continue to penetrate the home and business markets. Through a sophisticated and intensive broadcast and cable television advertising campaign that emphasizes the quality and reliability of the Company's Internet services and its responsiveness to customer needs and problems, the Company is able to elicit a strong response from potential customers, who are asked to contact the Company through a telephone call to 1-800-BE-A-GEEK. Television advertising also helps to reinforce brand awareness of Internet America. Outdoor Advertising and Other Media. Billboard campaigns are used by the Company to establish and reinforce brand awareness of Internet America. The Company uses other media to reach customers or potential customers only under special circumstances. For example, the Company has used alternative print media to reach Internet "power users." 34 36 Value-Added Resellers (VARs). The Company recently initiated a VAR program that enables smaller personal computer retailers to sell the Company's start-up package. The Company waives its usual activation fee so the ultimate cost to the consumer is the same. Initial results from the program are promising. The Company has made preparations to begin intensive advertising campaigns in other markets in the southwestern United States. The Company believes that its approach to marketing and sales can be successfully introduced into those markets without major revision. INFRASTRUCTURE The Company's current network provides customers with local dial-up access in all the major metropolitan areas of Texas, as well as several smaller communities. The Company's systems and network infrastructure are designed to provide customers with reliability and speed. Reliability is primarily achieved through redundancy in mission critical systems that minimizes the number of single points of failure. Speed is achieved through clustered systems, diverse network architecture, multi-peered Internet backbone connections and aggressive load balancing. Network Infrastructure. The Company's primary internal network consists of Fiber Distributed Data Interface networks that incorporate FDDI Full Duplex Technology, coupled with a Dual Redundant Digital GIGASwitch. This internal backbone solution is superior in its ability to handle sustained high-speed traffic, resilience to failure and redundancy. The internal backbone's level of redundancy substantially reduces potential data loss and avoids congestion common with other backbone architectures. The technology incorporated into the GIGASwitch is capable of operating under extreme loads and is fault-tolerant. This design and backbone network system is similar to that deployed at most of the more advanced Internet switching centers worldwide. The Company's network system incorporates safety features to separate internal data from external sources, as well as provides a redundant network in case of catastrophic network failure. The Company's facilities are powered by a computer controlled uninterruptible power supply that provides company wide battery backup, surge protection and power conditioning. An automatic onsite diesel generator provides power for prolonged power outages. The Company also maintains a Network Operations and Control Center ("NOCC") with a full-time staff. This continually staffed facility is responsible for monitoring the status of all networking facilities, components, applications and equipment deployed throughout the Company's infrastructure. The NOCC is responsible for all operational communications between the internal departments of the Company as well as external providers of services to the Company. The NOCC utilizes software which provides real-time monitoring of each component or application and is responsible for notifications of quality of service problems as well as failures. Sophisticated historical and statistical analysis software used in the NOCC provides data to management about the quality of service the Company's customers are experiencing, as well as information to help control costs by purchasing additional bandwidth and services only when needed. The Company maintains its applications on a variety of systems from a number of vendors. The major applications, such as e-mail and news access services, utilize a network of servers connected directly to the Company's FFDT backbone. These systems are also connected, via another FFDT network, to the Company's high-availability network file server. This direct connection minimizes latency for customers accessing these applications. The Company deploys PC style hardware in clusters for distributing the load of other applications and providing fault-tolerance against application failure. These distributed applications are housed on low cost, easily obtainable components with minimal interdependency. Utilizing lower cost hardware has resulted in significantly reduced operations expense and high reliability. The Company expects to minimize its future use of high cost equipment by employing multiple lower cost hardware components as it develops and applies new technologies. Notwithstanding the attributes of the Company's network, it is subject to malfunctions and other limitations, any of which could have a material adverse effect on the Company's 35 37 business, financial condition and results of operations. See "Risk Factors -- Dependence on Network Infrastructure; Capacity; Risk of System Failure." Physical POPs. The Company's physical POPs are located in leased space containing inbound local telephone lines, modems and related communications equipment. The Company serves the San Angelo, Denison, Corsicana and Weatherford, Texas markets with these POPs. Traffic from these POPs is routed to the Company's internal network over leased lines. The Company also maintains a physical POP in Dallas, but is currently in the process of migrating these customers in Dallas to the Virtual POP architecture. The Company's intent is to transition these customers in these markets to the Virtual POP architecture as soon as services, capacity and reliability are available at reasonable costs. Virtual POPs. Historically, ISPs have invested heavily in inbound local telephone lines, modems, related equipment and facilities. The Company, however, is implementing a "Virtual POP" architecture, which allows the Company to provide local access services without deploying physical infrastructure. The benefits of this architecture include substantially reduced capital expenditures, lower operating costs and reduced exposure to technological obsolescence. In addition, when entering new markets, the Virtual POP architecture allows the Company to more precisely match capacity needs to actual sales in that market. The Virtual POP architecture enables customers to dial a local phone number and connect to a modem owned by and housed at a telecommunications provider. The customer's data call is then routed across leased lines to the Company's internal network. Currently, Internet America has deployed this Virtual POP architecture with various telecommunications providers in Dallas, Ft. Worth, Houston, Austin, San Antonio and Denton, Texas. At June 30, 1998, approximately 50% of the Company's customers were serviced by Virtual POPs. Unlike simply leasing network capacity from a third-party provider, the Virtual POP architecture allows the Company to maintain substantial control over quality of service and capacity. Other regional ISPs commonly use leased network capacity, which can result in their customers' Internet experiences being almost entirely outside of the ISPs' control. In fact, utilizing a leased network may cause the customer to compete with customers of other ISPs for access and bandwidth. In contrast, the Company's Virtual POP architecture uses private networks to carry customer data calls back to the Company's network and application servers. In this manner, the Company maintains strict quality control over its customers' Internet experiences, leading to higher levels of customer satisfaction. The Company's Virtual POP architecture and user density business model position the Company to quickly take advantage of emerging high-speed technologies such as xDSL, wireless and other Internet delivery methods. Leveraging a dense customer base should enable the Company to economically offer other emerging technologies, such as Internet telephony, particularly Voice Over Internet Protocol ("VoIP"), video and audio distribution and other high-bandwidth, low latency technologies. Management Information Systems. The Company's MIS department uses a near real-time customer database, billing and flow-through fulfillment system. This system handles all customer contact and billing information for the Company's dial-up access, Airnews.net and Airmail.net services. The system maintains access controls for the authentication servers and various applications. The system also creates customer invoices and automatically processes credit card charges and automatic check handling. The Company is currently transitioning to an integrated financial and information reporting system that will automate many additional functions inside the Company and provide financial, marketing and management reports. TECHNOLOGY AND DEVELOPMENT The Company continuously evaluates new technology and applications for possible introduction. In particular, the Company is preparing to deploy a high-speed connectivity technology, xDSL, in its established markets. xDSL uses existing twisted copper pair wires running from a LEC's central office to a customer's home or office to provide high-speed connectivity. Initially, provisioning of xDSL service is expected to be difficult and time-consuming, requiring close coordination between the provisioning LEC, the ISP and the ISP's customer. The Company believes that because of its user density business model, it is well positioned to 36 38 market and deploy xDSL. The Company expects that it will be able to spread the personnel, hardware, marketing and other costs of such deployment over a sufficiently large base of customers in a specific local market. High-speed connectivity is essential to the commercially viable deployment of new, value-added services such as Internet telephony, particularly VoIP, video and audio programming distribution and other high-bandwidth, low-latency applications. Again, the Company believes that its user density business model is particularly well suited to the marketing and deployment of these services. The Company continues to stay abreast of developments in these and other areas. PROPRIETARY RIGHTS General. Although the Company believes that its success is more dependent upon its technical, marketing and customer service expertise than its proprietary rights, the Company's success and ability to compete are dependent in part upon its proprietary rights. The Company relies on a combination of copyright, trademark and trade secret laws. "Internet America" and "1-800-BE-A-GEEK" are registered service marks of Internet America. Service mark applications are pending for the registration of "Airnews.net," "Airmail.net," "Airweb.net," their respective logos and the Internet America logo. There can be no assurance that the steps taken by the Company will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. See "Risk Factors -- Proprietary Rights; Infringement Claims." Licenses. The Company has obtained authorization to use the products of each manufacturer of software that the Company bundles in its front-end software product for Windows and Macintosh subscribers. The particular applications included in the Internet America start-up package have, when necessary, been licensed. The Company currently intends to maintain or negotiate renewals of all existing software licenses and authorizations as necessary. The Company may also want or need to license other applications in the future. Other applications included in the Internet America start-up package are shareware that the Company has obtained permission to distribute or that are from the public domain and are freely distributable. COMPETITION The market for the provision of Internet access to individuals is extremely competitive and highly fragmented. There are no substantial barriers to entry, and the Company expects that competition will continue to intensify. The Company believes that the primary competitive factors determining success in this market are a reputation for reliability and service, access speed, effective customer support, pricing, creative marketing, easy-to-use software and geographic coverage. Other important factors include the timing of introductions of new products and services and industry and general economic trends. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations. The Company's current and prospective competitors include many large companies that have substantially greater market presence and financial, technical, marketing and other resources than the Company. The Company currently competes or expects to compete with the following types of Internet access providers: (i) national commercial providers, such as Verio, Inc., Mindspring Enterprises, Inc. and EarthLink Network, Inc.; (ii) numerous regional and local commercial providers which vary widely in quality, service offerings and pricing such as Websight Services, Inc. and PDQ Net, Inc.; (iii) established online commercial information service providers, such as America Online, Inc.; (iv) computer hardware and software and other technology companies, such as International Business Machines Corporation, Microsoft Corp. and Gateway, Inc.; (v) national telecommunications providers, such as AT&T, MCI, WorldCom, Inc., Sprint and WindStar Communications, Inc.; (vi) regional telecommunications providers, such as SBC Communications and IXC Communications; (vii) cable operators, such as Tele-Communications, Inc., Time Warner, Inc., TCA Cable, Inc. and Marcus Cable, Inc.; (viii) wireless communications companies; (ix) satellite companies; and (x) nonprofit or educational Internet access providers. 37 39 The Company believes that new competitors, including large computer hardware and software, media and telecommunications companies, will continue to enter the Internet services market, resulting in even greater competition for the Company. Telecommunications providers, such as MCI, AT&T and Sprint, have also recently entered the Internet access market. In addition, as consumer awareness of the Internet grows, existing competitors are likely to further increase their emphasis on Internet access services, resulting in even greater competition for the Company. The ability of these competitors or others to enter into business combinations, strategic alliances or joint ventures or to bundle services and products with Internet access could put the Company at a significant competitive disadvantage. Moreover, the Company expects to face competition in the future from companies that provide connections to consumers' homes, including national and regional telecommunications providers, cable companies, electric utility companies and terrestrial and satellite wireless communications companies. For example, technologies have been developed that enable cable television operators to offer Internet access through their cable facilities at significantly faster rates than existing analog modem speeds. Such companies include Internet access in their basic bundle of services or offer such access for a nominal additional charge, and could prevent the Company from delivering Internet access through the wire and cable connections that such companies own. Any such developments could materially adversely affect the Company's business, financial condition and results of operations. See "Risk Factors -- Competition." GOVERNMENT REGULATION The Company provides Internet access, in part, through transmissions over public telephone lines. These transmissions are governed by regulatory policies establishing charges and terms for communications. The Company, as an Internet access provider, is not currently subject to direct regulation by the Federal Communications Commission (the "FCC") or any other agency, other than regulations applicable to businesses generally. In a report to Congress adopted on April 10, 1998, the FCC reaffirmed that Internet access providers should be classified as unregulated "information service providers" rather than regulated "telecommunications providers" under the terms of the 1996 Telecommunications Act. The consequence of this finding is that the Company is not subject to regulations applicable to telephone companies and similar carriers merely because the Company provides its services via telecommunications networks. The Company also is not required to contribute to the universal service fund, which subsidizes phone service for rural and low income consumers and supports Internet access among schools and libraries. The FCC action may also discourage states from regulating Internet access providers as telecommunications carriers or imposing similar subsidy obligations. Nevertheless, Internet-related regulatory policies are continuing to develop, and it is possible that the Company could be exposed to regulation in the future. For example, in the same report to Congress, the FCC stated its intention to consider whether to regulate voice and fax telephony services provided over the Internet as "telecommunications" even though Internet access itself would not be regulated. The FCC is also considering whether such Internet-based telephone services should be subject to the universal service support obligations discussed above, or should pay carrier access charges on the same basis as traditional telecommunications companies. Access charges are assessed by local telephone companies to long distance companies for the use of the local telephone network to originate and terminate long distance calls, generally on a per-minute basis. Access charges have been a matter of continuing dispute, with long distance companies complaining that the rates are substantially in excess of cost and local telephone companies arguing that access rates are justified to subsidize lower local rates for end users and other purposes. Both local and long distance companies, however, contend that Internet-based telephony should be subject to these charges. The Company currently does not offer telephony, and so is not directly affected by these developments. However, should the Company offer telephony in the future, it may be affected by these issues. Additionally, the Company cannot predict whether these debates will cause the FCC to reconsider its current policy of not regulating Internet access providers. In a notice of proposed rulemaking adopted on August 6, 1998, the FCC proposed that if an incumbent LEC established a separate affiliate to pursue the deployment of advanced telecommunications services such as xDSL and that affiliate interconnected with the LEC's network on the same terms and conditions as the 38 40 LEC's competitors did, then the affiliate would not be subject to the unbundling requirement that applied to the LEC. If the FCC ultimately adopted this proposal or similar proposals, the Company's access to xDSL and other high-speed data technology could be curtailed. Such curtailment could have a material adverse effect on the Company's business, financial condition and results of operations. Due to the increasing popularity and use of the Internet, it is possible that additional laws and regulations may be adopted with respect to the Internet, covering issues such as content, privacy, pricing, encryption standards, consumer protection, electronic commerce, taxation, copyright infringement and other intellectual property issues. The Company cannot predict the impact, if any, that any future regulatory changes or development may have on its business, financial condition and results of operations. Changes in the regulatory environment relating to the Internet access industry, including regulatory changes that directly or indirectly affect telecommunication costs or increase the likelihood or scope of competition from regional telephone companies or others, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Government Regulation." PROPERTIES Internet America's corporate office is located in downtown Dallas at One Dallas Centre, 350 N. St. Paul, Suite 3000, where all executive, systems, sales and technical support functions exist. The Company leases approximately 31,000 square feet under multiple leases that terminate November 1, 2001. Aggregate monthly rental payments under such leases are approximately $33,000. The Company also has leased small equipment room facilities for each of its other physical POPs in Corsicana, Denison, Weatherford and San Angelo, Texas. The Company does not own any real estate. The Company believes that all of its facilities are adequately maintained and suitable for their present use. EMPLOYEES As of June 30, 1998, the Company had approximately 90 employees, which includes 48 customer care employees. The Company anticipates that the development of its business will require the hiring of additional employees. None of the Company's current employees are represented by a labor organization, and the Company's management considers its employee relations to be good. See "Risk Factors -- Dependence on and Ability to Attract Key Personnel." LEGAL PROCEEDINGS The Company is not involved in any material pending legal proceeding. 39 41 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The names, ages and positions of the executive officers and directors of the Company, are:
NAME AGE POSITION ---- --- -------- Michael T. Maples.................... 42 President, Chief Executive Officer and Director Douglas L. Davis..................... 32 Executive Vice President and Chief Operating Officer James T. Chaney...................... 43 Vice President, Chief Financial Officer, Secretary and Treasurer John James Stewart III............... 38 Vice President -- Customer Care Douglas G. Sheldon................... 38 Vice President -- Marketing and Director William O. Hunt(1)(2)................ 64 Chairman of the Board Jack T. Smith(1)(2).................. 45 Director Gary L. Corona(1)(2)................. 47 Director
- --------------- (1) Member of the Compensation Committee. (2) Member of the Audit Committee. Directors are elected to hold office until the next annual meeting of the shareholders or until their successors are duly elected and qualified. Officers serve at the discretion of the Board of Directors. MICHAEL T. MAPLES has served as President and Chief Executive Officer of the Company since March 1997 and has served as a director since April 1997. Mr. Maples joined the Company in September 1996. Prior to joining the Company, Mr. Maples was Vice President of Westcott Communications, Inc. ("Westcott Communications"), a provider of educational, motivational and instructional programming for various industries via satellite delivered television or videotape. From 1988 to 1996 Mr. Maples was the General Manager of the Automotive and Government Services business units of Westcott Communications. DOUGLAS L. DAVIS has served as Executive Vice President and Chief Operating Officer of the Company since July 1996, and served as Chief Technology Officer of the Company from January to July 1996. Mr. Davis joined the Company as the head of R&D in November 1995. From 1991 to October 1995 Mr. Davis was the Director of Computer Operations for the School of Engineering and Applied Science at Southern Methodist University, where he was in charge of developing and supporting the school's technological infrastructure and also contributed to and published several papers on Internet matters. From 1989 to 1991 Mr. Davis was a software engineer for Dallas-based Logic Process, Inc., a company that manufactures single and multi-processor Unix systems. JAMES T. CHANEY joined the Company in December 1997 as Chief Financial Officer, and has served as Vice President, Chief Financial Officer, Secretary and Treasurer of the Company since February 1998. Prior to joining the Company, Mr. Chaney was Tax Manager at Judd, Thomas, Smith & Co., CPA's, Dallas, Texas, where he managed the tax department and performed tax and financial planning for clients in the real estate and oil and gas industries. From 1990 to 1994, he was self-employed as a Certified Public Accountant. JOHN JAMES STEWART III has served as Vice President -- Customer Care since May 1997. Mr. Stewart joined the Company in September 1995 as the Director of Technical Support, and has also served as Director of Training and Customer Retention Officer. From February 1993 until joining the Company, Mr. Stewart was employed by Toys R Us. While at Toys R Us, he served as Assistant Store Director and Department Manager. DOUGLAS G. SHELDON has served the Company as Vice President -- Marketing since September 1997 and as a director since June 1996. From 1986 through May 1996, Mr. Sheldon served in a managerial capacity with the combined companies of the American Broadcasting Co., Capital Cities/ABC, Inc. and The Disney Company. He has also served as a director of FuturDallas, Dallas Advertising League, American Women in Radio and Television and President and director of D/FW Radio Marketing Association. 40 42 WILLIAM O. HUNT has served as Chairman of the Board and a director of the Company since May 1995. Mr. Hunt is currently Chairman of the Board and director of Intellicall, Inc., a diversified telecommunications company providing products and services to pay telephone networks on a worldwide basis. From December 1992 to May 1998, Mr. Hunt served as Chief Executive Officer of Intellicall, Inc. From August 1990 to March 1996, Mr. Hunt served as Chairman or Vice Chairman of the Board and director of Hogan Systems, Inc., a designer of integrated online application software products for financial institutions. He is also a director of American Homestar Corporation, Dr. Pepper Bottling Holdings, Inc. , The Allen Group, Inc., DSC Communications Corporation and OpTel, Inc. JACK T. SMITH has served as a director of the Company since November 1995. Mr. Smith is currently the President and Chief Operating Officer of Jayhawk Acceptance Corporation ("Jayhawk"), a specialized financial services company, and has served as a director of Jayhawk since its inception. From June 1996 to September 1997, Mr. Smith was employed as an independent business consultant. From 1989 until its acquisition by Primedia, Inc., in June 1996, Mr. Smith was President and Chief Operating Officer of Westcott Communications. He is also a director of First Extended Service Corporation and FFG Insurance Company. GARY L. CORONA has served as a director of the Company since May 1998. Mr. Corona is currently the General Manager of the Automotive Division of Jayhawk. From July 1996 to July 1997, Mr. Corona served as a business consultant for Carl Westcott LLC. From July 1990 until its acquisition by Primedia, Inc., in June 1996, Mr. Corona was Vice President, New Business Development of Westcott Communications. Mr. Corona is a director of First Extended Service Corporation and FFG Insurance Company. BOARD COMMITTEES The Compensation Committee currently consists of Messrs. Hunt, Smith and Corona. The Compensation Committee recommends compensation for all executive officers and administers incentive compensation and benefit plans. The Audit Committee currently consists of Messrs. Hunt, Smith and Corona. The Audit Committee will meet periodically with management and the Company's independent auditors and will review the results and scope of the audit and other services provided by the Company's independent auditors, the Company's accounting procedures and the adequacy of the Company's internal controls. COMPENSATION OF DIRECTORS Upon consummation of the Offering, directors who are not employees of the Company ("Independent Directors") will receive an annual retainer upon election to the Board of $6,000 (pro rata for existing Independent Directors for the first partial year) and an additional $750 for each Board meeting attended. All directors of the Company will be reimbursed for travel, lodging and other out-of-pocket expenses in connection with their attendance at Board and committee meetings. After consummation of the Offering, each Independent Director, upon election to the Board of Directors will receive a non-qualified option to purchase 22,500 shares of Common Stock (which will be immediately exercisable), and following his initial term, if reelected, and every fourth year thereafter, if reelected, such director will receive a non-qualified option to purchase 20,000 shares of Common Stock (with such options vesting 25% annually, commencing on the date of issuance and continuing on the first, second and third anniversaries of the date of issuance, subject to such director's continued reelection to the Board of Directors). Each Independent Director holding office at the time of consummation of this Offering will receive such options as if he had been initially elected as of such date. All options issued after consummation of the Offering to Independent Directors will be issued pursuant to the 1998 Option Plan. See "-- 1998 Nonqualified Stock Option Plan." COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Board of Directors has a Compensation Committee, which currently is comprised of Messrs. Hunt, Smith and Corona. None of the executive officers of the Company currently serves on the compensation committee of another entity or any other committee of the board of directors of another entity performing similar functions. 41 43 EXECUTIVE COMPENSATION The following table sets forth the information regarding compensation (on an annualized basis) for the Chief Executive Officer and the Company's other most highly compensated executive officer for the period indicated. No other executive officers of the Company were compensated over $100,000 in fiscal 1998. SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION ------------ ----------------------- SECURITIES OTHER ANNUAL UNDERLYING NAME AND PRINCIPAL POSITION YEAR SALARY COMPENSATION OPTIONS - --------------------------- ---- -------- ------------ ------------ Michael T. Maples, Chief Executive Officer................. 1998 $108,333 -- 157,500(1) Douglas L. Davis, Chief Operating Officer................. 1998 110,000 -- --
- --------------- (1) Mr. Maples was granted an option to purchase 157,500 shares of Common Stock at an exercise price of $1.67 per share on March 24, 1998. The following table sets forth the information regarding option grants during the last fiscal year for the Chief Executive Officer and the Company's other executive officers. OPTION GRANTS IN LAST FISCAL YEAR INDIVIDUAL GRANTS
NUMBER OF PERCENTAGE OF SECURITIES TOTAL OPTIONS UNDERLYING GRANTED TO OPTIONS EMPLOYEES IN EXERCISE PRICE NAME GRANTED FISCAL YEAR ($/SHARE) EXPIRATION DATE - ---- ---------- ------------- -------------- --------------- Michael T. Maples............... 157,500 40% $1.67 March 24, 2008 Douglas L. Davis................ -- -- -- -- James T. Chaney................. 78,750 20% $1.67 March 24, 2008 John James Stewart, III......... 56,250 14% $1.67 March 24, 2008 Douglas G. Sheldon.............. 67,500 17% $1.67 March 24, 2008
The following table sets forth the information regarding the Company's aggregate option exercises in the last fiscal year and fiscal year-end option values for the Chief Executive Officer and the Company's other executive officers. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS SHARES OPTIONS AT FY END(#) AT FY END($)(1) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ----------- ----------- ------------- ----------- ------------- Michael T. Maples......... -- -- 67,500 157,500 $562,275 $1,311,975 Douglas L. Davis.......... -- -- 112,500 -- 937,125 -- James T. Chaney........... -- -- -- 78,750 -- 655,988 John James Stewart, III... -- -- 743 59,202 6,189 493,153 Douglas G. Sheldon........ -- -- 22,500 67,500 187,425 562,275
- --------------- (1) The value of the options is based on the difference between the option exercise price of $1.67 per share for all options and the initial public offering price of the Common Stock (based on an assumed initial public offering price of $10.00) multiplied by the number of shares of Common Stock underlying the option. No public market existed for the Common Stock at the fiscal year ended June 30, 1998. 42 44 1996 INCENTIVE STOCK OPTION PLAN The Company's 1996 Incentive Stock Option Plan (the "1996 Option Plan") was adopted by the Board of Directors and the Company's shareholders in December 1996. Pursuant to the 1996 Option Plan, the Company may grant incentive and nonstatutory (nonqualified) stock options to key employees and directors of the Company. A total of 225,000 shares of Common Stock have been reserved for issuance under the 1996 Option Plan. The Compensation Committee has the authority to select the employees and directors of the Company to whom stock options are granted. Subject to the limitations set forth in the 1996 Option Plan, the Compensation Committee has the sole discretion and authority to determine from time to time the persons to whom options shall be granted and the number of shares covered by each option, to interpret the 1996 Option Plan, to establish vesting schedules, to specify the type of consideration to be paid to the Company upon exercise and, subject to certain restrictions, to specify other terms of the options. The maximum term of options granted under the 1996 Option Plan is ten years. The aggregate fair market value of the stock with respect to which incentive stock options are first exercisable in any calendar year may not exceed $100,000 per incidence. Options granted under the 1996 Option Plan are in most cases nontransferable and generally expire within three months after the termination of the optionee's services to the Company. In general, if an optionee is disabled, dies or retires from his or her service to the Company, such option may be exercised up to 12 months following such disability or death, unless the Compensation Committee determines to allow a longer period for exercise. The exercise price of incentive stock options must be not less than the fair market value of the Common Stock on the date of grant. The exercise price of incentive stock options granted to any person who at the time of grant owns stock possessing more than 10% of the total combined voting power of all classes of stock must be at least 110% of the fair market value of such stock on the date of grant, and the term of those options cannot exceed five years. The Company currently has 61,756 options outstanding to its employees under the 1996 Option Plan. These options are exercisable at $1.67 per share of Common Stock. The exercise price of 38,619 of such options was adjusted from $3.33 per share to $1.67 per share on March 24, 1998 by the Board of Directors. NONQUALIFIED STOCK OPTIONS Mr. Maples was granted an option to purchase 67,500 shares of Common Stock at an exercise price of $3.33 per share on October 27, 1996. The exercise price of this option was adjusted to $1.67 per share by the Board of Directors on March 24, 1998. Additionally, on March 24, 1998, Mr. Maples was granted an option to purchase 157,500 shares of Common Stock at an exercise price of $1.67 per share. Mr. Sheldon was granted an option to purchase 22,500 shares of Common Stock at an exercise price of $3.33 per share (such exercise price was adjusted to $1.67 per share on March 24, 1998) and an option to purchase 67,500 shares of Common Stock at an exercise price of $1.67 per share, on June 27, 1996 and March 24, 1998, respectively. On April 5, 1996, Messrs. Hunt and Smith were each granted an option to purchase 22,500 shares of Common Stock at an exercise price of $1.67 per share. On December 15, 1995, Mr. Davis was granted an option to purchase 112,500 shares of Common Stock at an exercise price of $1.67 per share. Mr. Chaney was granted an option to purchase 78,750 shares of Common Stock at an exercise price of $1.67 per share on March 24, 1998. Mr. Stewart was granted an option to purchase 56,250 shares of Common Stock at an exercise price of $1.67 per share on March 24, 1998. All of the options granted to the Company's directors and officers are nonqualified stock options. Additionally, on October 27, 1996, 215,026 options were granted to certain founders of the Company at an exercise price of $3.33 per share in connection with such founders' pledge of their stock of the Company to guarantee the bridge loan from First Computer Services Corporation ("First Computer"). The exercise price of these options was adjusted to $1.67 per share by the Board of Directors on March 24, 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Certain Transactions." 43 45 The Company currently has 1,184,657 nonqualified options outstanding to certain of its officers, employees and advisors. These options are exercisable at prices ranging from $0.09 per share of Common Stock to $3.33 per share of Common Stock. 1998 NONQUALIFIED STOCK OPTION PLAN The Company's 1998 Nonqualified Stock Option Plan (the "1998 Option Plan") was adopted by the Board of Directors and the Company's shareholders on July 13, 1998. The purpose of the 1998 Option Plan is to promote the growth and general prosperity of the Company by permitting the Company to grant to its employees, directors and advisors options to purchase Common Stock of the Company. Pursuant to the 1998 Option Plan, the Company may grant nonstatutory (nonqualified) stock options to employees, directors and advisors of the Company. A total of 400,000 shares of Common Stock have been reserved for issuance under the 1998 Option Plan. In July 1998, Mr. Corona was issued an option to purchase 22,500 shares of Common Stock at an exercise price of $8.00 per share pursuant to the 1998 Option Plan. The Compensation Committee has the authority to select the employees, directors and advisors of the Company to whom stock options are granted. Subject to the limitations set forth in the 1998 Option Plan, the Compensation Committee has the sole discretion and authority to determine from time to time the persons to whom options shall be granted and the number of shares covered by each option, to interpret the 1998 Option Plan, to establish vesting schedules, to specify the type of consideration to be paid to the Company upon exercise and, subject to certain restrictions, to specify other terms of the options. The maximum term of options granted under the 1998 Option Plan is ten years. Options granted under the 1998 Option Plan are in most cases nontransferable and generally expire within 30 days after the termination of the optionee's services to the Company, except in cases when the optionee is terminated "for cause" (as such term is defined therein). In such cases, the option typically expires automatically on the date of termination. In general, if an optionee is disabled or dies, such option may be exercised up to 12 months following such disability or death, unless the Compensation Committee determines to allow a longer period for exercise. In general, if an optionee retires from his or her service to the Company, such option may be exercised up to three months following such retirement, unless the Compensation Committee determines to allow a longer period for exercise. 44 46 CERTAIN TRANSACTIONS On September 25, 1996, the Company entered into a Securities Purchase Agreement (the "Purchase Agreement") with First Computer, which is owned by Carl Westcott, a principal shareholder of the Company. First Computer acted as a nominee for Jack T. Smith, a director of the Company, Michael T. Maples, the Chief Executive Officer and a director of the Company, and Carl Westcott. Under the terms of the Purchase Agreement, in exchange for $2.0 million in cash, First Computer purchased 544,149 shares of Common Stock and a promissory note from the Company in favor of First Computer in the original principal amount of $1,767,713 (the "First Computer Note"). The First Computer Note bore interest at 10% per annum, with a default rate of 18% per annum, and all principal and interest were originally payable on September 25, 1997. The First Computer Note, which was in default, was refinanced at prime rate in June 1998 as set forth below. The First Computer Note was collateralized by the present and future assets of the Company. The founding shareholders, Robert Maynard, John Nanni and Tim Martin, pledged their stock in the Company to collateralize the First Computer Note, and as consideration were granted vested stock options exercisable at $3.33 per share (subsequently adjusted in March 1998 to $1.67 per share) and equal to 10% of their stock holdings, or 89,926 options to Mr. Maynard, 63,562 options to Mr. Nanni, and 61,538 options to Mr. Martin. Under the Purchase Agreement, First Computer, as nominee for Messrs. Westcott, Maples and Smith, was granted certain registration rights. See "Description of Securities -- Registration Rights." On January 31, 1997, the Company entered into a letter agreement (the "First Extended Agreement") with First Extended, Inc. (successor in interest to First Computer) ("First Extended") and William O. Hunt, a director of the Company. First Extended acted as a nominee for Messrs. Smith, Maples and Westcott. Under the terms of the First Extended Agreement, the Company made a promissory note in the original principal amount of $650,000 in favor of First Extended (the "First Extended Note"). The First Extended Note and First Extended Agreement provided that the Company could borrow up to $650,000 from First Extended. All advances under the First Extended Note and First Extended Agreement were made at First Extended's discretion. The Company had borrowed a total of $250,000 under the First Extended Note and First Extended Agreement. The First Extended Note bore interest at 18% per annum, and all principal and interest were originally payable on April 1, 1997. The First Extended Note, which was in default, was refinanced at prime rate in June 1998 as set forth below and was paid off on July 14, 1998. Mr. Hunt has personally guaranteed payment under a promissory note made by the Company in the original principal amount of $350,000 payable to NationsBank, N.A. (the "NationsBank Note"). A total of $225,000 has been borrowed under the NationsBank Note. The note bears interest at the bank's prime rate. The NationsBank Note originally matured on July 15, 1997 but has been renewed through December 15, 1998. A guarantee fee will accrue to Mr. Hunt at 18% minus the bank's prime rate if the NationsBank Note is in default. The guarantee fee and all principal are payable upon demand of the guarantor. All advances under the NationsBank Note require the consent of the guarantor. On March 24, 1998, Carl Westcott LLC, as nominee for Messrs. Westcott, Maples, Smith, Corona and others, and Messrs. Hunt and Sheldon entered into a Stock Purchase Agreement (the "1998 Purchase Agreement"), pursuant to which Carl Westcott LLC, as nominee, and Messrs. Hunt and Sheldon purchased all of the 1,987,124 shares of Common Stock held by Messrs. Maynard, Nanni and Martin in exchange for $883,166. In June 1998, the Company refinanced the First Computer Note and the First Extended Note pursuant to a Letter Agreement between the Company and Messrs. Hunt, Smith and Westcott (the "Letter Agreement"). Pursuant to the Letter Agreement, the Company made the following promissory notes: (i) Amended and Restated Promissory Note payable to Mr. Smith in the principal amount of $229,450, (ii) Amended and Restated Promissory Note payable to Mr. Smith in the principal amount of $77,694, (iii) Amended and Restated Promissory Note payable to Mr. Westcott in the principal amount of $1,538,263 and (iv) Amended and Restated Promissory Note payable to Mr. Westcott in the principal amount of $172,306 (collectively, the "Amended Notes"). All of the Amended Notes bear interest per annum at the NationsBank of Texas, N.A. prime rate. Pursuant to the Letter Agreement, the Company must make a monthly payment of $140,000, which will be applied pro rata to the repayment of the Amended Notes and the NationsBank Note. In the 45 47 event of default under any of the Amended Notes, the outstanding indebtedness of such note is convertible into shares of Common Stock at the price of $0.44 per share at the option of the noteholders. Under the Amended Notes and the Letter Agreement, in the event of any offering of the Company's securities pursuant to a registration statement declared effective by the Securities and Exchange Commission or the sale or issuance of the Company's securities through which the Company raises a minimum of $1.0 million, the Company must use all of the proceeds of such offering, sale or issuance to pay off the Amended Notes and the NationsBank Note until all such debt is extinguished. The Company intends to use approximately $2.2 million of the net proceeds of this Offering to prepay the Amended Notes and the NationsBank Note. Mr. Maples sold his interest in the Amended Notes to Carl Westcott. Chase Bank has made available a stand-by letter of credit in the original principal amount of $150,000. Payment under this letter of credit has been personally guaranteed by Mr. Hunt. Approximately $131,000 of this letter of credit has been pledged as collateral under a three year capital lease. Carl Westcott owns a significant interest in Jayhawk, First Extended Service Corporation and FFG Insurance Company. Carl Westcott LLC and Westcott Communications are current and former affiliates of Carl Westcott. The Company has had no material business transactions with any of these entities. FUTURE TRANSACTIONS The Company has adopted a policy providing that all transactions between the Company and related parties will be subject to approval by a majority of all disinterested directors and must be on terms no less favorable than those that could otherwise be obtained from unrelated third parties. 46 48 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information as of August 25, 1998, regarding the beneficial ownership of Common Stock of (i) each person or group known by the Company to beneficially own 5% or more of the outstanding shares of Common Stock, (ii) each of the directors and the executive officers of the Company, (iii) all executive officers and directors of the Company as a group and (iv) each Selling Shareholder. The Company's officers, directors and certain principal shareholders have agreed not to offer, sell, contract to sell or otherwise dispose of any shares of Common Stock for a period of 180 days from the date of this Prospectus without the prior written consent of Hoak Breedlove Wesneski & Co. Unless otherwise noted, the persons named below have sole voting and investment power with respect to the shares shown as beneficially owned by them.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED OWNED PRIOR TO THE OFFERING AFTER THE OFFERING NAME, ADDRESS AND OFFICE --------------------- SHARES ---------------------- OF BENEFICIAL OWNER(1) NUMBER PERCENT OFFERED(4) NUMBER(4) PERCENT(4) ------------------------ ---------- -------- ---------- --------- ---------- Michael T. Maples(2).............. 242,404 6.7% -- 242,404 3.8% Douglas L. Davis(2)............... 225,000 6.2% -- 225,000 3.5% James T. Chaney................... -- -- -- -- -- John James Stewart III(2)......... 743 * -- 743 * Douglas G. Sheldon(2)............. 315,002 8.6% -- 315,002 4.9% William O. Hunt(2)(3)............. 1,432,490 39.0% 200,000(5) 1,232,490 19.2% Jack T. Smith(2).................. 534,311 11.9% 60,000 474,311 7.8% Gary L. Corona(2)................. 44,999 * -- 44,999 * Carl Westcott..................... 1,141,811 32.3% 340,000 801,811 12.7% All directors and executive officers as a group (eight persons)(2)..................... 2,794,949 73.5% 260,000 2,534,949 38.4%
