10-Q 1 v140337_10q.htm QUARTERLY REPORT Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2008

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES ACT OF 1934

FOR THE TRANSITION PERIOD FROM _________ TO _________

COMMISSION FILE NUMBER   000-25147

INTERNET AMERICA, INC.
(Exact name of registrant as specified in its charter)

TEXAS
86-0778979
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)

10930 West Sam Houston Pkwy., N., Suite 200, Houston
77064
(Address of principal executive offices)
(Zip Code)

(713) 968-2500
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x               No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  o  (Do not check if a smaller reporting company)
Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o               No x

As of February 17, 2009, registrant had 16,857,031 shares of Common Stock at $.01 par value, outstanding.

Transitional Small Business Disclosure Format (check one).
Yes o  No x
 
 



 

 
INTERNET AMERICA, INC. AND SUBSIDIARIES
 
   
December 31,
    
June 30,
  
   
2008
    
2008
  
   
(unaudited)
    
(audited)
  
ASSETS
            
CURRENT ASSETS:
            
Cash and cash equivalents
   $ 3,045,630     $ 3,911,680  
Restricted cash
     6,432       6,432  
Accounts receivable, net of allowance for uncollectible accounts of $5,798 and $5,863
                
as of December 31, 2008 and June 30, 2008, respectively
     142,790       170,231  
Inventory
     300,592       285,410  
Prepaid expenses and other current assets
     704,196       610,865  
Total current assets
     4,199,640       4,984,618  
Property and equipment---Net
     2,143,963       2,328,954  
Goodwill---Net
     3,533,127       3,533,127  
Subscriber acquisition costs---Net
     1,061,407       1,310,537  
Other assets---Net
     13,518       38,087  
TOTAL
   $ 10,951,655     $ 12,195,323  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
                
CURRENT LIABILITIES:
                
Trade accounts payable
   $ 262,270     $ 204,056  
Accrued liabilities
     383,740       654,187  
Deferred revenue
     1,118,776       1,271,901  
Current portion of long-term debt
     658,163       620,585  
Total current liabilities
     2,422,949       2,750,729  
                 
Long-term debt, net of current portion
     1,007,089       1,331,096  
Minority interest in subsidiary
     5,639       5,696  
Total liabilities
     3,435,677       4,087,521  
                 
COMMITMENTS AND CONTINGENCIES
     —       —  
                 
SHAREHOLDERS' EQUITY:
                
Preferred stock 10% cumulative, convertible, $.01 par value: 5,000,000 shares authorized, 2,889,076
          
issued and outstanding as of December 31, 2008 and June 30, 2008, respectively
     28,891       28,891  
Common stock, $.01 par value: 40,000,000 shares authorized, 16,857,031
                
issued and outstanding as of  December 31, 2008 and June 30, 2008
     168,571       168,571  
Additional paid-in capital
     63,633,146       63,588,884  
Accumulated deficit
     (56,314,630 )     (55,678,544 )
Total shareholders' equity
     7,515,978       8,107,802  
TOTAL
   $ 10,951,655     $ 12,195,323  
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
Financial Statements - Continued
 
INTERNET AMERICA, INC. AND SUBSIDIARIES
(Unaudited)
 
   
Three Months Ended
    
Six Months Ended
  
   
December 31,
    
December 31,
  
   
2008
    
2007
    
2008
    
2007
  
REVENUES:
                        
Internet services
   $ 1,930,332     $ 2,154,708     $ 3,885,047     $ 4,249,166  
Other
     57,585       115,299       107,723       191,132  
Total
     1,987,917       2,270,007       3,992,770       4,440,298  
                                 
OPERATING COSTS AND EXPENSES:
                                
Connectivity and operations
     1,339,613       1,394,726       2,690,791       2,846,410  
Sales and marketing
     72,832       172,878       142,845       311,286  
General and administrative
     613,377       1,186,169       1,201,306       1,847,316  
Provision for (recoveries of) bad debt
     (1,152 )     (7,460 )     (65 )     3,895  
Depreciation and amortization
     277,307       304,232       573,104       570,655  
Total
     2,301,977       3,050,545       4,607,981       5,579,562  
                                 
LOSS FROM OPERATIONS
     (314,060 )     (780,538 )     (615,211 )     (1,139,264 )
INTEREST INCOME
      11,803        24,524        27,525        34,354  
INTEREST EXPENSE
     (23,052 )     (31,672 )     (48,457 )     (56,948 )
                                 
Minority interest in loss of consolidated subsidiary
     87       204       57       395  
                                 
NET LOSS
   $ (325,222 )   $ (787,482 )   $ (636,086 )   $ (1,161,463 )
                                 
NET LOSS PER COMMON SHARE:
                                
BASIC
   $ (0.02 )   $ (0.06 )   $ (0.04 )   $ (0.09 )
DILUTED
   $ (0.02 )   $ (0.06 )   $ (0.04 )   $ (0.09 )
                                 
WEIGHTED AVERAGE COMMON SHARES
                                
OUTSTANDING:
                                
BASIC
     16,857,031       13,682,584       16,857,031       13,120,749  
DILUTED
     16,857,031       13,682,584       16,857,031       13,120,749  
 
 
See accompanying notes to condensed consolidated financial statements.