- --------------- * Less than one percent. (1) The address of each of the principal and Selling Shareholders is in care of the Company, One Dallas Centre, 350 North St. Paul, Suite 3000, Dallas, Texas 75201. (2) Includes options to purchase 67,500, 112,500, 743, 22,500, 22,500, 22,500 and 22,500 shares of Common Stock granted to Messrs. Maples, Davis, Stewart, Sheldon, Hunt, Smith, Corona and all directors and executive officers as a group, respectively, that are exercisable within 60 days of August 25, 1998. (3) Includes 497,301 shares of Common Stock owned by BCG Partnership, Ltd., a limited partnership in which Mr. Hunt and his wife serve as general partners, 329,304 shares of Common Stock owned by B&G Partnership, Ltd., a limited partnership in which Mr. Hunt and his wife serve as general partners, and 583,385 shares of Common Stock owned by the William O. Hunt Retirement Trust, for which Mr. Hunt serves as trustee. (4) Messrs. Hunt (through the William O. Hunt Retirement Trust), Smith and Westcott have granted the Underwriters an over-allotment option, exercisable not later than 30 days after the date of this Prospectus, to purchase 120,000, 25,000 and 200,000 shares of Common Stock, respectively, at the initial public offering price set forth on the cover of this Prospectus, less the underwriting discount. See "Underwriting." (5) The Selling Shareholder is BCG Partnership, Ltd. 47 49 DESCRIPTION OF SECURITIES GENERAL The Company is a Texas corporation and its affairs are governed by the Articles, Bylaws and the Texas Business Corporation Act (the "TBCA"). The following description of the Company's capital stock is qualified in all respects by the Articles and the Bylaws, which have been filed as exhibits to the Registration Statement to which this Prospectus forms a part. The authorized capital stock of the Company consists of 40,000,000 shares of Common Stock, par value $0.01 per share, and 5,000,000 shares of preferred stock, par value $0.01 per share (the "Preferred Stock"). COMMON STOCK As of August 25, 1998, the Company had 35 holders of its Common Stock. The holders of outstanding shares of Common Stock are entitled to receive dividends out of assets legally available therefor at such times and in such amounts as the Board of Directors may, from time to time, determine, subject to any preferences which may be granted to the holders of Preferred Stock. Holders of Common Stock do not have cumulative voting rights and are entitled to one vote per share on all matters on which the holders of Common Stock are entitled to vote. The Common Stock is not entitled to preemptive rights and is not subject to redemption or conversion. Upon liquidation, dissolution or winding-up of the Company, the assets (if any) legally available for distribution to shareholders are distributable ratably among the holders of Common Stock after payment of all debts and liabilities of the Company and the liquidation preference of any outstanding class or series of Preferred Stock. All outstanding shares of Common Stock are, and the shares of Common Stock to be issued pursuant to this Offering will be, when issued and delivered, validly issued, fully paid and nonassessable. The rights, preferences and privileges of holders of Common Stock will be subject to the preferential rights of any outstanding class or series of Preferred Stock that the Company may issue in the future. PREFERRED STOCK The Board of Directors may, without further action of the shareholders of the Company, issue shares of Preferred Stock in one or more series and fix or alter the rights and preferences thereof, including the voting rights, redemption provisions (including sinking fund provisions), dividend rights, dividend rates, liquidation preferences, conversion rights and any other rights, preferences, privileges and restrictions of any wholly unissued series of Preferred Stock. The rights of holders of Common Stock will be subject to, and may be adversely affected by, the rights of holders of any Preferred Stock. On November 10, 1995, the Board of Directors issued a series of Preferred Stock, which currently consists of 400,000 shares of Preferred Stock (such amount may from time to time be increased or decreased by the Board of Directors), designated as Series A Preferred Stock (the "Series A Preferred Stock"). The Series A Preferred Stock, with respect to rights on liquidation, winding up and dissolution, ranks senior to all classes and series of Common Stock and may rank senior to other classes of Preferred Stock. The Series A Preferred Stock has no specified dividend rate and the holders of Series A Preferred Stock are entitled to receive the same dividends as the holders of the Common Stock. The holders of Series A Preferred Stock are entitled to vote in all matters as to which the holders of the Common Stock are entitled to vote (on an "as converted" basis) in the same manner and with the same effect as such holders of Common Stock, voting together with the holders of Common Stock and Series A Preferred Stock as one class. Each share of Series A Preferred Stock is convertible at any time into 2.25 shares of Common Stock and shall be automatically converted, without further action on the part of the Company or the holder thereof, into 2.25 fully paid and nonassessable shares of Common Stock on the date 30 days after the successful completion of the Offering. On May 15, 1996, the Board of Directors issued a series of Preferred Stock, which currently consists of 300,000 shares of Preferred Stock (such amount may from time to time be increased or decreased by the Board of Directors), designated as Series B Preferred Stock (the "Series B Preferred Stock"). The Series B Preferred Stock, with respect to rights on liquidation, winding up and dissolution, ranks equally to the Series A Preferred Stock, ranks senior to all classes and series of Common Stock and may rank senior to other classes 48 50 of Preferred Stock. The Series B Preferred Stock has no specified dividend rate and the holders of Series B Preferred Stock are entitled to receive the same dividends as the holders of the Common Stock. The holders of Series B Preferred Stock are entitled to vote in all matters as to which the holders of the Common Stock are entitled to vote, in the same manner and with the same effect as such holders of Common Stock (on an "as converted" basis), voting together with the holders of Common Stock, Series A Preferred Stock and Series B Preferred Stock as one class. Each share of Series B Preferred Stock is convertible at any time into 2.25 shares of Common Stock and shall be automatically converted, without further action on the part of the Company or the holder thereof, into 2.25 fully paid and nonassessable shares of Common Stock on the date 30 days after the successful completion of the Offering. As of August 25, 1998, the Company had 26 holders of its Series A Preferred Stock and 3 holders of its Series B Preferred Stock. REGISTRATION RIGHTS Holders of 1,660,769 shares of Common Stock (the "Holders") have certain rights to have such shares registered under the Securities Act pursuant to the terms of agreements between such holders and the Company. Specifically, the Holders have the one-time right to demand that the Company use its best efforts to register all their shares of Common Stock. Additionally, if at any time the Company proposes to register its securities under the Securities Act (other than on a Form S-4 or Form S-8), the Company must notify the Holders of such proposed offering, and, upon their request the Company must use its best efforts to register all shares of Common Stock owned by the Holders. In such instances, the Company is responsible for the expenses related to the registration of such shares. LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS The Articles of Incorporation of the Company provide that to the fullest extent permitted by applicable law, a director of the Company will not be liable to the Company or its shareholders for monetary damages for an act or omission in the director's capacity as a director. The TBCA permits the indemnification of directors, employees, officers and agents of Texas corporations. The Company's Articles and Bylaws provide that the Company shall indemnify any person to the fullest extent permitted by law. Under the TBCA, an officer or director may be indemnified if he acted in good faith and reasonably believed that his conduct (i) was in the best interests of the Company and if he acted in his official capacity or (ii) was not opposed to the best interests of the Company in all other cases. In addition, the indemnitee may not have reasonable cause to believe that his conduct was unlawful in the case of a criminal proceeding. In any case, the indemnitee may not have been found liable to the Company for improperly receiving a personal benefit or for willful or intentional misconduct in the performance of his duty to the Company. The Company (i) must indemnify an officer or director for reasonable expenses if he is successful, (ii) may indemnify an officer or director for such reasonable expenses unless he was found liable for willful or intentional misconduct in the performance of his duty to the Company and (iii) may advance reasonable defense expenses if the officer or director undertakes to reimburse the Company if he is later found not to satisfy the standard for indemnification expenses. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. This provision in the Articles does not eliminate the duty of care, and in appropriate circumstances equitable remedies such as an injunction or other forms of nonmonetary relief would remain available under Texas law. This provision also does not affect a director's responsibilities under any other laws, such as the federal securities laws or state or federal environmental laws. For a discussion of provisions of the underwriting agreement with regard to indemnification of the Underwriters, see "Underwriting." 49 51 TRADING MARKET, TRANSFER AGENT AND REGISTRAR The Company has applied to list the Common Stock on the Nasdaq National Market under the symbol "GEEK." The Transfer Agent and Registrar for the Common Stock is ChaseMellon Shareholder Services, L.L.C. TEXAS ANTI-TAKEOVER LAW AND CERTAIN PROVISIONS As a Texas corporation, the Company is subject to the provisions of the Texas Business Combination Law ("TBCL") that became effective on September 1, 1997. In general, the TBCL prohibits a Texas "issuing public corporation" (such as the Company) from engaging in a "business combination" with any shareholder who is a beneficial owner of 20% or more of the corporation's outstanding stock for a period of three years after such shareholder's acquisition of a 20% ownership interest, unless: (i) the board of directors of the corporation approves the transaction or the shareholder's acquisition of the shares prior to the acquisition or (ii) two-thirds of the unaffiliated shareholders of the corporation approve the transaction at a shareholders' meeting. The TBCL may have the effect of inhibiting a non-negotiated merger or other business combination involving the Company. The Company is subject to the terms of the TBCL, unless its shareholders or directors take action electing not to be governed by its terms (which action is not currently contemplated). The Company's Articles and Bylaws prevent shareholders from calling a special meeting of shareholders, prevent shareholders from amending the Bylaws and prohibit shareholder action by written consent. The Bylaws also authorize only the Board of Directors to fill vacancies, including newly-created directorships and state that directors of the Company may be removed only for cause and only by the affirmative vote of holders of at least a majority of the outstanding shares of the voting stock, voting together as a single class. 50 52 SHARES ELIGIBLE FOR FUTURE SALE GENERAL Upon completion of the Offering, the Company will have an aggregate of 6,285,957 shares of Common Stock outstanding. Of these shares, all of the shares sold in the Offering will be freely transferable without restriction or limitation under the Securities Act, except for any shares purchased by "affiliates" (as such term is defined under the Securities Act) of the Company. The remaining 3,985,957 shares constitute "restricted securities" within the meaning of Rule 144, and the resale of such shares is restricted for one year from the date they were acquired. Of these "restricted securities," 1,886,333 shares have been held for the required one-year period and will be freely tradeable upon completion of the Offering, subject to the 180-day lock-up period described below and subject to the 90-day information requirement of Rule 144 for shares held by affiliates or for less than the required two-year period. In addition, the holders of 1,660,769 outstanding shares have certain rights to have shares registered under the Securities Act pursuant to the terms of agreements between such holders and the Company. See "Description of Securities -- Registration Rights." Of those 1,660,769 shares, 769,149 shares are freely tradeable upon completion of the Offering, subject to the 180-day lock-up period described below and subject to the 90-day information requirement of rule 144 for shares held by affiliates or for less than the required two-year period. In general, under Rule 144, as currently in effect, a person (or persons whose shares are required to be aggregated) who has beneficially owned, for at least one year, shares of Common Stock that have not been registered under the Securities Act or that were acquired from an "affiliate" of the Company is entitled to sell within any three-month period the number of shares of Common Stock which does not exceed the greater of one percent of the number of then outstanding shares or the average weekly reported trading volume during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to certain notice and manner of sale requirements and to the availability of current public information about the Company and must be made in unsolicited brokers' transactions or to a market maker. A person (or persons whose shares are aggregated) who is not an "affiliate" of the Company under the Securities Act during the three months preceding a sale and who has beneficially owned such shares for at least two years is entitled to sell such shares under Rule 144 without regard to the volume, notice, information and manner of sale provisions of such rule. Rule 144 does not require the same person to have held the securities for the applicable periods. The Company, its officers, directors and certain shareholders, who will hold collectively 3,066,017 outstanding shares of Common Stock after the Offering, have agreed not to offer or sell any shares of Common Stock for a period of 180 days following the date of this Prospectus without the prior written consent of Hoak Breedlove Wesneski & Co., subject to certain limited exceptions. If this 180-day lock-up period is waived by Hoak Breedlove Wesneski & Co., then 2,459,284 of the 3,066,017 shares would be freely tradeable subject to the 90-day information requirement of Rule 144 for shares held by affiliates or for less than the required two-year period. After the Offering, the Company intends to file a Registration Statement on Form S-8 to register 800,000 shares of Common Stock, which is the aggregate of all shares reserved for issuance pursuant to the 1996 Option Plan and the 1998 Option Plan and shares underlying certain nonqualified options granted to officers and directors. Accordingly, shares issued upon exercise of such options will be freely tradeable by holders who are not affiliates of the Company and, subject to the volume and other limitations of Rule 144, by holders who are affiliates of the Company. Prior to the Offering, there has been no market for the Common Stock. No predictions can be made of the effect, if any, that market sales of shares of Common Stock or the availability of such shares for sale will have on the market price prevailing from time to time. Nevertheless, sales of significant amounts of Common Stock could adversely affect the prevailing market price of the Common Stock, as well as impair the ability of the Company to raise capital through the issuance of additional equity securities. See "Risk Factors -- Shares Eligible for Future Sale." 51 53 UNDERWRITING The Underwriters named below, represented by Hoak Breedlove Wesneski & Co. and Ferris, Baker Watts, Incorporated (the "Representatives"), have severally agreed, subject to the terms and conditions contained in the underwriting agreement (the "Underwriting Agreement"), by and between the Company and the Underwriters, to purchase from the Company and the Selling Shareholders the number of shares of Common Stock indicated below opposite their respective names, at the initial public offering price less the underwriting discount set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent and that the Underwriters are committed to purchase all of the shares of Common Stock if they purchase any.
NUMBER UNDERWRITER OF SHARES ----------- --------- Hoak Breedlove Wesneski & Co. .............................. Ferris, Baker Watts, Incorporated........................... --------- Total............................................. 2,300,000 =========
The Representatives have advised the Company that the Underwriters propose initially to offer the shares of Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow to selected dealers a concession of not more than $ per share; and the Underwriters may allow, and such dealers may reallow, a concession of not more than $ per share to certain other dealers. After the initial distribution of the Offering, the public offering price and other selling terms may be changed by the Representatives. The Common Stock is offered subject to receipt and acceptance by the Underwriters, and to certain other conditions, including the right to reject orders in whole or in part. The Selling Shareholders have granted an option to the Underwriters, exercisable during the 30-day period after the date of this Prospectus, to purchase up to a maximum of 345,000 additional shares of Common Stock, to cover over-allotments, if any, at the same price per share as the initial shares to be purchased by the Underwriters. To the extent that the Underwriters exercise this option, the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with this Offering. The Underwriting Agreement provides that the Company and the Selling Shareholders will indemnify the Underwriters against certain liabilities, including civil liabilities under the Securities Act, or will contribute to payments the Underwriter may be required to make in respect thereof. The Company, its officers, directors and certain principal shareholders, as well as the Selling Shareholders, have agreed not to offer, sell or otherwise dispose of any shares of Common Stock, options to acquire shares of Common Stock or any other securities convertible into shares of Common Stock for a period of 180 days from the date of this Prospectus without the prior written consent of Hoak Breedlove Wesneski & Co., subject to certain limited exceptions. 52 54 The Representatives have informed the Company that the Underwriters do not expect to make sales of Common Stock offered by this Prospectus to accounts over which they exercise discretionary authority in excess of 5% of the shares of Common Stock offered hereby. Prior to the Offering, there has been no public market for the Common Stock. The initial public offering price for the Common Stock will be determined by negotiations between the Company, the Selling Shareholders and the Representatives. Among the factors to be considered in determining the initial public offering price are prevailing market and economic conditions, revenues and earnings of the Company, market valuations of other companies engaged in activities similar to the Company, estimates of the business potential and prospects of the Company, the present state of the Company's business operations, the Company's management and other factors deemed relevant. The estimated initial public offering price range set forth on the cover of this prospectus is subject to change as a result of market conditions and other factors. Certain persons participating in this Offering may over-allot or effect transactions which stabilize, maintain or otherwise affect the market price of Common Stock at levels above those which might otherwise prevail in the open market, including by entering stabilizing bids, effecting syndicate covering transactions or imposing penalty bids. A stabilizing bid means the placing of any bid or effecting of any purchase, for the purpose of pegging, fixing or maintaining the price of the Common Stock. A syndicate covering transaction means the placing of any bid on behalf of the underwriting syndicate or the effecting of any purchase to reduce a short position created in connection with the Offering. A penalty bid means an arrangement that permits the Underwriters to reclaim a selling concession from a syndicate member in connection with the Offering when shares of Common Stock sold by the syndicate member are purchased in syndicate covering transactions. Such transactions may be effected on the Nasdaq National Market, or otherwise. Such stabilizing, if commenced, may be discontinued at any time. Hoak Breedlove Wesneski & Co. was formed in 1996 by the combination of two investment banks. The founders and senior professionals of Hoak Breedlove Wesneski & Co. have substantial backgrounds in investment banking, principal investing and corporate management. Hoak Breedlove Wesneski & Co. has served as a co-manager of several other public offerings. LEGAL MATTERS The validity of the Common Stock offered hereby will be passed upon the Company by Jackson Walker L.L.P., Dallas, Texas. Richard F. Dahlson, a partner of Jackson Walker L.L.P., beneficially owns 5,333 shares of Series A Preferred Stock. Locke Purnell Rain Harrell (A Professional Corporation), Dallas, Texas, is acting as counsel for the Underwriters in connection with certain legal matters relating to the Offering. EXPERTS The Financial Statements as of June 30, 1997 and 1998 and for the years then ended included in this Prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein, and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. 53 55 AVAILABLE INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form SB-2 (the "Registration Statement"), pursuant to the Securities Act with respect to the Common Stock offered by this Prospectus. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits thereto. THE STATEMENTS CONTAINED IN THIS PROSPECTUS AS TO THE CONTENTS OF ANY CONTRACT OR OTHER DOCUMENT IDENTIFIED AS EXHIBITS IN THIS PROSPECTUS ARE NOT NECESSARILY COMPLETE, AND IN EACH INSTANCE, REFERENCE IS MADE TO A COPY OF SUCH CONTRACT OR DOCUMENT FILED AS AN EXHIBIT TO THE REGISTRATION STATEMENT, EACH STATEMENT BEING QUALIFIED IN ANY AND ALL RESPECTS BY SUCH REFERENCE. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement and exhibits which may be inspected without charge at the Commission's principal office at Judiciary Plaza, 450 Fifth Street, N.W., Washington, DC 20549. Upon consummation of this Offering, the Company will become subject to the reporting requirements of the Exchange Act and in accordance therewith will file reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information can be inspected and copied at the public reference facilities of the Commission at 450 Fifth Street, N.W., Washington, DC 20549 and at its New York Regional Office, Room 1300, 7 World Trade Center, New York, New York 10048; and at its Chicago Regional Office, Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such material may also be obtained from the Public Reference Section of the Commission at prescribed rates. The Company's Registration Statement as well as any reports to be filed under the Exchange Act can also be obtained electronically after the Company has filed such documents with the Commission through a variety of databases, including among others, the Commission's Electronic Data Gathering, Analysis And Retrieval ("EDGAR") program, Knight-Ridder Information, Inc., Federal Filings/ Dow Jones and Lexis/Nexis. Additionally, the Commission maintains a Web site (at http://www.sec.gov) that will contain such information regarding the Company. The Company intends to furnish its shareholders with annual reports containing audited financial statements and such other reports as the Company deems appropriate or as may be required by law. 54 56 GLOSSARY OF TECHNICAL TERMS ADSL Asymmetric Digital Subscriber Line. A new technology that allows more data to be sent over existing copper telephone lines (POTS). ADSL supports data rates of from 1.5 to 9.0 Mbps when receiving data (known as the downstream rate) and from 16 to 640 Kbps when sending data (known as the upstream rate). ADSL requires a special ADSL modem. ANSI American National Standards Institute. Founded in 1918, ANSI is a voluntary organization composed of over 1,300 members (including all the large computer companies) that creates standards for the computer industry. ANSI sets standards for a wide range of technical areas, from electrical specifications to programming languages to communications protocols. BACKBONE A high-speed network that connects smaller, independent networks. BANDWIDTH The number of bits of information that can move over a communications medium in a given amount of time. BROADBAND A transmission facility that has a bandwidth greater than a voice grade line of 3 kHz and which may carry numerous voice, video and data channels simultaneously. CENTRAL OFFICE A switching unit in a telecommunications system which provides service to the general public, having the necessary equipment and operating arrangements for terminating and interconnecting customer lines and trunks or trunks only. DOMAIN NAME Part of the official name of a computer on the Internet. DUAL REDUNDANT A device which contains a backup or spare part which is automatically put into service when a primary part fails. ELECTRONIC MAIL OR E-MAIL An application that allows a user to send or receive messages to or from any other user with an Internet address, commonly termed an e-mail address. FDDI Fiber Distributed Data Interface Network. A set of ANSI protocols for sending digital data over fiber optic cable. FDDI networks are token-passing networks, and support data rates of up to 100 Mbps (100 million bits) per second. FDDI networks are typically used as backbones for wide-area network extensions to FDDI, called FDDI-2, supports the transmission of voice and video information as well as data. FFDT FDDI Full Duplex Technology. Another variation of FDDI-2 that uses the same network infrastructure but can potentially support data rates up to 200 Mbps. FTP File Transfer Protocol. A protocol that allows file transfer between a host and a remote computer. GRAPHICAL USER INTERFACE A means of communicating with a computer by manipulating icons and windows rather than using text commands. INTERNET An open global network of interconnected commercial, educational and governmental computer networks that utilize a common communications protocol, TCP/IP. 55 57 INTERNET BACKBONE The Internet backbone consists of high-speed networks that link the smaller, independent networks of the Internet. IRC Internet Relay Chat. A system that enables individuals on the Internet to talk to each other in real time (rather than after a delay, as with e-mail messages). ISDN Integrated Services Digital Network. A digital network that combines voice and digital network services through a single medium, making it possible to offer subscribers digital data services as well as voice connections. ISP Internet Service Provider. A company that provides access to the Internet. For a monthly fee, the service provider gives you a software package, username, password and access phone number. Equipped with a computer and modem, you can then connect to the Internet and browse the World Wide Web and USENET, and send and receive e-mail. LEC Local Exchange Carrier. A telecommunications utility that has been granted either a certificate of convenience and necessity or a certificate of operating authority to provide local exchange telephone service, basic local telecommunications service, or switched access service within the state. A local exchange carrier is also referred to as a local exchange company. LOCAL EXCHANGE TELEPHONE SERVICE Telecommunications service provided within an exchange to establish connections between customer premises within the exchange, including connections between a customer premises and a long distance provider serving the exchange. The term includes tone dialing, service connection charges, and directory assistance services when offered in connection with basic local telecommunications service and interconnection with other service providers. Local exchange telephone service may also be referred to as local exchange service. However, a competitive exchange service is not local exchange telephone service. This fact, and the definition of competitive exchange service, shall be liberally construed to encourage a competitive marketplace. MODEM A piece of equipment that connects a computer to a data transmission line (typically a telephone line). NEWSGROUP Same as forum, an on-line discussion group. On the Internet, there are literally tens of thousands of newsgroups covering every conceivable interest. To view and post messages to a newsgroup, you need a news reader, a program that runs on your computer and connects you to a news server on the Internet. ON-LINE SERVICES Commercial information services that offer a computer user access through a modem to specific menus of information, entertainment and communications data. These services are generally closed systems and many offer limited, if any, Internet access. POP Point of Presence. The Company defines a POP as a local geographic point of presence where subscribers can access the Company's services via a local telephone call. To the Company's knowledge, there is no industry-wide definition of an Internet access POP, and other companies may define a POP differently. 56 58 ROUTER A device that receives and transmits data packets between segments in a network or different networks. SDSL Symmetric Digital Subscriber Line. A new technology that allows more data to be sent over existing copper telephone lines (POTS). SDSL supports data rates up to 3 Mbps. SDSL works by sending digital pulses in the high-frequency area of telephone wires. Since these high frequencies are not used by normal voice communications, SDSL can operate simultaneously with voice connections over the same wires. SDSL requires a special SDSL modem. SDSL is called symmetric because it supports the same data rates for upstream and downstream traffic. SERVER Software that allows a computer to offer a service to another computer. Other computers contact the server program by means of matching client software. In addition, such term means the computer on which server software runs. T-1 A data communications line capable of transmission speeds of 1.54 Mbps. TERMINAL SERVER A specialized computer that supports multiple communications connections. USENET A worldwide bulletin board system that can be accessed through the Internet or through many online services. The USENET contains tens of thousands of forums, called newsgroups, that cover every imaginable interest group. It is used daily by millions of people around the world. VIRTUAL POP Modems without a geographically specific location typically housed or co-located at central offices inside of a LEC Network. Private networks connect these facilities with the Company. VoIP Voice Over Internet Protocol. A category of hardware and software that enables people to use the Internet as the transmission medium for voice telephone calls or faxes. WINDOWS A computer operating system developed by Microsoft Corporation that provides a graphical user interface and multitasking capabilities. WORLD WIDE WEB A network of computer servers that uses a special communications protocol to link different servers throughout the Internet and permits communication of graphics, video and sound. xDSL An abbreviation that refers collectively to all types of digital subscriber lines, the two main categories being ADSL and SDSL. Two other types of xDSL technologies are High-data-rate DSL ("HDSL") and symmetric digital subscriber lines ("SDSL"). DSL technologies use sophisticated modulation schemes to pack data onto copper wires. They are sometimes referred to as last-mile technologies because they are used only for connections from a telephone switching station to a home or office, not between switching stations. xDSL is similar to ISDN inasmuch as both operate over existing copper telephone lines (POTS) and both require the short runs to a central telephone office (usually less than 20,000 feet). However, xDSL offers much higher speeds -- up to 32 Mbps for downstream traffic. 57 59 INDEX TO FINANCIAL STATEMENTS Independent Auditors' Report................................ F-2 Financial Statements: Balance Sheets............................................ F-3 Statements of Operations.................................. F-4 Statements of Shareholders' Equity (Deficit).............. F-5 Statements of Cash Flows.................................. F-6 Notes to Financial Statements............................. F-7
F-1 60 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Internet America, Inc. We have audited the accompanying balance sheets of Internet America, Inc. (the "Company") as of June 30, 1997 and 1998, and the related statements of operations, shareholders' equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at June 30, 1997 and 1998, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. Dallas, Texas August 12, 1998 F-2 61 INTERNET AMERICA, INC. BALANCE SHEETS ASSETS
JUNE 30, ------------------------- 1997 1998 ----------- ----------- CURRENT ASSETS: Cash and cash equivalents................................. $ -- $ 565,182 Accounts receivable, net of allowance for uncollectible accounts of $126,707 and $198,155 in 1997 and 1998, respectively........................................... 224,180 327,533 Prepaid expenses and other current assets................. 53,666 30,824 ----------- ----------- Total current assets.............................. 277,846 923,539 PROPERTY AND EQUIPMENT -- Net............................... 2,510,623 1,625,022 OTHER ASSETS -- Net......................................... 325,678 601,298 ----------- ----------- TOTAL............................................. $ 3,114,147 $ 3,149,859 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Trade accounts payable.................................... $ 1,451,969 $ 882,246 Accrued liabilities....................................... 673,672 1,069,191 Current portion of capital lease obligations.............. 408,251 332,895 Current maturities of long-term debt...................... 419,468 431,898 Advances under line of credit............................. 243,000 225,000 Notes payable to shareholders............................. 2,017,713 2,017,713 Bank overdrafts........................................... 226,979 -- Deferred revenue.......................................... 1,670,392 1,926,979 ----------- ----------- Total current liabilities......................... 7,111,444 6,885,922 CAPITAL LEASE OBLIGATIONS, net of current portion........... 375,851 31,192 LONG-TERM DEBT, net of current portion...................... 308,109 -- ----------- ----------- Total liabilities................................. 7,795,404 6,917,114 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY (DEFICIT): Series A convertible preferred stock, $.01 par value; 400,000 shares authorized, 379,672 issued and outstanding in 1997 and 1998........................... 3,796 3,796 Series B convertible preferred stock, $.01 par value, 300,000 shares authorized, 73,667 issued and outstanding in 1997 and 1998........................... 737 737 Common stock, $.01 par value; 40,000,000 shares authorized, 3,560,330 and 3,532,205 issued in 1997 and 1998, respectively, and 3,532,205 outstanding in 1997 and 1998............................................... 35,603 35,322 Additional paid-in capital................................ 2,920,333 2,816,114 Common stock in treasury, 28,125 shares at cost in 1997... (12,500) -- Accumulated deficit....................................... (7,629,226) (6,623,224) ----------- ----------- Total shareholders' equity (deficit).............. (4,681,257) (3,767,255) ----------- ----------- TOTAL............................................. $ 3,114,147 $ 3,149,859 =========== ===========
See notes to financial statements. F-3 62 INTERNET AMERICA, INC. STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, ------------------------- 1997 1998 ----------- ----------- REVENUES: Access.................................................... $ 8,177,300 $ 9,565,815 Business services......................................... 1,044,689 1,036,145 Other..................................................... 248,933 41,312 ----------- ----------- Total............................................. 9,470,922 10,643,272 ----------- ----------- OPERATING COSTS AND EXPENSES: Connectivity and operations............................... 6,185,100 4,508,781 Sales and marketing....................................... 1,912,265 1,140,279 General and administrative................................ 2,747,225 1,919,325 Depreciation and amortization............................. 1,618,089 1,473,779 Impairment of equipment................................... 350,787 -- ----------- ----------- Total............................................. 12,813,466 9,042,164 ----------- ----------- INCOME (LOSS) FROM OPERATIONS............................... (3,342,544) 1,601,108 INTEREST EXPENSE 480,985 571,106 ----------- ----------- INCOME (LOSS) BEFORE INCOME TAXES........................... (3,823,529) 1,030,002 INCOME TAX EXPENSE.......................................... -- 24,000 ----------- ----------- NET INCOME (LOSS)........................................... $(3,823,529) $ 1,006,002 =========== =========== NET INCOME (LOSS) PER COMMON SHARE: BASIC..................................................... $ (1.12) $ 0.28 =========== =========== DILUTED................................................... $ (1.12) $ 0.21 =========== =========== PRO FORMA (Unaudited)..................................... $ (0.86) $ 0.21 =========== ===========
See notes to financial statements. F-4 63 INTERNET AMERICA, INC. STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL TREASURY STOCK ---------------- ------------------- PAID-IN ------------------ SHARES AMOUNT SHARES AMOUNT CAPITAL SHARES AMOUNT ------- ------ --------- ------- ---------- ------- -------- BALANCE, JUNE 30, 1996........................ 453,339 $4,533 3,001,180 $30,012 $2,707,787 -- $ -- Issuance of common stock: For cash..................................... -- -- 544,149 5,441 226,846 -- -- For services................................. -- -- 15,001 150 24,850 -- -- Deferred compensation for stock options issued below deemed fair value...................... -- -- -- -- (39,150) -- -- Purchase of treasury stock at cost............ -- -- -- -- -- 28,125 (12,500) Net loss...................................... -- -- -- -- -- -- -- ------- ------ --------- ------- ---------- ------- -------- BALANCE, JUNE 30, 1997........................ 453,339 4,533 3,560,330 35,603 2,920,333 28,125 (12,500) Purchase of stock options..................... -- -- -- -- (92,000) -- -- Cancellation of treasury stock................ -- -- (28,125) (281) (12,219) (28,125) 12,500 Net income.................................... -- -- -- -- -- -- -- ------- ------ --------- ------- ---------- ------- -------- BALANCE, JUNE 30, 1998........................ 453,339 $4,533 3,532,205 $35,322 $2,816,114 -- $ -- ======= ====== ========= ======= ========== ======= ======== TOTAL SHAREHOLDERS' ACCUMULATED EQUITY DEFICIT (DEFICIT) ----------- ------------- BALANCE, JUNE 30, 1996........................ $(3,805,697) $(1,063,365) Issuance of common stock: For cash..................................... -- 232,287 For services................................. -- 25,000 Deferred compensation for stock options issued below deemed fair value...................... -- (39,150) Purchase of treasury stock at cost............ -- (12,500) Net loss...................................... (3,823,529) (3,823,529) ----------- ----------- BALANCE, JUNE 30, 1997........................ (7,629,226) (4,681,257) Purchase of stock options..................... -- (92,000) Cancellation of treasury stock................ -- -- Net income.................................... 1,006,002 1,006,002 ----------- ----------- BALANCE, JUNE 30, 1998........................ $(6,623,224) $(3,767,255) =========== ===========
See notes to financial statements. F-5 64 INTERNET AMERICA, INC. STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, ------------------------- 1997 1998 ----------- ----------- OPERATING ACTIVITIES: Net income (loss)......................................... $(3,823,529) $ 1,006,002 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.......................... 1,618,089 1,473,779 Loss on impairment..................................... 350,787 -- Provision for allowance for uncollectible accounts..... 57,661 63,448 Issuance of stock for services......................... 25,000 -- Deferred compensation.................................. (39,150) -- Changes in operating assets and liabilities: Accounts receivable.................................. (114,796) (166,801) Prepaid expenses and other current assets............ 55,715 22,842 Other assets......................................... (12,625) (44,841) Accounts payable and accrued liabilities............. (545,877) (401,183) Deferred revenue..................................... 998,715 (155,835) ----------- ----------- Net cash provided by (used in) operating activities....................................... (1,430,010) 1,797,411 ----------- ----------- INVESTING ACTIVITIES: Purchases of property and equipment, net.................. (1,177,894) (356,535) Purchase of subscribers................................... (356,670) (50,000) Proceeds from sale of equipment........................... 21,500 -- ----------- ----------- Net cash used in investing activities............. (1,513,064) (406,535) ----------- ----------- FINANCING ACTIVITIES: Proceeds from issuance of common stock.................... 232,287 -- Purchase of treasury stock................................ (12,500) -- Purchase of stock options................................. -- (92,000) Proceeds from sale and leaseback.......................... 422,302 -- Proceeds from issuance of long-term debt.................. 2,905,288 -- Principal payments of long-term debt...................... (361,666) (295,679) Principal payments under capital lease obligations........ (358,119) (420,015) Proceeds (payments) on line of credit..................... 93,000 (18,000) Loan origination fees..................................... (56,289) -- ----------- ----------- Net cash provided by (used in) financing activities....................................... 2,864,303 (825,694) ----------- ----------- NET INCREASE (DECREASE) IN CASH............................. (78,771) 565,182 CASH, BEGINNING OF PERIOD................................... 78,771 -- ----------- ----------- CASH, END OF PERIOD......................................... $ -- $ 565,182 =========== =========== SUPPLEMENTAL INFORMATION: Cash paid for interest.................................... $ 285,070 628,920 Equipment acquired under capital leases................... $ 816,235 $ -- Subscriber purchase assumption of service obligations..... $ -- $ 412,422