 
Financial Statements - Continued
 
INTERNET AMERICA, INC. AND SUBSIDIARIES
(Unaudited)
 
   
Six Months Ended
  
   
December 31,
  
   
2008
    
2007
  
OPERATING ACTIVITIES:
            
Net loss
   $ (636,086 )   $ (1,161,463 )
Adjustments to reconcile net loss to net cash
                
used in operating activities:
                
Minority interest
     (57 )     (395 )
Depreciation and amortization
     573,104       570,655  
Loss on disposal of fixed assets
     2,170       —  
Provision for (recoveries of) bad debt
     (65 )     5,801  
Non-cash stock compensation expense
     44,262       58,665  
Changes in operating assets and liabilities (net of effects
                
of assets acquired, less liabilities assumed):
                
Accounts receivable
     27,505       (35,546 )
Inventory
     (15,182 )     (79,435 )
Prepaid expenses and other current assets
     (93,331 )     (126,868 )
Other assets
     24,569       (22,125 )
Accounts payable and accrued liabilities
     (212,233 )     180,454  
Deferred revenue
     (153,125 )     40,301  
Net cash used in operating activities
     (438,469 )     (569,956 )
INVESTING ACTIVITIES:
                
Purchases of property and equipment, net
     (152,086 )     (442,659 )
Change in restricted cash
     —       (6,432 )
Proceeds from sale of property and equipment
     10,934       —  
Cash provided by acquisitions
     —       655,102  
Net cash provided by (used in) investing activities
     (141,152 )     206,011  
FINANCING ACTIVITIES:
                
Proceeds from issuance of common stock
     —       3,987,625  
Proceeds from issuance of preferred stock
     —       1,307,183  
Proceeds from issuance of long term debt
     —       71,787  
Principal payments of long-term debt
     (286,429 )     (188,204 )
Net cash provided by (used in) financing activities
     (286,429 )     5,178,391  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
     (866,050 )     4,814,446  
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
     3,911,680       782,887  
CASH AND CASH EQUIVALENTS, END OF PERIOD
   $ 3,045,630     $ 5,597,333  
SUPPLEMENTAL INFORMATION:
                
Cash paid for interest
   $ 46,847     $ 56,948  
                 
 NON-CASH INVESTING AND FINANCING ACTIVITIES:
                
 Stock issued in connection with acquisitions
   $ —     $ 770,443  
 Debt assumed in connection with acquisitions
   $ —     $ 100,529  
 Debt issued in connection with acquisitions, net
   $ —     $ 863,500  
 Minority interest liability
   $ —     $ 6,420  
 Borrowings extinguished for preferred stock
   $ —     $ 300,000  
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
INTERNET AMERICA, INC. AND SUBSIDIARIES
 (Unaudited)

1.  
 Basis of Presentation

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to Article 8 of Regulation S-X of the Securities and Exchange Commission.  The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary to achieve a fair presentation of Internet America, Inc.’s (“the Company’s”) consolidated financial position and results of operations for the interim periods presented.  All such adjustments are of a normal and recurring nature.  These condensed financial statements should be read in conjunction with the consolidated financial statements for the year ended June 30, 2008, included in the Company’s Annual Report on Form 10-KSB (SEC Accession No. 0001144204-08-055890).
 
2.  
Reclassifications

Certain reclassifications have been made to the 2007 financial statements to conform to the 2008 presentation.  These classifications had no effect on 2007 net loss or shareholders’ equity.
 
3.
Basic and Diluted Net Loss Per Share

There are no adjustments required to be made to net loss for the purpose of computing basic and diluted earnings per share (“EPS”) for the three and six months ended December 31, 2008 and 2007.  During the three and six months ended December 31, 2008 and 2007, options to purchase 585,278 and 331,141 shares of common stock, respectively, were not included in the computation of diluted EPS because the options were not “in the money” as of December 31, 2008 and 2007, respectively.  There were no options “in the money” at December 31, 2008 and 2007.  There were no options exercised to purchase shares of common stock during the three and six months ended December 31, 2008 or 2007.
 
4. 
Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these estimates.
 
5. 
Goodwill and Subscriber Acquisition Costs

Pursuant to Statement of Financial Accounting Standard (“SFAS”) No. 142, the Company performs an impairment test annually during the fourth quarter of its fiscal year or when events and circumstances indicate goodwill might be permanently impaired. Accordingly, during the year ended June 30, 2008, the Company recorded $780,000 as impairment of goodwill related to potential reduction in future cash flows from the acquisitions of NeoSoft and PDQ.Net. The Company concluded that no impairment of goodwill occurred during the six months ended December 31, 2008.

The Company allocates the purchase price for acquisitions to acquired subscriber bases and goodwill based on fair value at the time of acquisition.  Subscriber acquisition costs, net of amortization, totaled approximately $1,061,000 and $1,311,000, as of December 31, 2008 and June 30, 2008, respectively.  The weighted average amortization period for subscriber acquisition costs is 48 months for both dial-up and wireless broadband Internet customers. Amortization expense for the three and six months ended December 31, 2008 was $120,096 and $249,130, respectively.  As of December 31, 2008, amortization expense for the fiscal years ended June 30, 2009, 2010, 2011 and 2012 is expected to be approximately $485,000, $427,000, $394,000 and $5,000, respectively.
 
 
 
 
6. 
Income Taxes

During the three and six months ended December 31, 2008, the Company generated a net loss of $325,222 and $636,086, respectively.  During the three and six months ended December 31, 2007, the Company generated a net loss of $787,482 and $1,161,463, respectively.   No provision for income taxes has been recorded for the three and six months ended December 31, 2008 and 2007, as the Company has net operating losses generated in the current and prior periods.   As of December 31, 2008, the Company continues to maintain a full valuation allowance for its net deferred tax assets of approximately $13.7 million.  Given its limited history of generating net income, the Company has concluded that it is not more likely than not that the net deferred tax assets will be realized.

On July 1, 2007, the Company adopted Financial Account Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”).  As a result of the implementation of FIN 48, management assessed its various income tax positions, and this assessment resulted in no adjustment. The preparation of various tax returns requires the use of estimates for federal and state income tax purposes.  Those estimates may be subject to review by respective taxing authorities.  A revision, if any, to an estimate may result in assessment of additional taxes, penalties and interest.  At this time, a range in which our estimates may change is not quantifiable and a change, if any, is not expected to be material.  The Company will account for interest and penalties related to uncertain tax positions in the current period income statement, as necessary.  The 2004, 2005, 2006 and 2007 tax periods remain subject to examination by various federal and state tax jurisdictions.
 