See notes to financial statements. F-6 65 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS 1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General -- Internet America, Inc. (the "Company") was incorporated in Arizona on December 13, 1994, commenced operations on January 13, 1995 and reincorporated on July 21, 1995 as a Texas corporation. The Company is a provider of Internet access, serving both individual and corporate customers in the North Texas area. The Company has experienced cumulative operating losses, and its operations are subject to certain risks and uncertainties including, among others, risks associated with technology and regulatory trends, evolving industry standards, dependence on its network infrastructure and suppliers, growth and acquisitions, actual and prospective competition by entities with greater financial and other resources, the development of the Internet market and need for additional capital or refinancing of existing obligations. There can be no assurance that the Company will be successful in sustaining profitability and positive cash flow in the future. Revenue Recognition -- Revenues are derived from monthly subscribers and set-up charges are recognized as services are provided. The Company bills its subscribers in advance for direct access to the Internet, but defers recognition of these revenues until the service is provided. Credit Risk -- The Company's accounts receivable potentially subjects the Company to credit risk, as collateral is generally not required. The Company's risk of loss is limited due to advance billings to customers for services, the use of preapproved charges to customer credit cards, and the ability to terminate access on delinquent accounts. The large number of customers comprising the customer base mitigates the concentration of credit risk. Financial Instruments -- The carrying amounts of cash, accounts receivable, accounts payable and accrued liabilities approximate fair value because of the short maturity of these instruments. The floating interest rate on the Company's lines of credit reflects current market rates and, accordingly, their carrying values approximate fair value. The fair values for other debt and lease obligations, which have fixed interest rates, do not differ materially from their carrying values. Property and Equipment -- Property and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets, ranging from one to five years. Equipment Under Capital Lease -- The Company leases certain of its data communication and other equipment under agreements accounted for as capital leases. The assets and liabilities under capital leases are recorded at the lesser of the present value of aggregate future minimum lease payments, including estimated bargain purchase options, or the fair value of the assets under lease. Assets under capital lease are depreciated over the shorter of their estimated useful lives or the related lease term. Acquired Subscriber Base -- The Company capitalizes specific costs incurred for the purchase of subscriber bases from other Internet Service Providers ("ISPs"). The subscriber acquisition costs include the actual fee paid to the selling ISPs as well as the assumption of deferred service obligations and legal expenses specifically related to the transactions. Amortization is provided using the straight line method over three years commencing when the subscriber base is received. Long-Lived Assets -- On an annual basis, the Company reviews the values assigned to long-lived assets, such as property and equipment to determine if any impairments are other than temporary. Provisions for asset impairments are based on discounted cash flow projections in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and such assets are written down to their estimated fair values. Management believes that the long-lived assets in the accompanying balance sheets are properly valued. An impairment loss of $350,787 related to the write down of modem equipment was recognized during the year ended June 30, 1997. F-7 66 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Common Stock Based Compensation -- The Company continues to account for its employee stock based compensation in accordance with the provisions of Accounting Principles Board Opinion No. 25 ("APB No. 25") and provides pro forma disclosures in the notes to the financial statements, as if the measurement provisions of SFAS No. 123 "Accounting for Stock-Based Compensation," had been adopted. Advertising Expenses -- The Company accounts for advertising costs as expenses in the period in which they are incurred. Advertising expenses for the years ended June 30, 1997 and 1998 were $728,404 and $736,222, respectively. Income Taxes -- Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amount of existing assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. Net Earnings Per Share -- Share and per share amounts have been adjusted retroactively for the 2.25-to-1.00 stock split which was effected in July 1998. Basic earnings per share is computed using the weighted average number of common shares outstanding and excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share reflects the potential dilution that could occur upon exercise or conversion of these instruments. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these estimates. Recent Accounting Pronouncements -- In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure," which establishes standards for disclosing information about an entity's capital structure and is effective for financial statements for periods ending after December 15, 1997. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components in the financial statements for fiscal years beginning after December 15, 1997. The FASB also issued, in June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for the way public companies disclose information about operating segments, products and services, geographic areas and major customers. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. The Company has determined that the impact on its financial statements of adopting SFAS Nos. 129, 130 and 131 is not material. In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," which is effective for fiscal quarters ending after June 15, 1999. The Company does not expect the adoption of SFAS No. 133 to have a material impact on its financial statements. Certain Reclassifications -- Certain reclassifications have been made to prior period amounts to conform to the fiscal 1998 presentation. F-8 67 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 2. PROPERTY AND EQUIPMENT Property and equipment consist of:
JUNE 30, -------------------------- 1997 1998 ----------- ----------- Data communications and office equipment.................. $ 3,327,224 $ 3,557,646 Leasehold improvements.................................... 453,937 450,360 Furniture and fixtures.................................... 255,787 255,787 Computer software......................................... 88,757 219,440 ----------- ----------- 4,125,705 4,483,233 Less accumulated depreciation and amortization............ (1,615,082) (2,858,211) ----------- ----------- $ 2,510,623 $ 1,625,022 =========== ===========
Property under capital lease, primarily data communications equipment included above, amounted to $1,084,809 at June 30, 1997 and 1998. Included in accumulated depreciation and amortization are amounts related to property under capital lease of $379,486 and $729,865 at June 30, 1997 and 1998, respectively. Depreciation expense charged to operations was $1,485,782 and $1,242,138 for the years ended June 30, 1997 and 1998, respectively, and included $300,312 and $350,379, respectively, pertaining to property under capital lease. 3. OTHER ASSETS Other assets consist of:
JUNE 30, ------------------------ 1997 1998 --------- --------- Acquired subscriber base................................... $ 356,670 $ 819,092 Loan origination fees...................................... 61,289 20,353 Deposits................................................... 40,331 35,172 Deferred costs............................................. -- 50,000 --------- --------- 458,290 924,617 Less accumulated amortization.............................. (132,612) (323,319) --------- --------- $ 325,678 $ 601,298 ========= =========
In July 1996 the Company acquired approximately 900 subscribers of Webstar, Inc. for approximately $357,000. On November 26, 1997, the Company acquired approximately 4,600 subscribers of WHY? Telecommunications, Inc. for a cash payment of $50,000 and the assumption of deferred service obligations of approximately $412,000 and certain contingent consideration. Management does not anticipate any additional consideration to be paid related to this transaction. 4. LINE OF CREDIT AGREEMENTS The Company may borrow up to $150,000 under a revolving credit agreement that matures September 30, 1998. Borrowings under the agreement bear interest at the bank's prime rate plus 2% (10.5% at June 30, 1997 and 1998) and are collateralized by substantially all assets of the Company, and by the guarantees of a director and shareholder. The outstanding borrowings at June 30, 1997 and 1998 were $18,000 and $0; respectively, with $131,291 committed to a standby letter of credit securing a lease. F-9 68 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Also, the Company may borrow, subject to the approval of a director of the Company, up to $350,000 under a revolving credit agreement that matures December 15, 1998 or upon the effective date of a defined securities registration. Borrowings under the agreement bear interest at the bank's prime rate (8.5% at June 30, 1997 and 1998) and are guaranteed by a Director. The Director receives guaranty fees, payable on demand, equal to 18% of the outstanding borrowings, less interest paid to the bank. The outstanding borrowings at June 30, 1997 and 1998 were $225,000. 5. LONG-TERM DEBT Long-term debt consists of:
JUNE 30, --------------------- 1997 1998 --------- --------- Note payable to an unrelated third party, bearing interest at 16.5%, payable in equal monthly installments of $10,266, including interest, through January 1999. The note is collateralized by substantially all of the assets of the Company and contains, among other things, a restriction on the payment of dividends on common stock. In connection with this note, the Company issued detachable warrants during March 1996 to purchase 33,750 shares of common stock at $1.67 per share. The fair value of the warrants have not been reflected in the financial statements as the amount was immaterial. The warrants are exercisable from January 1, 1998 through December 31, 1999...................................................... $ 191,482 $ 79,773 Notes payable to vendors maturing through February 1998, bearing interest at 6% to 18%............................. 183,970 -- Note payable in connection with acquisition of Webstar, Inc. subscriber base, due June 30, 1999 or upon the effective date of a defined securities registration, bearing interest at 14%, payable monthly. Prior to the end of any calendar quarter, the lender may demand a principal payment of up to $50,000.................................. 352,125 352,125 --------- --------- 727,577 431,898 Less current portion........................................ (419,468) (431,898) --------- --------- $ 308,109 $ -- ========= =========
6. NOTES PAYABLE TO SHAREHOLDERS During fiscal 1997, the Company entered into two loan agreements with entities acting as nominees for current shareholders, with borrowings of $1,767,713 and $250,000. The notes bear interest at 10% and 18% and were due September 25, 1997 and April 1, 1997, respectively. The assets of the Company collateralized the notes. On June 30, 1998, the loan agreements, which were in default, were renewed at the prime rate (8.5% as of June 30 ,1998), with borrowings due in monthly payments approximating $129,000 or upon the effective date of a defined securities registration or sale. In the event of default, the borrowings convert to common stock at the price of $0.44 per share at the option of the noteholder. F-10 69 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 7. COMMITMENTS AND CONTINGENCIES The Company leases certain of its facilities under operating leases. Rental expense under these leases was approximately $373,000 and $574,000 for the years ended June 30, 1997 and 1998, respectively. At June 30, 1998, future minimum lease payments on capital and operating leases were approximately as follows:
CAPITAL OPERATING LEASES LEASES --------- ---------- 1999...................................................... $ 361,423 $ 563,756 2000...................................................... 55,082 522,337 2001...................................................... -- 441,572 --------- ---------- Total minimum lease payments.............................. 416,505 $1,527,665 ========== Less amounts representing interest........................ (52,418) --------- Present value of minimum capitalized lease payments....... 364,087 --------- Less current portion...................................... (332,895) --------- Long-term capitalized lease obligations $ 31,192 =========
In August 1997, the Company entered into a network services agreement for telecommunications services with a competitive local exchange carrier ("CLEC") that commits the Company to the CLEC's services through December 31, 1998. The Company is in the process of converting customers to this service and estimates that the monthly recurring commitment will be approximately $50,000. The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations and cash flows. 8. SHAREHOLDERS' EQUITY (DEFICIT) Common Stock -- The Company has authorized 40,000,000 shares of $0.01 par value common stock. During the year ended June 30, 1997, the Company issued 544,149 shares of its common stock in exchange for cash of $232,287. The Company also issued 15,001 shares of common stock in exchange for services provided by one of the Company's employees. The shares issued were recorded at $25,000, the value of the services provided. During March 1998, three former shareholders of the Company sold 1,987,124 shares of common stock to an entity acting as nominee for current shareholders in exchange for $883,166. Preferred Stock -- The Company has authorized 5,000,000 shares of preferred stock issuable in series. The Company has authorized 400,000 shares of $0.01 par value Series A Preferred Stock. Each share of the Series A Preferred Stock is convertible at any time into 2.25 shares of the Company's common stock and has the same dividend rights as the common stock. Each share of the Series A Preferred Stock will automatically be converted into 2.25 shares of the Company's common stock 30 days following the successful completion of a public offering of shares of common stock of the Company. In order for the shares to convert, the gross proceeds from such public offering must exceed $5 million and the per share price of the common stock must be at least $2.22 per share. In the event of liquidation of the Company, whether voluntary or involuntary, the holders of the Series A Preferred Stock then outstanding shall be entitled to be paid out of the assets of the Company available for distribution to its shareholders, an amount in cash equal to the purchase price for each share of the Series A Preferred Stock outstanding, prior to any distributions to common shareholders. F-11 70 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) The Company has authorized 300,000 shares of $0.01 par value Series B Preferred Stock. Each share of Series B Preferred Stock is convertible at any time into 2.25 shares of the Company's common stock. The Series B Preferred Stock automatically converts to common stock 30 days following the successful completion of a public offering of shares of the Company's common stock. In order for the shares to convert, the gross proceeds from the public offering must be at least $5 million and the per share price of the common stock offered must be at least $3.33 per share. In the event of liquidation of the Company, whether voluntary or involuntary, the holders of Series B Preferred Stock are entitled to receive an amount in cash equal to the purchase price for each share of Series B Preferred Stock outstanding, prior to any distributions to common shareholders. The liquidation preference payable to holders of Series A and Series B Preferred Stock shall be made based on the aggregate purchase price for the shares of the Series A Preferred Stock and Series B Preferred Stock, respectively. The Series A and Series B Preferred Stock have no specific dividend rate and the holders of each class of preferred stock are entitled to receive the same dividends as holders of common stock. The Company has agreed with the holders of Series A Preferred Stock that the Company will not issue common stock, or securities convertible into or exchangeable for shares of common stock, or any options, warrants or other rights to acquire shares of common stock at a price per share less than $1.67. However, as noted above, the Company issued common stock at a price of $0.44 per share, with the express permission of the holders of Series A Preferred Stock. Stock Option Plan -- The Company's 1996 Incentive Stock Option Plan (the "1996 Option Plan") was adopted by the Board of Directors and the Company's shareholders in December 1996. Pursuant to the 1996 Option Plan, the Company may grant incentive and nonqualified stock options to key employees of the Company. A total of 225,000 shares of common stock have been reserved for issuance under the 1996 Option Plan. The maximum term of options granted under the 1996 Option Plan is ten years. The aggregate fair market value of the stock with respect to which incentive stock options are first exercisable in any calendar year may not exceed $100,000 per incidence. The exercise price of incentive stock options must be equal or greater than the fair market value of common stock on the date of grant. The exercise price of incentive stock options granted to any person who at the time of grant owns stock possessing more than 10% of the total combined voting power of all classes of stock must be at least 110% of the fair market value of such stock on the date of grant, and the term of these options cannot exceed five years. The Company currently has 61,756 options outstanding to its employees under the 1996 Option Plan. These options are exercisable at either $1.67 per share of common stock or $3.33 per share of common stock. In October 1996, 67,500 stock options at an exercise price of $3.33 per share were granted to an officer of the Company and 215,026 nonqualified stock options at an exercise price of $3.33 per share were granted to certain founders of the Company in connection with such founders' pledge of their stock of the Company to guarantee a bridge loan. The Board of Directors adjusted the exercise price of these options to $1.67 per share in March 1998. In March 1998, 393,750 options to purchase shares of common were granted to certain officers and employees of the Company at an exercise price of $1.67 per share. During May 1998, outstanding options to purchase 258,750 shares of common stock with an exercise price of $0.09 per share were repurchased from former employees for $0.36 per share. The Company currently has 1,184,657 nonqualified options outstanding to certain of its officers, employees and advisors. These options are exercisable at prices ranging from $0.09 per share of common stock to $3.33 per share of common stock. F-12 71 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) The Company applies APB No. 25 and related Interpretations in accounting for its plans. The estimated fair value of each option grant was determined by reference to recent private arm's length sales of common and preferred stock. In cases where these were no arm's length transactions on or around the date of an option grant, the value was determined by the Board of Directors. There was no compensation cost charged against operations for the stock options during the years ended June 30, 1997 and 1998, respectively. Had compensation cost for the Company's stock options been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the Company's net income (loss) and income (loss) per share would have been the pro forma amounts indicated below:
1997 1998 ----------- ---------- Net income (loss) As reported............................................... $(3,823,529) $1,006,002 Pro Forma................................................. (3,843,651) 991,540 Basic income (loss) per share As reported............................................... $ (1.12) $ 0.28 Pro Forma................................................. (1.12) 0.28 Diluted income (loss) per share As reported............................................... $ (1.12) $ 0.21 Pro Forma................................................. (1.12) 0.21
A summary of the status of the Company's stock options as of June 30, 1998 and 1997, and changes during the years ended on those dates is presented below:
1997 1998 -------------------------- -------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE --------- -------------- --------- -------------- Outstanding at beginning of period 1,206,765.. $1.37 1,255,045 $1.85 Granted............................ 563,778 3.30 393,750 1.67 Exercised.......................... -- -- -- -- Forfeited.......................... (515,498) 2.30 (205,388) 2.43 Purchased.......................... -- -- (258,750) 0.09 --------- --------- Outstanding at end of period......... 1,255,045 1.85 1,184,657 2.07 ========= ========= Options exercisable at year end...... 997,526 1.62 728,473 1.55 ========= =========
The following table summarizes information about stock options outstanding at June 30, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------- ------------------------- NUMBER WEIGHTED-AVERAGE NUMBER NUMBER RANGE OF OUTSTANDING REMAINING CONTRACTUAL EXERCISABLE EXERCISABLE EXERCISE PRICES AT 6/30/98 LIFE AS OF 6/30/98 (YEARS) AT 6/30/97 AT 6/30/98 --------------- ----------- -------------------------- ----------- ----------- $0.09......................... 78,750 7.4 337,500 78,750 1.67......................... 1,083,407 8.9 366,251 627,224 3.33......................... 22,500 8.6 293,775 22,500
All options granted during the years ended June 30, 1997 and 1998 were granted above the market price. The weighted average grant date fair value of options granted during the year ended June 30, 1997 and 1998 was $0. During March 1998, the exercise price of a total of 343,645 options to purchase shares of common stock was adjusted from $3.33 per share to $1.67 per share, of which 310,541 options were exercisable at F-13 72 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) June 30, 1998. The adjustment of the exercise price of these options decreased the weighted-average exercise price of the outstanding options as of June 30, 1998 by $0.40 per share. 9. INCOME TAXES No provision for income taxes was recognized for the year ended June 30, 1997 as the Company incurred net operating losses for income tax purposes. A current tax provision of $24,000 was recognized for the year ended June 30, 1998 related to federal corporate alternative minimum tax. Deferred tax assets and liabilities as of June 30, 1997 and 1998, consist of:
JUNE 30, ------------------------- 1997 1998 ----------- ----------- Deferred tax assets: Net operating loss carryforwards......................... $ 2,005,000 $ 1,672,000 Stock options granted at a discount...................... 142,000 31,000 Deferred revenue......................................... 141,000 44,000 Impairment of equipment.................................. 119,000 74,000 Allowance for doubtful accounts.......................... 43,000 67,000 Depreciation and amortization............................ 67,000 234,000 Other.................................................... 55,000 44,000 ----------- ----------- Total deferred tax assets........................ 2,572,000 2,166,000 Deferred tax liabilities................................... -- -- ----------- ----------- Net deferred tax asset..................................... 2,572,000 2,166,000 Valuation allowance........................................ (2,572,000) (2,166,000) ----------- ----------- $ -- $ -- =========== ===========
The Company has provided a valuation allowance for net deferred tax assets, as it is more likely than not that these assets will not be realized. At June 30, 1998, the Company has net operating loss carryforwards of approximately $5 million for income tax purposes. These net operating loss carryforwards may be carried forward in varying amounts until 2012 and may be limited in their use due to significant changes in the Company's ownership. The differences between the Company's effective tax rate and the federal statutory rate of 34% for the fiscal years ended June 30, 1997 and 1998 are as follows:
YEARS ENDED JUNE 30, ----------- 1997 1998 ---- ---- Income tax expense (benefit) at statutory rate.............. (34)% (34)% State tax benefit, net of federal benefit................... (3)% (3)% Valuation allowance......................................... 37% 37% Alternative minimum tax..................................... 0% 2% --- --- Total income tax expense.......................... 0% 2% === ===
10. EMPLOYEE BENEFIT PLAN The Company has established a 401(k) plan for the benefits of its employees. Employees may contribute to the plan up to 15% of their salary, pursuant to a salary reduction agreement, upon meeting age requirements. The Company made no discretionary contributions to the Plan through June 30, 1998. F-14 73 INTERNET AMERICA, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 11. NET EARNINGS PER SHARE A reconciliation of shares used in calculation of basic and diluted and unaudited pro forma net earnings per share follows:
YEARS ENDED JUNE 30, ------------------------ 1997 1998 ----------- ---------- Net income (loss)........................................... $(3,823,529) $1,006,002 =========== ========== Net income (loss) per common share: Basic..................................................... $ (1.12) $ 0.28 =========== ========== Diluted................................................... $ (1.12) $ 0.21 =========== ========== Pro forma (unaudited)..................................... $ (0.86) $ 0.21 =========== ========== Reconciliation of weighted average shares: Shares used in computing basic net income (loss) per share.................................................. 3,417,808 3,532,205 Adjusted to reflect the assumed conversion of preferred stock and certain option exercises..................... -- 1,251,098 ----------- ---------- Shares used in computing diluted net income (loss) per share.................................................. 3,417,808 4,783,292 ----------- ---------- Adjusted to reflect assumed conversion of preferred stock.................................................. 1,020,002 Shares used in computing unaudited pro forma net income (loss) per share....................................... 4,437,810 4,783,292 =========== ==========
Potentially dilutive securities have been excluded from the computation for the year ended June 30, 1997 as their effect is antidilutive. Warrants and certain options have been excluded for the year ended June 30, 1998 as their exercise prices are equal to or exceed the estimated fair value of the common shares during that period. Had the Company been in a net income position, diluted earnings per share would have included an additional 319,500 shares related to outstanding options and warrants, (determined using the treasury stock method at the estimated average fair value) and for 1,020,002 shares convertible preferred stock for the year ended June 30, 1997. During July 1998, the board of directors authorized the filing of a registration statement with the Securities and Exchange Commission permitting the Company to issue shares of its common stock in an initial public offering early in fiscal 1999. Conversion of 453,339 shares of preferred stock to common stock will automatically occur 30 days after completion of an offering and is considered in the calculation of unaudited pro forma net income (loss) per share. 12. SUBSEQUENT EVENTS (UNAUDITED) During July 1998, the Company's Board of Directors authorized an initial public offering of the Company's common stock, changed the number of authorized shares of common stock to 40,000,000, approved and effected a 2.25-to-1.00 stock split in the form of a dividend and adopted the 1998 Nonqualified Stock Option Plan providing for the issuance of up to 400,000 stock options exercisable for shares of common stock. During July 1998, options to purchase 22,500 shares of common stock were granted to a director of the Company under the 1998 Nonqualified Stock Option Plan. Such options are immediately exercisable at $8.00 per share and expire in 10 years. F-15 74 - Inside back cover will contain photographs of the Company's television and billboard advertisements. 75 - ------------------------------------------------------ - ------------------------------------------------------ NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING SHAREHOLDERS OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY ANY OF THE COMMON STOCK OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE. ------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary.................... 3 Risk Factors.......................... 7 Use Of Proceeds....................... 18 Dividend Policy....................... 19 Capitalization........................ 20 Dilution.............................. 21 Selected Financial and Operating Data................................ 22 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 24 Business.............................. 31 Management............................ 40 Certain Transactions.................. 45 Principal and Selling Shareholders.... 47 Description of Securities............. 48 Shares Eligible for Future Sale....... 51 Underwriting.......................... 52 Legal Matters......................... 53 Experts............................... 53 Available Information................. 54 Glossary of Technical Terms........... 55 Index to Financial Statements......... F-1
------------------ UNTIL , 1998 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING) ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ 2,300,000 SHARES INTERNET AMERICA LOGO COMMON STOCK ------------------------ PROSPECTUS ------------------------ HOAK BREEDLOVE WESNESKI & CO. FERRIS, BAKER WATTS INCORPORATED , 1998 - ------------------------------------------------------ - ------------------------------------------------------ 76 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Registrant has authority under Article 2.02-1 of the Texas Business Corporation Act to indemnify its directors and officers to the extent provided in such statute. The Registrant's Articles of Incorporation, as amended, provide that the Registrant shall indemnify its executive officers and directors to the fullest extent permitted by law either now or hereafter. The Registrant has also entered into an agreement with each of its directors and certain of its officers wherein it has agreed to indemnify each of them to the fullest extent permitted by law. At present, there is no pending litigation or proceeding involving a director or officer of the Registrant as to which indemnification is being sought, nor is the Registrant aware of any threatened litigation that may result in claims for indemnification by any officer or director. Pursuant to the Underwriting Agreement, the Underwriters have agreed to indemnify the directors, officers and controlling persons of the Registrant against certain civil liabilities that may be incurred in connection with this Offering, including certain liabilities under the Securities Act. ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The Registrant estimates that expenses payable by the Registrant in connection with the offering described in this registration statement (other than the underwriting discount) will be as follows: Securities and Exchange Commission registration fee......... $ 8,583 NASD filing fee............................................. 3,410 Nasdaq listing fee.......................................... 33,215 Printing and engraving expenses............................. 100,000 Accounting fees and expenses................................ 100,000 Legal fees and expenses..................................... 125,000 Fees and expenses (including legal fees) for qualification under state securities laws............................... 12,000 Registrar and Transfer Agent's fees and expenses............ 5,000 Miscellaneous............................................... 62,792 -------- Total............................................. $450,000 ========
All amounts except the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq listing fee are estimated. The Company is paying all of the expenses related to the sale of Common Stock offered by the Company and the Selling Shareholders. ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES. During July 1995, the Registrant issued 263,059 shares of Common Stock to a director in exchange for $150,000 cash. The shares were issued to the director, a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. Also during July 1995, the Registrant issued 29,999 shares of Common Stock to a founder of the Registrant in consideration for the extinguishment of certain indebtedness of the Registrant in the amount of $50,000. The shares were issued to the founder, a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. During July 1995, the Registrant issued 263,059 shares of Common Stock to a director at approximately $0.57 per share, for aggregate proceeds of $150,000 cash. During December 1995, the Registrant issued 4,500 shares of Common Stock to the same director at $0.0004 per share, for aggregate proceeds of $20 cash. The II-1 77 shares were issued to the director, a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. From July to October 1996, the Company issued 575,822 shares of its Common Stock to ten sophisticated investors at prices ranging from $0.57 to $1.67 per share in separate transactions for aggregate proceeds of $671,135 cash. The shares were issued in reliance on the exemption from registration under section 4(2) of the Securities Act. In a private offering completed in February 1996 and exempt under Regulation D, the Registrant sold 227,368 shares of Series A Preferred Stock, at $3.75 per share, for aggregate proceeds of $852,630 cash. Additionally, 342,684 shares of Common Stock were converted into 152,304 shares of Series A Preferred Stock. The shares were sold to a total of 27 institutional and individual investors that qualify as "accredited investors" under the federal securities laws. The Registrant did not engage any brokers to act as placement agents, and the private offering was made on a best efforts basis. The shares sold by the Registrant in the private offering were sold in reliance on the exemption from registration under the Securities Act provided by Rule 506 of Regulation D promulgated thereunder. On March 31, 1996 the Registrant issued a warrant to M.J. Capital Partners, L.P. as partial consideration for a loan in the amount of $375,000. There are 33,750 Shares of Common Stock underlying the warrant, at an exercise price of $1.67 per share. The warrant was issued to M.J. Capital Partners, L.P., a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. During June 1996, the Registrant issued 1,125 shares of Common Stock in exchange for services valued at $3,750 provided by an officer of the Registrant. The shares were issued to the officer, a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. In a private offering completed in June 1996 and exempt under Regulation D, the Registrant sold 73,667 shares of Series B Preferred Stock at $7.50 per share, for aggregate proceeds of $552,503 cash. The shares were sold to a total of three institutional and individual investors that qualify as "accredited investors" under the federal securities laws. The Registrant did not engage any brokers to act as placement agents, and the private offering was made on a best efforts basis. The shares sold by the Registrant in the private offering were sold in reliance on the exemption from registration under the Securities Act provided by Rule 506 of Regulation D promulgated thereunder. On September 25, 1996, the Registrant entered into a Securities Purchase Agreement with First Computer Services Corporation, pursuant to which the Registrant issued 544,149 shares of Common Stock to First Computer Services Corporation at a price equal to approximately $0.43 per share, for aggregate proceeds of $233,984 cash. The shares were issued to First Computer Services Corporation, a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. During fiscal 1997, the Registrant also issued 15,001 shares of Common Stock in exchange for services valued at $6,667 provided by one of the employees of the Registrant. The shares were issued to the employee, a sophisticated investor, in reliance on the exemption from registration under section 4(2) of the Securities Act. Pursuant to the Registrant's 1996 Incentive Stock Option Plan, as of March 31, 1998 the Registrant had 61,756 options at a weighted average exercise price of $1.67 per share outstanding to its employees. During December 1995, an officer of the Registrant was granted an option to purchase 112,500 shares of Common Stock at an exercise price of $1.67 per share. During fiscal 1996, options to purchase 45,000 shares of Common Stock were granted to two directors of the Registrant at an exercise price of $1.67 per share. Also in 1996, an option to purchase 22,500 shares of Common Stock was granted to a director of the Registrant at an exercise price of $3.33 per share. The Board of Directors adjusted the exercise price of this option to $1.67 per share in March 1998. In addition to the above, in October 1996, an option to purchase 67,500 shares of Common Stock at an exercise price of $3.33 per share was granted to an officer of the Registrant. The Board of Directors adjusted the exercise price of this option to $1.67 per share in March 1998. Additionally, in II-2 78 March 1998, 393,750 options to purchase shares of Common Stock were granted to certain officers and employees of the Company at an exercise price of $1.67 per share. During October 1996, 215,026 nonqualified stock options were granted to certain founders of the Registrant in connection with such founders' pledge of their stock of the Registrant to guarantee a bridge loan. The Registrant had 1,381,651 nonqualified options outstanding as of March 31, 1998 to certain of its officers, employees and advisors. These options are exercisable at prices ranging from $0.09 per share of Common Stock to $3.33 per share of Common Stock. In July 1998, 22,500 nonqualified stock options were granted to a director at an exercise price of $8.00 per share of Common Stock. On July 13, 1998, the Company's Board authorized a 2.25-for-1.00 stock split of Common Stock effected in the form of a dividend. The stock split was effected on July 13, 1998. Unless otherwise indicated, the issuance of the securities described above was effected without the involvement of an underwriter. II-3 79 ITEM 27. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits:
EXHIBIT DESCRIPTION ------- ----------- 1.1 -- Proposed form of Underwriting Agreement* 3.1 -- Internet America, Inc.'s Articles of Incorporation(3) 3.2 -- Internet America, Inc.'s Articles of Amendment to Articles of Incorporation(3) 3.3 -- Internet America, Inc.'s Bylaws(3) 3.4 -- Internet America, Inc.'s Amendment to Bylaws(3) 3.5 -- Application for Certificate of Withdrawal of Internet America, Inc.* 3.6 -- Articles of Merger merging Internet America, Inc., an Arizona Corporation, with and into INTRNTUSA, INC., a Texas corporation* 4.1 -- Specimen Common Stock certificate(3) 4.2 -- Certificate of Designation of the Series A Preferred Stock of Internet America, Inc.* 4.3 -- Amended Certificate of Designation of the Series A Preferred Stock of Internet America, Inc.* 4.4 -- Certificate of Designation of the Series B Preferred Stock of Internet America, Inc.* 5.1 -- Opinion of Jackson Walker L.L.P.(1) 10.1 -- Securities Purchase Agreement, dated September 25, 1996, by and among First Computer Services Corporation and Internet America, Inc.(3) 10.2 -- Asset Purchase Agreement, dated July 31, 1996 by and between Internet America, Inc. and Webstar, Inc.* 10.3 -- Asset Purchase Agreement, dated November 26, 1997 by and between Internet America, Inc. and Why? Telecommunications, Inc.* 10.4 -- Network Services Agreement, dated August 25, 1997 by and between Internet America, Inc. and Golden Harbor of Texas, Inc.* 11.1 -- Statement regarding computation of per share earnings(2) 16.1 -- Letter on change in certifying accountant.(3) 23.1 -- Consent of Jackson Walker L.L.P. (to be included in its opinion to be filed as Exhibit 5.1)(1) 23.2 -- Consent of Deloitte & Touche LLP* 24.1 -- Reference is made to the Signatures section of this Registration Statement for the Power of Attorney contained therein 27.1 -- Financial Data Schedule*
- --------------- * Filed herewith (1) To be filed by amendment. (2) Statement omitted because not applicable or because the required information is contained in the Financial Statements or Notes thereto. (3) Previously filed ITEM 28. UNDERTAKINGS (a) The undersigned Registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) To reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information set forth in the Registration Statement; II-4 80 (iii) To include any additional or changed material information with respect to the plan of distribution; and (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the Offering. (b) The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. (c) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (d) The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of a registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1), or (4) or 497(h) under the Securities Act shall be deemed to be part of the Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 81 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements of filing on Form SB-2 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Dallas, State of Texas, on August 28, 1998. INTERNET AMERICA, INC. By: /s/ MICHAEL T. MAPLES ---------------------------------- Michael T. Maples (Principal Executive Officer)
SIGNATURE TITLE DATE --------- ----- ---- /s/ MICHAEL T. MAPLES Chief Executive Officer, President August 28, 1998 - ----------------------------------------------------- and Director (Principal Michael T. Maples Executive Officer) /s/ JAMES T. CHANEY Chief Financial Officer, Vice August 28, 1998 - ----------------------------------------------------- President, Secretary and James T. Chaney Treasurer (Principal Financial and Accounting Officer) /s/ DOUGLAS G. SHELDON* Vice President -- Marketing, August 28, 1998 - ----------------------------------------------------- Director Douglas G. Sheldon /s/ WILLIAM O. HUNT* Chairman of the Board August 28, 1998 - ----------------------------------------------------- William O. Hunt /s/ JACK T. SMITH* Director August 28, 1998 - ----------------------------------------------------- Jack T. Smith /s/ GARY L. CORONA* Director August 28, 1998 - ----------------------------------------------------- Gary L. Corona
- --------------- * signed on behalf of such person by Michael T. Maples pursuant to a Power of Attorney granted on July 21, 1998. II-6 82 INDEX TO EXHIBITS
EXHIBIT DESCRIPTION ------- ----------- 1.1 -- Proposed form of Underwriting Agreement* 3.1 -- Internet America, Inc.'s Articles of Incorporation(3) 3.2 -- Internet America, Inc.'s Articles of Amendment to Articles of Incorporation(3) 3.3 -- Internet America, Inc.'s Bylaws(3) 3.4 -- Internet America, Inc.'s Amendment to Bylaws(3) 3.5 -- Application for Certificate of Withdrawal of Internet America, Inc.* 3.6 -- Articles of Merger merging Internet America, Inc., an Arizona Corporation, with and into INTRNTUSA, INC., a Texas corporation* 4.1 -- Specimen Common Stock certificate(3) 4.2 -- Certificate of Designation of the Series A Preferred Stock of Internet America, Inc.* 4.3 -- Amended Certificate of Designation of the Series A Preferred Stock of Internet America, Inc.* 4.4 -- Certificate of Designation of the Series B Preferred Stock of Internet America, Inc.* 5.1 -- Opinion of Jackson Walker L.L.P.(1) 10.1 -- Securities Purchase Agreement, dated September 25, 1996, by and among First Computer Services Corporation and Internet America, Inc..(3) 10.2 -- Asset Purchase Agreement, dated July 31, 1996 by and between Internet America, Inc. and Webstar, Inc.* 10.3 -- Asset Purchase Agreement, dated November 26, 1997 by and between Internet America, Inc. and Why? Telecommunications, Inc.* 10.4 -- Network Services Agreement, dated August 25, 1997 by and between Internet America, Inc. and Golden Harbor of Texas, Inc.* 11.1 -- Statement regarding computation of per share earnings(2) 16.1 -- Letter on change in certifying accountant.(3) 23.1 -- Consent of Jackson Walker L.L.P. (to be included in its opinion to be filed as Exhibit 5.1)(1) 23.2 -- Consent of Deloitte & Touche LLP* 24.1 -- Reference is made to the Signatures section of this Registration Statement for the Power of Attorney contained therein 27.1 -- Financial Data Schedule*