7. 
Long-Term Debt
 
Long-term debt consists of:
 
   
December 31,
    
June 30,
  
   
2008
    
2008
  
Note payable due July 19, 2009, payable in quarterly payments of $7,751 with interest imputed at 9% (net of unamortized discount of $4,570)
   $ 49,623     $ 62,452  
Note payable due January 23, 2011 payable in bi-annual installments of $13,917 with interest imputed at 8% (net of unamortized discount of $3,033)
     23,106       23,106  
Note payable due February 12, 2009 payable in monthly installments of $1,261
     2,521       10,084  
Note payable due August 28, 2010, payable in monthly installments of $1,033 with interest imputed at 9% (net of unamortized discount of $877)
     19,614       21,219  
Note payable due June 20, 2012, payable in monthly installments of $2,088 with interest imputed at 9% (net of unamortized discount of $12,707)
     74,982       83,900  
Note payable due July 20, 2010, payable in monthly installments of $1,818 with interest imputed at 6.5% (net of unamortized discount of $1,802)
     32,733       42,392  
Note payable due July 20, 2010, payable in monthly installments of $1,409 with interest imputed at 6.5% (net of unamortized discount of $1,396)
     25,370       32,855  
Amount payable due in equal quarterly installments beginning 120 days from issuance of note with interest payable at a rate to be determined by the 12-month LIBOR rate at date of note issuance
     93,991       95,324  
Note payable due December 23, 2010, payable in monthly payments of $26,199 with interest imputed at 5.5% (net of unamortized discount of $33,121)
     595,665        735,083  
Loan and Security Agreement with United States Department of Agriculture Rural Utilities Service
     747,647       845,266  
      1,665,252       1,951,681  
Less current portion
     (658,163 )     (620,585 )
Long-term debt, net of current portion
   $ 1,007,089     $ 1,331,096  

The Company’s secured long-term debt totals approximately $1,490,000 and $1,681,000 as of December 31, 2008 and June 30, 2008, respectively.   Amounts are secured by certificates of deposit and certain inventory and equipment.   The prime rate at December 31, 2008 and June 30, 2008 was 3.25% and 5.00%, respectively.

 
 
8. 
Related Parties

The following table shows amounts paid to four non-employee directors for serving on the Company’s board of directors and payments made to Cynthia Ocker, former owner of TeleShare, for contract services during the six months ended December 31, 2008 and 2007:
 
   
Six Months Ended
  
   
December 31,
  
   
2008
    
2007
  
Troy LeMaile Stovall
   $ 8,676     $ 11,500  
Justin McClure
     8,250       11,500  
John Palmer
     9,073       16,662  
Steven Mihaylo
     8,893       4,378  
Cindy Ocker
     76,834       56,623  
    $ 111,726     $ 100,663  

9. 
New Accounting Pronouncements
 
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements,” which provides guidance for using fair value to measure assets and liabilities. SFAS No. 157 establishes a definition of fair value, provides a framework for measuring fair value and expands the disclosure requirements about fair value measurements. SFAS No. 157 as issued is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted. On February 12, 2008, FASB Staff Position No. FAS 157-2 was issued which delays the effective date to fiscal years beginning after November 15, 2008 for certain non-financial assets and liabilities. Adoption of the pronouncement as it relates to our financial assets and liabilities had no impact on our consolidated financial position or results of operations and the Company is currently evaluating the impact of SFAS No. 157 on our non-financial assets and liabilities.
 
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity's first fiscal year beginning after November 15, 2007.  Adoption of this pronouncement had no impact on our consolidated financial position and results of operations.
 
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," which amends SFAS No. 141, and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008 and is to be applied prospectively. The Company is currently evaluating the potential impact of adopting SFAS No. 141(R) on our consolidated financial position and results of operations.
 
In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements — an Amendment of ARB No. 51.” SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be recorded as equity in the consolidated financial statements. This Statement also requires that consolidated net income shall be adjusted to include the net income attributed to the noncontrolling interest. Disclosure on the face of the income statement of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest is required. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. Earlier adoption is not permitted. The Company is currently evaluating the impact of SFAS No. 160 on our financial statements.
 
 
 
 
 
10. 
Merger Agreement with KeyOn Communications Holdings, Inc. and Subsequent Events
 
On November 14, 2008, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with KeyOn Communications Holdings, Inc., a Delaware corporation (“KeyOn”), and IA Acquisition, Inc. (“AcquisitionSub”), a Delaware corporation wholly owned by Internet America, pursuant to which AcquisitionSub will be merged with and into KeyOn with KeyOn continuing as the surviving corporation wholly-owned by Internet America (the “Merger”).
 
If the merger is consummated, the Company will issue an aggregate of 16,155,906 shares of Company common stock to KeyOn shareholders in a stock-for-stock exchange for all outstanding shares of KeyOn common stock. Upon completion of the Merger, KeyOn shareholders will own 45%, and Internet America shareholders will own 55%, of the aggregate number of shares of common and preferred stock of the Company outstanding. The ratio between the 16,155,906 shares of Internet America common stock and the number of shares of outstanding KeyOn common stock at the effective time of the Merger is referred to as the “Exchange Ratio”.
 
If the merger is consummated, Internet America will assume all options to purchase shares outstanding at July 28, 2008, and warrants to purchase an aggregate of 281,875 shares, of KeyOn common stock, that are not otherwise exercised in accordance with their terms before the effective time of the Merger. Assumed options and warrants will become exercisable to purchase shares of Internet America common stock and will generally retain their same terms and conditions, except that the number of shares of Internet America common stock subject to such options and warrants, and the exercise price thereof, will each be adjusted by the Exchange Ratio.
 