- --------------- * Filed herewith (1) To be filed by amendment. (2) Statement omitted because not applicable or because the required information is contained in the Financial Statements or Notes thereto. (3) Previously filed EX-1.1 2 UNDERWRITING AGREEMENT 1 EXHIBIT 1.1 2,300,000 Shares Internet America, Inc. Common Stock UNDERWRITING AGREEMENT , 1998 -------------------- HOAK BREEDLOVE WESNESKI & CO. FERRIS, BAKER WATTS, INCORPORATED As Representatives of the several Underwriters c/o Hoak Breedlove Wesneski & Co. One Galleria Tower 13355 Noel Road, Suite 1650 Dallas, Texas 75240 Dear Sirs: SECTION 1. Introductory. Internet America, Inc., a Texas corporation (the "Company"), proposes to issue and sell to the several underwriters named in Schedule A (the "Underwriters") an aggregate of 1,700,000 shares of its authorized but unissued Common Stock, $.01 par value per share (the "Common Stock"), and the shareholders of the Company who are named in Schedule B annexed hereto (the "Selling Shareholders") propose to sell 600,000 shares of issued and outstanding Common Stock to the Underwriters. Said shares, aggregating a total of 2,300,000 shares, are herein referred to as the "Firm Common Shares." In addition, the Selling Shareholders propose to grant to the Underwriters options to purchase up to 345,000 additional shares of Common Stock (such 345,000 shares being referred to as the "Optional Common Shares"), as provided in Section 5 hereof. The Firm Common Shares and, to the extent such option is exercised, the Optional Common Shares, are hereinafter collectively referred to as the "Common Shares." Hoak Breedlove Wesneski & Co. and [Co-Manager] have agreed to act as representatives of the several Underwriters (in such capacity, the "Representatives") in connection with the offering and sale of the Common Shares. You have advised the Company and the Selling Shareholders that the Underwriters propose to make a public offering of the Common Shares on the effective date of the registration statement hereinafter referred to, or as soon thereafter as in their judgment is advisable. The Underwriters, the Company and the Selling Shareholders hereby confirm their respective agreements with respect to the purchase of the Common Shares by the Underwriters as follows: SECTION 2. Representations and Warranties of the Company. The Company hereby represents and warrants to the Underwriters that: (a) A registration statement on Form SB-2 (File No. 333-59527) with respect to the Common Shares has been prepared by the Company in conformity with the requirements of the Securities Act of 1933, as amended (the "Act"), and the rules and regulations (the "Rules and Regulations") of the Securities and Exchange Commission (the "Commission") thereunder, and has been filed with the Commission. The Company has met all of the eligibility requirements for the use of a registration statement on Form SB-2. There have been delivered to each Representative two signed copies of such registration statement and amendments, together with two copies of each exhibit filed therewith. Conformed copies of such registration statement and amendments (but without exhibits) and of the related preliminary prospectus have been delivered to each Representative in such reasonable quantities as each of them has requested. The Company will next file with the Commission one of the following: (i) prior to effectiveness of such registration statement, a further amendment thereto, including the form of final prospectus, or (ii) a final 2 prospectus in accordance with Rules 430A and 424(b) of the Rules and Regulations. As filed, such amendment and form of final prospectus, or such final prospectus, shall include all Rule 430A Information (as hereinafter defined) and, except to the extent that the Representatives shall agree in writing to a modification, shall be in all substantive respects in the form furnished to the Representatives prior to the date and time that this Agreement was executed and delivered by the parties hereto, or, to the extent not completed at such date and time, shall contain only such specific additional information and other changes (beyond that contained in the latest Preliminary Prospectus) as the Company shall have previously advised the Representatives would be included or made therein. The term "Registration Statement" as used in this Agreement shall mean such registration statement at the time such registration statement becomes effective and, in the event any post-effective amendment thereto becomes effective prior to the First Closing Date (as hereinafter defined), shall also mean such registration statement as so amended; provided, however, that such term shall also include all Rule 430A Information deemed to be included in such registration statement at the time such registration statement becomes effective as provided by Rule 430A of the Rules and Regulations. Any registration statement filed by the Company pursuant to Rule 462(b) under the Securities Act is called the "Rule 462(b) Registration Statement", and from and after the date and time of filing of the Rule 462(b) Registration Statement, the term "Registration Statement" shall include the Rule 462(b) Registration Statement. The term "Preliminary Prospectus" shall mean any preliminary prospectus referred to in the preceding paragraph and any preliminary prospectus included in the Registration Statement at the time it becomes effective that omits Rule 430A Information. The term "Prospectus" as used in this Agreement shall mean the prospectus relating to the Common Shares in the form in which it is first filed with the Commission pursuant to Rule 424(b) of the Rules and Regulations or, if no filing pursuant to Rule 424(b) of the Rules and Regulations is required, shall mean the form of final prospectus included in the Registration Statement at the time such registration statement becomes effective. The term "Rule 430A Information" means information with respect to the Common Shares and the offering thereof permitted to be omitted from the Registration Statement when it becomes effective pursuant to Rule 430A of the Rules and Regulations. All references in this Agreement to the Registration Statement, the Rule 462(b) Registration Statement, a Preliminary Prospectus, or the Prospectus, or any amendments or supplements to any of the foregoing, shall refer to the copy thereof filed with the Commission pursuant to its Electronic Data Gathering, Analysis and Retrieval System. (b) To the knowledge of the Company, the Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus. Each Preliminary Prospectus has conformed in all material respects to the requirements of the Act and the Rules and Regulations and, as of its date, has not included any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and at the time the Registration Statement becomes effective, and at all times subsequent thereto up to and including each Closing Date hereinafter mentioned, the Registration Statement and the Prospectus, and any amendments or supplements thereto, will contain all material statements and information required to be included therein by the Act and the Rules and Regulations and will in all material respects conform to the requirements of the Act and the Rules and Regulations, and neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, will include any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of circumstances under which they were made; provided, however, no representation or warranty contained in this subsection 2(b) shall be applicable to information contained in any Preliminary Prospectus, the Registration Statement, the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by or on behalf of the Representatives or the Selling Shareholders pursuant to Item 7 of Form SB-2 specifically for use in the preparation thereof. (c) The Company does not own or control, directly or indirectly, any corporation, association or other entity. The Company has been duly incorporated and is validly existing as a corporation in good -2- 3 standing under the laws of the State of Texas, with full corporate power and authority (corporate and other) to own and lease its properties and conduct its business as described in the Prospectus; the Company is in possession of and is operating in compliance with all authorizations, licenses, permits, consents, certificates and orders material to the conduct of its business, except where noncompliance would not have a material adverse effect on the business or financial condition of the Company; the Company is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the ownership or leasing of properties or the conduct of its business requires such qualification, except for jurisdictions in which the failure to so qualify would not have a material adverse effect upon the Company; and no proceeding has been instituted in any such jurisdiction revoking, limiting or curtailing, or seeking to revoke, limit or curtail, such power and authority or qualification. (d) The Company has an authorized and outstanding capital stock as set forth under the heading "Capitalization" in the Prospectus as of the date of the Prospectus; the issued and outstanding shares of Common Stock have been duly authorized and validly issued, will be fully paid and nonassessable, will have been issued in compliance with all federal and state securities laws, will have not been issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities, and will conform to the description thereof contained under the heading "Description of Securities" in the Prospectus. On the thirtieth day following the First Closing Date all outstanding shares of the Company's preferred stock (the "Preferred Stock") shall automatically convert into 1,575,000 shares of Common Stock, without any further action on the part of any party, and no party will have any legal right, authority or ability to prevent or hinder such conversion in any way. The holders of the Preferred Stock shall have no right, whether accrued, due or payable, to receive anything of value with respect to such preferred shares other than the aforementioned shares of Common Stock and cash in lieu of fractional shares. Except as disclosed in or contemplated by the Prospectus and the financial statements of the Company, and the related notes thereto, included in the Prospectus, the Company has no outstanding options to purchase, or any preemptive rights or other rights to subscribe for or to purchase, any securities or obligations convertible into, or any contracts or commitments to issue or sell, shares of its capital stock or any such options, rights, convertible securities or obligations. The description of the Company's outstanding warrants, stock options, and other stock plans or arrangements, and the options or other rights granted and exercised thereunder, set forth in the Prospectus, accurately and fairly presents in all material respects the information required to be shown with respect to such warrants, options, plans, arrangements, and rights. (e) The Common Shares to be sold by the Company have been duly authorized and, when issued, delivered and paid for in the manner set forth in this Agreement, will be duly authorized, validly issued, fully paid and nonassessable, and will conform to the description thereof contained in the Prospectus; and when duly countersigned by the Company's transfer agent and registrar, and delivered to the Underwriters in accordance with the provisions of this Agreement, good and valid title thereto will pass to the Underwriters free and clear of any liens, claims, equities or other encumbrances of any kind or character. No preemptive rights or other rights to subscribe for or purchase exist with respect to the issuance and sale of the Common Shares by the Company pursuant to this Agreement. There are no persons with registration or other similar rights to have any equity or debt securities registered for sale under the Registration Statement or included in the offering contemplated by this Agreement with respect to the Common Shares included in the Registration Statement other than the Selling Shareholders and other persons whose rights have been duly waived in writing. (f) The Company has full legal right, power and authority to enter into this Agreement and perform the transactions contemplated hereby. This Agreement has been duly authorized, executed and delivered by the Company and constitutes a valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except to the extent that (i) the validity and binding effect and enforcement of this Agreement may be limited by any applicable bankruptcy, reorganization, moratorium, or similar laws of general application, (ii) the availability of equitable remedies may be limited by principles of equity, whether considered in a proceeding at law or in equity, and (iii) the terms thereof (including, without limitation, indemnity) may be limited by applicable securities laws and the policies -3- 4 embodied therein. The making and performance of this Agreement by the Company and the consummation of the transactions herein contemplated by the Company or the performance by the Company of the transactions contemplated hereby does not: require any consent, approval, authorization or order of or registration or filing with any court, regulatory body, administrative agency or other governmental body, agency or official (except such as may be required for the registration of the Common Shares under the Act and compliance with the securities or Blue Sky laws and the clearance of the public offering of the Common Shares by the National Association of Securities Dealers, Inc. (the "NASD")); or conflict with, or constitute a breach of, or a default under, the Articles of Incorporation or Bylaws of the Company; or conflict with or constitute a breach of or a default under any agreement, indenture, lease or other instrument to which the Company is a party or by which any of its properties may be bound where such conflict or breach could have a material adverse effect on the Company's financial condition or results of operation, taken as a whole (except for such conflicts, breaches or defaults for which waivers or consents have been obtained); or violate any statute, law, regulation or filing or judgment, injunction, order or decree applicable to the Company or any of its properties; or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company pursuant to the terms of any agreement or instrument to which the Company is a party or by which it may be bound or to which any of the property or assets of the Company is subject, except, in each case for such conflicts, breaches, defaults, violations, or encumbrances that would not singly or in the aggregate have a material adverse effect on the ability of the Company to fulfill its obligations hereunder. (g) Deloitte & Touche LLP ("Deloitte"), who have expressed their opinion with respect to the financial statements filed with the Commission as a part of the Registration Statement and included in the Prospectus, are independent accountants as required by the Act and the Rules and Regulations. (h) Financial Statements; Financial Data and Statistical Data. (i) The audited financial statements and the related notes thereto of the Company included in the Registration Statement and the Prospectus (such financial statements being herein referred to as the "Financial Statements") present fairly the financial condition of the Company as of the respective dates of such Financial Statements, and present fairly the results of operations and changes in financial position of the Company covered by such Financial Statements for the respective periods covered thereby. Such Financial Statements and the related notes thereto have been prepared in accordance with the generally accepted accounting principles applied on a consistent basis, except as otherwise stated therein, and have been certified by Deloitte, the Company's independent accountants. (ii) The audited selected financial data for the fiscal years ended June 30, 1996, 1997 and 1998 and the unaudited quarterly financial data set forth in the Prospectus under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations-Selected Quarterly Results of Operations" and "Selected Financial and Operating Data" have been prepared in accordance with generally accepted accounting principles (subject to normal year-end adjustments) applied on a consistent basis and present fairly the financial condition of the Company, as of such dates. (iii) No financial statements, schedules or financial data, other than as included in the Registration Statement, are required to be included in the Registration Statement. (iv) The financial and statistical data set forth in the Prospectus under the captions "Prospectus Summary," "Risk Factors," "Use of Proceeds," "Capitalization," "Dilution," "Selected Financial and Operating Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business," "Management," "Certain Transactions," "Principal and Selling Shareholders" and "Shares Eligible for Future Sale" fairly present the information set forth therein on the basis stated in the Registration Statement. -4- 5 (i) The Company is not in violation or default of any provision of its Articles of Incorporation; the Company is not in violation or default of any provision of its Bylaws or in breach of or default with respect to any provision of any judgment, decree or order, or in breach of or default with respect to any provision of any material agreement, mortgage, deed of trust, lease, loan agreement, security agreement, license, indenture, permit or other instrument to which it is a party or by which it or any of its properties is bound; and there does not exist any state of facts which constitutes an event of default on the part of the Company as defined in such documents or which, with notice or lapse of time or both, would constitute such an event of default, except for conflicts, breaches, defaults, violations or encumbrances that would not have a material adverse effect on the Company's financial condition or results of operations, taken as a whole. (j) There are no contracts or other documents required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement by the Act or by the Rules and Regulations which have not been described or filed as required. The contracts so described in the Prospectus are in full force and effect on the date hereof; and neither the Company, nor to the best of the Company's knowledge any other party, is in breach of or default under any material provision of any such contract which would have a material adverse effect on the Company. (k) There are no legal or governmental actions, suits or proceedings pending or, to the best of the Company's knowledge, threatened to which the Company is or may be a party or with respect to which property owned or leased by the Company is or may be the subject, or related to environmental, employment of aliens or discrimination matters, which actions, suits or proceedings might, individually or in the aggregate, prevent or adversely affect the transactions contemplated by this Agreement or result in a material adverse change in the condition (financial or otherwise), properties, business, results of operations or prospects of the Company and no labor disturbance by the employees of the Company exists or, to the knowledge of the Company is imminent which might be expected to result in a material adverse change in the condition (financial or otherwise), properties, business, results of operations or prospects of the Company. The Company is not a party to, or subject to the provisions of, any material injunction, judgment, decree or order of any court, regulatory body, administrative agency or other governmental body. (l) The Company has good and marketable title in fee simple to all real property and good and marketable title to all personal property owned by it in the financial statements hereinabove described (or as reflected or described elsewhere in the Prospectus), subject to no lien, mortgage, pledge, charge or encumbrance of any kind except (i) those, if any, reflected in such financial statements (or elsewhere in the Prospectus), or (ii) those which do not materially adversely affect the use made and proposed to be made of such property by the Company. The Company holds its leased properties under valid and binding leases, with such exceptions as are not materially significant in relation to the business of the Company. Except as disclosed in the Prospectus, the Company owns or leases all such properties as are necessary to its operations as now conducted. (m) Since the respective dates as of which information is given in the Registration Statement and Prospectus, and except as described in or specifically contemplated by the Prospectus, (i) the Company has not incurred any liabilities or obligations, direct, indirect or contingent, or entered into any verbal or written agreement or other transaction which is not in the ordinary course of business and which reasonably could be expected to result in a material reduction in the future earnings of the Company; (ii) the Company has not sustained any material loss or interference with respect to its business or properties from fire, flood, windstorm, accident or other calamity, whether or not covered by insurance; (iii) the Company has not paid or declared any dividends or other distributions with respect to its capital stock, and the Company is not in default in the payment of principal or interest on any outstanding debt obligations; (iv) there has not been any change in the capital stock of the Company (other than upon the sale of the Common Shares hereunder) or indebtedness material to the Company; and (v) there has not been any material adverse change in the condition (financial or otherwise), business, properties or results of operations of the Company. -5- 6 (n) The Company has sufficient trademarks, trade names, patent rights, mask works, copyrights, licenses, approvals and governmental authorizations to conduct its business as now conducted; the Company has no knowledge of any infringement by it of trademarks, trade name rights, trade dress, patent rights, mask works, copyrights, licenses, trade secret or other similar rights of others; and except as disclosed in the Prospectus, the Company has no knowledge of any infringement by others of the Company's trademarks, trade name rights, trade dress, patent rights, mask works, copyrights, licenses, trade secrets or other similar rights that would be material to the business or financial condition of the Company; and there is no claim being made against the Company regarding trademark, trade name, trade dress, patent right, mask work, copyright, license, trade secret or other infringement which could have a material adverse effect on the condition (financial or otherwise), business, results of operations or prospects of the Company. (o) The Company has not been advised, and has no reason to believe, that either it is not conducting business in compliance with all applicable laws, rules and regulations of the jurisdictions in which it is conducting business, including, without limitation, all applicable local, state and federal telecommunications, employment, truth-in-advertising, franchising, immigration and environmental laws and regulations, except where failure to be so in compliance would not materially adversely affect the condition (financial or otherwise), business, results of operations or prospects of the Company. (p) The Company has filed all federal, state and foreign income and franchise tax returns or extensions therefor required to be filed and have paid all taxes shown as due thereon; and the Company has no knowledge of any tax deficiency which has been or might be asserted or threatened against the Company which could materially and adversely affect the business, operations or properties of the Company. (q) The Company maintains a system of internal accounting controls sufficient to provide reasonable assurances that (i) sales and other business transactions are executed in accordance with management's general or specific authorizations; (ii) sales and other business transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; and (iii) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (r) The Company is not required to make, and following receipt of the proceeds from the sale of the Common Shares will not be required to make, any filing or to register under the Investment Company Act of 1940, as amended. (s) There is no proceeding pending or threatened which may lead to the revocation, suspension, termination or nonrenewal or any certificate, order, license, permit, easement, consent, waiver, approval, franchise, grant, authorization or concession required to conduct the business of the Company as now conducted and as proposed to be conducted and which are material to the Company. (t) There is no proceeding pending or threatened which may lead to the disqualification, delisting or suspension from trading of the Common Stock on the Nasdaq National Market. (u) Neither the Company nor any subsidiary of the Company conducts business with the Government of Cuba, or in Cuba, or with any Cuban business entity or enterprise. (v) No transfer taxes are required to be paid under the laws of the State of Texas in connection with the sale and delivery of the Common Shares to the Underwriters hereunder. -6- 7 SECTION 3. Representations, Warranties and Covenants of the Selling Shareholders. (a) Each Selling Shareholder severally represents and warrants to, and agrees with, the several Underwriters that: (i) Such Selling Shareholder has good and valid title to the Common Shares proposed to be sold by such Selling Shareholder hereunder and the full right, power and authority to enter into this Agreement and to sell, assign, transfer and deliver such Common Shares hereunder, free and clear of all liens, claims, equities or other encumbrances of any kind or character, other than those pursuant to this Agreement and those which will be waived or terminated prior to the First Closing Date or the Second Closing Date, as the case may be; and upon delivery of and payment for such Common Shares hereunder, the Underwriters will acquire good and valid title thereto, free and clear of all liens, claims, equities or other encumbrances of any kind or character. (ii) Such Selling Shareholder has executed and delivered a Custody Agreement and Power of Attorney (hereinafter referred to as the "Shareholder Agreement") and, in connection herewith, such Selling Shareholder further represents, warrants and agrees that it has deposited in custody, under the Shareholder Agreement with the agent named therein (the "Agent") as custodian, certificates in negotiable form for the Common Shares to be sold hereunder by such Selling Shareholder for the purpose of further delivery pursuant to this Agreement. Such Selling Shareholder agrees that the Common Shares owned by such Selling Shareholder and to be sold on deposit with the Agent are subject to the interests of the Company and the Underwriters, that the arrangements made for such custody are in that extent irrevocable, and that the obligations of such Selling Shareholder hereunder shall not be terminated, except as provided in this Agreement or in the Shareholder Agreement, by any act of such Selling Shareholder, by operation of law, by the death or incapacity of such Selling Shareholder or by the occurrence of any other event. If such Selling Shareholder should die, become incapacitated, or if any other event should occur before the delivery of the Common Share owned by such Selling Shareholder and hereunder, the certificates and documents evidencing Common Shares owned by such Selling Shareholder then on deposit with the Agent shall be delivered by the Agent in accordance with the terms and conditions of this Agreement as if such death, incapacity or other event had not occurred, regardless of whether the Agent shall have received notice thereof. This Agreement and the Shareholder Agreement have been duly executed and delivered by or on behalf of such Selling Shareholder. (iii) The performance of this Agreement and the Shareholder Agreement and the consummation of the transactions contemplated hereby and by the Shareholder Agreement will not result in a breach or violation by such Selling Shareholder of any of the terms or provisions of, or constitute a default by, such Selling Shareholder under any indenture, mortgage, deed of trust, trust (constructive or other), loan agreement, lease, franchise, license or other agreement or instrument to which such Selling Shareholder is a party or by which such Selling Shareholder or any of its properties is bound, or any statute, judgment, decree, order, rule or regulation of any court or governmental agency or body applicable to such Selling Shareholder or any of its properties. (iv) Such Selling Shareholder has not taken and will not take, directly or indirectly, any action designed to, or which has constituted or which might reasonably be expected to cause or result in, stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Common Shares. (v) The information pertaining to such Selling Shareholder in each Preliminary Prospectus, Prospectus and Registration Statement in response to Item 507 of Regulation S-B -7- 8 promulgated under the Act is complete and accurate in all material respects. Such Selling Shareholder has reviewed the Preliminary Prospectus and will review the Prospectus and the Registration Statement. To the best knowledge of such Selling Shareholder, each Preliminary Prospectus has not included any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein not misleading in light of the circumstances under which they were made; and, to the best knowledge of such Selling Shareholder, neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto will include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading. (vi) To the best knowledge of such Selling Shareholder, the representations and warranties of the Company set forth in Section 2 above are true and correct in all material respects. SECTION 4. Representations and Warranties of the Underwriters. (a) The Underwriters represent and warrant to the Company and the Selling Shareholders that the information set forth (i) on the cover page of the Prospectus with respect to price, underwriting discount and terms of the offering; and (ii) under "Underwriting" in the Prospectus furnished to the Company by the Representatives for use in connection with the preparation of the Registration Statement and the Prospectus is true, accurate and correct in all material respects and contains all information required to be included therein by applicable laws, rules and regulations. The Company and the Selling Shareholders acknowledge that this information is the sole information furnished to the Company by the Representatives for inclusion in the Registration Statement, any Preliminary Prospectus, any Prospectus, or any amendment or supplement thereto. (b) The Underwriters are registered as broker/dealers with the Commission and the NASD. Each of the Representatives is a corporation validly existing and in good standing in its jurisdiction of incorporation and has the full legal right, power and authority to enter into this Agreement and perform the transactions contemplated hereby. This Agreement has been duly authorized, executed and delivered by the Representatives and constitutes a valid and binding obligation of the Underwriters, enforceable against the Underwriters in accordance with its terms, except to the extent that (i) the validity and binding effect and enforcement of this Agreement may be limited by any applicable bankruptcy, reorganization, moratorium, or similar law of general application, (ii) the availability of equitable remedies may be limited by principles of equity, whether considered in a proceeding at law or in equity, and (iii) the terms thereof (including, without limitation, indemnity) may be limited by applicable securities laws and the policies embodied therein. The Representatives have obtained clearance of the Underwriters' compensation by the NASD and have taken all action deemed necessary in their judgment to register or qualify the sale of the Firm Common Shares and the Optional Common Shares in each state in which such Firm and/or Optional Common Shares are to be offered and sold and each Underwriter is registered and qualified to offer and sell the Common Shares in each state in which such Common Shares will be offered and sold by such Underwriters. There is not now pending nor overtly threatened against either Representative any material action or proceeding before the Commission, the NASD, any state securities commission, the Commodities Futures Trading Commission or any state or federal court prohibiting or attempting to prohibit, or penalizing it from or for acting as an underwriter, broker, dealer, salesman or agent for the sale of securities. SECTION 5. Purchase, Sale and Delivery of Common Shares. On the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company agrees to issue and sell to the Underwriters 1,700,000 Firm Common Shares, and the Selling Shareholders agree to sell to the Underwriters 600,000 Firm Common Shares, and the Underwriters agree, severally and not jointly, to purchase from the Company and the Selling Shareholders the number of Firm Common Shares set forth opposite their respective names in Schedule A hereto. The purchase price per share to be paid by the Underwriters to the Company and the Selling Shareholders shall be $_______ per share. -8- 9 Delivery of certificate(s) for the Firm Common Shares to be purchased by the Underwriters shall be made by or on behalf of the Company and the Selling Shareholders to the Underwriters or to the account of Hoak Breedlove Wesneski & Co. at the Depositary Trust Corporation, New York, New York ("DTC"), as the Representatives may direct, for the respective accounts of the Underwriters against payment of the purchase price. In the event certificates are delivered to the Underwriters other than through DTC, such delivery shall be made on the First Closing Date (as hereinafter defined) or the Second Closing Date (as hereinafter defined), as applicable, at the offices of Jackson Walker L.L.P., 901 Main Street, Suite 6000, Dallas, Texas 75202 (or such other place as may be agreed upon by the Company, the Selling Shareholders and the Representatives). Delivery of certificates, whether through DTC or otherwise, shall be made at such time and date, not later than the third (or, if the Firm Common Shares are priced, as contemplated by Rule 15cb-1(c) promulgated under the Securities Exchange Act of 1934, as amended, after 4:30 p.m., Washington, D.C. time, the fourth) full business day following the first day that any of Common Shares are released by the Underwriters for sale to the public, as the Representatives shall designate (the "First Closing Date"); provided, however, that if the Prospectus is at any time prior to the First Closing Date recirculated to the public, the First Closing Date shall occur upon the later of the third or fourth, as the case may be, full business day following the first date that any of the Common Shares are released by the Underwriters for sale to public or the date that is 48 hours after the date that the Prospectus has been so recirculated. The certificates for the Firm Common Shares shall be registered in such names and denominations as the Representatives shall have requested at least two full business days prior to the First Closing Date and shall be made available for checking and packaging on the business day preceding the First Closing Date at a location in New York, New York, as may be designated by the Representatives. Time shall be of the essence, and delivery at the time and place specified in this Agreement is a further condition to the obligations of the Underwriters. Payment by the Underwriters for the purchase price for the Firm Common Shares shall be made by wire transfer to such accounts as designated in writing by the Company and the Selling Shareholders. In addition, on the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Selling Shareholders hereby grant an option to the Underwriters to purchase up to the number of Optional Common Shares indicated on the first page of this Agreement at the purchase price per share to be paid for the Firm Common Shares, for use solely in covering any over-allotments made by the Underwriters in the sale and distribution of the Firm Common Shares. The option granted hereunder may be exercised at any time within 30 days after the first date that any of the Firm Common Shares are released by the Underwriters for sale to the public upon notice by the Underwriters to the Company and the Selling Shareholders setting forth the aggregate number of Optional Common Shares as to which the Underwriters are exercising the option, the names and denominations in which the certificates for such shares are to be registered and the time and place at which such certificates will be delivered. Such time of delivery (which may not be earlier than the First Closing Date), being herein referred to as the "Second Closing Date," shall be determined by the Underwriters, but if at any time other than the First Closing Date shall not be earlier than three nor later than five full business days after delivery of such notice of exercise. The number of Optional Common Shares to be purchased by each Underwriter shall be determined by multiplying the aggregate number of Optional Common Shares with respect to which are the options are exercised pursuant to such notice of exercise by a fraction, the numerator of which is the number of Firm Common Shares to be purchased by such Underwriter as set forth opposite its name in Schedule A and the denominator of which is the total number of Firm Common Shares (subject to such adjustments to eliminate any fractional share purchases as the Underwriters in their discretion may make). Certificates for the Optional Common Shares will be made available for checking and packaging on the business day preceding the Second Closing Date at a location in New York, New York, designated by you. The manner of payment for and delivery of the Optional Common Shares shall be the same as for the Firm Common Shares purchased, as specified in this Section 5. At any time before lapse of the option, the Underwriters may cancel such option by giving written notice of such cancellation to the Company. If the option is canceled or expires unexercised in whole or in part, the Company will deregister under the Act the number of Optional Common Shares as to which the option has not been exercised. -9- 10 Subject to the terms and conditions hereof, the Underwriters propose to make a public offering of their respective portions of the Firm Common Shares, and of the Optional Common Shares if and to the extent that the Underwriters exercise their option to purchase Optional Common Shares, as soon after the effective date of the Registration Statement as in the judgment of the Underwriters is advisable and at the public offering price set forth on the cover page of and on the terms set forth in the Prospectus. Not later than 12:00 p.m. on the second business day following the date the Common Shares are released by the Underwriters for sale to the public, the Company shall deliver or cause to be delivered copies of the Prospectus in such quantities and at such places as the Representatives shall request. SECTION 6. Covenants of the Company. The Company covenants and agrees that: (a) The Company will use its best efforts to cause the Registration Statement and any amendment thereof, if not effective at the time and date that this Agreement is executed and delivered by the parties hereto, to become effective. If the Registration Statement has become or becomes effective pursuant to Rule 430A of the Rules and Regulations, or the filing of the Prospectus is otherwise required under Rule 424(b) of the Rules and Regulations, the Company will file the Prospectus, properly completed, pursuant to the applicable paragraph of Rule 424(b) of the Rules and Regulations within the time period prescribed and will provide evidence satisfactory to the Representatives of such timely filing. The Company will promptly advise the Representatives in writing (i) of the receipt of any comments of the Commission; (ii) of any request of the Commission for amendment of or supplement to the Registration Statement (either before or after it becomes effective), any Preliminary Prospectus or the Prospectus or for additional information; (iii) when the Registration Statement shall have become effective; and (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or of the institution of any proceedings for that purpose. If the Commission shall enter any such stop order at any time, the Company will use its best efforts to obtain the lifting of such order at the earliest possible moment. The Company will not file any amendment or supplement to the Registration Statement (either before or after it becomes effective), any Preliminary Prospectus or the Prospectus of which the Representatives have not been furnished with a copy a reasonable time prior to such filing or to which the Representatives reasonably object in writing or which is not in compliance with the Act and the Rules and Regulations. (b) The Company will prepare and file with the Commission, promptly upon the Representatives' request, any amendments or supplements to the Registration Statement or the Prospectus which in the Representatives' judgment may be necessary or advisable to enable the Underwriters to continue the distribution of the Common Shares and will use its best efforts to cause the same to become effective as promptly as possible. The Company will fully and completely comply with the provisions of Rule 430A of the Rules and Regulations with respect to information omitted from the Registration Statement in reliance upon such Rule. (c) If at any time within the nine-month period referred to in Section 10(a)(3) of the Act during which a prospectus relating to the Common Shares is required to be delivered under the Act any event occurs as a result of which the Prospectus, including any amendments or supplements, would include an untrue statement of a material fact, or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, or if it is necessary at any time to amend the Prospectus, including any amendments or supplements, to comply with the Act or the Rules and Regulations, the Company will promptly advise the Representatives thereof and will promptly prepare and file with the Commission, at its own expense, an amendment or supplement which will correct such statement or omission or an amendment or supplement which will effect such compliance and will use its best efforts to cause the same to become effective as soon as possible; and, in case any Underwriter is required to -10- 11 deliver a prospectus after such nine-month period, the Company, upon request, but at the expense of such Underwriter, will promptly prepare such amendment or amendments to the Registration Statement and such Prospectus or Prospectuses as may be necessary to permit compliance with the requirements of Section 10(a)(3) of the Act. (d) As soon as practicable, but not later than 45 days after the end of the first quarter ending after one year following the "effective date of the Registration Statement" (as defined in Rule 158(c) of the Rules and Regulations), the Company will make generally available to its security holders an earnings statement (which need not be audited) covering a period of 12 consecutive months beginning after the effective date of the Registration Statement which will satisfy the provisions of the last paragraph of Section 11(a) of the Act. (e) During such period as a prospectus is required by law to be delivered in connection with sales by an Underwriter or dealer, the Company, at its expense, but only for the nine-month period referred to in Section 10(a)(3) of the Act, will furnish to the Underwriters or mail copies of the Registration Statement, the Prospectus, the Preliminary Prospectus and all amendments and supplements to any such documents, in each case as soon as available and in such quantities as the Representatives may request, for the purposes contemplated by the Act. (f) The Company shall cooperate with the Representatives and their counsel in order to qualify or register the Common Shares for sale under (or obtain exemptions from the application of) the Blue Sky laws of such jurisdictions as the Representatives designate, will comply with such laws and will continue such qualifications, registrations and exemptions in effect so long as reasonably required for the distribution of the Common Shares. The Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any such jurisdiction where it is not presently qualified or where it would be subject to taxation as a foreign corporation. The Company will advise the Representatives promptly of the suspension of the qualification or registration of (or any such exemption relating to) the Common Shares for offering, sale or trading in any jurisdiction or any initiation or overt threat of any proceeding for any such purpose, and in the event of the issuance of any order suspending such qualification, registration or exemption, the Company, with the Representatives' cooperation, will use its best efforts to obtain the withdrawal thereof. (g) During the period of five years hereafter, the Company will furnish to each of the Representatives: (i) as soon as practicable after the end of each fiscal year, copies of the Annual Report to Shareholders of the Company containing the balance sheet of the Company as of the close of such fiscal year and statements of income, shareholders' equity and cash flows for the year then ended and the opinion thereon of the Company's independent public accountants; (ii) as soon as practicable after the filing thereof, copies of each proxy statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Report on Form 8-K or other report filed by the Company with the Commission, the NASD or any securities exchange; and (iii) as soon as available, copies of any report or communication of the Company mailed generally to holders of its Common Stock. (h) During the period of 180 days from the date of the Prospectus, without the prior written consent of Hoak Breedlove Wesneski & Co. (the giving or withholding of such written consent being in the sole discretion of Hoak Breedlove Wesneski & Co.), the Company will not issue, offer, sell, grant options to purchase or otherwise dispose of any of the Company's equity securities or any other securities convertible into or exchangeable with its Common Stock or other equity security, except for securities used as consideration in acquisitions of the assets, stock or business of another person or entity, securities issued upon exercise or conversion of securities outstanding on the date of this Agreement, and the grant of options -11- 