The proposed Merger is intended to be a tax-free reorganization under Section 368(a) of the Internal Revenue Code of 1986, as amended. The Merger was approved by the holders of a majority of the outstanding shares of KeyOn by written consent.  The consummation of the Merger is subject to effectiveness of the Form S-4 Registration Statement filed by the Company with the Securities and Exchange Commission, the mailing of the Prospectus to KeyOn shareholders, the completion of certain conditions to closing, and other customary closing conditions.  Among other obligations, KeyOn is required to reach a liquidity threshold by reducing or eliminating certain current liabilities combined with raising additional equity, to meet certain financial covenants and to restructure its $4,500,000 short-term obligation into a long-term debt obligation with a 5 year maturity and a ten-year amortization.  Each party to the Merger Agreement has rights to terminate that agreement if certain covenants of the other party are not performed or conditions to the closing are not met. A copy of the Merger Agreement was filed as Exhibit 2.1 to the Company’s Form 8-K Current Report on November 18, 2008.
 
 
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements contained in this Form 10-Q constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These statements, identified by words such as "anticipate," "believe," "estimate," "should," "expect" and similar expressions include our expectations and objectives regarding our future financial position, operating results and business strategy.  These statements reflect the current views of management with respect to future events and are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from those described in the forward-looking statements.  We do not intend to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information.  Our Annual Report on Form 10-KSB for the fiscal year ended June 30, 2008 and other publicly filed reports discuss some additional important factors that could cause our actual results to differ materially from those in any forward-looking statements.

Overview

Internet America, Inc. (the “Company” or “Internet America”) is an Internet service provider ("ISP") that provides an array of Internet services to residential and business subscribers and is currently serving approximately 28,400 subscribers in Texas as of December 31, 2008. Of the Company’s 28,400 total subscribers, approximately 7,900 are wireless broadband Internet subscribers. A subscriber represents an active, billed service.  One customer account may represent multiple subscribers depending on the number of active and billed services for that customer. Wireless revenues continue to grow and totaled approximately $1,061,000, or 53.4% of total revenues, for the quarter ending December 31, 2008, compared to approximately $1,036,000, or 45.6% of total revenues, for the same period last fiscal year.
 
On November 14, 2008, the Company entered into a definitive agreement to merge with KeyOn Communications Holdings, Inc. (“KeyOn”) in a stock-for-stock transaction, with KeyOn shareholders maintaining 45% of the merged companies. Management expects the efficiencies derived from scale economies as a result of the merger will enable the Company to immediately reduce and maintain lower overall operating expenses.  Operating margins are also expected to be positively impacted by the cross-selling of existing products and the introduction of new, related services across the expanded customer base.  As part of its conditions to closing among other obligations, KeyOn is required to reach a liquidity threshold by reducing or eliminating certain current liabilities combined with raising additional equity. The closing is also subject to, among other customary closing conditions, the performance of certain financial covenants and the effectiveness of the registration statement filed with the SEC.  Extensive information about the merger, including the risks involved, is contained in the Form S-4/A registration statement of the Company.
 
The Company continues to experience an attrition of dial-up Internet service customers. The loss of these customers is primarily attributable to their moving to broadband connectivity with other service providers. The largest competitors in broadband access are the cable companies and regional Bell operating companies.  We operate in a highly competitive market for each of our non-wireless service offerings.  The competitive environment impacts the churn rates we experience. Near the end of October 2008, the Company entered into an agreement with an aggregator that allows the Company to resell DSL broadband internet service over most of the metropolitan and suburban areas of the United States where it is currently available.  Management does not anticipate this arrangement adding significant profits in the near term but we anticipate it helping us to offset the attrition of dial-up customers to other broadband providers and allowing us to fulfill additional demand for this service.
 
The Company is focused on remaining prepared for a more difficult economic environment.  First, we raised sufficient capital in the fall of 2007 to fund internally our capital needs for 2008.  We then entered into a nine month process of improving quality and customer satisfaction as well as simplifying our internal systems and procedures as further discussed below.  Quality process implementation substantially improved our productivity, which can be measured in ways such as headcount reduction from 93 total employees in December 2007 to 57 at the end of December 2008.  At the same time we have made investments in our infrastructure to improve quality and network capacity by investing approximately $1.2 million in fiscal 2008 and an additional $152,000 in the six months ending December 31, 2008.
 
 
During calendar 2008, the Company made capital investments to upgrade and expand areas where our network has been experiencing congestion due to the bandwidth demands created by the growth of our customer base.  While upgrading, we restricted the addition of new customers to those areas of the network that did not have capacity and performance issues.  We created “no sale” regions for any wireless Broadband coverage areas scheduled for improvement projects. These “no sale” regions were internally restricted from the addition of new customers until the upgrades were completed and tested. We experienced a decline in new customer additions as a direct result of our deliberate actions during the upgrade and, to a lesser extent, of the challenging present economic environment.   The Company’s customer count for wireless broadband Internet services remained relatively stable, decreasing from 8,000 subscribers at June 30, 2008 to approximately 7,900 subscribers through the first two fiscal quarters of 2009. We believe that customer stability during the “no sale” period and the beginnings of the recession is a positive sign that we should be able to maintain a relatively stable wireless customer base during an economic recession, as some demand may continue to exist in areas previously covered by our internal “no sale” restrictions. We continue to remove selling restrictions only on a regional basis, as improvements are completed.
 
The Company experienced significant reductions in headcount as it adopted quality processes.  Staffing was previously increased during the first and second quarters of the year ended June 30, 2008, with the highest headcount being 93 employees in December 2007.  As our productivity has increased due to quality initiatives, we have reduced headcount by more than one-third to 57 people at the date of this filing. There was a corresponding decrease in salaries and wages of approximately $126,000 to $920,000 as of December 31, 2008 compared to $1,046,000 as of December 31, 2007.
 
During 2008 we experienced increases in telecommunications cost per subscriber by increasing network capacity to provide higher quality service to our customers as we increased our wireless broadband footprint. This cost increase is offset partially by entering into more favorable agreements with telecommunications service providers.  Overall, decreases in telecommunications costs from the six months ended December 31, 2008 compared to the same period in the previous year, totaled approximately $293,000.
 
The rural and suburban wireless ISP (“WISP”) industry is fragmented with ample consolidation opportunity.   The Company estimates that there are up to 2,500 potential WISP acquisition candidates in the United States, including approximately 150 in Texas. Although we will continue to consider development and acquisition opportunities in non-metropolitan markets in Texas, our current focus is on larger acquisition opportunities outside our current geographical region which offer greater opportunities for expanding our subscriber base.
 
While there is no guarantee that we will make significant or numerous acquisitions, the management of the Company believes that there are many WISPS that are not in a strong financial position today and that have not made efforts similar  to Internet America’s to improve quality and systems.  We believe other WISPs are impacted by recent economic conditions and will now be more interested in combinations which offer the management experience that Internet America offers and that also need access to the systems and capital that will be necessary to grow their businesses.  The Company is focusing on markets that enhance its geographic and strategic plans.  As we have gained experience in both opening de novo markets and acquiring smaller ISPs and WISPs, acquisitions remain attractive as an important method of acquiring substantial subscriber bases that we can enlarge and to which we can provide qualified, experienced management. The Company is currently focused on larger acquisitions that will be accretive after completing integration and that will not materially drain our cash resources. Larger acquisitions with geographic expansion would provide us with an opportunity to spread the cost of our well developed systems, superior network performance, high quality customer care and technical support over an increased number of subscribers. Financing for such an acquisition would likely come from the public issuance of equity securities and/or the private sale of debt or equity securities.
 
Over the past year, Company management has actively addressed the declining subscriber base and decrease in its total revenues and the related impact on profitability while preparing for an economic turndown.  We completed the sale of additional securities in private placements to provide ample capital to make investments in infrastructure and withstand temporary operating losses.  We invested capital in quality process improvements that have substantially improved our productivity. For the six months ended December 31, 2008, net loss plus non-cash items used cash of $16,000, compared to cash used of $527,000 for the same period last year, which is a measurement of the results of our efficiency and cost reduction measures.  We will continue these efforts of improvement, stabilization and growth possibilities, and management believes we are in a fortunate position today, able better to withstand an economic slowdown or to capitalize on growth possibilities.  Additionally these continued efforts may yield improvements in profitability and cash flow from operations. Today, Internet America is a leaner, more efficient organization that is better prepared to sustain more challenging economic times.  We believe that we have sufficient capital resources and cash on hand to withstand a short or prolonged economic downturn, and we are in a strong position to grow internally and through additional acquisitions should the economy strengthen.
 
 
 
Company management believes the initiatives identified above are instrumental to the achievement of our goals, but they may be subject to competitive, regulatory, and other events and circumstances that are beyond our control. We can provide no assurance that we will be successful in achieving any or all of the initiatives, that the achievement or existence of such initiatives will result in profit improvements, or that other factors will not arise that would adversely affect future profits.
 
Statement of Operations
 
Internet services revenue is derived from dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, wireless access, bulk dial-up access, web hosting services, and value-added services, such as multiple e-mail boxes, personalized e-mail addresses and Fax-2-Email services.   In addition to miscellaneous revenue, other revenue for fiscal year 2009 and 2008 includes telex messaging service revenues.

A brief description of each element of our operating expenses follows:

Connectivity and operations expenses consist primarily of setup costs for new subscribers, telecommunication costs, merchant processing fees, and wages of network operations and customer support personnel. Connectivity costs include (i) fees paid to telephone companies for subscribers' dial-up connections to our network; (ii) fees paid to backbone providers for connections from our network to the Internet; and (iii) equipment and tower lease costs for our new wireless networks.
 
Sales and marketing expenses consist primarily of creative and production costs, costs of media placement, management salaries and call center wages. Advertising costs are expensed as incurred.
 
General and administrative expenses consist primarily of administrative salaries, professional services, rent and other general office and business expenses.
 
Bad debt expense consists primarily of customer accounts that have been deemed uncollectible and will potentially be written off in future periods, net of recoveries.  Historically, the expense has been based on the aging of customer accounts whereby all customer accounts that are 90 days or older have been provided for as a bad debt expense. Recoveries of bad debt represent the collection of accounts which had previously been written off.
 
Depreciation expense is computed using the straight-line method over the estimated useful lives of the assets or the capital lease term, as appropriate.  Data communications equipment, computers, data servers and office equipment are depreciated over five years. We depreciate furniture, fixtures and leasehold improvements over five years or the lease term.  Buildings are depreciated over fifteen years. Amortization expense consists of the amortization of subscriber acquisition costs, which are amortized over four years.
 
Our business is not subject to any significant seasonal influences.

 
 
 
Results of Operations

Three Months Ended December 31, 2008 Compared to Three Months Ended December 31, 2007
 
The following table sets forth certain unaudited financial data for the three months ended December 31, 2008 and 2007.  Operating results for any period are not indicative of results for any future period.  Amounts are shown in thousands (except share, per share and subscriber count data).
 
   
Three Months Ended December 31,
  
   
2008
    
% of
Revenues
    
2007
    
% of
Revenues
  
STATEMENT OF OPERATIONS DATA:
                        
REVENUES:
                        
Internet services
   $ 1,931       97.1 %   $ 2,155       94.9 %
Other
     58       2.9 %     115       5.1 %
Total
     1,989       100.0 %     2,270       100.00 %
OPERATING COSTS AND EXPENSES:
                                
Connectivity and operations
     1,340       67.4 %     1,395       61.5 %
Sales and marketing
     73       3.7 %     172       7.6 %
General and administrative
     614       30.8 %     1,186       52.3 %
Recoveries of bad debt
     (1 )     (0.1 )%     (7 )     (0.3 )%
Depreciation and amortization
     277       13.9 %     304       13.3 %
Total
     2,303       115.7 %     3,050       134.4 %
OPERATING LOSS
     (314 )     (15.7 )%     (780 )     (34.4 )%
INTEREST INCOME
     12       0.6 %     25       1.1 %
INTEREST EXPENSE
     (23 )     (1.2 )%     (32 )     (1.4 )%
Minority interest in loss of consolidated subsidiary
     (0 )     0.0 %     (0 )     (0.0 )%
NET LOSS
   $ (325 )     (16.3 )%   $ (787 )     (34.7 )%
NET LOSS PER COMMON SHARE:
                                