12 in the ordinary course of business pursuant to the Company's 1996 Incentive Stock Option Plan and 1998 Nonqualified Stock Option Plan, as described in the Prospectus. (i) The Company will deliver on or prior to the date hereof lock-up agreements, in a form reasonably satisfactory to you, from all officers, directors and Selling Shareholders, and their respective affiliates. (j) The Company will apply the net proceeds of the sale of the Common Shares sold by it substantially in accordance with its statements under the caption "Use of Proceeds" in the Prospectus. (k) The Company will qualify or register its Common Stock for sale in non-issuer transactions under (or obtain exemptions from the application of) the Blue Sky laws of the State of California (and thereby permit market making transactions and secondary trading in the Common Stock in California), will comply with such Blue Sky laws and will use its best efforts to maintain such qualifications, registrations and exemptions in effect for a period of three years after the date hereof. The Representatives may, in their sole discretion, waive in writing the performance by the Company of any one or more of the foregoing covenants or extend the time for their performance. SECTION 7. Payment of Expenses. Whether or not the transactions contemplated hereunder are consummated or this Agreement becomes effective or is terminated, the Company agrees to pay all costs, fees and expenses incurred in connection with the performance of its and the Selling Shareholders' obligations hereunder, including without limiting the generality of the foregoing, (i) all expenses incident to the issuance and delivery of the Common Shares (including all printing and engraving costs), (ii) all fees and expenses of the registrar and transfer agent of the Common Stock, (iii) all necessary issue, transfer and other stamp taxes in connection with the issuance and sale of the Common Shares to the Underwriters, (iv) all fees and expenses of the Company's counsel, Selling Shareholders' counsel and the Company's independent accountants, (v) all costs and expenses incurred in connection with the preparation, printing, filing, shipping and distribution to the Underwriters and dealers of the Registration Statement, each Preliminary Prospectus and the Prospectus (including all exhibits and financial statements) and all amendments and supplements provided for herein, this Agreement, the Agreement Among Underwriters, the Selected Dealers Agreement, the Underwriters' Questionnaire, the Underwriters' Power of Attorney and the preliminary Blue Sky memorandum and final Blue Sky memorandum, (vi) all filing fees, attorneys' fees and expenses incurred by the Company or the Underwriters in connection with qualifying or registering (or obtaining exemptions from the qualification or registration of) all or any part of the Common Shares for offer and sale under the Blue Sky laws, not to exceed $10,000 plus reasonable and documented out-of-pocket expenses, (vii) the filing fee of the NASD and attorneys fees and expenses incurred by the Company in obtaining a letter of no objection from the NASD, and (viii) all other fees, costs and expenses referred to in Item 25 of the Registration Statement; provided, however, that the Selling Shareholders shall pay their own underwriting discounts and commissions for the Common Shares sold by them. Except as provided in this Section 7 and in Section 9 and Section 11 hereof, the Underwriters shall pay all of their own costs and expenses, including the fees and disbursements of their counsel (excluding those relating to qualification, registration or exemption under the Blue Sky laws and the Blue Sky memoranda), travel, general advertising expenses associated with the offering and related out-of-pocket expenses). SECTION 8. Conditions of the Obligations of the Underwriters. The obligations of the Underwriters to purchase and pay for the Firm Common Shares on the First Closing Date and the Optional Common Shares on the Second Closing Date shall be subject to the accuracy of the representations and warranties on the part of the Company and the Selling Shareholders herein set forth as of the date hereof and as of the First Closing Date or the Second Closing Date, as the case may be, to the accuracy of the statements of Company officers and the Selling -12- 13 Shareholders made pursuant to the provisions of this Agreement, to the performance by the Company and the Selling Shareholders of their respective obligations hereunder, and to the following additional conditions: (a) The Registration Statement shall have become effective; if the filing of the Prospectus, or any supplement thereto, is required pursuant to Rule 424(b) of the Rules and Regulations, the Prospectus shall have been filed in the manner and within the time period required by Rule 424(b) of the Rules and Regulations; and prior to such Closing Date, no stop order suspending the effectiveness of the Registration Statement, any Rule 462(b) Registration Statement or any post-effective amendment to the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or, to the knowledge of the Company, the Selling Shareholders or the Representatives, shall be contemplated by the Commission; and any request of the Commission for inclusion of additional information in the Registration Statement, or otherwise, shall have been complied with to the Representatives' satisfaction. (b) The Representatives shall be satisfied that since the respective dates as of which information is given in the Registration Statement and Prospectus, (i) there shall not have been any change in the capital stock of the Company or any material change in the indebtedness of the Company, except as contemplated by the Prospectus; (ii) except as set forth in or contemplated by the Registration Statement or the Prospectus, no material verbal or written agreement or other transaction shall have been entered into by the Company which is not in the ordinary course of business and which reasonably could be expected to result in a material reduction in the future earnings of the Company; (iii) no loss or damage (whether or not insured) to the property of the Company shall have been sustained which materially and adversely affects the condition (financial or otherwise), business, results of operations or prospects of the Company; (iv) no legal or governmental action, suit or proceeding affecting the Company which could have a material adverse effect upon the Company, or which affects or may affect the transactions contemplated by this Agreement shall have been instituted or threatened; and (v) there shall not have been any material change in the condition (financial or otherwise), business, management, results of operations or prospects of the Company which makes it impractical or inadvisable in the judgment of the Representatives to proceed with the public offering or purchase of the Common Shares as contemplated hereby. For all purposes of this Agreement, the "prospects" of the Company shall refer to the business outlook and the potential or foreseeable opportunities available to the Company. (c) There shall have been furnished to the Representatives on each Closing Date, in form and substance satisfactory to the Representatives, such documents and certificates as the Representatives shall reasonably request, including the following: (i) An opinion of Jackson Walker L.L.P., counsel for the Company and for the Selling Shareholders, addressed to the Representatives and dated the First Closing Date, or the Second Closing Date, as the case may be, to the effect that: (1) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation, is duly qualified to do business as a foreign corporation and is in good standing in all other jurisdictions where, to the knowledge of such counsel, the ownership or leasing of properties or the conduct of its business requires such qualification, except for jurisdictions in which the failure to so qualify would not have a material adverse effect on the Company, and it has full corporate power to own its properties and conduct its business as described in the Registration Statement; -13- 14 (2) The authorized capital stock of the Company is as set forth under the caption "Capitalization" in the Prospectus as of the date set forth under such caption, and the number of shares of Common Stock that will be issued and outstanding after the consummation of the transactions contemplated hereby is as set forth under the caption "Prospectus Summary - The Offering" (assuming the Underwriters do not elect to purchase any of the Optional Common Shares, and after giving effect to the conversion of all outstanding shares of Preferred Stock into the indicated number of shares of Common Stock); all necessary and proper corporate proceedings have been taken in order to validly authorize such authorized Common Stock and to validly issue such issued and outstanding Common Stock; all outstanding shares of Common Stock (including the Firm Common Shares and Optional Common Shares, if any) have been duly and validly authorized and issued, are, to the knowledge of such counsel after due inquiry, fully paid and nonassessable, were not, to the knowledge of such counsel after due inquiry, issued in violation of any preemptive rights or other rights to subscribe for or purchase any securities and conform to the description thereof contained in the Prospectus; without limiting the foregoing, to the knowledge of such counsel after due inquiry, there are no preemptive or other rights to subscribe for or purchase any of the Common Shares to be sold by the Company hereunder; neither the Articles of Incorporation nor Bylaws of the Company, nor, to the knowledge of such counsel after due inquiry, does any contract contain any restriction upon the voting or transfer of any of the shares of capital stock of the Company (including the Firm Common Shares and the Optional Common Shares), except such restrictions as may be imposed by federal and state securities laws or as may be expressly described in the Prospectus and except for a Voting Agreement which will terminate upon consummation of this offering; (3) To the best of such counsel's knowledge, the Company does not own or control, directly or indirectly, any interest in any corporation, association or other entity. (4) The certificate(s) evidencing the Common Shares to be delivered hereunder and sold by the Company are in due and proper form under Texas law, and when duly countersigned by the Company's transfer agent and registrar, and delivered to the Underwriters or to the order of the Underwriters against payment of the agreed consideration therefor in accordance with the provisions of this Agreement, the Common Shares represented by such certificate(s) will be duly authorized and validly issued, fully paid and nonassessable, will pass to the Underwriters free and clear of any liens, claims, equities or other encumbrances of any kind or character, to the knowledge of such counsel after due inquiry, will not have been issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities, and will conform to the description thereof contained in the Prospectus; (5) Except as disclosed in the Prospectus, to the knowledge of such counsel after due inquiry, there are no outstanding options, warrants or other rights calling for the issuance of, and no commitments or obligations to issue, any shares of capital stock of the Company or any security convertible into or exchangeable for capital stock of the Company; (6) Assuming no amendment to the Certificate of Designations of the Company, on the thirtieth day following the First Closing Date all shares of Preferred Stock will automatically convert into 1,575,000 shares of Common Stock, without any -14- 15 further required action on the part of any party, and, to the best knowledge of such counsel after due inquiry, no party will have any legal right, authority or ability to prevent or hinder such conversion in any way. To the best knowledge of such counsel after due inquiry, the holders of the Preferred Stock have no right, whether accrued, due or payable, to receive anything of value with respect to such preferred shares other than the aforementioned shares of Common Stock; (7) (a) The Registration Statement has become effective under the Act, and, to such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement or preventing the use of the Prospectus has been issued and no proceedings for that purpose have been instituted or are pending or overtly threatened by the Commission; any required filing of the Prospectus and any supplement thereto pursuant to Rule 424(b) of the Rules and Regulations has been made in the manner and within the time period required by such Rule 424(b); (b) The Registration Statement, the Prospectus and each amendment or supplement thereto (except for the financial statements and schedules and other statistical financial data and schedules included therein, as to which such counsel need express no opinion), as of their respective effective or issue dates, comply as to form in all material respects with the requirements of the Act and the Rules and Regulations; and (c) To such counsel's knowledge, there are no franchises, leases, contracts, agreements or documents of a character required to be disclosed in the Registration Statement or Prospectus or to be filed as exhibits to the Registration Statement which are not disclosed or filed, as required; (d) The description of the Company's capital stock as set forth under the caption "Description of Securities" in the Registration Statement and Prospectus is true and correct in all material respects. (8) The Company has full corporate power and authority to enter into this Agreement and to sell and deliver the Common Shares to be sold by it to the Underwriters; this Agreement has been duly and validly authorized by all necessary corporate action by the Company, has been duly and validly executed and delivered by and on behalf of the Company, and is a valid and binding agreement of the Company enforceable against the Company in accordance with its terms, except to the extent that (i) the validity and binding effect and enforcement of this Agreement may be limited by any applicable bankruptcy, reorganization, moratorium, or similar laws of general application, (ii) the availability of equitable remedies may be limited by principles of equity, whether considered in a proceeding at law or in equity, and (iii) the terms hereof (including, without limitation, indemnity) may be limited by applicable securities laws and the policies embodied therein; and no approval, authorization, order, consent, registration, filing, qualification, license or permit of or with any court, regulatory, administrative or other governmental body is required for the execution and delivery of this Agreement by the Company or the consummation of the transactions contemplated by this Agreement, except such as have been obtained and are in full force and effect under the Act and such as may be required under applicable Blue Sky laws in connection with the purchase and distribution of the Common Shares by the Underwriters and the obtaining of a letter of -15- 16 no objection from the NASD with respect to such offering, provided that such counsel shall not be required to express any opinion as to the requirements of any Blue Sky laws; (9) The execution and performance of this Agreement, the issuance, sale and delivery of the Common Shares and the consummation of the transactions herein contemplated will not violate any of the provisions of the Articles of Incorporation or Bylaws of the Company, in each case as amended, or conflict with, result in the breach of, or constitute, either by itself or upon notice or the passage of time or both, a default under any agreement, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument filed as an exhibit to the Registration Statement or otherwise identified on an exhibit attached to the letter of opinion that is acceptable to the Representatives to which the Company is a party or by which the Company or any of its property may be bound or affected, or violate any statute, judgment, decree, order, rule or regulation of any court or government body having jurisdiction over the Company or any of its property (other than state securities or Blue Sky laws and regulations as to which counsel need not express any opinion); (10) To the best of such counsel's knowledge after due inquiry, the Company is not in violation of its Articles of Incorporation or Bylaws and is not in breach of or default with respect to any provision of any agreement, mortgage, deed of trust, lease, loan agreement, security agreement, license, indenture, permit or other instrument to which the Company is a party or by which the Company or any of its properties may be bound or affected, except where such default would not materially adversely affect the Company; and, to such counsel's knowledge, the Company is in compliance with all laws, rules, regulations, judgments, decrees, orders and statutes of any court or jurisdiction to which they are subject, except where noncompliance would not materially adversely affect the Company; (11) To such counsel's knowledge, there are no legal actions, suits or governmental proceedings pending or threatened before any court or governmental agency, authority or body which, if determined adversely to the Company would have a material adverse effect on the financial position, shareholders' equity or results of operations of the Company; (12) To such counsel's knowledge, no holders of securities of the Company have rights to the registration of shares of Common Stock or other securities which would be required to be included in the Registration Statement filed by the Company or included in the offering contemplated thereby which have not been duly waived in writing; (13) No transfer taxes are required to be paid under the laws of the State of Texas in connection with the sale and delivery of the Common Shares to the Underwriters hereunder; (14) The Company has Federal registrations of the service marks "Internet America" and "1-800-BE-A-GEEK" (the "Registered Marks"). Based solely on a trademark search conducted by such counsel and a certificate of the Company, except for a Company in Michigan using the "Internet America" name, to such counsel's knowledge, the Registered Marks do not infringe the rights of any other person or entity and no claims of any infringement or violation are pending or have been threatened or asserted against the Company with respect to the Registered Marks. To such counsel's -16- 17 knowledge after due inquiry, the Company has not entered into any license, release, order or other agreement that restricts the right of the Company to use the Registered Marks in any way. (15) Each Selling Shareholder which is not a natural person has full right, power and authority to enter into and to perform its obligations under this Agreement and the Shareholders Agreement to be executed and delivered by it in connection with the transactions contemplated in this Agreement; this Agreement and the Shareholders Agreements have been duly authorized, executed and delivered by the Selling Shareholders; the performance of this Agreement and the Shareholder Agreements and the consummation of the transactions herein contemplated by the Selling Shareholders will not result in a breach of, or constitute a default under, any indenture, mortgage, deeds of trust, trust (constructive or other), loan agreement, lease, franchise, license or other agreement or instrument known to such counsel after due inquiry to which any of the Selling Shareholders is a party or by which any of the Selling Shareholders or any of their properties may be bound, or violate any statute, judgment, decree, order, rule or regulation known to such counsel of any court or governmental body having jurisdiction over the Selling Shareholders or any of the properties of the Selling Shareholders; and to such counsel's knowledge, no approval, authorization, order or consent of any court, regulatory body, administrative agency or other governmental body is required for the execution and delivery of this Agreement or the consummation by the Selling Shareholders of the transactions contemplated by this Agreement, except such as have been obtained and are in full force and effect under the Act and such as may be required under the rules of NASD, applicable Blue Sky laws; (16) The Selling Shareholders have the full right, power and authority to enter into this Agreement and the Shareholder Agreements and to sell, transfer and deliver the Common Shares to be sold by the Selling Shareholders on the Closing Date, and, to the knowledge of such counsel offer due inquiry, valid marketable title to such Common Shares so sold, free and clear of all liens, claims, equities or other encumbrances of any kind or character, will be transferred to the Underwriters who have purchased such Common Shares hereunder; and (17) This Agreement and the Shareholder Agreements are valid and binding agreements of the Selling Shareholders and are enforceable against the Selling Shareholders in accordance with their terms except to the extent that (i) the validity and binding effect and enforcement of this Agreement and the Shareholder Agreements may be limited by any applicable bankruptcy, reorganization, moratorium, or similar laws of general application; (ii) the availability of equitable remedies may be limited by principles of equity, whether considered in a proceeding at law or in equity; and (iii) the indemnification provisions contained in this Agreement may be limited by applicable securities laws and the policies embodied therein. In rendering such opinion, such counsel may rely, as to matters of fact, on certificates of the Selling Shareholders and of officers of the Company and of governmental officials, in which case their opinion shall state that they are so doing and that the Underwriters are justified in relying on such certificates and copies of such certificates are to be attached to the opinion. The opinion shall be furnished to the Representatives and shall expressly state that the Underwriters may rely on such opinion as if it were addressed to them. -17- 18 In addition, such counsel shall state that they have participated in conferences with officers, employees and other representatives of the Company, counsel for the Underwriters, representatives of the independent public accountants for the Company and representatives of the Underwriters at which the contents of the Registration Statement and Prospectus and related matters were discussed and, although such counsel is not passing upon and does not assume any responsibility for, the accuracy, completeness or fairness of the statements contained in the Registration Statement and Prospectus and has not made any independent check or verification thereof, on the basis of the foregoing (relying as to materiality to a large extent upon the statements of officers, employees and other representatives of the Company), no facts have come to such counsel's attention that lead them to believe that either the Registration Statement at the time such Registration Statement became effective contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein in light of the circumstances in which they were made, not misleading, or the Prospectus as of its date contained an untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, except, in each case, that such counsel need express no opinion with respect to the financial statements, schedules and other statistical and financial data included in the Registration Statement or Prospectus. In addition, such counsel may state that its opinion is limited to matters governed by the federal laws of the United States of America and the corporate laws of the State of Texas. Subject to the opinions set forth in paragraphs (2), 7(b) and 7(d) and to the statements in the immediately preceding paragraph, the opinions of such counsel may be qualified by a statement to the effect that such counsel does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement or Prospectus. (ii) Such opinion or opinions of Locke Purnell Rain Harrell (A Professional Corporation), counsel for the Underwriters, dated the First Closing Date or the Second Closing Date, as the case may be, with respect to such matters as the Representatives may reasonably require, and the Company and the Selling Shareholders shall have furnished to such counsel such documents and shall have exhibited to them such papers and records as they reasonably may request for the purpose of enabling them to pass upon such matters. In connection with such opinions, such counsel may rely on representations or certificates of the Selling Shareholders and of officers of the Company and governmental officials. (iii) A certificate of the Company executed by the Chief Executive Officer and the Chief Financial Officer of the Company, dated the First Closing Date or the Second Closing Date, as the case may be, to the effect that as of such date: (1) The representations and warranties of the Company set forth in Section 2 of this Agreement are true and correct as of the date of this Agreement and as of the First Closing Date or the Second Closing Date, as the case may be, and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied on or prior to such Dates, respectively; (2) The Commission has not issued any order preventing or suspending the use of the Prospectus or any Preliminary Prospectus filed as a part of the Registration Statement or any amendment thereto; no stop order suspending the effectiveness of the Registration Statement has been issued; and to the best of the knowledge of the respective -18- 19 signers, no proceedings for that purpose have been instituted or are pending or overtly threatened under the Act; (3) Each of the respective signers of the certificate has carefully examined the Registration Statement and the Prospectus; in his opinion and to the best of his knowledge, the Registration Statement and the Prospectus and any amendments or supplements thereto contain all statements required to be stated therein regarding the Company, and neither the Registration Statement nor the Prospectus nor any amendment or supplement thereto includes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances under which they were made; (4) Since the initial date on which the Registration Statement was filed, no agreement, written or oral, transaction or event has occurred which should have been set forth in an amendment to the Registration Statement or in a supplement to or amendment of any Prospectus which has not been disclosed in such a supplement or amendment; (5) Since the respective dates as of which information is given in the Registration Statement and the Prospectus, and except as disclosed in or contemplated by the Prospectus, there has not been any material adverse change or a development involving a material adverse change in the condition (financial or otherwise), business, properties, results of operations, management or prospects of the Company; and no legal or governmental action, suit or proceeding is pending or, to the best knowledge of the respective signors, threatened against the Company which is material to the Company, whether or not arising from transactions in the ordinary course of business, or which may adversely affect the transactions contemplated by this Agreement; the Company has not entered into any verbal or written agreement or other transaction which is not in the ordinary course of business or which reasonably could be expected to result in a material reduction in the future earnings of the Company, or incurred any material liability or obligation, direct, contingent or indirect, made any change in its capital stock, made any material change in its short-term debt or long-term debt or repurchased or otherwise acquired any of the Company's capital stock; and the Company has not declared or paid any dividend, or declared or made any other distribution, with respect to its outstanding capital stock payable to shareholders of record, except as disclosed in the Prospectus, on a date prior to the First Closing Date or Second Closing Date, as the case may be; and (6) Since the respective dates as of which information is given in the Registration Statement and the Prospectus and except as disclosed in or contemplated by the Prospectus, the Company has not sustained a material loss or damage by strike, fire, flood, windstorm, accident or other calamity (whether or not insured). (iv) On the First Closing Date, a certificate, dated such Closing Date and addressed to the Underwriters, signed by or on behalf of each Selling Shareholder to the effect that the representations and warranties of such Selling Shareholder set forth in Section 3 of this Agreement are true and correct as if made at and as of such Closing Date, and such Selling Shareholder has complied with all the agreements and satisfied all the conditions to be performed or satisfied prior to the First Closing Date. -19- 20 (v) On the date before this Agreement is executed and also on the First Closing Date and the Second Closing Date, a letter addressed to the Representatives from Deloitte, independent accountants, the first letter to be dated the day before the date of this Agreement, the second letter to be dated the First Closing Date and the third letter (in the event of a Second Closing) to be dated the Second Closing Date, in form and substance satisfactory to you. All such opinions, certificates, letters and documents shall be in compliance with the provisions hereof only if they are reasonably satisfactory to the Representatives and to Locke Purnell Rain Harrell (A Professional Corporation), counsel for the Underwriters. The Company and the Selling Shareholders shall furnish the Representatives with such manually signed or conformed copies of such opinions, certificates, letters and documents as the Representatives request. Any certificate signed by any officer of the Company and delivered to the Representatives shall be deemed to be a representation and warranty by the Company to the Underwriters as to the statements made therein. If any condition to the Underwriters' obligations hereunder to be satisfied prior to or at the First Closing Date is not so satisfied, this Agreement at the election of the Representatives will terminate upon notification by the Representatives to the Company without liability on the part of any Underwriter or the Company, except for the expenses to be paid or reimbursed by the Company pursuant to Sections 7 and 9 hereof and except to the extent provided in Section 12 hereof. SECTION 9. Reimbursement of Underwriters' Expenses. If this Agreement shall be terminated by the Representatives pursuant to Section 8, or if the sale to the Underwriters of the Common Shares at the First Closing Date is not consummated because of any refusal, inability or failure on the part of the Company or Selling Shareholders to perform any agreement herein or to comply with any provision hereof, the Company agrees to reimburse the Representatives and the other Underwriters (or such Underwriters as have terminated this Agreement with respect to themselves), severally, upon demand for all out-of-pocket expenses that shall have been reasonably incurred by the Representatives and the Underwriters in connection with the proposed purchase and the sale of the Common Shares, including but not limited to fees and disbursements of Underwriters' counsel, printing expenses, travel expenses, postage, telecopy charges and telephone charges relating directly to the offering contemplated by the Prospectus. Any such termination shall be without liability of any party to any other party, except that the provisions of this Section, Section 7 and Section 11 shall at all times be effective and shall apply. SECTION 10. Effectiveness of Registration Statement. The Representatives and the Company will use their respective best efforts to cause the Registration Statement to become effective, to prevent the issuance of any stop order suspending the effectiveness of the Registration Statement and, if such stop order be issued, to obtain as soon as possible the lifting thereof. SECTION 11. Indemnification. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of the Act against any losses, claims, damages, liabilities or expenses, joint or several, to which such Underwriter or such controlling person may become subject, under the Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of the Company), insofar as such losses, claims, damages, liabilities or expenses (or actions in respect thereof as contemplated below) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state in any of them a material fact required to be stated therein or necessary to make -20- 21 the statements in any of them not misleading in light of the circumstances under which they were made, or arise out of or are based in whole or in part on any inaccuracy in the representations and warranties of the Company contained herein or any failure of the Company to perform its obligations hereunder or under law; and will reimburse each Underwriter and each such controlling person for any legal and other expenses as such expenses are reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action; provided, that the Company will not be liable in any such case to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with the information furnished to the Company by the Representatives pursuant to Section 4 hereof; and provided further, that with respect to any untrue statement or omission or alleged untrue statement or omission made in any Preliminary Prospectus, the indemnity agreement contained in this paragraph shall not inure to the benefit of any Underwriter from whom the person asserting any such losses, claims, damages, liabilities or expenses purchased the Common Shares concerned (or to the benefit of any person controlling such Underwriter) to the extent that any such loss, claim, damage, liability or expense of such Underwriter or controlling person results from the fact that a copy of the Prospectus was not sent or given to such person at or prior to the written confirmation of sale of such Common Shares to such person as required by the Act, and if the untrue statement or omission has been corrected in the Prospectus, unless such failure to deliver the Prospectus was a result of noncompliance by the Company with its obligations under Section 6(e) hereof. (b) Each Selling Shareholder severally agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of the Act against any losses, claims, damages, liabilities or expenses, to which such Underwriter or such controlling person may become subject, under the Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of such Selling Shareholder), insofar as such losses, claims, damages, liabilities or expenses (or actions in respect thereof as contemplated below) arise out of or are based in whole or in part on any inaccuracy in the representations and warranties of such Selling Shareholder contained herein or any failure of such Selling Shareholder to perform its obligations hereunder or under law; and will reimburse each Underwriter and each such controlling person for any legal and other expenses as such expenses are reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action; provided, that such Selling Shareholder will not be liable in any such case to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with the information furnished by the Representatives pursuant to Section 4 hereof; and provided further, that with respect to any untrue statement or omission or alleged untrue statement or omission made in any Preliminary Prospectus, the indemnity agreement contained in this paragraph shall not inure to the benefit of any Underwriter from whom the person asserting any such losses, claims, damages, liabilities or expenses purchased the Common Shares concerned (or to the benefit of any person controlling such Underwriter) to the extent that any such loss, claim, damage, liability or expense of such Underwriter or controlling person results from the fact that a copy of the Prospectus was not sent or given to such person at or prior to the written confirmation of sale of such Common Shares to such person as required by the Act, and if the untrue statement or omission has been corrected in the Prospectus, unless such failure to deliver the Prospectus was a result of noncompliance by the Company with its obligations under Section 6(e) hereof; and, provided further, that the aforesaid liability of each Selling Shareholder under this Section 11(b) shall -21- 22 not exceed the sum of the net proceeds received by such Selling Shareholder from the Common Shares sold by such Selling Shareholder pursuant hereto. (c) In addition to their other obligations under this Section 11, the Company and the Selling Shareholders jointly and severally agree that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, or any inaccuracy in the representations and warranties of the Company or the Selling Shareholders herein or failure to perform the respective obligations of the Company and the Selling Shareholders hereunder, all as described in Section 11(a) and (b), the Company and the Selling Shareholders will reimburse each Underwriter on a quarterly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's or the Selling Shareholders' obligations to reimburse each Underwriter for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, each Underwriter shall promptly return such payment to the Company and the Selling Shareholders, pro rata, together with interest, compounded daily, determined on the basis of the prime rate (or other commercial lending rate for borrowers of the highest credit standing) announced from time to time by The Chase Manhattan Bank (the "Prime Rate"). Any such interim reimbursement payments which are not made to an Underwriter within 30 days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. This indemnity agreement will be in addition to any liability which the Company and the Selling Shareholders may otherwise have. Notwithstanding anything set forth in this Section 11(c), under no circumstances shall any Selling Shareholder be obligated to make any interim reimbursement payments to the Underwriters under this Section 11(c) unless and until the Underwriters shall have made a written demand on the Company for such payments and such demand shall not have been paid by the Company within sixty (60) days after the receipt of such demand by the Company. (d) Each Underwriter will severally indemnify and hold harmless the Company and the Selling Shareholders, each of their respective directors, each of their respective officers who signed the Registration Statement, and each person, if any, who controls the Company or any Selling Shareholder within the meaning of the Act, against any losses, claims, damages, liabilities or expenses to which the Company, any Selling Shareholder, or any such director, officer, or controlling person may become subject under the Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of such Underwriter), insofar as such losses, claims, damages, liabilities or expenses (or actions in respect thereof as contemplated below) arise out of or are based upon any untrue or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement thereto, in reliance upon and in conformity with the information furnished to the Company pursuant to Section 4 hereof (which information is the sole information furnished to the Company by the Underwriters for inclusion in the Registration Statement, any Preliminary Prospectus, any Prospectus, or any amendment or supplement thereto); and will reimburse the Company, or any such director, officer, Selling Shareholder, or controlling person for any legal and other expense reasonably incurred by the Company, or any such director, officer, Selling Shareholder or controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action. In addition to its other obligations under this Section 11(d), -22- 23 each Underwriter severally agrees that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 11(d) which relates to information furnished to the Company pursuant to Section 4 hereof, it will reimburse the Company (and, to the extent applicable, each officer, director, Selling Shareholder or controlling person) on a quarterly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Underwriters' obligation to reimburse the Company (and, to the extent applicable, each officer, director, Selling Shareholder or controlling person) for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, the Company (and, to the extent applicable, each officer, director, Selling Shareholder or controlling person) shall promptly return such payment to the Underwriters, together with interest, compounded daily, determined on the basis of the Prime Rate. Any such interim reimbursement payments which are not made within 30 days of a request for reimbursement, shall bear interest at the Prime Rate from the date of such request. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. (e) Promptly after receipt by an indemnified party under this Section of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under this Section, notify the indemnifying party in writing of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party for contribution or otherwise hereunder to the extent it is not materially prejudiced as a proximate result of such failure. In case any such action is brought against any indemnified party and such indemnified party seeks or intends to seek indemnity from an indemnifying party, the indemnifying party will be entitled to participate in, and, to the extent that it may wish, jointly with all other indemnifying parties similarly notified, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party; provided, however, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be a conflict between the positions of the indemnifying party and the indemnified party in conducting the defense of any such action and that it would be inappropriate under applicable standards of professional conduct to have the same counsel represent both parties, the indemnified party or parties shall have the right to select separate counsel to assume such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of its election so to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under this Section for any legal expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed such counsel in connection with the assumption of legal defenses in accordance with the proviso to the next preceding sentence (it being understood, however, that the indemnifying party shall not be liable for the expenses of more than one separate counsel, approved by the Underwriters in the case of Section 11(a) or (b), representing the indemnified parties who are parties to such action) or (ii) the indemnifying party shall not have employed counsel reasonably satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying party. (f) If the indemnification provided for in this Section 11 is required by its terms, but for any reason is held to be unavailable to or otherwise insufficient to hold harmless any indemnified party under paragraphs (a), (b), (c) or (d) in respect of any losses, claims, damages, liabilities or expenses as referred to herein, then each applicable indemnifying party shall contribute to the amount paid or payable by such -23- 24 indemnified party as a result of any losses, claims, damages, liabilities or expenses referred to herein (i) in such proportion as is appropriate to reflect the relative benefits received by the Company, the Selling Shareholders and the Underwriters from the offering of the Common Shares or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, then such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company, the Selling Shareholders and the Underwriters in connection with the statements or omissions or inaccuracies in their representations and warranties herein which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The respective relative benefits received by the Company, the Selling Shareholders and the Underwriters shall be deemed to be in the same proportion, in the case of the Company and the Selling Shareholders as the total price paid to the Company and the Selling Shareholders, respectively for the Common Shares sold by them to the Underwriters (before deducting expenses), and in the case of Underwriters as the underwriting commissions received by them, bears to the total of such amounts paid to the Company and the Selling Shareholders and the amounts received by the Underwriters as underwriting commissions. The relative fault of the Company, the Selling Shareholders and the Underwriters shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission of a material fact or the inaccurate or the alleged inaccurate representations and/or warranty relates to the information supplied by the Company, the Selling Shareholders or the Underwriters and the parties relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, claims, damages, liabilities and expenses referred to above shall be deemed to include, subject to the limitations set forth in subsection (e) of this Section 11, any legal or other fees or expenses reasonably incurred by such party in connection with investigating or defending any action or claim. The provisions set forth in subsection (e) of this Section 11 with respect to notice of commencement of any action shall apply if a claim for contribution is to be made under this subsection (f); provided, however, that no additional notice shall be required with respect to any action for which notice has been given under subsection (d) for the purposes of indemnification. The Company, the Selling Shareholders, and the Underwriters agree that it would not be just inequitable if contribution pursuant to this Section 11 were determined solely by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take into account the equitable considerations referred to in this subsection (f). Notwithstanding the provisions of this Section 11, no Underwriter shall be required to contribute any amount in excess of the amount of the total underwriting commissions received by such Underwriter in connection with the Common Shares underwritten by it and distributed to the public, and no Selling Shareholder shall be required to contribute any amount in excess of the amount of the net proceeds received by such Selling Shareholder from the Common Shares sold by such Selling Shareholder pursuant hereto. No person guilty of fraudulent misrepresentation (within a meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute pursuant to this Section 11 are several in proportion to their respective underwriting commitments and not joint. (g) It is agreed that any controversy arising out of the operation of the interim reimbursement arrangements set forth in this Section 11, including the amounts of any requested reimbursement payments and the method of determining such amounts, shall be settled by arbitration conducted under the provisions of the Code of Arbitration Procedure of the NASD. Any such arbitration must be commenced by service of a written demand for arbitration or written notice of intention to arbitrate, therein electing the arbitration tribunal. In the event the party demanding arbitration does not make such designation of an arbitration tribunal in such demand or notice, then the party responding to said demand or notice is authorized to do so. Such an arbitration would be limited to the operation of the interim reimbursement provisions contained in this Section 11 and would not resolve the ultimate propriety or enforceability of the obligation to reimburse expenses which is created by the provisions of this Section 11. -24- 25 (h) The Company and the Selling Shareholders may agree, as among themselves and without limiting the rights of the Underwriters under this Agreement, as to their respective amounts of indemnification liability for which they each shall be responsible, and this Agreement shall not modify or supersede any agreements now in effect between the Company and the Selling Shareholders with respect thereto. SECTION 12. Default of One or More of the Several Underwriters. If, on the First Closing Date or the Second Closing Date, as the case may be, any one or more of the several Underwriters shall fail or refuse to purchase Common Shares that it or they have agreed to purchase hereunder on such date, and the aggregate number of Common Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase does not exceed 10% of the aggregate number of the Common Shares to be purchased on such date, the other Underwriters shall be obligated, severally, in the proportions that the number of Firm Common Shares set forth opposite their respective names on Schedule A bears to the aggregate number of Firm Common Shares set forth opposite the names of all such non-defaulting Underwriters, or in such other proportions as may be specified by the Representatives with the consent of the nondefaulting Underwriters, to purchase the Common Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date. If, on the First Closing Date or the Second Closing Date, as the case may be, any one or more of the Underwriters shall fail or refuse to purchase Common Shares and the aggregate number of Common Shares with respect to which such default occurs exceeds 10% of the aggregate number of Common Shares to be purchased on such date, and arrangements satisfactory to the Representatives and the Company with respect to the First Closing Date or the Second Closing Date for the purchase of such Common Shares are not made within 48 hours, the Agreement shall terminate without liability of any party to any other party except that the provisions of Section 7 and Section 11 shall at all times be effective and survive such termination. In any such case either the Representatives or the Company, acting jointly, shall have the right to postpone the First Closing Date and the Second Closing Date, as the case may be, but in no event for longer than seven days in order that the required changes, if any, to the Registration Statement and the Prospectus or any other documents or arrangements may be effected. As used in this Agreement, the term "Underwriter" shall be deemed to include any person substituted for a defaulting Underwriter under this Section 12. Any action taken under this Section 12 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. SECTION 13. Effective Date. This Agreement shall become effective at such time as the Registration Statement has become effective and you shall have released the Firm Common Shares for sale to the public; provided, however, that the provisions of Sections 7, 9, 11, 14 and 15 hereof shall at all times be effective. For the purposes of this Section 13, the Firm Common Shares shall be deemed to have been so released upon the release by the Underwriters for publication, at any time after the Registration Statement has become effective, of any newspaper advertisement relating to any of the Common Shares, or upon the release by the Underwriters of any of the Common Shares for sale to the public, whichever may occur first. SECTION 14. Termination. Without limiting the right to terminate this Agreement pursuant to any other provision hereof: (a) This Agreement may be terminated by the Company and the Selling Shareholders by notice to the Representatives or by the Representatives by notice to the Company and the Selling Shareholders at any time prior to the time this Agreement shall become effective as to all its provisions, and any such termination shall be without liability on the part of the Company or the Selling Shareholders to the Underwriters (except for the expenses to be paid or reimbursed by the Company pursuant to Sections 7 and 9 hereof and except to the extent provided in Sections 11 and 15 hereof) or of any Underwriter to the Company (except to the extent provided in Sections 7 and 11 hereof). -25- 26 (b) This Agreement may also be terminated by the Representatives prior to the First Closing Date or prior to the Second Closing Date, as the case may be, by notice to the Company and the Selling Shareholders (i) if additional material governmental restrictions not in force and effect on the date hereof shall have been imposed upon trading in securities generally or minimum or maximum prices shall have been generally established on the New York Stock Exchange or on the American Stock Exchange or in the Nasdaq National Market or in the over the counter market by the NASD, or trading in securities generally shall have been suspended on either such Exchange or in the Nasdaq National Market or in the over the counter market by the NASD or the Commission, or a general banking moratorium shall have been established by federal, New York or Texas authorities, (ii) if an outbreak of hostilities or other national or international calamity or any material change in political, financial or economic conditions shall have occurred or shall have accelerated to such an extent that the effect on the financial markets shall, in the judgment of the Representatives, affect adversely the marketability of the Common Shares, (iii) if any adverse event shall have occurred or shall exist which makes untrue or incorrect in any material respect any statement or information contained in the Registration Statement or Prospectus or which is not reflected in the Registration Statement or Prospectus but should be reflected therein in order to make the statements or information contained therein not misleading in any material respect, or (iv) if there shall be any action, suit or proceeding pending or threatened, or there shall have been any development or prospective development involving particularly the business or properties or securities of the Company or the transactions contemplated by this Agreement, which, in the judgment of the Representatives, may materially and adversely affect the business or earnings of the Company or makes it impracticable to offer or sell the Common Shares. Any termination pursuant to this subsection (b) shall be without liability on the part of the Underwriters to the Company or the Selling Shareholders or on the part of the Company or the Selling Shareholders to the Underwriters (except for expenses to be paid or reimbursed by the Company or the Selling Shareholders pursuant to Sections 7 or 11 hereof and except to the extent provided in Sections 11 and 15). SECTION 15. Failure of the Selling Shareholders to Sell and Deliver. If the Selling Shareholders fail to sell and deliver to the Underwriters the Common Shares to be sold and delivered by the Selling Shareholders at the First Closing Date or the Second Closing Date under the terms of this Agreement, then the Representatives may at their option, by written notice to the Company and the Selling Shareholders, either (i) terminate this Agreement without any liability on the part of any Underwriter or, except as provided in Sections 7, 9, and 11 hereof, the Company or the Selling Shareholders, or (ii) purchase the shares which the Company has sold and delivered to the Underwriters in accordance with the terms hereof. In the event of a failure by the Selling Shareholders to sell and deliver as referred to in this Section, either the Representatives or the Company shall have the right to postpone the Closing Date for a period not exceeding seven (7) business days in order that the necessary changes in the Registration Statement, Prospectus and any other documents, as well as any other arrangements, may be effective. SECTION 16. Representations and Indemnities to Survive Delivery. The respective indemnities, agreements, representations, warranties and other statements of the Company and its officers, the Selling Shareholders and of the Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of the Underwriters or the Company, or the Selling Shareholders, or any of their partners, officers or directors or any controlling person, as the case may be, and will survive delivery of and payment for the Common Shares sold hereunder and any termination of this Agreement. SECTION 17. Notices. All communications hereunder shall be in writing and, if sent to the Underwriters, shall be mailed, delivered or telecopied or telegraphed and confirmed to the Underwriters at Hoak Breedlove Wesneski & Co., One Galleria Tower, 13355 Noel Road, Suite 1650, Dallas, Texas 75240, Attention: Lawrence E. Wesneski, with a copy to Locke Purnell Rain Harrell (A Professional Corporation), 2200 Ross Avenue, Suite 2200, Dallas, Texas 75201, Attention: John B. McKnight; and if sent to the Company or the Selling Shareholders -26- 27 shall be mailed, delivered or telecopied or telegraphed and confirmed to the Company at One Dallas Center, 350 N. St. Paul, Suite 3000, Dallas, Texas 75201, Attention: Michael T. Maples, President, with a copy to Jackson Walker L.L.P, 901 Main Street, Suite 6000, Dallas, Texas 75202, Attention: Richard F. Dahlson. The Company, the Selling Shareholders or the Underwriters may change the address for receipt of communications hereunder by giving notice to the others. SECTION 18. Successors. This Agreement will inure to the benefit of and be binding upon the parties hereto, including any substitute Underwriters pursuant to Section 12 hereof, and to the benefit of the officers and directors and controlling persons referred to in Section 11, and in each case their respective successors, personal representatives and assigns, and no other person will have any right or obligation hereunder. No such assignment shall relieve any party of its obligations hereunder. The term "successors" shall not include any purchaser of the Common Shares as such from any of the Underwriters merely by reason of such purchase. SECTION 19. Partial Unenforceability. The invalidity or unenforceability of any Section, subsection, paragraph or provision of this Agreement shall not affect the validity or enforceability of any other Section, paragraph or provision hereof. If any Section, subsection, paragraph or provision of this Agreement is for any reason determined to be invalid or unenforceable, there shall be deemed to be made such minor changes (and only such minor changes) as are necessary to make it valid and enforceable. SECTION 20. Applicable Law. This Agreement shall be governed by and construed in accordance with the internal laws (and not the laws pertaining to conflicts of laws) of the State of Texas. SECTION 21. General. This Agreement constitutes the entire agreement of the parties to this Agreement and supersedes all prior written or oral and all contemporaneous oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may be executed in several counterparts, each one of which shall be an original, and all of which shall constitute one and the same document. In this Agreement, the masculine, feminine and neuter genders and the singular and the plural include one another. The section headings in this Agreement are for the convenience of the parties only and will not affect the construction or interpretation of this Agreement. This Agreement may be amended or modified, and the observance of any term of this Agreement may be waived, only by a writing signed by the Company, the Selling Shareholders and the Underwriters. If the foregoing is in accordance with the Underwriters' understanding of our agreement, kindly sign and return to us the enclosed copies hereof, whereupon it will become a binding agreement among the Company, the Selling Shareholders and the Underwriters, all in accordance with its terms. Very truly yours, INTERNET AMERICA, INC. By: --------------------------------- Name: ------------------------------- Title: ------------------------------ -27- 28 SELLING SHAREHOLDERS BCG PARTNERSHIP, LTD. ------------------------------------ WILLIAM O. HUNT, General Partner WILLIAM O. HUNT RETIREMENT TRUST By: -------------------------------- WILLIAM O. HUNT, Trustee -------------------------------- JACK T. SMITH -------------------------------- CARL WESTCOTT The foregoing Underwriting Agreement is hereby confirmed and accepted by the Representatives as of the date first above written, acting as Representatives of the several Underwriters named in the attached Schedule A. HOAK BREEDLOVE WESNESKI & CO. FERRIS, BAKER WATTS, INCORPORATED By: HOAK BREEDLOVE WESNESKI & CO. By: ----------------------- Name: --------------------- Title: ------------------- -28- 29 SCHEDULE A
Number of Firm Common Name of Underwriter Shares to be Purchased - ------------------- ---------------------- Hoak Breedlove Wesneski & Co. Ferris, Baker Watts, Incorporated [NAMES OF OTHER UNDERWRITERS] --------------- Total 2,300,000 ===============
30 SCHEDULE B
Number of Common Shares Name of Selling Shareholder to be Sold by Selling Shareholder - --------------------------- --------------------------------- Firm Common Option Common Shares Shares -------------- ------------- BCG Partnership, Ltd. 200,000 -- William O. Hunt Retirement Trust -- 120,000 Jack T. Smith 60,000 25,000 Carl Westcott 340,000 200,000 -------------- ------------- Total 600,000 345,000
EX-3.5 3 APPLICATION FOR CERTIFICATE OF WITHDRAWAL 1 EXHIBIT 3.5 APPLICATION FOR CERTIFICATE OF WITHDRAWAL OF INTERNET AMERICA, INC. To the Secretary of State of the State of Texas: Pursuant to the provisions of Article 8.14 of the Texas Business Corporation Act, the undersigned corporation hereby applies for a certificate of withdrawal from the State of Texas, and for that purpose submits the following statement: 1. The name of the corporation is Internet America, Inc. 2. It is incorporated under the laws of Arizona. 3. It is not transacting business in the State of Texas. 4. It hereby surrenders its authority to transact business in said state. 5. It revokes the authority of its registered agent in the State of Texas to accept service of process and consents that service of process in any action, suit or proceeding based upon any cause of action arising in the State of Texas during the time it was authorized to transact business therein may thereafter be made on it by service thereof on the secretary of state of the State of Texas. 6. The post office address to which the secretary of state may mail a copy of any process against the corporation that may be served on it is 350 N. St. Paul, Suite 200, Dallas, Texas 75201. 7. All sums due or accrued by this corporation to the State of Texas have been paid, or adequate provision has been made for the payment thereof. 8. All known creditors or claimants have been paid or provided for and the corporation is not involved in or threatened with litigation in any court in the State of Texas. By: /s/ John N. Nanni ---------------------------------- John N. Nanni, President EX-3.6 4 ARTICLES OF MERGER 1 EXHIBIT 3.6 ARTICLES OF MERGER MERGING INTERNET AMERICA, INC., AN ARIZONA CORPORATION, WITH AND INTO INTRNTUSA, INC., A TEXAS CORPORATION Pursuant to the provisions of Article 5.04 of the Texas Business Corporation Act and Section 10-074 of the Arizona General Corporation Law, the undersigned corporations adopt the following Articles of Merger for the purpose of effecting a merger in accordance with the provisions of Article 5 of the Texas Business Corporation Act and Article 4 of the Arizona General Corporation Law. 1. An Agreement and Plan of Merger (the "Plan of Merger") adopted in accordance with the provisions of Article 5.03 of the Texas Business Corporation Act and the Arizona General Corporation Law attached hereto as Exhibit A and is hereby incorporated herein by reference, which provides for the merger of Internet America, Inc., an Arizona corporation ("IA Arizona"), with and into INTRNTUSA, Inc., a Texas corporation ("IA Texas"), and resulting in IA Texas being the surviving corporation (the "Surviving Corporation"). Pursuant to the Plan of Merger, the Surviving Corporation's name will be changed to "Internet America, Inc." 2. As to each of the undersigned corporations, the approval of whose shareholders is required, the number of outstanding shares of stock of such corporation entitled to vote on the Plan of Merger is as follows:
Number of Name of Shares Corporation Outstanding ----------- ----------- Internet America, Inc. 1,099,500 shares of Common Stock INTRNTUSA, Inc. 1 share of Common Stock
3. As to each of the undersigned corporations, the approval of whose shareholders is required, the number of shares voted for and against the Plan of Merger, respectively, is as follows:
Total Total Name of Voted Voted Total Corporation For Against Abstaining ----------- --- ------- ---------- Internet America, Inc. 1,099,500 0 0 INTRNTUSA, Inc. 1 0 0
2 4. IA Arizona hereby declares that the approval of the Plan of Merger was duly authorized by all action required by the laws under which it was incorporated or organized and by its constituent documents. 3 IN WITNESS WHEREOF, the undersigned have executed these Articles of Merger as of the 21st day of July, 1995. INTRNTUSA, INC., a Texas corporation /s/ John N. Nanni ------------------------------------------ John N. Nanni, President INTERNET AMERICA, INC., an Arizona corporation /s/ Robert J. Maynard ------------------------------------------ Robert J. Maynard, Chief Executive Officer 4 Exhibit A AGREEMENT AND PLAN OF MERGER This Agreement and Plan of Merger (this "Agreement") is made and entered into as of July 21, 1995, by and among INTRNTUSA, Inc., a Texas corporation ("IA Texas"), and Internet America, Inc., an Arizona corporation ("IA Arizona"). RECITALS: A. IA Arizona desires to merge with and into IA Texas, and IA Texas desires to merge with IA Arizona (the "Merger"). B. The terms and conditions of Merger, the mode of carrying the same into effect, the manner and basis of canceling the shares of $.01 par value common stock of IA Arizona ("IA Arizona Common Stock"), the issuance of the shares of $.01 par value common stock of IA Texas ("IA Texas Common Stock"), and such other terms and provisions as the parties desire to be stated in this Agreement are set forth below. C. The current shareholders of IA Arizona shall be the only shareholders of IA Texas immediately upon the completion of the Merger, and each such shareholder shall own the same percentage of IA Texas Common Stock as he owned of IA Arizona Common Stock prior to the Merger. D. The Boards of Directors of IA Arizona and IA Texas deem the Merger to be desirable and in the best interests of their respective corporations and shareholders. THEREFORE, in consideration of the premises and the mutual agreements contained herein, the parties hereto agree as follows: AGREEMENTS ARTICLE I THE MERGER 1.1 Merger. At the Effective Time (as defined in Section 1.2), IA Arizona shall be merged with and into IA Texas, the separate existence of IA Arizona shall cease, and IA Texas, as the surviving corporation (the "Surviving Corporation"), shall continue to exist by virtue of and shall be governed by the laws of the State of Texas, and the name of the Surviving Corporation shall be changed to "Internet America, Inc." 5 1.2 Effective Time of Merger. The Articles of Merger setting forth the information required by, and otherwise in compliance with, the Texas Business Corporation Act with respect to the Merger, shall be delivered for filing with the Secretary of State of the State of Texas. Certified copies of the Articles of Merger and the Agreement and Plan of Merger ("Certified Copies"), issued by the Secretary of State of the State of Texas and setting forth the information required by, and otherwise in compliance with the General Corporation Law of the State of Arizona, shall be delivered for filing to the Arizona Corporation Commission. The Merger shall become effective on the day and at the time the Secretary of State of the State of Texas files such Articles of Merger (the time of such effectiveness is herein called the "Effective Time"). Notwithstanding the foregoing, either IA Arizona or IA Texas, by action of its Board of Directors, may terminate this Agreement at any time prior to the earlier of (i) the filing of the Articles of Merger with the Secretary of State of the State of Texas or (ii) the filing of the Certified Copies with the Arizona Corporation Commission. 1.3 Effects of Merger. At the Effective Time, IA Texas, without further action, as provided by the laws of the State of Arizona and the laws of the State of Texas, shall succeed to and possess all of the rights, privileges, powers, and franchises, of a public as well as of a private nature, of IA Arizona; and all property, real, personal and mixed, and all debts due on whatsoever account, including subscriptions to shares, and all other choses in action, and all and every other interest, of or belonging to or due to IA Arizona shall be deemed to be vested in IA Texas without further act or deed; and the title to any real estate, or any interest therein, vested in IA Texas or IA Arizona shall not revert or be in any way impaired by reason of the Merger. Such transfer to and vesting in IA Texas shall be deemed to occur by operation of law, and no consent or approval of any other person shall be required in connection with any such transfer or vesting unless such consent or approval is specifically required in the event of merger or consolidation by law or express provision in any contract, agreement, decree, order, or other instrument to which IA Texas or IA Arizona is a party or by which either of them is bound. IA Texas shall thenceforth be responsible and liable for all debts, liabilities, and duties of IA Arizona which may be enforced against IA Texas to the same extent as if said debts, liabilities, and duties had been incurred or contracted by it. Neither the rights of creditors nor any liens upon the property of IA Arizona and IA Texas shall be impaired by the Merger. 1.4 Articles of Incorporation. The Articles of Incorporation of IA Texas before the merger shall be and remain the Articles of Incorporation of IA Texas after the Effective Time, until the same shall thereafter be altered, amended, or repealed in accordance with law and IA Texas's Articles of Incorporation; provided, however, that at the time of the Merger the Articles of Incorporation of IA Texas shall be amended as provided on Exhibit I, attached hereto and incorporated herein by reference, in order to change the name of the Surviving Corporation to Internet America, Inc. 1.5 Bylaws. The Bylaws of IA Texas as in effect at the Effective Time shall be and remain the Bylaws of IA Texas, as the Surviving Corporation, until the same shall thereafter be 2 6 altered, amended, or repealed in accordance with law, IA Texas's Articles of Incorporation, or such Bylaws. ARTICLE II EFFECT ON OUTSTANDING STOCK 2.1 IA Texas Common Stock. At the Effective Time, all of the shares of IA Texas Common Stock that were outstanding immediately before the Effective Time shall, without any action on the part of the holder thereof, be canceled. 2.2 IA Arizona Common Stock. At the Effective Time, each outstanding share of IA Arizona Common Stock shall, without any action on the part of the holders thereof, be deemed converted into and represent the same number of shares of IA Texas Common Stock as each holder of IA Arizona Common Stock owned prior to the Merger. 2.3 Surrender of Certificates of IA Arizona Common Stock. At or after the Effective Time, each holder of IA Arizona Common Stock that was outstanding immediately before the Effective Time shall surrender the certificate(s) that represented that holder's shares immediately before the Effective Time, and IA Texas shall, upon receipt of such certificate(s), immediately cancel such certificate(s) and issue certificate(s) for IA Texas Common Stock in the name of that holder or in the name of any person that the holder so directs. Whether or not so surrendered, at and after the Effective Time, the certificate(s) representing IA Arizona Common Stock shall be deemed for all purposes to have been canceled and shall not evidence any right or interest in or claim against IA Texas or IA Arizona. ARTICLE III OFFICERS AND DIRECTORS 3.1 Directors. At the Effective Time, each of the persons who was serving as a director of IA Texas immediately prior to the Effective Time shall continue to be a director of IA Texas, and each shall serve in such capacity until the next annual meeting of shareholders of IA Texas and until his successor is duly elected and qualified or, if earlier, until his death, resignation, or removal from office. 3.2 Officers. At the Effective Time, each of the persons who was serving as an officer of IA Texas immediately prior to the Effective Time shall continue to be an officer of IA Texas and shall continue to serve in such capacity at the pleasure of the Board of Directors of IA Texas or, if earlier, until their respective death or resignation. 3 7 ARTICLE IV MISCELLANEOUS 4.1 Headings. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 4.2 Amendment. To the extent permitted by law, this Agreement may be amended or supplemented at any time and in any respect, to the extent such amendment or supplement relates to the Merger, by action taken by the Boards of Directors of IA Arizona and IA Texas, if prior to the Effective Time, or by the Board of Directors of IA Texas, if on or after the Effective Time. 4.3 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas with respect to all matters except to the extent the laws of the State of Arizona apply to matters of corporate governance relating to IA Arizona. 4.4 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same agreement. 4 8 IN WITNESS WHEREOF, each of the parties hereto has executed this Agreement as of the date first written above. INTRNTUSA, INC., a Texas corporation By: /s/ Robert J. Maynard --------------------------------- Title: CEO INTERNET AMERICA, INC., an Arizona corporation By:/s/ John N. Nanni --------------------------------- Title: President 5 EX-4.2 5 CERTIFICATE OF DESIGNATION 1 EXHIBIT 4.2 CERTIFICATE OF DESIGNATION OF THE SERIES A PREFERRED STOCK ($.01 PAR VALUE) OF INTERNET AMERICA, INC. Pursuant to Article 2.13 of the TEXAS BUSINESS CORPORATION ACT ------------------------ The undersigned DOES HEREBY CERTIFY that the following resolution was duly adopted on November 10, 1995 by the Board of Directors (the "Board") of Internet America, Inc., a Texas corporation (the "Company"), acting pursuant to the provisions of Article 2.13 of the Texas Business Corporation Act. Such resolution was duly adopted by all necessary action on the part of the Company. RESOLVED, that pursuant to authority expressly granted to and vested in the Board by provisions of the Articles of Incorporation of the Company, as amended (the "Articles of Incorporation"), the issuance of a series of Preferred Stock, par value $.0l per share, which shall consist of 350,000 shares of Preferred Stock designated as Series A Preferred Stock, be, and the same hereby is, authorized, and the Board hereby fixes the designations, preferences, limitations, and relative rights, including voting rights, of the shares of such series to the same extent that such designations, preferences, limitations, and relative rights could be stated if fully set forth in the Articles of Incorporation, but subject to and within the limitations set forth in the Articles of Incorporation as follows: 1. DESIGNATION: The distinctive serial designation of the series of Preferred Stock authorized by this resolution shall be "Series A Preferred Stock" (the "Series A Preferred Stock"). The number of shares of Series A Preferred Stock shall initially be 350,000, which number may from time to time be increased or decreased (but not below the number then outstanding) by the Board of Directors. Shares of Series A Preferred Stock which have been issued and reacquired in any manner, including shares purchased or converted, shall be retired. 2. RANK. The Series A Preferred Stock, with respect to rights on liquidation, winding up and dissolution, shall rank senior to all classes and series of the common stock, par value $.0l per share ("Common Stock") of the Company and may rank senior to other classes of Preferred Stock now or hereafter authorized, issued or outstanding (collectively, the "Junior Securities"). Notwithstanding the preceding sentence, the Company reserves the right, and may in its discretion, 2 issue other series of Preferred Stock of the Company with dividend rights and rights on liquidation, winding up and dissolution, pari passu with the Series A Preferred Stock. 3. DIVIDENDS. The Series A Preferred Stock shall have no specified dividend rate and the holders of the shares of Series A Preferred Stock shall be entitled to receive dividends (i) pari passu with the holders of Common Stock as though the shares of Series A Preferred Stock had been converted into shares of Common Stock, and (ii) when, as and if otherwise declared by the Board of Directors, out of funds legally available therefor. 4. LIQUIDATION PREFERENCE. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company, then, before any distribution or payment shall be made to the holders of any Junior Securities, including the Common Stock, the holders of the shares of Series A Preferred Stock then outstanding shall be entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to the purchase price for each share of Series A Preferred Stock outstanding (which amount is hereinafter referred to as the "liquidation preference"). If the assets of the Company are not sufficient to pay in full the liquidation preference payments payable to the holders of all outstanding shares of the Series A Preferred Stock (plus holders of any shares of Preferred Stock holding rights on liquidation, winding up and dissolution pari passu with the Series A Preferred Stock), then the holders of all such Preferred Shares shall share ratably in any distribution of assets in accordance with the proportionate amount which would be payable on such distribution if the amounts to which the holders of outstanding shares of Series A Preferred Stock are entitled were paid in full. (b) For the purposes of this paragraph 4, neither the voluntary sale, conveyance, exchange or transfer (for cash, shares of stock, securities or other consideration) of all or substantially all of the property or assets of the Company nor the consolidation or merger of the Company with any other corporation shall be deemed to be a voluntary or involuntary liquidation, dissolution or winding up of the Company, unless such voluntary sale, conveyance, exchange, transfer, consolidation or merger shall be in connection with a plan of liquidation, dissolution or winding up of the Company. 5. CONVERSION. (a) Each share of the Series A Preferred Stock shall be convertible at any time and from time to time into one share of the Company's Common Stock (the "Common Stock Equivalent"). Each share of the Series A Preferred Stock shall automatically be converted, without further action by the Company, into one fully paid and nonassessable share of the Company's Common Stock on the date thirty (30) days after the "successful completion" of a public offering of shares of Common Stock of the Company pursuant to a registration statement filed with and declared effective by the Securities and Exchange Commission under the Securities Act of 1933, as amended (or such registration statement shall have otherwise become effective). For purposes of this subsection, "successful completion" shall mean that the receipt by the Company of gross proceeds from such public offering of at least $5,000,000 where the per share price of the Common Stock offered therein was at least $5.00 per share. 3 (b) In order to exercise the conversion privilege, a holder of the Series A Preferred Stock shall surrender the certificate(s) evidencing the shares, duly endorsed or assigned to the Company or in blank, at the Company's principal executive offices accompanied by written notice to the Company that the holder elects to convert the Series A Preferred Stock. Upon the receipt by the Company of the conversion election notice as contemplated in the previous sentence (the "Conversion Date"), such election shall be binding on the electing holder of the Series A Preferred Stock and all such holder's shares, without any other action on the part of the holder thereof, shall be deemed automatically converted into an equal number of fully paid and nonassessable shares of the Common Stock, and at such time the rights of the holder in the Series A Preferred Stock shall cease, and the holder shall be entitled to receive the Common Stock issuable upon conversion and shall be treated for all purposes as the record holder of such Common Stock at such time. As promptly as practicable on or after the Conversion Date, the Company shall issue and deliver to the holder a certificate or certificates for the number of shares of Common Stock issuable upon conversion. In the event of a successful completion of a public offering of shares as contemplated in paragraph 5(a), the Company shall issue and deliver to the holder a certificate or certificates for the number of shares of Common Stock issuable upon such conversion upon receipt by the Company from the holder the certificate(s) evidencing the shares of Series A Preferred Stock so converted, duly endorsed or assigned to the Company or in blank. On the date set for automatic conversion as contemplated in paragraph 5(a), the rights of the holder in the Series A Preferred Stock shall cease and such holder shall be treated for all purposes as the record holder of such Common Stock at such time. (c) The conversion rate of the Series A Preferred Stock is subject to adjustment from time to time upon the occurrence of the events enumerated in this paragraph 5(c). For purposes of this paragraph 5(c), "Common Stock" means shares now or hereafter authorized of any class of common stock of the Company and any other stock of the Company, however designated, that has the right (subject to any prior rights of any class or series of Preferred Stock) to participate in any distribution of the assets or earnings of the Company without limit as to per share amount. If the Company: (1) subdivides, combines or reclassifies its outstanding shares of Common Stock; or (2) pays a dividend or makes a distribution on its Common Stock in shares of its Common Stock or any other series of stock convertible into Common Stock; then the number of shares of Common Stock comprising the Common Stock Equivalent shall be proportionately adjusted to reflect such action so that the total number of shares comprising the Common Stock Equivalent shall be equal to that number of shares that would have been owned immediately following such action if the conversion election had been exercised immediately prior to such actions. Any fractional shares resulting from any such adjustment shall be eliminated and the number of shares of Common Stock to be issued shall be rounded up to the nearest whole share. The adjustment shall become effective immediately after the record date in the case of a dividend 4 or distribution and immediately after the effective date in the case of a subdivision, combination or reclassification. 6. VOTING RIGHTS. In addition to any other rights provided in the Company's Bylaws or by law to the Series A Preferred Stock voting as a class, each share of Series A Preferred Stock shall entitle the holder thereof to one vote per share and such holders shall be entitled to vote on all matters as to which holders of Common Stock shall be entitled to vote, in the same manner and with the same effect as such holders of Common Stock, voting together with the holders of Common Stock and Series A Preferred Stock as one class. IN WITNESS WHEREOF, the undersigned has caused this Certificate to be made under the seal of the Company and signed by John N. Nanni and attested by Cindy B. Carradine, this 13th day of November, 1995. /s/ John N. Nanni --------------------------------- John N. Nanni, President [SEAL] /s/ Cindy B. Carradine --------------------------------- Cindy B. Carradine, Secretary EX-4.3 6 AMENDED CERTIFICATE OF DESIGNATION 1 EXHIBIT 4.3 AMENDED CERTIFICATE OF DESIGNATION OF THE SERIES A PREFERRED STOCK ($.01 PAR VALUE) OF INTERNET AMERICA, INC. Pursuant to Article 2.13 of the TEXAS BUSINESS CORPORATION ACT ---------------------------- The undersigned DOES HEREBY CERTIFY that the following resolution was duly adopted on March 22, 1996, by the Board of Directors (the "Board") of Internet America, Inc., a Texas corporation (the "Company"), acting pursuant to the provisions of Article 2.13 of the Texas Business Corporation Act. Such resolution was duly adopted by all necessary action on the part of the Company. WHEREAS, pursuant to resolutions adopted on November 10, 1995 by the Board of Directors of the Company, the Board of Directors authorized a series of preferred stock entitled "Series A Preferred Stock" and authorized the Company to issue 350,000 shares of Series A Preferred Stock; and WHEREAS, the Company has or anticipates receiving subscriptions for an aggregate amount of Series A Preferred Stock in excess of 350,000 shares; and WHEREAS, the Board of Directors desire to authorize to increase the number of Series A Preferred Stock which the Company may issue; and WHEREAS, the initial designation for the Series A Preferred Stock contemplates an increase from time to time in the number of shares to be issued thereunder. NOW, THEREFORE, BE IT RESOLVED, that pursuant to authority expressly granted to and vested in the Board of Directors by provisions of the Articles of Incorporation of the Company, as amended (the "Articles of Incorporation"), the number of Series A Preferred Stock, which the Company may issue shall be increased to 400,000, which number may from time to time be further increased or decreased (but not below the number then outstanding) by the Board of Directors. The Series A Preferred Stock to be issued shall have such designations, preferences, 2 limitations and relative rights, including voting rights, as set forth in the designation of the Series A Preferred Stock as adopted by the Board of Directors on November 10, 1995. FURTHER RESOLVED, that the officers of the Company be, and each is hereby authorized, empowered and directed, for and on behalf of the Company, to execute any and all such certificates, documents and instruments as each may deem necessary or advisable to consummate any filings as may be required with the Secretary of State of Texas and/or as otherwise to fulfill the intent of the foregoing resolutions. IN WITNESS WHEREOF, the undersigned have caused this Certificate to be made under the seal of the Company and signed by Robert J. Maynard and attested by John Nanni this 3rd day of April, 1996. /s/ Robert J. Maynard --------------------------------- Robert J. Maynard, President [SEAL] /s/ John Nanni --------------------------------- John Nanni, Secretary EX-4.4 7 CERTIFICATE OF DESIGNATION 1 EXHIBIT 4.4 CERTIFICATE OF DESIGNATION OF THE SERIES B PREFERRED STOCK ($.01 PAR VALUE) OF INTERNET AMERICA, INC. Pursuant to Article 2.13 of the TEXAS BUSINESS CORPORATION ACT ------------------------------------ The undersigned DOES HEREBY CERTIFY that the following resolution was duly adopted on May 15, 1996, by the Board of Directors (the "Board") of Internet America, Inc., a Texas corporation (the "Company"), acting pursuant to the provisions of Article 2.13 of the Texas Business Corporation Act. Such resolution was duly adopted by all necessary action on the part of the Company. WHEREAS, pursuant to resolutions adopted on May 15, 1996 by the Board of Directors of the Company, the Board of Directors authorized a series of preferred stock entitled "Series B Preferred Stock" and authorized the Company to issue 300,000 shares of Series B Preferred Stock; and WHEREAS, the Board of Directors is authorized within the limitations and restrictions stated in the Articles of Incorporation of the Company, to fix by resolution or resolutions the designation of each series of preferred stock, $.01 par value of the Company (the "Preferred Stock") and the powers, preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions thereof, including, without limiting the generality of the foregoing, such provisions as may be desired concerning voting, dissolution or distribution of assets, conversion or exchange, and such other subjects or matters as may be fixed by resolutions of the Board of Directors under the Texas Business Corporation Act; and WHEREAS, it is the desire of the Board of Directors, pursuant to its authority as aforesaid, to authorize and fix the term of a series of Preferred Stock and the number of shares constituting such series. NOW, THEREFORE, BE IT RESOLVED, that pursuant to authority expressly granted to and vested in the Board by provisions of the Articles of Incorporation of the Company, as amended (the "Articles of Incorporation"), the issuance of a series of Preferred Stock, par value $.01 per share, which shall consist of 300,000 shares of Preferred Stock designated as Series B Preferred Stock, be, and the same hereby is, authorized, and the Board hereby fixes the designation, preferences, limitations, and relative rights, including voting rights, of the shares of such series to 2 the same extent that such designations, preferences, limitations, and relative rights could be stated if fully set forth in the Articles of Incorporation, but subject to and within the limitations set forth in the Articles of Incorporation as follows: 1. DESIGNATION. The distinctive serial designation of the series of Preferred Stock authorized by this resolution shall be "Series B Preferred Stock" (the "Series B Preferred Stock"). The number of shares of Series B Preferred Stock shall initially be 300,000, which number may from time to time be increased or decreased (but not below the number then outstanding) by the Board of Directors. Shares of Series B Preferred Stock which have been issued and reacquired in any manner, including shares purchased or converted, shall be retired. 2. RANK. The Series B Preferred Stock, with respect to rights on liquidation, winding up and dissolution, shall rank senior to all classes and series of the common stock, par value $.01 per share ("Common Stock") of the Company and may rank senior to other classes of Preferred Stock now or hereafter authorized, issued or outstanding (collectively, the "Junior Securities"). The Series B Preferred Stock, with respect to rights on liquidation shall rank pari passu with the previously issued Series A Preferred Stock. Notwithstanding the preceding sentences, the Company reserves the right and may in its discretion, issue other series of Preferred Stock of the Company with dividend rights and rights on liquidation, winding up and dissolution, pari passu with the Series B Preferred Stock. 3. DIVIDENDS. The Series B Preferred Stock shall have no specified dividend rate and the holders of the shares of Series B Preferred Stock shall be entitled to receive dividends (i) pari passu with the holders of Common Stock and the Series A Preferred Stock as though the shares of Series B Preferred Stock had been converted into shares of Common Stock, and (ii) when, as and if otherwise declared by the Board of Directors, out of funds legally available therefor. 4. LIQUIDATION PREFERENCES. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company, then, before any distribution or payment shall be made to the holders of any Junior Securities, including the Common Stock, the holders of the shares of Series B Preferred Stock then outstanding shall be entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to the purchase price for each share of Series B Preferred Stock then outstanding shall be entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to the purchase price for each share of Series B Preferred Stock outstanding (which amount is hereinafter referred to as the "liquidation preference"). The liquidation preference payments payable to the holders of Series B Preferred Stock shall be made pari passu with the holders of Series A Preferred Stock based on the aggregate purchase price for the shares of the Series A Preferred Stock and Series B Preferred Stock, respectively, held by each such holder. If the assets of the Company are not sufficient to pay in full the liquidation preference payments payable to the holders of all outstanding shares of the Series B Preferred Stock (plus holders of any shares of Preferred Stock holding rights on liquidation, winding up and dissolution pari passu with the Series B Preferred Stock, including the Series A Preferred Stock), then the holders of all such Preferred 3 Shares shall share ratably in any distribution of assets in accordance with the proportionate amount which would be payable on such distribution if the amounts to which the holders of outstanding shares of Series B Preferred Stock are entitled were paid in full. (b) For the purposes of this paragraph 4, neither the voluntary sale, conveyance, exchange or transfer (for cash, shares of stock, securities or other consideration) of all or substantially all of the property or assets of the Company nor the consolidation or merger of the Company with any other corporation shall be deemed to be a voluntary or involuntary liquidation, dissolution or winding up of the Company, unless such voluntary sale, conveyance, exchange, transfer, consolidation or merger shall be in connection with a plan of liquidation, dissolution or winding up of the Company. 5. CONVERSION. (a) Each share of the Series B Preferred Stock shall be convertible at any time and from time to time into one share of the Company's Common Stock (the "Common Stock Equivalent"). Each share of the Series B Preferred Stock shall automatically be converted, without further action by the Company, into one fully paid and nonassessable share of the Company's Common Stock on the date thirty (30) days after the "successful completion" of a public offering of shares of Common Stock of the Company pursuant to a registration statement filed with and declared effective by the Securities and Exchange Commission under the Securities Act of 1933, as amended (or such registration statement shall have otherwise become effective). For purposes of this subsection, "successful completion" shall mean that the receipt by the Company of gross proceeds from such public offering of at least $5,000,000 where the per share price of the Common Stock offered therein was at least $7.50 per share. (b) In order to exercise the conversion privilege, a holder of the Series B Preferred Stock shall surrender the certificate(s) evidencing the shares, duly endorsed or assigned to the Company or in blank, at the Company's principal executive offices accompanied by written notice to the Company that the holder elects to convert the Series B Preferred Stock. Upon the receipt by the Company of the conversion election notice as contemplated in the previous sentence (the "Conversion Date"), such election shall be binding on the electing holder of the Series B Preferred Stock and all such holder's shares, without any other action on the part of the holder thereof, shall be deemed automatically converted into an equal number of fully paid and nonassessable shares of the Common Stock, and at such time the rights of the holder in the Series B Preferred Stock shall cease, and the holder shall be entitled to receive the Common Stock issuable upon conversion and shall be treated for all purposes as the record holder of such Common Stock at such time. As promptly as practicable on or after the Conversion Date, the Company shall issue and deliver to the holder a certificate or certificates for the number of shares of Common Stock issuable upon conversion. In the event of a successful completion of a public offering of shares as contemplated in paragraph 5(a), the Company shall issue and deliver to the holder a certificate or certificates for the number of shares of Common Stock issuable upon such conversion upon receipt by the Company from the holder the certificate(s) evidencing the shares of Series B Preferred Stock so converted, duly endorsed or assigned to the Company or in blank. On the date set for automatic conversion as contemplated in paragraph 5(a), the rights of the holder in the Series B Preferred Stock shall cease 4 and such holder shall be treated for all purposes as the record holder of such Common Stock at such time. (c) The conversion rate of the Series B Preferred Stock is subject to adjustment from time to time upon the occurrence of the events enumerated in this paragraph 5(c). For purposes of this paragraph 5(c), "Common Stock" means shares now or hereafter authorized of any class of common stock of the Company and any other stock of the Company, however designated, that has the right (subject to any prior rights of any class or series of Preferred Stock) to participate in any distribution of the assets or earnings of the Company without limit as to per share amount. If the Company: (1) subdivides, combines or reclassifies its outstanding shares of Common Stock; or (2) pays a dividend or makes a distribution on its Common Stock in shares of its Common Stock or any other series of stock convertible into Common Stock; then the number of shares of Common Stock comprising the Common Stock Equivalent shall be proportionately adjusted to reflect such action so that the total number of shares comprising the Common Stock Equivalent shall be equal to that number of shares that would have been owned immediately following such action if the conversion election had been exercised immediately prior to such actions. Any fractional shares resulting from any such adjustment shall be eliminated and the number of shares of Common Stock to be issued shall be rounded up to the nearest whole share. The adjustment shall become effective immediately after the record date in the case of a dividend or distribution and immediately after the effective date in the case of a subdivision, combination or reclassification. 6. VOTING RIGHTS. In addition to any other rights provided in the Company's Bylaws or by law to the Series B Preferred Stock voting as a class, each share of Series B Preferred Stock shall entitle the holder thereof to one vote per share and such holders shall be entitled to vote on all matters as to which holders of Common Stock shall be entitled to vote, in the same manner and with the same effect as such holders of Common Stock, voting together with the holders of Common Stock, Series A Preferred Stock and Series B Preferred Stock as one class. IN WITNESS WHEREOF, the undersigned have caused this Certificate to be made under the seal of the Company and signed by Robert J. Maynard and attested by John Nanni this 20th day of May, 1996. /s/ Robert J. Maynard ---------------------------------- Robert J. Maynard, President [SEAL] /s/ John Nanni ---------------------------------- John Nanni, Secretary EX-10.2 8 ASSET PURCHASE AGREEMENT DATED 7/31/96 1 EXHIBIT 10.2 ASSET PURCHASE AGREEMENT This ASSET PURCHASE AGREEMENT (the "Agreement") is entered into effective this 31st day of July, 1996 by and between INTERNET AMERICA, INC., a Texas corporation ("Buyer"), and WEBSTAR, INC., a Texas corporation ("Seller"). W I T N E S S E T H: WHEREAS, Seller is in the business of providing dial-up internet access services and related services to customers, both individuals and businesses, in the San Angelo, Texas market (the "Business"); and WHEREAS, the parties hereto desire to enter into this Agreement for the purchase of the Business and to establish the parties ongoing business relationship regarding other matters. NOW, THEREFORE, for and in consideration of the mutual understandings, promises and covenants contained herein, the parties hereto agree as follows: 1. TERMS OF PURCHASE AND SALE; CLOSING. 1.1 Purchase and Sale of Certain Assets of the Seller. Upon the basis of the representations and warranties and subject to the terms and conditions of this Agreement, Buyer agrees to purchase and acquire from Seller, and Seller agrees to sell, convey, transfer, assign, and deliver to Buyer, on the Closing Date (as defined in Section 1.5 hereto) the Assets, free and clear of any pledge, lien, claim or other encumbrance of any kind whatsoever, except for those obligations as described in Section 1.1(b) below, against receipt on the Closing Date of the Purchase Price specified in Section 1.4 hereof. The term "Assets" shall mean all of the assets of the Seller relating to the Business including but not limited to: (a) All of Seller's rights, title and interest in and to those certain tangible assets and property as set forth on Schedule 1.1(a) (the "Fixed Assets"); and (b) All of Seller's rights, title and interest in Lease Agreements as set forth in Schedule 1.1(b), providing each named Lessor agrees to the assumption by Buyer; and (c) All of Seller's cash accounts, accounts receivable, billing receipts and collections systems, deposits; and (d) All of Seller's rights, title and interest in and to all of Seller's customers as of the effective date of this agreement, customer lists, all goodwill associated therewith (the "Customers"); and (e) All of Seller's existing marketing and promotional materials. ASSET PURCHASE AGREEMENT - Page 1 2 1.2 H & H Liabilities. Buyer shall not assume any liabilities, incurred by Seller, to H & H Consulting (related party of Seller). 1.3 Purchase Price. The purchase price (the "Purchase Price") for the Assets shall be cash in the amount of $8,000.00 and the issuance and delivery by Buyer of its promissory note in the original principal amount of $352,125.00 (the "Note"), such Note to be substantially in the form attached hereto as Exhibit "A". 1.4 Instruments of Transfer and Conveyance. (a) The sale, conveyance, transfer, assignment and delivery of the Assets, as herein provided, shall be effected by delivery by Seller on the Closing Date of such bills of sale, endorsements, assignments, certificates, drafts, checks or other instruments of transfer and conveyance, as Buyer shall reasonably deem necessary, to vest in Seller good and marketable title to the Assets. Except for those obligations as described in Section 1.1(b) above, such instruments of transfer and conveyance shall contain warranties as to marketable title and that such Assets are free and clear of all pledges, liens, options, security interests, mortgages, claims, charges or other encumbrances of any kind whatsoever. (b) Seller agrees that it will from time to time after the Closing Date, upon the request of Buyer, promptly do, execute, acknowledge and deliver, and will cause to be done, executed, acknowledged and delivered, all such further instruments, certificates, assignments, transfers, conveyances, powers of attorney, assurances and other documents, as may be reasonably necessary or advisable to assure or confirm Buyer's free and clear title to and interest in, or to enable Buyer to deal with and dispose of, any of the Assets. 1.5 Closing. The closing hereunder (the "Closing") shall be held at the offices of the Buyer as of the effective date of this Agreement, or at such other time and place as the parties may agree upon (the "Closing Date"). At the Closing: (a) Seller will execute and deliver to Buyer the following: a General Bill of Sale and Conveyance in the form acceptable to Buyer; and such other instruments of transfer and conveyance as are required pursuant to Section 1.4 above; and (b) Buyer will execute and deliver to Seller the Note; and (c) Each party will execute and deliver to the others such other agreements, certificates, assignments, consents and other documents as are required or specified in this Agreement or as may reasonably be requested by the other party to evidence compliance with the terms hereof Simultaneously with the deliveries contemplated herein, Seller will use its best efforts and take all such other action as may be reasonably necessary to put Buyer in possession and control of the Assets. 2. REPRESENTATIONS AND WARRANTIES OF SELLER. Seller represents and warrants to Buyer as follows: ASSET PURCHASE AGREEMENT - Page 2 3 2.1 Corporate Status. Seller is a corporation duly organized, validly existing and in good standing under the laws of Texas and has all necessary corporate power and authority to carry on its business as now conducted and to own or lease and operate its properties, and to execute, deliver and perform its obligations hereunder. 2.2 Authority for Agreement. This Agreement constitutes the valid and legally binding obligation of Seller and the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary action on the part of the board of directors and shareholders of Seller, will not conflict with or result in any violation of, or default under, any provisions of the charter or bylaws of Seller and will not conflict with or result in any violation of, or default with respect to, any mortgage, indenture, lease, agreement or other instrument affecting the Assets, or to which Seller or its affiliates, is a party, or by which Seller or its affiliates is bound. 2.3 Properties. Seller has good, valid and marketable title to the Assets subject to no liens, encumbrances, security interests or mortgages, except for those obligations as described in Section 1.1(b) above. The legal and beneficial interests in the Assets are owned exclusively by Seller. 2.4 Brokers, Finders, etc. No broker, finder or other financial consultant has acted on behalf of Seller or its affiliates in connection with the transactions contemplated by this Agreement and all negotiations relative to this Agreement have been carried on directly without the intervention of any such third party. 3. REPRESENTATIONS AND WARRANTIES OF BUYER. 3.1 Corporate Status. Buyer is a corporation duly organized, validly existing and in good standing under the laws of the State of Texas. Buyer has full power and authority to execute and deliver the Agreement on Buyer's behalf, and to perform its obligations hereunder. 3.2 Authority for Agreement. Buyer has all necessary power and authority to execute and deliver this Agreement and to carry out its obligations hereunder. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of Buyer. No notice, consent, approval, order or authorization of, or registration, declaration or filing with, any person or entities, or with any governmental authority is required in connection with the execution and delivery of this Agreement or the consummation by Seller of the transactions contemplated hereby or thereby. 3.3 Brokers, Finders, etc. No broker, finder or other financial consultant has acted on behalf of Buyer or its affiliates in connection with the transactions contemplated by this Agreement and all negotiations relative to this Agreement have been carried on directly without the intervention of any such third party. ASSET PURCHASE AGREEMENT - Page 3 4 4. INDEMNIFICATION. 4.1 Indemnification. (a) Seller covenants and agrees to indemnify and hold Buyer harmless from and against any and all losses, liabilities, damages, demands, claims, suits, actions, judgments or causes of action, assessments, costs and expenses, including, without limitation, interest, penalties, attorneys' fees, any and all expenses incurred in investigating, preparing or defending against any litigation, commenced or threatened, in writing or any other claim, and any and all amounts paid in settlement of any claim asserted in writing or litigation, asserted against, resulting to, imposed upon, or incurred or suffered by Buyer, directly or indirectly, as a result of or arising from the operation of the Business prior to the Closing Date and during the "Transitional Period" ("Transitional Period" is defined as the period between closing date and cessation of Seller's duties assumed under paragraph 5.3), other than as otherwise contemplated herein. (b) Buyer covenants and agrees to indemnify and hold Seller harmless from and against any and all losses, liabilities, damages, demands, claims, suits, actions, judgments or causes of action, assessments, costs and expenses, including, without limitation, interest, penalties, attorneys' fees, any and all expenses incurred in investigating, preparing or defending against any litigation, commenced or threatened, in writing or any other claim, and any and all amounts paid in settlement of any claim asserted in writing or litigation, asserted against, resulting to, imposed upon, or incurred or suffered by Seller, directly or indirectly, as a result of or arising from the operation of the Business from and after the Closing Date, other than as otherwise contemplated herein. 5. POST CLOSING COVENANTS. 5.1 Covenant Not to Compete. In exchange for the representations and warranties and fulfillment of the agreements contained herein by Buyer, Seller and each of its principals severally agrees not to compete, either directly or indirectly, as an officer, director, employee, partner, consultant or shareholder, for a period of three (3) years commencing with the Closing Date in the Territory, in any internet access endeavor which is in competition with the Business. For purposes of this Section 5.1, the term "Territory" shall mean any area where Buyer has a local point-of-presence (defined as equipment installed to cover a particular geographical area). Additionally, Seller agrees during the one year period following the Closing Date to forward any and all sales leads generated from the Territory to Buyer. 5.2 Utilities. Seller will transfer all utilities servicing the Business, including telephones, water and power to Buyer on or prior to closing date. 5.3 Consulting Fees. Buyer agrees to pay Seller a fee in the amount of $3,500.00 per month, payable on the first day of the month, for services consisting of continuation of billing, collection, and operating activities during the Transitional Period. Seller or Buyer may cancel these consulting services with seven days notice before the start of any month. ASSET PURCHASE AGREEMENT - Page 4 5 6. MISCELLANEOUS PROVISIONS. 6.1 Entire Agreement. This Agreement, together with all the schedules and exhibits hereto, constitutes the entire agreement among the parties hereto pertaining to the subject matter hereof and supersedes all prior and contemporaneous agreements,. understandings, negotiations and discussions, whether oral or written, of the parties, and there are no warranties, representations or other agreements between the parties in connection with the subject matter hereof except as specifically set forth herein. 6.2 Amendment. This Agreement may be amended by the parties hereto at any time, but only by an instrument in writing duly executed and delivered on behalf of each of the parties hereto. 6.3 Headings. The section headings are not to be considered part of this Agreement and are included solely for convenience and are not intended to be full or accurate descriptions of the contents thereof. References to Sections are to portions of this Agreement unless the context requires otherwise. 6.4 Exhibits, etc. Exhibits and schedules referred to in this Agreement are an integral part of and are incorporated in this Agreement by reference. 6.5 Assignment; Successors and Assigns. All of the terms and provisions of this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective transferees, successors and assigns. 6.6 Notices. All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered or sent Federal Express or other reputable overnight courier, postage prepaid or by certified mail, return receipt requested: (a) if to the Seller: WEBSTAR, INC. P.O. Box 505 Savoy, TX 75479 (b) if to Buyer: INTERNET AMERICA, INC. One Dallas Centre 350 N. St. Paul Street, Suite 200 Dallas, Texas 75201 6.7 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. ASSET PURCHASE AGREEMENT - Page 5 6 6.8 Severability. The provisions of this Agreement are severable, and in the event that any one or more provisions are deemed illegal or unenforceable, the remaining provisions shall remain in full force and effect. 6.9 Counterparts. This Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereby have duly executed this Agreement as of the day and year first above written. INTERNET AMERICA, INC. a Texas corporation By: /s/ MICHAEL MAY -------------------------------- Its: SR VP ------------------------------- WEBSTAR, INC. a Texas corporation By: /s/ WALT HARRIS -------------------------------- Its: President ------------------------------- Executed by the undersigned as of the day and year first above written to reflect the undersigned's agreement to the provisions of Section 5.1 hereof. /s/ Walt Harris - -------------------------------------- ----------------------------------- Signature Signature Walt Harris - -------------------------------------- ----------------------------------- Please Print Name Please Print Name ASSET PURCHASE AGREEMENT - Page 6 EX-10.3 9 ASSET PURCHASE AGREEMENT DATED 11/26/97 1 EXHIBIT 10.3 ASSET PURCHASE AGREEMENT This ASSET PURCHASE AGREEMENT (the "Agreement") is entered into effective this 26th day of November, 1997 by and between WHY? TELECOMMUNICATIONS, INC., a Texas corporation ("Seller"), and INTERNET AMERICA, INC., a Texas corporation ("Buyer"). W I T N E S S E T H: WHEREAS, Seller is in the business of providing internet access services to its customers (the "Business"); and WHEREAS, the parties hereto desire to enter into this Agreement for the purchase of the Business and to establish the parties ongoing business relationship regarding other matters; and WHEREAS, certain defined terms as utilized in this Agreement are set forth in Article 7 of this Agreement and such terms shall have the meanings set forth therein; NOW, THEREFORE, for and in consideration of the mutual understandings, promises and covenants contained herein (including the recitals set forth above), the parties hereto agree as follows: 1. TERMS OF PURCHASE AND SALE; CLOSING. 1.1 Purchase and Sale of Certain Assets of the Seller. Upon the basis of the representations and warranties and subject to the terms and conditions of this Agreement, Buyer agrees to purchase and acquire from Seller, and Seller agrees to sell, convey, transfer, assign, and deliver to Buyer, on or before the Closing Date (as defined in Section 1.6 hereto) the Assets, free and clear of any pledge, lien, claim or other encumbrance of any kind whatsoever, against receipt on the Closing Date and thereafter of the Purchase Price as specified in Section 1.3 hereof. The term "Assets" shall mean: ASSET PURCHASE AGREEMENT - Page 1 2 (a) all of Seller's right, title and interest in and to the list of its Subscribers including all pertinent customer information for each Subscriber and all pertinent credit and/or other billing information for each Subscriber and the expiration date of each Subscriber's service agreement; (b) all of Seller's right, title and interest in and to all service agreements for each Subscriber relating to the provision of internet access services; and (c) all related goodwill with regard to any of the foregoing. 1.2 Excluded Assets. Buyer shall not purchase from Seller, and Seller shall not sell to Buyer, any assets which are not described on Section 1.1 (the "Excluded Assets"). 1.3 Purchase Price. The purchase price (the "Purchase Price") for the Assets shall be calculated and paid as follows: (a) on the Closing Date, Buyer will pay to Seller an advance (the "Advance") of $50,000 which shall be credited against the first amounts due to Seller representing Adjusted Monthly Payments; and (b) on the tenth day of each month following the calculation of any Adjusted Monthly Payment, Buyer will pay to Seller seventy five percent (75%) of the Adjusted Monthly Payment then due after deduction of any amount of the Advance not previously deducted. The parties recognize that the calculation of Adjusted Monthly Payments shall be cumulative so that, in the event the calculation of the Adjusted Monthly Payment for any month is negative, no amounts shall be due for the following months until the cumulative amounts (including such negative amount) shall be positive and then only up to such positive amount; ASSET PURCHASE AGREEMENT - Page 2 3 (c) in addition to the Adjusted Monthly Payment, on the tenth day of each month following the calculation of the Bonus Amount, Buyer will pay to Seller seventy-five percent (75%) of the Bonus Amount then due after deduction of any amount of the Advance not previously deducted against the Adjusted Monthly Payment contemplated in Section 1.3(b), above. The parties shall treat payments of Bonus Amounts on a cumulative basis in the same fashion as the Adjusted Monthly Payments; and (d) on January 10, 1999 Buyer shall pay to Seller an amount not to exceed the cumulative Adjusted Monthly Payments and Bonus Amounts previously withheld from Seller less the Advance and all Adjusted Monthly Payments and Bonus Amounts actually paid. On or before the tenth day of each month during which any payments under this Agreement may be due and payable, Buyer shall provide Seller a written calculation of all Accepted Subscribers and Rejected Subscribers for the immediately preceding calendar month. Seller shall have the right to inspect such books and records of Buyer, not more often than once every three months, upon reasonable notice to the Buyer and during the normal business hours of the Buyer, in order to allow Seller to audit the calculations made by Buyer under this Section 1.3. 1.4 Liabilities Assumed. In exchange for the Payment Credit Buyer agrees to provide the Buyer's standard internet access services to the Subscribers for the balance of their original prepaid service agreement provided (i) no such service agreement shall have a term in excess of twelve (12) months from the date of this Agreement and (ii) each Subscriber complies with the acceptable use policies of Buyer. Buyer does not assume any other obligation or liability of Seller including, but not limited to, any obligation of Seller to maintain web pages for any Subscriber ASSET PURCHASE AGREEMENT - Page 3 4 or the obligation of Seller to provide any refunds, rebates, commissions, fees or payments to any Subscriber of other Person, all of which shall remain with Seller. 1.5 Instruments of Transfer and Conveyance. (a) The sale, conveyance, transfer, assignment and delivery of the Assets, as herein provided, shall be effected by delivery by Seller on the Closing Date of such bills of sale, endorsements, assignments, certificates, drafts, checks or other instruments of transfer and conveyance as Buyer shall reasonably deem necessary to vest in Buyer good and marketable title to the Assets. Such instruments of transfer and conveyance shall contain warranties as to marketable title and that such Assets are free and clear of all pledges, liens, options, security interests, mortgages, claims, charges or other encumbrances of any kind whatsoever. (b) Seller agrees that it will from time to time after the Closing Date, upon the request of Buyer, promptly do, execute, acknowledge and deliver, and will cause to be done, executed, acknowledged and delivered, all such further instruments, certificates, assignments, transfers, conveyances, powers of attorney, assurances and other documents, as may be reasonably necessary or advisable to assure or confirm Buyer's free and clear title to and interest in, or to enable Buyer to deal with and dispose of, any of the Assets. (c) Seller agrees to provide, and continue paying all monthly amounts relating to, and make available to Buyer, all telecommunication charges relating to Seller's Dallas Dial-Up, Ft. Worth Dial-Up and Business Line Services through December 8, 1997 and thereafter until December 31, 1997 Seller agrees to use its best efforts to maintain such lines in service. ASSET PURCHASE AGREEMENT - Page 4 5 1.6 Closing. The closing hereunder (the "Closing") shall be held at the offices of Buyer as of the effective date of this Agreement, or at such other time and place as the parties may agree upon (the "Closing Date"). At the Closing: (a) Seller will execute and deliver to Buyer the following: a General Bill of Sale and Conveyance in the form acceptable to Buyer and such other instruments of transfer and conveyance as are required pursuant to Section 1.5 above; (b) Buyer will execute and deliver to Seller an Assumption of Liabilities relating to the liabilities set forth in Section 1.4 above; and (c) Each party will execute and deliver to the others such other agreements, certificates, assignments, consents and other documents as are required or specified in this Agreement or as may reasonably be requested by the other party to evidence compliance with the terms hereof. Simultaneously with the deliveries contemplated herein, Seller will use its best efforts and take all such other action as may be reasonably necessary to put Buyer in possession and control of the Assets. 1.7 License. In addition to the Assets purchased hereunder, Seller hereby grants to Seller a one-year, paid-up, nontransferable, exclusive license to use Seller's domain name "Why.net." Following the expiration of one-year, all right, title and interest in and to such domain name shall revert back to Seller without further action by either party hereto. 2. REPRESENTATIONS AND WARRANTIES OF SELLER. Seller represents and warrants to Buyer as follows: ASSET PURCHASE AGREEMENT - Page 5 6 2.1 Corporate Status. Seller is a corporation duly organized, validly existing and in good standing under the laws of Texas and has all necessary corporate power and authority to carry on its business as now conducted and to own or lease and operate its properties, and to execute, deliver and perform its obligations hereunder. 2.2 Authority for Agreement. This Agreement constitutes the valid and legally binding obligation of Seller and the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary action on the part of the board of directors (listed on Schedule 2.2) and all shareholders (listed on Schedule 2.2) of Seller, will not conflict with or result in any violation of, or default under, any provisions of the charter or bylaws of Seller, will not conflict with or result in any violation of, or default with respect to, any mortgage, indenture, lease, agreement or other instrument affecting the Assets, or to which Seller or its affiliates is a party, or by which Seller or its affiliates is bound and will not require the consent or approval or notice to any Person or any governmental agency. 2.3 Properties. Seller has good, valid and marketable title to the Assets subject to no liens, encumbrances, security interests or mortgages whatsoever. The legal and beneficial interests in the Assets are owned exclusively by Seller. 2.4 Taxes. Seller has paid all federal, state and local income, sales, use, value-added, payroll, franchise and withholding taxes due and owing as a result of the operation of the Business prior to the Closing. 2.5 Litigation. There is no pending or threatened litigation or governmental or administrative proceeding to which the Seller is a party or by which the Business or the Assets may be adversely affected. ASSET PURCHASE AGREEMENT - Page 6 7 2.6 Brokers, Finders, etc. No broker, finder or other financial consultant has acted on behalf of Seller or its affiliates in connection with the transactions contemplated by this Agreement and all negotiations relative to this Agreement have been carried on directly without the intervention of any such third party. 3. REPRESENTATIONS AND WARRANTIES OF BUYER. 3.1 Corporate Status. Buyer is a corporation duly organized, validly existing and in good standing under the laws of the State of Texas. Buyer has full power and authority to execute and deliver this Agreement on Buyer's behalf, and to perform its obligations hereunder. 3.2 Authority for Agreement. Buyer has all necessary power and authority to execute and deliver this Agreement and to carry out its obligations hereunder. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of Buyer. No notice, consent, approval, order or authorization of, or registration, declaration or filing with, any person or entities, or with any governmental authority is required in connection with the execution and delivery of this Agreement or the consummation by Buyer of the transactions contemplated hereby or thereby. 3.3 Brokers, Finders, etc. No broker, finder or other financial consultant has acted on behalf of Buyer or its affiliates in connection with the transactions contemplated by this Agreement and all negotiations relative to this Agreement have been carried on directly without the intervention of any such third party. 4. INDEMNIFICATION. 4.1 Indemnification. Seller covenants and agrees to indemnify and hold Buyer harmless from and against any and all losses, liabilities, damages, demands, claims, suits, actions, ASSET PURCHASE AGREEMENT - Page 7 8 judgments or causes of action, assessments, costs and expenses, including, without limitation, interest, penalties, attorneys' fees, any and all expenses incurred in investigating, preparing or defending against any litigation, commenced or threatened, in writing or any other claim, and any and all amounts paid in settlement of any claim asserted in writing or litigation (each a "Loss") asserted against, resulting to, imposed upon, or incurred or suffered by Buyer, directly or indirectly, as a result of or arising from the operation of the Seller or Business prior to the Closing Date, other than as otherwise contemplated herein. To the extent Buyer suffers any Loss under this Section 4.1(a), or has identified a loss but has not quantified the dollar value thereof, Buyer may withhold and off-set any payments due to Seller under this Agreement to compensate (to the extent of any such payment due) Seller for any such Loss. 5. POST CLOSING COVENANTS. 5.1 Covenant Not to Compete. In exchange for the representations and warranties and fulfillment of the agreements contained herein by Buyer, Seller, and by their signature hereto each of Sellers' shareholders, directors and officers agrees not to compete, either directly or indirectly, for a period of one (1) year commencing with the Closing Date in the Territory, in any endeavor competitive with the Business. For purposes of this Section 5.1 the term "Territory" shall mean the State of Texas. Additionally, Seller agrees during the one year period following the Closing Date to forward any and all sales leads for the provision of consumer dial-up and dedicated internet access services generated from the Territory to Buyer. 6. MISCELLANEOUS PROVISIONS. 6.1 Entire Agreement. This Agreement, together with all the schedules and exhibits hereto, constitutes the entire agreement among the parties hereto pertaining to the subject matter ASSET PURCHASE AGREEMENT - Page 8 9 hereof and supersedes all prior and contemporaneous agreements, understandings, negotiations and discussions, whether oral or written, of the parties, and there are no warranties, representations or other agreements between the parties in connection with the subject matter hereof except as specifically set forth herein. 6.2 Amendment. This Agreement may be amended by the parties hereto at any time, but only by an instrument in writing duly executed and delivered on behalf of each of the parties hereto. 6.3 Headings. The section headings are not to be considered part of this Agreement and are included solely for convenience and are not intended to be full or accurate descriptions of the contents thereof. References to Sections are to portions of this Agreement unless the context requires otherwise. 6.4 Exhibits, etc. Exhibits and schedules referred to in this Agreement are an integral part of and are incorporated in this Agreement by reference. 6.5 Assignment; Successors and Assigns. All of the terms and provisions of this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective transferees, successors and assigns. 6.6 Notices. All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered or sent Federal Express or other reputable overnight courier, postage prepaid or by certified mail, return receipt requested: (a) if to the Seller: 201 E. Abram, Suite 640 Arlington, Texas 76010 Attn: President ASSET PURCHASE AGREEMENT - Page 9 10 (b) if to the Buyer: One Dallas Center 350 N. St. Paul Street, Suite 200 Dallas, Texas 75201 Attn: President 6.7 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. 6.8 Severability. The provisions of this Agreement are severable, and in the event that any one or more provisions are deemed illegal or unenforceable, the remaining provisions shall remain in full force and effect. 6.9 Counterparts. This Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 6.10 Publicity and Disclosures. Seller and its officers and directors agree not to issue or cause the publication of any press release or other announcement with respect to this Agreement or the other transactions contemplated hereby without the prior written consent of Buyer except to the extent disclosure by Seller is required by any applicable law or regulation, by an authorized administrative or governmental agency. 7. DEFINITIONS. The following capitalized terms as used in this Agreement shall have the following meanings: 7.1 "Accepted Subscriber" shall mean a Subscriber who purchases internet access services from Buyer pursuant to one of Buyer's standard internet access service offerings on or before the calendar month during which such Subscriber's original prepaid service agreement with Seller shall expire. ASSET PURCHASE AGREEMENT - Page 10 11 7.2 "Adjusted Monthly Payment" shall mean an amount for each calendar month following the Closing equal to the Unadjusted Monthly Payment less an amount equal to $100 multiplied by the Rejected Subscribers for such month. The Adjusted Monthly Payment may be a negative number. 7.3 "Base Price" means an amount equal to (i) the Subscribers Transferred multiplied by $100 less (ii) $350,000 (the "Payment Credit"). 7.4 "Bonus Amount" means an amount calculated each month equal to $20 multiplied by that number of Accepted Subscribers in excess of fifty percent (50%) of the Subscribers whose original prepaid service agreement expired during such month. 7.5 "Person" means an individual, corporation, partnership, trust, joint venture or other legal entity. 7.6 "Per Subscriber Price" means an amount equal to the Base Price divided by the number of Subscribers Transferred. 7.7 "Rejected Subscriber" shall mean a Subscriber who does not purchase internet access services from Buyer pursuant to one of Buyer's standard internet access service offerings before the expiration of calendar month during which such Subscriber's original prepaid service agreement with Seller shall expire. 7.8 "Subscriber" shall mean a Person to whom Seller provides internet access services prior to the date of this Agreement pursuant to a prepaid service agreement with a term not to exceed twelve (12) months from the initiating date of such services. 7.9 "Subscribers Transferred" means 8,213 Subscribers who are given notice by Seller to commence utilizing the internet access services of Buyer pursuant to a transfer notice posted by Seller to the Subscribers prior to the date of this Agreement. 7.10 "Unadjusted Monthly Payment" shall mean an amount calculated each calendar month following the effective date of this Agreement equal to the number of Subscribers whose ASSET PURCHASE AGREEMENT - Page 11 12 original prepaid service agreement with Seller shall expire during such month multiplied by the Per Subscriber Price. The parties acknowledge that each Subscriber may only be counted once for purposes of this calculation, and that Subscribers whose original prepaid service agreement with Seller extends beyond twelve (12) months from the effective date of this Agreement shall not be counted. IN WITNESS WHEREOF, the parties hereby have duly executed this Agreement as of the day and year first above written. WHY? TELECOMMUNICATIONS, INC. a Texas corporation By: /s/ MARK WRIGHT ---------------------------------- Its: President ---------------------------------- INTERNET AMERICA, INC. a Texas corporation By: /s/ MIKE MAPLES ---------------------------------- Its: CEO ---------------------------------- By their signature hereto each of the following agree to be individually bound by the provisions of Section 5.1 and 6.10 of this Agreement. /s/ RUSSELL B. WRIGHT ---------------------------------- Russell B. Wright /s/ MARK C. WRIGHT ---------------------------------- Mark C. Wright ASSET PURCHASE AGREEMENT - Page 12 EX-10.4 10 NETWORK SERVICES AGREEMENT DATED 8/25/97 1 EXHIBIT 10.4 GOLDEN HARBOR OF TEXAS, INC. NETWORK SERVICES AGREEMENT This Network Services Agreement (this "Agreement") is made as of August 25, 1997 by and between Golden Harbor of Texas, Inc., a Texas corporation with principal offices at 401 Carlson Circle, San Marcos, Texas 78666 ("Golden Harbor"), and Internet America, Inc., a Texas corporation with principal offices at One Dallas Centre, 350 N. St. Paul, Suite 200, Dallas, Texas 75201 ("Customer"). Golden Harbor offers local telephone and Internet access network services (collectively, the "Available Services") to its customers. The Available Services are described more particularly in the Service Description which is attached hereto and incorporated herein by reference as Schedule 1. Golden Harbor agrees to provide and Customer agrees to purchase one or more of the Available Services (the "Services") as set forth on the attached service orders from the originating areas identified on the attached service orders. During the term of this Agreement, Customer and Golden Harbor may agree to the purchase and provision of additional Available Services by attaching to this Agreement additional service orders specifying such services and executed by both parties. As part of a promotional offer of a new service offering, Golden Harbor and Customer have agreed that because Customer may experience some inconveniences due to Golden Harbor's initial facility limitations from the local exchange companies and because Customer will be assisting in testing Golden Harbor's network, the charges for services used by Customer will accrue but not be due and payable until after a certain transition period. 1. TERM OF SERVICES. (A) Term. This Agreement shall be effective as of the date first above written and shall continue through December 31, 1998 (the "initial term"). Upon the expiration of the initial term, this Agreement shall automatically renew for successive one year terms under the same terms and conditions except that there shall be no "Transition Period" as described in Subsection 1(D) and no provisions for delayed billing with respect thereto for any subsequent renewal term, subject to termination by either party upon written notice to the other party at least 60 days prior to the expiration of the initial term or applicable subsequent renewal term (such initial term and any subsequent renewal term shall be the "Term"). Customer shall be liable for all charges associated with the usage of the Services during the Term. (B) Service Order. The Service Orders executed by both parties and attached as Exhibits hereto are incorporated herein by reference (the "Service Orders"). The Service Orders set forth the charges for the Services due under this Agreement, the originating areas from which the Services are available, and other pertinent information. EXECUTION COPY 2 (C) Start of Service. Golden Harbor's obligation to provide and Customer's obligation to accept and pay for non-usage sensitive charges for Services shall be binding to the extent provided for in this Agreement or the fully executed Service Orders. Customer's obligation to pay for usage sensitive, user sensitive or other variable recurring charges for a Service and the billing for such charges shall commence, after such Service is made available to Customer, on the date ("Start of Service") that is the earlier of (i) the "Requested Service Date" set forth in the applicable Service Order, or (ii) the date such Service is accepted by Customer. (D) Transition Period. Commencing on September 1, 1997 (the "Commencement Date"), Golden Harbor and Customer shall begin transferring Customer's customers to Golden Harbor's network. The transfer of Customer's customers will be phased in as Golden Harbor is able to obtain the necessary facilities from the appropriate local exchange company. For purposes of this Agreement, the "Transition Period" shall mean the period from and including the Commencement Date through the Cutover Date (as defined in Subsection 3(E)). (E) Service Area. As Golden Harbor obtains the necessary network facilities, the Services shall be provided to Customer in the Originating Areas identified on the Service Orders. 