BASIC AND DILUTED
   $ (0.02 )           $ (0.06 )        
WEIGHTED AVERAGE COMMON
                                
SHARES OUTSTANDING:
                                
BASIC AND DILUTED
     16,857,031               13,682,584          
OTHER DATA:
                                
Subscribers at end of period (1)
     28,400               33,200          
EBITDA(loss)(2)
   $ (37 )           $ (476 )        
EBITDA margin(3)
     (1.9 %)             (21.0 %)        
Reconciliation of net loss to EBITDA (loss):
                                
Net loss
   $ (325 )           $ (787 )        
Add:
                                
Depreciation and amortization
     277               304          
Interest income
     (12 )             (25 )        
Interest expense
     23               32          
EBITDA (loss)(2)
   $ (37 )             (476 )        
                                 
(1) 
A subscriber represents an active, billed service.  One customer account may represent multiple subscribers depending on the number of active and billed services for that customer.
(2) 
EBITDA (earnings before interest, taxes, depreciation and amortization) is not a measurement of financial performance under generally accepted accounting principles (GAAP) and should not be considered an alternative to net income as a measure of performance.  Management has consistently used EBITDA on a historical basis as a measurement of the Company’s current operating cash income.
(3) 
EBITDA margin represents EBITDA as a percentage of total revenue.


Three Months Ended December 31, 2008 Compared to Three Months Ended December 31, 2007 (Continued)

Total revenue.  Total revenue decreased by $281,000, or 12.4%, to $1,989,000 for the three months ended December 31, 2008, from $2,270,000 for the three months ended December 31, 2007.  The Company’s total subscriber count decreased by 4,800, or 14.5%, to 28,400 as of December 31, 2008 compared to 33,200 as of December 31, 2007.  The Company’s wireless broadband Internet subscriber count increased slightly to 7,900 as of December 31, 2008, compared to 7,800 as of December 31, 2007. Wireless broadband Internet revenue increased by $25,000 to $1,061,000 as of December 31, 2008 compared to $1,036,000 as of December 31, 2007.  During the Company’s upgrade process in calendar 2008, we restricted the addition of new customers while improvements were made. The slight increase in wireless broadband Internet revenues was offset by the decrease in dial-up Internet subscriber counts and related revenue of $249,000, which is attributed to the loss of dial-up customers moving to other providers’ broadband service. In connection with the acquisition of TeleShare, the Company derives other revenues from providing telex messaging services since July 27, 2007.  Messaging revenues for the three months ended December 31, 2008 totaled $58,000 and varies based on customer demand.
 
Connectivity and operations. Connectivity and operations expense decreased by $55,000, or 3.9%, to $1,340,000 for the three months ended December 31, 2008, from $1,395,000 for the three months ended December 31, 2007. Data and telecommunications expense decreased by $134,000 to $373,000 as of December 31, 2008 compared to $507,000 as of December 31, 2007.  The decrease in data and telecommunications expense is due to our renegotiating more favorable terms with telecommunications service providers. The remaining decrease in expense relates primarily to a $5,000 decrease in travel and other costs and a $7,000, or 14%, decrease in merchant fees as a result of a 12.4% decrease in revenues.
 
The decreases in the previously discussed expenses were offset by an increase in consumable supplies and installation and repair expenses of $71,000 to $160,000 as of December 31, 2008 compared to $89,000 as of December 31, 2007. This increase is due to significant increase in service calls in the Greater Houston Texas region after the natural disaster, Hurricane Ike.  Additionally, in an effort to reduce capital expenditures and to make best use of resources, the Company aggressively increased its repair and recycle program for customer premise equipment.  The costs of refurbishing equipment are currently expensed as incurred. Tower lease expense increased by $11,000 to $105,000 as of December 31, 2008 compared to $94,000 as of December 31, 2007. The increase in tower leases relates to the growth of the Company’s wireless broadband Internet subscriber operations and to a lesser extent due to increases in tower rental rates. Salaries, wages and related personnel costs increased approximately $9,000 to $627,000 as of December 31, 2008 compared to $618,000 as of December 31, 2007.
 
Sales and marketing. Sales and marketing expense decreased by $99,000, or 57.6%, to $73,000 for the three months ended December 31, 2008, compared to $172,000 for the three months ended December 31, 2007.  Salaries and wages decreased $68,000 to $49,000 as of December 31, 2008 compared to $117,000 as of December 31, 2007 due to ongoing efforts to enhance efficiency and reduce headcount, including the present vacancy of the position of Vice President of Marketing.  A decrease in advertising, travel and consulting expenses by $37,000 to $18,000 as of December 31, 2008 compared to $55,000 as of December 31, 2007 is the result of a non-recurring expense of approximately $50,000 during fiscal year 2008 for reselling municipal Wi-Fi in Corpus Christi, offset by an increase in direct mail campaign costs during the three months ended December 31, 2008.  The above decreases were offset by a $6,000 increase in facilities expense for the three months ended December 31, 2008.
 
General and administrative.  General and administrative expense (G&A) decreased by $572,000, or 48.2%, to $614,000 for the three months ended December 31, 2008, from $1,186,000 for the three months ended December 31, 2007.  The decreases were related primarily to decreases in rent expense and professional and consulting fees as well as overall decreases in all G&A costs as a result of our ongoing cost reduction measures.
 
Rent expenses decreased by $324,000 to $66,000 as of December 31, 2008 compared to $390,000 as of December 31, 2007. In December 2007, the Company closed all operations at its downtown Dallas office resulting in $296,000 of additional expenses in the quarter ended December 31, 2007. The remaining decrease of $28,000 relates to the closing of additional field offices in late fiscal year 2008.
 