2. CANCELLATION. (A) Cancellation Charge. After a Service Order is accepted by Golden Harbor, Customer may cancel all or a portion of the Services described therein during the initial term if Customer provides written notification thereof to Golden Harbor at least 30 days prior to the effective date of cancellation. In the event that such cancellation occurs during the initial term but after the Transition Period, Customer shall pay to Golden Harbor all charges for Services provided through the effective date of such cancellation plus a cancellation charge equal to the number of months remaining in the initial term after the effective date of such cancellation, multiplied by either (i) $30,000, if, after such cancellation is effective, Customer does not maintain the "Minimum Requirement" (as defined in Subsection 3(E) hereof), dedicated for Customer dial-up access Internet products; or (ii) 50% of the average charges for the canceled Services, if, after such cancellation is effective, Customer continues to maintain the Minimum Requirement. In the event that such cancellation occurs during the Transition Period, Customer shall pay to Golden Harbor all charges for Services provided through the effective date of such cancellation plus a cancellation charge equal to: (i) the number of months remaining in the initial term after the effective date of such cancellation, multiplied by (ii) the amount equal to the accrued charges for Services for the month in the Transition Period that had the highest usage of Services. In the event that such cancellation occurs during a renewal term, Customer must provide at least 90 days prior written notice of cancellation, and Customer and Golden Harbor shall mutually agree as to the cancellation charges that will apply. (B) Liquidated Damages. It is agreed that Golden Harbor's damages in the event Customer cancels any Service shall be difficult or impossible to ascertain. The provision for a cancellation charge in Subsection 2(A) and for additional charges in Subsection 2(C) is intended, 2 3 therefore, to establish liquidated damages in the event of a cancellation and is not intended as a penalty. (C) Additional Charges. In the event of any cancellation described in Subsection 2(A), Customer shall also pay Golden Harbor an amount equal to any termination charges, expenses, fees or penalties incurred by Golden Harbor from any third party for reducing the number or size of network facilities that connect the premises of Golden Harbor and Customer as a result of such cancellation: 3. CUSTOMER'S RESPONSIBILITIES (A) Expedite Charges. In the event Customer requests expeditious Service and/or changes to Service Orders and Golden Harbor agrees to such request, Golden Harbor will pass through the charges assessed by any suppliers or providers involved at the same rate to Customer. Golden Harbor may further condition its performance of such request upon Customer's payment of additional charges to Golden Harbor. (B) Preparation; Customer Facilities. (1) In conformity with each Service Order, Customer shall, at its own expense: (i) provide all necessary preparations required to comply with Golden Harbor's installation and maintenance specifications; (ii) be responsible for the costs of relocation of Service once installed by Golden Harbor, and (iii) provide to Golden Harbor and its contractors, agents and their respective employees and the suppliers of communications lines reasonable access to Customer's premises to perform any acts required by this Agreement. Customer has the sole responsibility for installation, testing and operation of facilities, services, hardware, equipment and software other than that specifically provided by Golden Harbor as part of the Services described in a Service Order (such facilities, services, hardware, equipment and software are "Customer Facilities"). In no event will the untimely installation or non-operation of Customer Facilities (including local access when Customer is responsible therefor and Customer premises equipment) relieve Customer of its obligation to pay charges for the Services as of Start of Service. (2) Golden Harbor shall not be responsible for the installation, operation, maintenance or repair of Customer Facilities; nor shall Golden Harbor be responsible for the transmission or reception of information by the Customer Facilities. (3) Customer shall be responsible for the use and compatibility of all Customer Facilities. In the event that Customer uses Customer Facilities that impair Customer's use of the Services, Customer shall nonetheless be liable for payment for the Services. Upon notice from Golden Harbor that Customer Facilities are causing or are likely to cause hazard, interference or service obstruction, Customer shall eliminate the likelihood of hazard, interference or service obstruction. Customer shall, if necessary and if Golden Harbor agrees to perform such troubleshooting, pay Golden Harbor to troubleshoot difficulties caused by Customer Facilities at 3 4 a rate of: $75.00 per hour with a one hour minimum between 8:00 a.m. and 5:00 p.m. on weekdays that are not holidays observed by national banking associations in San Marcos, Texas; and $90.00 per hour with a two hour minimum between 5:01 p.m. and 7:59 a.m. on weekdays and at any time on weekends and holidays. (4) Golden Harbor shall not be responsible if any changes in the Services cause Customer Facilities to become obsolete, require modification or alteration, or otherwise affect performance of equipment or hardware not provided by Golden Harbor. (C) Use of Services. If any "Service Abuse" (as defined below) occurs, Golden Harbor may send Customer a written notice of Service Abuse (an "Abuse Notice"). From the date of the Abuse Notice, Customer shall have a cure period of six business days within which to terminate the Service Abuse. If Customer fails to terminate such Service Abuse within the cure period or fails to take appropriate action to prevent any similar Service Abuse from occurring from the same source within the cure period, then Golden Harbor may, at its option and in addition to all other rights or remedies that Golden Harbor may have under this Agreement at law, or in equity (i) terminate this Agreement or (ii) suspend all or any portion of the Services until such time as the Service Abuse is terminated and Customer has taken appropriate action to prevent any similar Service Abuse from occurring from the same source, provided that Golden Harbor shall not be precluded from terminating this Agreement at any time after suspending service if the appropriate cure and assurance is not made by the date of termination. If Golden Harbor elects to terminate this Agreement under this Section, such termination shall be effective on the date the cure period expires. In the event of such termination, Customer shall not be relieved of its obligations to pay Golden Harbor the applicable cancellation and other charges described in Section 2. Notwithstanding the foregoing, upon Customer's receipt of any oral or written notice of a Service Abuse, Customer shall immediately take all diligent actions to terminate the Service Abuse and, if possible, in a shorter time period than six business days. If Customer provides Golden Harbor with sufficient evidence of a valid and effective order from a court with proper jurisdiction that requires Customer, for purposes of a pending law enforcement investigation, to continue providing service that may constitute a Service Abuse or Material Service Abuse, Golden Harbor shall not suspend Service or terminate this Agreement under this Section solely due to such Service Abuse or Material Service Abuse (if Golden Harbor's Service is a necessary component for Customer to be able to comply with such order) until such order or investigation terminates or is no longer in effect. Notwithstanding anything in this Agreement to the contrary, if Golden Harbor has a reasonable basis for believing that a "Material Service Abuse" (as defined below) has occurred and is continuing or there is a reasonable likelihood that a similar Material Service Abuse will occur, then, without notice or an opportunity to cure, Golden Harbor may terminate this Agreement and/or deny Customer access to all or part of the Services. In the event of such termination of this Agreement, Customer shall not be relieved of its obligations to pay Golden Harbor the applicable cancellation and other charges described in Section 2. If Golden Harbor denies Customer access to the Services because of such a Material Service Abuse, neither Customer nor 4 5 Customer's customers or authorized users shall have any right (i) to access the Services, (ii) to access through Golden Harbor any materials stored on the Internet, (iii) to obtain any credit(s) otherwise due to Customer, or (iv) to access third party services, merchandise or information on the Internet through Golden Harbor or the Services, and Golden Harbor shall have no responsibility to notify any third-party providers of services, merchandise or information of such denial of access nor any responsibility for any consequences resulting from lack of notification. For purposes of this Agreement a "Service Abuse" shall mean that Customer or any of its customers or authorized users or any other person: (i) abuses or fraudulently uses any Service in any way, or (ii) uses any Service in violation of the law or in aid of any unlawful act or uses any Service in any way that would constitute a criminal offense, give rise to civil liability, violate a copyright or other proprietary right or otherwise violate any local, state, national or international law or regulation. For purposes of this Agreement, a "Material Service Abuse" means a Service Abuse that (i) may have a material adverse effect on Golden Harbor or any of its customers, (ii) may give rise to a danger or harm to the public, or (iii) is related to an investigation, injunction or order of any court, agency or federal, state or local government. Upon the occurrence of any Service Abuse, Golden Harbor shall be completely released from any liability arising out of or relating to any Service Abuse and Customer shall be liable to Golden Harbor for all costs and damages incurred by Golden Harbor resulting therefrom. (D) Billing and User ID/Password Policy. Customer agrees to comply with, if applicable, Golden Harbor's Billing and User ID/Password Policy, a copy of which is attached hereto as Schedule 2 and is incorporated herein by reference. Customer agrees that Golden Harbor may, at its sole discretion, modify such policy as necessary or desirable, with notice to Customer. (E) Minimum Requirement. Customer shall maintain and pay Golden Harbor the charges related to the Minimum Requirement through the Term from the date (the "Cutover Date") that is the later of (i) November 30, 1997 or (ii) the date that Golden Harbor has the facilities available to provide the Services to Customer's customers with an aggregate amount of at least 30,000 User/IDs. For purposes of this Agreement, the "Minimum Requirement" shall mean Customer's customers with an aggregate amount of at least 30,000 User IDs that obtain Internet access through at least 40 Golden Harbor Ascend Max 4004s that are dedicated for Customer's dial-up access Internet products. For purposes of this Agreement and the Service Orders, an "Ascend Max 4004" shall mean an Ascend Max 4004 or another communications access server. If Customer requests that Golden Harbor provide Services in excess of the Minimum Requirement, Golden Harbor will make available to Customer additional Ascend Max 4004s, as Golden Harbor acquires such equipment, provided that Golden Harbor is able to obtain the local exchange company facilities that are necessary to deliver the Services. 5 6 (F) Use of Golden Harbor's NXXs. For the use of the Services, Customer shall use Golden Harbor's NXXs and the local telephone numbers that Golden Harbor assigns to Customer. Customer agrees to: (i) have Customer's customers dial any applicable local telephone number that Golden Harbor assigns to Customer for dial-up access and/or (ii) forward to Golden Harbor Customer's telephone numbers that are used for dial-up access to the Internet. (G) Transfer; Forecasts. Customer shall coordinate with Golden Harbor in the orderly transfer of Customer's customers to the Golden Harbor network. Customer will provide reasonable notice to Golden Harbor of anticipated peak demands for Golden Harbor's facilities from the orderly transfer of Customer's customers during the Transition Period and any anticipated peak demands after the Transition Period. Notwithstanding anything in this Agreement to the contrary, Golden Harbor will not be responsible for any blockage or busy signal that occurs due to Customer's underestimation of the facility requirements during the Term. If Golden Harbor has facilities available, Golden Harbor will allocate additional Ascend Max 4004s to minimize the impact of blockage or busy signal that results from Customer's underestimation of the number of Ascend Max 4004s that are required at any time during the Term, provided that Customer consents to such additional allocation. In such event, Customer will be liable for any applicable monthly charges for each Ascend Max 4004 added by Golden Harbor to minimize the impact of such blockage. 4. CHARGES AND PAYMENT TERMS. (A) Invoices. Customer agrees to pay all charges incurred hereunder. All charges will be invoiced monthly and calculated according to the rates set forth in the applicable Service Order. Notwithstanding anything in this Section to the contrary, the charges for Services provided to Customer during the Transition Period will be accrued monthly and invoiced on or about December 5, 1997. All subsequent charges will be invoiced monthly. Customer acknowledges that the summary of the call detail on a Golden Harbor invoice may not be directly associated with calls completed in that month. During the Transition Period, Customer will incur accrued charges for each Ascend Max 4004 that is dedicated to Customer at any time during each month. For purposes of determining the number of Ascend Max 4004s dedicated to Customer during a given month, simultaneously dedicated Ascend Max 4004s will be counted. For example, if one Ascend Max 4004 is dedicated to Customer on September 1 and one Ascend Max 4004 is added on September 20, the accrued charges for September will be for two Ascend Max 4004s. After the Transition Period, the Minimum Requirement applies and Customer will be charged for at least a minimum of 40 Ascend Max 4004s per month. Charges for dedicated Ascend Max 4004s will be considered variable monthly recurring charges under the Billing and User ID/Password Policy. (B) Due Dates; Interest. All charges hereunder shall be due and payable by Customer to Golden Harbor by the date (the "Due Date") that is 30 days after the date of the invoice from Golden Harbor. Any amount due and payable to Golden Harbor by Customer hereunder, but not 6 7 received in Golden Harbor's office or as otherwise directed by Golden Harbor, on the Due Date specified above, will be deemed past due. Any past due amount is subject to a late charge in the amount of one and one-half percent (1.5%) per month, or the maximum rate allowable by applicable law, whichever is less, from the Due Date until payment is received by Golden Harbor. (C) Taxes. Customer acknowledges and understands that Golden Harbor computes all charges herein exclusive of any applicable federal, state or local use, excise, gross receipts, sales and privilege taxes, duties, fees or similar liabilities (other than general income or property taxes), whether charged to or against Golden Harbor or Customer because of Services furnished to Customer ("Additional Fees"). Customer shall pay such Additional Fees in addition to all other charges provided for herein. (D) Price Changes; Modification of Services. Golden Harbor reserves the right to eliminate Service offerings and/or modify charges or rates for Service offerings and/or to increase the charges or rates for any usage of Services other than the Minimum Requirement upon not less than 90 days prior notice to Customer, which notice will state the effective date for the charge, rate or Service modifications. Golden Harbor reserves the right to eliminate service offerings and/or modify charges or rates for service offerings and/or to increase the charges or rates for the Minimum Requirement, upon not less than 90 days prior notice to Customer, to be effective during any renewal term, which notice will state the effective date for the charge, rate or service modifications. In the event Golden Harbor notifies Customer of the elimination of a Service offering or an increase in the charges or rates for Service offerings, Customer may terminate the affected Service, without incurring a cancellation charge or other charge by notifying Golden Harbor, in writing, at least 30 days prior to the effective date of the increase in charges, subject to Golden Harbor's option of cancellation or termination under Subsection 5(C). (E) Billing Disputes. Late fees shall apply (but shall not be due and payable for a period of 60 days following the Due Date therefor) for amounts reasonably and in good faith disputed by Customer, provided Customer: (i) pays all undisputed charges on or before the Due Date; (ii) presents a written statement of any billing discrepancies to Golden Harbor in reasonable detail within 20 days after the Due Date of the invoice in question; and (iii) negotiates in good faith with Golden Harbor for the purpose of resolving the dispute within such 60 day period. In the event such dispute is resolved in favor of Golden Harbor, Customer agrees to pay Golden Harbor the disputed amounts together with any applicable late fees within five days of the resolution. In the event such dispute is resolved in favor of Customer, Customer shall receive a credit for the disputed charges in question and late fees applicable to such disputed charges. Each party shall use reasonable, good faith efforts to resolve any billing dispute. In the event the dispute is not resolved within such 60 day period, Customer shall pay Golden Harbor all disputed amounts together with applicable late fees immediately and in no event later than five days after the expiration of such 60 day period. The preceding sentence shall not be construed to prevent Customer from pursuing any available legal remedies. Golden Harbor shall not be obligated to consider any Customer notice of billing discrepancies that are received by Golden 7 8 Harbor more than 20 days after the Due Date of the invoice in question. Golden Harbor has no obligation to investigate discrepancies between invoices and reporting data provided where the discrepancy is ten percent (10%) or less. (F) Suspension of Service. If (i) payment in full is not received from Customer on or before 30 days following the Due Date with respect to undisputed amounts or on or before 60 days following the Due Date with respect to amounts reasonably disputed in accordance with the requirements of Subsection 4(E), (ii) Golden Harbor gives Customer six business days prior notice of suspension, and (iii) Customer fails to cure during the six business day period, then Golden Harbor shall have the right to suspend all or any portion of the Services until such time as Customer has paid in full all charges then due, including any late fees as specified herein. Following such payment, Golden Harbor shall be required to reinstitute Service to Customer only upon the provision by Customer of assurance satisfactory to Golden Harbor of Customer's ability to pay for Services (such as a deposit) and Customer's advance payment of the cost of reinstituting Services. If Customer fails to make such payment by a date determined by and acceptable to Golden Harbor, Customer will be deemed to have canceled the suspended Service effective the date of such suspension. Such cancellation shall not relieve Customer of its obligations to pay to Golden Harbor the applicable cancellation and additional charges described in Section 2. (G) In each month of the Term that Customer is in compliance with all of the terms and conditions of this Agreement, including without limitation the requirements set forth in Subsections 3(E) and 3(F), Golden Harbor shall waive the fees for that month for any Dedicated Local Service or Local Service Resale (as defined in Schedule 1) provided to Customer solely for administrative purposes at Customer's business offices located in Dallas, Texas. 5. TERMINATION OF AGREEMENT. (A) By Golden Harbor For Cause. In addition to Golden Harbor's right to terminate for cause as provided in Subsection 3(C), upon the expiration of the six business day cure period from the date of written notice to Customer of the occurrence of an Event of Default (as defined herein), Golden Harbor may, if such Event is not cured during such cure period, at Golden Harbor's option and in addition to such other rights or remedies as Golden Harbor may have under this Agreement, at law, or in equity: (i) suspend the Services to Customer until such time as such circumstance is corrected, provided Golden Harbor shall not be precluded from terminating this Agreement at any time after suspending Services if the appropriate cure has not been made by the date of termination; or (ii) terminate this Agreement. For purposes of this Agreement, an "Event of Default" shall mean that: (1) Customer breaches or violates any provision of this Agreement, including but not limited to the provisions regarding payment, the Minimum Requirement set forth in Subsection 3(E), and the use of NXX and telephone number requirement set forth in Subsection 3(F); or 8 9 (2) Customer breaches or violates any provision of any agreement between Customer and any entity controlling, controlled by or under common control with Golden Harbor; or (3) Customer files or initiates proceedings or has proceedings filed or initiated against it, relating to its liquidation, insolvency, reorganization or other relief (such as the appointment of a trustee, receiver, liquidator, custodian or other official) under any bankruptcy, insolvency or other similar law which remains undismissed for more than 30 days, or makes an assignment for the benefit of its creditors or enters into an agreement for the composition, extension or adjustment of its obligations in connection with the foregoing. With respect to an Event of Default described in the foregoing clause (1) or (2) and subject to the terms of Subsection 3(C), Golden Harbor shall not suspend Service and/or terminate the Agreement unless Customer fails to cure within the six business days after Customer's receipt of a notice of an Event of Default. With respect to an Event of Default described in the foregoing clause (3), Golden Harbor may terminate this Agreement or suspend Services without giving Customer any notice or any opportunity to cure. (B) By Golden Harbor Without Cause. Upon at least 90 days prior written notice to Customer, Golden Harbor may terminate this Agreement, in its sole discretion, for any reason or no reason. Such 90 days prior written notice shall not be required for termination under Subsection 5(A). (C) By Golden Harbor Upon Cancellation of Service by Customer. Notwithstanding anything in this Agreement to the contrary, if Customer cancels any Service hereunder for any reason other than for cause under Subsection 5(D) such that the Minimum Requirement is not maintained by Customer after such cancellation, Golden Harbor, in its sole discretion, may cancel any or all of the remaining Services or terminate this Agreement in its entirety immediately upon delivery of written notice of such cancellation to Customer. In the event of any such termination, Customer shall not be relieved of its obligations to pay the applicable cancellation charges under Section 2. (D) By Customer for Unsatisfactory Service. Network availability shall be maintained to published standards for telecommunications services, currently the P.01 standard average busy-hour grade of service as provided by the incumbent local exchange company. (Inbound grade of service is the responsibility of the incumbent local exchange company; Golden Harbor will coordinate with the incumbent local exchange company.) Quality of connection shall be maintained based on empirical comparisons to be performed jointly by Customer and Golden Harbor. Connection problems reported to Golden Harbor will be investigated expeditiously. Service affecting problems associated with the malfunction of Golden Harbor equipment will be resolved expeditiously. In the event that Golden Harbor fails to provide a P.01 level of service on Golden Harbor's circuits for local access arrangements under Golden Harbor's control or 9 10 otherwise fails to provide a competitive level of service as compared to data transmission rates (as of the date of this Agreement) of providers of services that are substantially similar to the Services, for any reason other than due to a Force Majeure Event (as defined in Section 10), for more than 30 days after Customer delivers written notice to Golden Harbor of the failure to provide such level of service, then Customer may terminate this Agreement upon delivery of written notice of termination to Golden Harbor, and in the event of such a termination, Customer shall have no obligation to pay any cancellation charge or other charge under Subsection 2(A) or 2(C). Customer's termination rights under this Subsection 5(D) shall not apply, however, in the event any failure to maintain the P.01 level or such other competitive level of service is caused or contributed to, directly or indirectly, by any act or omission of Customer or any of its customers, affiliates, agents, representatives, invitees or licensees. (E) By Successor or Assign Upon Change in Ownership and Control. Subject to the consent requirements set forth in Section 17 hereof, in the event of a transfer of substantially all of the assets of Customer (including without limitation this Agreement), Customer's permitted successor or assign shall have the right to provide Golden Harbor at least 180 days prior written notice of intent to terminate the Agreement. In the event of such termination, Customer's permitted successor or assign shall have no obligation to pay any cancellation charge or other charge under Subsection 2(A) or 2(C). Subject to the consent requirements set forth in Section 17 hereof, in the event of a transfer in ownership of 75% or more of the outstanding stock of Customer, Customer shall have the right to provide Golden Harbor at least 180 days prior written notice of intent to terminate the Agreement. In the event of such termination due to a transfer of at least 75% of the outstanding stock of Customer to a third party who is an affiliate, employee, shareholder, director, lender or lessor of Customer, Customer shall pay the applicable cancellation charges and other charges under Subsection 2(A) and 2(C). In the event of such termination due to a transfer of at least 75% of the outstanding stock of Customer to a third party who is not an affiliate, employee, shareholder, director, lender or lessor of Customer, Customer shall have no obligation to pay any cancellation charge or other charge under Subsection 2(A) or 2(C). (F) By Customer without Cause during Term. During a renewal term, Customer may terminate this Agreement, in its sole discretion, for any reason or no reason, provided that Customer delivers at least 90 days prior written notice of termination to Golden Harbor. 6. NETWORK TROUBLE RESOLUTION Golden Harbor will provide telephone numbers or pager numbers for Customer to reach a network technician for the purpose of reporting network trouble 24 hours per day, seven days per week. Network technicians are available for regular network trouble resolution status updates. Upon resolution of network trouble, a network technician will notify a Customer representative responsible for accepting such information. Customer realizes that one or more underlying networks may impair Golden Harbor's capability to synchronize its equipment with that of Customer. 10 11 7. CREDITWORTHINESS. If at any time there is a material adverse change in Customer's creditworthiness, then in addition to any other remedies available to Golden Harbor, Golden Harbor may elect, in its sole discretion, to exercise one or more of the following remedies: (i) cause Start of Service for Services described in a previously executed Service Order to be withheld; (ii) cease providing Services upon written notice of suspension with a six business day opportunity to cure; or (iii) decline to accept a Service Order or other requests from Customer to provide Services unless Customer gives an assurance of payment which shall be a deposit or such other means satisfactory to Golden Harbor to establish reasonable assurance of payment. A "material adverse change" in Customer's creditworthiness shall mean: (i) Customer's breach or default of its obligations to Golden Harbor or any of its affiliates under this or any other agreement with Golden Harbor; (ii) failure of Customer to make full payment of charges due hereunder or thereunder or before the Due Date on three or more occasions during any period of 12 or fewer months or Customer's failure to make such payment on or before the Due Date in any two consecutive months; (iii) acquisition of Customer (whether in whole or by majority or controlling interest) by an entity which is insolvent, which is subject to bankruptcy or insolvency proceedings, which owes past due amounts to Golden Harbor or any Golden Harbor affiliate or which is a greater credit risk than Customer; or (iv) Customer is subject to or has filed for bankruptcy or insolvency proceedings, and such proceedings continue undismissed or unstayed and in effect for a period of 60 days or Customer is insolvent. 8. DISCLAIMER OF WARRANTIES. (A) Customer understands that Customer and its customers or authorized users may access the Internet through the Services, if the attached Service Orders include Services that permit Internet access. Customer understands further that neither Golden Harbor nor any of its affiliates operates or controls the Internet in any way, and that all merchandise, information and services offered or made available or accessible on the Internet are offered or made available or accessible by third parties who are not affiliated with Golden Harbor or its affiliates. CUSTOMER ASSUMES TOTAL RESPONSIBILITY AND RISK FOR CUSTOMER'S USE AND FOR CUSTOMER'S CUSTOMERS' AND AUTHORIZED USERS' USE OF THE SERVICES AND THE INTERNET. NEITHER GOLDEN HARBOR NOR ITS AFFILIATES MAKE ANY EXPRESS OR IMPLIED WARRANTIES, REPRESENTATIONS OR ENDORSEMENTS WHATSOEVER (INCLUDING WITHOUT LIMITATION WARRANTIES OF TITLE OR NONINFRINGEMENT OR THE IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE) WITH REGARD TO ANY MERCHANDISE, INFORMATION OR SERVICE PROVIDED THROUGH THE SERVICES OR THE INTERNET, AND THEY SHALL NOT BE LIABLE FOR ANY COST OR DAMAGE ARISING EITHER DIRECTLY OR INDIRECTLY FROM ANY SUCH TRANSACTION. IT IS SOLELY CUSTOMER'S RESPONSIBILITY AND CUSTOMER'S CUSTOMERS' AND AUTHORIZED USERS' RESPONSIBILITY TO 11 12 EVALUATE THE ACCURACY, COMPLETENESS AND USEFULNESS OF ALL OPINIONS, ADVICE, SERVICES AND OTHER INFORMATION, AND THE QUALITY AND MERCHANTABILITY OF ALL MERCHANDISE, PROVIDED THROUGH THE SERVICES OR ON THE INTERNET GENERALLY. (B) CUSTOMER UNDERSTANDS FURTHER THAT THE INTERNET CONTAINS UNEDITED MATERIALS SOME OF WHICH ARE SEXUALLY EXPLICIT OR MAY BE OFFENSIVE TO SOME PEOPLE. CUSTOMER, CUSTOMER'S CUSTOMERS AND CUSTOMER'S AUTHORIZED USERS ACCESS SUCH MATERIALS AT CUSTOMER'S OWN RISK. GOLDEN HARBOR HAS NO CONTROL OVER AND ACCEPTS NO RESPONSIBILITY WHATSOEVER FOR SUCH MATERIALS. (C) ALL OF GOLDEN HARBOR'S SERVICES ARE PROVIDED ON AN "AS IS" AND "AS AVAILABLE" BASIS WITHOUT WARRANTIES OF ANY KIND, EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO WARRANTIES OF TITLE, NONINFRINGEMENT OR QUALITY OF SERVICE OR IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. NO ADVICE OR INFORMATION GIVEN BY GOLDEN HARBOR, ITS AFFILIATES OR ITS CONTRACTORS OR AGENTS OR ANY OF THEIR RESPECTIVE EMPLOYEES SHALL CREATE A WARRANTY. NEITHER GOLDEN HARBOR NOR ITS AFFILIATES WARRANTS THAT ANY OF THE SERVICES WILL BE UNINTERRUPTED OR ERROR FREE OR THAT ANY INFORMATION, SOFTWARE OR OTHER MATERIAL ACCESSIBLE ON THE SERVICES IS FREE OF VIRUSES, WORMS, TROJAN HORSES OR OTHER HARMFUL COMPONENTS. (D) UNDER NO CIRCUMSTANCES SHALL GOLDEN HARBOR, ITS AFFILIATES OR ITS CONTRACTORS, AGENTS OR EMPLOYEES BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, PUNITIVE OR CONSEQUENTIAL DAMAGES THAT RESULT IN ANY WAY FROM CUSTOMER'S (OR CUSTOMER'S CUSTOMERS' OR AUTHORIZED USERS') USE OF OR INABILITY TO USE ANY OF THE SERVICES OR TO ACCESS THE INTERNET OR ANY PART THEREOF, OR CUSTOMER'S (OR CUSTOMER'S CUSTOMERS' OR AUTHORIZED USERS') RELIANCE ON OR USE OF INFORMATION, SERVICES OR MERCHANDISE PROVIDED ON OR THROUGH THE SERVICES, OR THAT RESULT FROM MISTAKES, OMISSIONS, INTERRUPTIONS, DELETION OF FILES, ERRORS, DEFECTS, DELAYS IN OPERATION, OR TRANSMISSION, OR ANY FAILURE OF PERFORMANCE. (E) If Customer is dissatisfied with any of the Services or with any terms, conditions, rules, policies, guidelines, or practices of Golden Harbor in operating such Services, Customer's sole and exclusive remedy is to terminate this Agreement in accordance with Section 2 above and discontinue using such Services, except as otherwise provided in Subsection 5(D). 12 13 (F) Golden Harbor has no obligation to monitor any of the Services. However, Customer agrees that Golden Harbor has the right to monitor the Services electronically from time to time and to disclose any information as necessary to satisfy any law, regulation or other governmental request, to operate the Services properly, or to protect itself or its customers or their respective authorized users. Golden Harbor will not intentionally monitor or disclose any private electronic-mail message unless required by law, regulation or governmental request. Golden Harbor reserves the right to refuse to post or to remove any information or materials, in whole or in part, that, in its sole discretion, are unacceptable, undesirable or in violation of this Agreement. 9. LIMITATION OF LIABILITY AND INDEMNIFICATION (A) Limited Liability. In no event shall Golden Harbor be liable, either in contract or in tort, for protection from unauthorized access of Customer's Facilities, including without limitation, Customer's transmission facilities and Customer premises equipment, or from unauthorized access to or alteration, theft or destruction of Customer's data files, programs, procedures or information through accident, fraudulent means or devices, or any other method. NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, GOLDEN HARBOR SHALL NOT BE LIABLE FOR ANY INDIRECT, CONSEQUENTIAL, SPECIAL, OR PUNITIVE DAMAGES, OR FOR ANY LOST PROFITS OF ANY KIND OR NATURE WHATSOEVER, WHETHER IN CONTRACT OR IN TORT, AND CUSTOMER'S SOLE AND EXCLUSIVE REMEDY IS SET FORTH IN SUBSECTION 8(E). Notwithstanding anything in this Agreement to the contrary, in no event shall Golden Harbor be liable to Customer for more than an amount equal to more than the total amount received by Golden Harbor for monthly charges hereunder. Notwithstanding anything in this Agreement to the contrary, Golden Harbor shall not be liable for claims or damages resulting from or caused by: (i) Customer's fault, negligence or failure to perform Customer's responsibility; (ii) claims against Customer by any other party; (iii) any act or omission of any other party; (iv) equipment or services furnished by any other party; or (v) any "Service Abuse" (as defined in Subsection 3(C). (B) Indemnity by Customer. CUSTOMER SHALL INDEMNIFY, DEFEND AND HOLD GOLDEN HARBOR AND ITS AFFILIATES AND THEIR RESPECTIVE EMPLOYEES AND ITS AGENTS, UNDERLYING PROVIDERS, SUPPLIERS AND CONTRACTORS (COLLECTIVELY, THE "INDEMNITEES") HARMLESS FROM ANY AND ALL LIABILITIES, CAUSES OF ACTION, CLAIMS, LOSSES, SUITS FOR INJURY TO OR DEATH OF ANY PERSONS OR DAMAGE TO ANY PROPERTY, COSTS AND EXPENSES, INCLUDING REASONABLE ATTORNEYS' FEES INCURRED IN SEEKING TO PROVE THE INDEMNITEES' RIGHT TO INDEMNIFICATION AS WELL AS TO DEFEND THE INDEMNITEES, RELATED TO OR ARISING FROM: (i) ANY VIOLATION OF THIS AGREEMENT BY CUSTOMER, CUSTOMER'S CUSTOMERS OR AUTHORIZED USERS; (ii) THE USE OF THE SERVICES OR THE INTERNET OR THE PLACEMENT OR TRANSMISSION OF ANY MESSAGE, INFORMATION, SOFTWARE OR OTHER MATERIALS ON THE INTERNET BY CUSTOMER, CUSTOMER'S 13 14 CUSTOMERS OR AUTHORIZED USERS; (iii) ANY AND ALL ACTS OR OMISSIONS OF CUSTOMER'S OFFICERS, EMPLOYEES, AGENTS OR CONTRACTORS IN CONNECTION WITH THE CONSTRUCTION, INSTALLATION, MAINTENANCE, PRESENCE, USE OR REMOVAL OF SYSTEMS, CHANNELS OR TERMINAL EQUIPMENT OR SOFTWARE NOT PROVIDED BY GOLDEN HARBOR WHICH ARE CONNECTED OR ARE TO BE CONNECTED TO THE SERVICES; (iv) ANY AND ALL CLAIMS FOR INFRINGEMENT OF PATENTS ARISING FROM THE USE OF EQUIPMENT AND SOFTWARE APPARATUS AND SYSTEMS NOT PROVIDED BY GOLDEN HARBOR IN CONNECTION WITH THE SERVICES; (v) FRAUDULENT USE OF OR FRAUDULENT TRANSACTIONS ARISING OUT OF THE USE OF THE SERVICES; (vi) ANY AND ALL CLAIMS FOR LIBEL, SLANDER OR THE INFRINGEMENT OF COPYRIGHT ARISING FROM THE MATERIAL TRANSMITTED USING THE SERVICES OR THE USE THEREOF BY THE CUSTOMER; OR (vi) ANY "SERVICE ABUSE" (AS DEFINED IN SUBSECTION 3(C) HEREOF). 10. FORCE MAJEURE. If Golden Harbor's performance of this Agreement or any obligation hereunder is prevented, restricted or interfered with by any events or causes beyond its reasonable control (each such event or cause shall be a "Force Majeure Event") including, but not limited to, acts of God, fire, explosion, vandalism, cable or power outage, terrorism, storm or other similar occurrence, any law, order, regulation, direction, action or request of the United States government, or state or local governments, or of any agency, commission, court, bureau, corporation or other instrumentality of any one or more such governments, or of any civil or military authority, or national emergency, insurrection, riot, war, strike, lockout or work stoppage or other labor difficulties, or supplier or provider failure, shortage, breach or delay, or any event or condition whereby Golden Harbor is unable to acquire facilities at a commercially reasonable cost, then Golden Harbor shall be excused from such performance on a day-to-day basis to the extent of such restriction or interference. Golden Harbor shall use reasonable efforts under the circumstances to avoid or remove such causes of nonperformance and shall proceed to perform with reasonable dispatch whenever such events or causes are removed or cease. 11. NOTICES. Notice required to be given under this Agreement shall be deemed given (1) three days after deposited in the U.S. Mail, postage paid, via certified mail, return receipt requested, (ii) upon transmission via facsimile, (iii) one day after sent by overnight service with a reputable overnight courier, or (iv) when delivered in person, to the attention of the person at the address or facsimile number set forth in this Agreement, or such other address or facsimile number as each of the parties may from time to time advise the other in accordance with this Section. 14 15 If to Customer: Internet America, Inc. One Dallas Centre 350 N. St. Paul, Suite 200 Dallas, Texas 75201 Attention: Mike Maples, President and CEO Telephone No.: (214) 861-2540 Facsimile No.: (214) 861-2663 With a copy to: Patrick V. Stark Kane, Russell, Coleman & Logan 3700 Thanksgiving Tower 1601 Elm Street Dallas, Texas 75201 Telephone No.: (214) 416-4260 Facsimile No.: (214) 416-4299 If to Golden Harbor: Golden Harbor of Texas, Inc. 401 Carlson Circle San Marcos, Texas 78666 Attention: Jerry L. James, General Manager Telephone No.: (512) 392-6284 Facsimile No.: (512) 392-6276 With a copy to: Golden Harbor of Texas, Inc. 401 Carlson Circle San Marcos, Texas 78666 Attention: Harold E. Lovelady, President Telephone No.: (512) 392-6284 Facsimile No.: (512) 392-6276 12. NO WAIVER. No term or provision of this Agreement shall be deemed waived and no breach or default shall be deemed consented to unless such waiver or consent shall be in writing and signed by the party claimed to have waived or consented. Such a waiver or consent by either party, whether express or implied, shall not constitute a waiver of any term or provision on any other occasion or consent to any different or subsequent breach or default. 13. PARTIAL INVALIDITY; GOVERNMENT ACTION. (A) Partial Invalidity. If any part of any provision of this Agreement or any other agreement, document or writing given pursuant to or in connection with this Agreement shall be invalid or unenforceable under applicable law, rule or regulation, that part shall be ineffective to 15 16 the extent of such invalidity only, without in any way affecting the remaining parts of that provision or the remaining provisions of this Agreement. In such event, Customer and Golden Harbor will negotiate in good faith with respect to any such invalid or unenforceable part to the extent necessary to render such part valid and enforceable. (B) Government Action. Upon 30 days prior notice, either party shall have the right, without liability to the other, to cancel an affected portion of the Services if any material rate or term contained herein and relevant to the affected Services is substantially changed (to the detriment of the terminating party) or found to be unlawful or the relationship between the parties hereunder is found to be unlawful by the highest court of competent jurisdiction to which the matter is appealed, the FCC (if it has jurisdiction), or other local, state or federal governmental authority of competent jurisdiction. 14. USE OF SERVICE; USE OF NAME. Upon Golden Harbor's acceptance of a Service Order hereunder, Golden Harbor will provide the Services specified therein to Customer upon the condition that the Services shall not be used for any unlawful purpose. The provision of Services will not create a partnership or joint venture between the parties or result in a joint communications service offering to any third parties. Only upon express prior written consent of Golden Harbor shall Customer be permitted to use Golden Harbor's name, trademarks, tradename, service marks or any other intangible property owned by Golden Harbor. 15. CHOICE OF LAW; LIMITATION. (A) Law. This Agreement shall be governed by and construed under the laws of the State of Texas without regard to that state's choice of law principles. (B) Limitation of Action. Subject to the limitations set forth herein, any legal action arising out of failure, malfunction or defect in the Services shall be brought within one year of the discovery of the occurrence. 16. CONFIDENTIAL INFORMATION. (A) Limited Disclosure. Customer understands and agrees that the terms and conditions of this Agreement and all documents referenced herein are confidential and shall not be disclosed by Customer to any person or entity other than Customer's directors, lenders, officers, agents, and employees who have a need to know the same and have specifically agreed to nondisclosure of the terms and conditions hereof, except if the information (i) is or becomes publicly known through no wrongful act of Customer; or (ii) is required to be disclosed by Customer to any governmental agency or is otherwise required to be disclosed by applicable law, provided that before making such disclosure, Customer shall give Golden Harbor prior written notice of such required disclosure in order that Golden Harbor may interpose an objection thereto 16 17 or otherwise take action to protect the confidentiality of such information. Any violation by Customer or any of its directors, officers, employees, or agents of the foregoing sentence shall entitle Golden Harbor to an injunction or restraining order. Remedies stated in this paragraph are in addition to, and not exclusive of, other remedies available at law or in equity. (B) Survival of Confidentiality. The provisions of this Section 16 will be effective as of the date first above written and remain in full force and effect for a period which will be the longer of (i) two years following the date of Agreement or (ii) one year from the termination of all Services hereunder. 17. SUCCESSORS AND ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors or assigns, provided, however, that Customer shall not assign or transfer its rights or obligations under this Agreement without the prior written consent of Golden Harbor, which consent shall not be unreasonably withheld or delayed. 18. GENERAL. (A) Survival of Terms. The terms and provisions contained in this Agreement that by their sense and context are intended to survive the performance thereof by the parties hereto shall so survive the completion of performance and termination of this Agreement, including, without limitation, the provisions of Sections 8 and 9 and the provisions regarding the making of any and all payments due hereunder. (B) Headings. Descriptive headings in this Agreement are for convenience only and shall not affect the construction of this Agreement. (C) Industry Terms. Words having well-known technical or trade meanings shall be so construed, and all listings of items shall not be taken to be exclusive, but shall include other items, whether similar or dissimilar to those listed, as the context reasonably requires. (D) Rules of Construction. No rule of construction requiring interpretation against the drafting party hereof shall apply in the interpretation of this Agreement. 19. ENTIRE AGREEMENT. This Agreement consists of (i) all the terms and conditions contained herein, and, (ii) all documents incorporated herein specifically by reference. This Agreement constitutes the complete and exclusive statement of the understandings between the parties and supersedes all proposals and prior agreements (oral or written) between the parties relating to the Services provided hereunder. No subsequent agreement between the parties concerning the Services shall be effective or binding unless it is made in writing and executed by Customer and Golden Harbor. 17 18 Golden Harbor: Customer: Golden Harbor of Texas, Inc. Internet America, Inc. By: /s/ ILLEGIBLE By: /s/ MIKE MAPLES ------------------------------- -------------------------------- Printed Name: ILLEGIBLE Printed Name: Mike Maples ------------------- ------------------ Title: Vice President Title: CEO -------------------------- -------------------------- 18 EX-23.2 11 CONSENT OF DELOITTE & TOUCHE LLP 1 EXHIBIT 23.2 INDEPENDENT AUDITORS' CONSENT We consent to the use in this Amendment No. 1 to Registration Statement No. 333-59527 of Internet America, Inc. of our report dated August 12, 1998, appearing in the Prospectus, which is part of this Registration Statement and to the reference to us under the headings "Selected Financial and Operating Data" and "Experts" in such Prospectus. /s/ DELOITTE & TOUCHE LLP - ----------------------------------- Deloitte & Touche LLP Dallas, Texas August 28, 1998 EX-27.1 12 FINANCIAL DATA SCHEDULE
5 1,000 YEAR YEAR 9-MOS JUN-30-1996 JUN-30-1997 JUN-30-1998 JUL-01-1995 JUL-01-1996 JUL-01-1997 JUN-30-1996 JUN-30-1997 JUN-30-1998 79 0 565 0 0 0 184 351 526 17 127 198 0 0 0 355 278 924 3,281 4,126 4,483 542 1,615 2,858 3,127 3,114 3,150 3,817 7,111 6,886 0 0 0 0 0 0 5 5 5 30 36 35 0 (13) 0 (1,063) (4,681) (3,767) 0 0 0 3,777 9,471 10,643 0 0 0 7,129 12,814 9,042 0 0 0 0 0 0 77 481 571 (3,429) (3,824) 1,030 0 0 24 (3,429) (3,824) 1,006 0 0 0 0 0 0 0 0 0 (3,429) (3,824) 1,006 (1.15) (1.12) .28 (1.15) (1.12) .21
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