Professional and consulting fees decreased by approximately $123,000, to $135,000 as of December 31, 2008 compared to $258,000 as of December 31, 2007 primarily due to non-recurring expenses incurred in 2007.  During the quarter ended December 31, 2007, the Company incurred $51,000 in expenses related to investor relations, professional fees and costs incurred related to the annual meeting in December 2007. Additionally, during the quarter ended December 31, 2007, the Company expensed non-recurring legal fees of $38,000 related to ongoing litigation against a former landlord, in which the Company was the plaintiff and which was settled.  Consulting expenses related to outsource management fees for telex messaging customers acquired from TeleShare in July 2007 decreased by $34,000 for the three months ended December 31, 2008 compared to the three months ended December 31, 2007.
 
 
 
Telecommunications expense decreased by $30,000 to $44,000 as of December 31, 2008 compared to $74,000 as of December 31, 2007. The decrease in data and telecommunications expense is due to our renegotiating more favorable terms with telecommunications service providers.  Salaries and wages decreased $28,000 to $244,000 as of December 31, 2008 compared to $272,000 as of December 31, 2007 due to ongoing efforts to enhance efficiency and reduce headcount. The expense related to the issuance of stock options and directors fees decreased by $14,000 to $41,000 as of December 31, 2008 compared to $55,000 as of December 31, 2007 due to the continued vesting. Insurance expenses decreased by $13,000 primarily due to the renegotiation of commercial insurance rates. Travel expenses were consistent with only a slight decrease of $1,000 to $6,000 as of December 31, 2008 from $7,000 as of December 31, 2007.
 
Provision for bad debt expense (recovery).  Provision for bad debt expense increased by $6,000 to ($1,000) recovery for the three months ended December 31, 2008, from ($7,000) recovery for the three months ended December 31, 2007. As of December 31, 2008, we are fully reserved for all customer accounts that are at least 90 days old.
 
Depreciation and amortization.  Depreciation and amortization decreased by $27,000, or 8.9%, to $277,000 for the three months ended December 31, 2008, from $304,000 for the three months ended December 31, 2007.  The decrease in depreciation totaling $17,000 relates to the increase in fully depreciated assets still in use, offset by the improvement of the Company’s wireless broadband Internet network. The decrease in amortization expense totaling $10,000 for acquired subscriber costs is the result of early wireless acquisitions in fiscal 2005 becoming fully amortized.
 
Interest income and expense. For the three months ended December 31, 2008 and 2007, the Company recorded interest expense of $23,000 and $32,000, respectively.  The $9,000 decrease in interest expense is due to the reduction of the Company’s long-term debt.  For the three months ended December 31, 2008 and 2007, the Company recorded interest income of $12,000 and $25,000, respectively. The $13,000 decrease in interest income is due to changes in cash on hand  and declining interest rates.



Six Months Ended December 31, 2008 Compared to Six Months Ended December 31, 2007

The following table sets forth certain unaudited financial data for the six months ended December 31, 2008 and 2007.  Operating results for any period are not indicative of results for any future period.  Amounts are shown in thousands (except share, per share and subscriber count data).
 
   
Six Months Ended December 31,
  
   
2008
    
% of
Revenues
    
2007
    
% of
Revenues
  
STATEMENT OF OPERATIONS DATA:
                        
REVENUES:
                        
Internet services
   $ 3,885       97.3 %   $ 4,249       95.7 %
Other
     108       2.7 %     192       4.3 %
Total
     3,993       100.0 %     4,441       100.0 %
OPERATING COSTS AND EXPENSES:
                                
Connectivity and operations
     2,691       67.4 %     2,846       64.1 %
Sales and marketing
     143       3.6 %     311       7.0 %
General and administrative
     1,202       30.1 %     1,847       41.6 %
Provision for (recoveries of ) bad debt
     (0 )     0.0 %     4       0.1 %
Depreciation and amortization
     573       14.3 %     571       12.9 %
Total
     4,609       115.4 %     5,579       125.7 %
OPERATING LOSS
     (616 )     (15.4 )%     (1,138 )     (25.7 )%
INTEREST INCOME
     28       0.7 %     34       0.8 %
INTEREST EXPENSE
     (48 )     (1.2 )%     (57 )     (1.3 )%
Minority interest in loss of consolidated subsidiary
     (0 )     0.0 %     (0 )     0.0 %
NET LOSS
   $ (636 )     (15.9 )%   $ (1,161 )     (26.2 )%
NET LOSS PER COMMON SHARE:
                                
BASIC AND DILLUTED
   $ (0.04 )           $ (0.09 )        
WEIGHTED AVERAGE COMMON
                                
SHARES OUTSTANDING:
                                
BASIC AND DILLUTED
     16,857,031               13,120,749          
OTHER DATA:
                                
Subscribers at end of period (1)
     28,400               33,200          
EBITDA (loss)(2)
   $ (42 )           $ (567 )        
EBITDA margin(3)
     (1.1 %)             (12.8 %)        
                                 
Reconciliation of net loss to EBITDA:
                                
Net loss
   $ (636 )           $ (1,161 )        
Add:
                                
Depreciation and amortization
     573               571          
Interest income
     (28 )             (34 )        
Interest expense
     48               57          
EBITDA (loss)(2)
   $ (43 )           $ (567 )        
                                 
(1) 
A subscriber represents an active, billed service.  One customer account may represent multiple subscribers depending on the number of active and billed services for that customer.
(2) 
EBITDA (earnings before interest, taxes, depreciation and amortization) is not a measurement of financial performance under generally accepted accounting principles (GAAP) and should not be considered an alternative to net income as a measure of performance.  Management has consistently used EBITDA on a historical basis as a measurement of the Company’s current operating cash income.
(3) 
EBITDA margin represents EBITDA as a percentage of total revenue.
 
 
 
Six Months Ended December 31, 2008 Compared to Six Months Ended December 31, 2007 (Continued)

Total revenue.  Total revenue decreased by $448,000, or 10.1%, to $3,993,000 for the six months ended December 31, 2008, from $4,441,000 for the six months ended December 31, 2007.  The Company’s total subscriber count decreased by 4,800, or 14.5%, to 28,400 as of December 31, 2008 compared to 33,200 as of December 31, 2007.  The Company’s wireless broadband Internet subscriber count increased slightly to 7,900 as of December 31, 2008, compared to 7,800 as of December 31, 2007.  Wireless broadband Internet revenue increased by $181,000 to $2,102,000 as of December 31, 2008 compared to $1,921,000 as of December 31, 2007.  During the Company’s upgrade process in calendar 2008, we restricted the addition of new customers while improvements were made. The slight increase in wireless broadband Internet revenues was offset by the decrease in dial-up Internet subscriber counts and other internet service related revenue of $544,000, which is attributed to the loss of dial-up customers moving to other providers’ broadband service. In connection with the acquisition of TeleShare, the Company derives other revenues from providing telex messaging services since July 27, 2007, which decreased by $84,000 to $108,000 for the six months ended December 31, 2008 and varies based on customer demand.
 
Connectivity and operations. Connectivity and operations expense decreased by $155,000, or 5.5%, to $2,691,000 for the six months ended December 31, 2008, from $2,846,000 for the six months ended December 31, 2007.  There was a decrease in salaries and wages of approximately $28,000 to $1,278,000 as of December 31, 2008 compared to $1,306,000 as of December 31, 2007.  Data and telecommunications expense decreased by $230,000 to $767,000 as of December 31, 2008 compared to $997,000 as of December 31, 2007.  The decrease in data and telecommunications expense is due to our renegotiating more favorable terms with telecommunications service providers.  The remaining decrease in expense primarily relates to a decrease in merchant fees by $14,000 and a decrease in travel expenses by $24,000.
 
The decreases in the previously discussed expenses were offset by an increase in installation expenses of $105,000 to $294,000 as of December 31, 2008 compared to $189,000 as of December 31, 2007. This increase is due to significant increase in service calls in the Greater Houston Texas region after the natural disaster, Hurricane Ike, and ongoing network improvement activity.  Additionally, in an effort to reduce capital expenditures and to make best use of resources, the Company aggressively increased its repair and recycle program for customer premise equipment.  The costs of refurbishing equipment are currently expensed as incurred.  Tower lease expense increased by $35,000 to $201,000 as of December 31, 2008 compared to $166,000 as of December 31, 2007. The increase in tower leases relates to the growth of the Company’s wireless broadband Internet subscriber counts and operations and the positioning of our Company for our anticipated future growth being driven by our wireless broadband Internet operations and to a lesser extent due to increases in tower rental rates. Other miscellaneous costs increased by $1,000.
 
Sales and marketing. Sales and marketing expense decreased by $168,000, or 54.1%, to $143,000 for the six months ended December 31, 2008, compared to $311,000 for the six months ended December 31, 2007.  Salaries and wages decreased $85,000 to $111,000 as of December 31, 2008 compared to $196,000 as of December 31, 2007. This decrease was due to ongoing efforts to enhance efficiency and reduce headcount, including the elimination of outside sales force and present vacancy of the position of Vice President of Marketing.   Advertising, travel and consulting expenses decreased by $95,000 to $20,000 as of December 31, 2008 compared to $115,000 as of December 31, 2007.  Approximately $50,000 of non-recurring advertising was incurred during our initial launch of reselling municipal Wi-Fi in Corpus Christi, which occurred during the six months ended December 31, 2007. These decreases were slightly offset by allocation of facilities expense for inside sales force of $12,000.
 
General and administrative.  G&A decreased by $645,000, or 34.9%, to $1,202,000 for the six months ended December 31, 2008 from $1,847,000 for the six months ended December 31, 2007. Facilities costs decreased by $410,000 to $147,000 as of December 31, 2008 compared to $557,000 as of December 31, 2007 primarily due to the write off of the abandoned corporate headquarters lease in Dallas in the previous year and also to the closing of additional regional field offices.
 
Professional and consulting fees decreased by $157,000 to $238,000 as of December 31, 2008 compared to $395,000 as of December 31, 2007 primarily due to non-recurring expenses incurred in 2007.  During the six months ended December 31, 2007, the Company incurred $85,000 in expenses related to investor relations consulting fees and costs incurred related to the annual meeting in December 2007. Additionally, during the quarter ended December 31, 2007, the Company expensed non-recurring legal fees of $38,000 related to ongoing litigation against a former landlord, in which the Company was the plaintiff and which was settled.  Consulting expenses related to outsource management fees for telex messaging customers acquired from TeleShare in July 2007 decreased by $34,000 for the three months ended December 31, 2008 compared to the three months ended December 31, 2007.
 
 
 
Property taxes and insurance expenses decreased by $13,000 to $61,000 as of December 31, 2008 from $74,000 as of December 31, 2007 due to the renegotiation of insurance contracts. Telecommunications expense decreased by $63,000 to $82,000 as of December 31, 2008 compared to $145,000 as of December 31, 2007 due primarily to decreased long distance services by entering into a more favorable agreement with the telecommunications service provider. A net decrease in stock compensation and director fees of $8,000 to $77,000 as of December 31, 2008 compared to $85,000 as of December 31, 2007 was due to the continued vesting of stock options.  Salaries and wages were relatively consistent totaling $480,000 as of December 31, 2008 compared to $473,000 as of December 31, 2007. The remaining net decrease of $1,000 was primarily a result of various cost saving measures implemented during fiscal 2009.
 
Provision for bad debt expense.  Provision for bad debt expense decreased by $4,000 for the six months ended December 31, 2008.  This decrease is due primarily to a sales effort to increase the number of customers enrolled in electronic payment methods, whereby non-payment for services is decreased.  As of December 31, 2008, we are fully reserved for all customer accounts that are at least 90 days old.
 
Depreciation and amortization.  Depreciation and amortization increased by $2,000, or 0.4%, to $573,000 for the six months ended December 31, 2008 from $571,000 for the six months ended December 31, 2007.  The net increase relates to a decrease of $13,000 in depreciation and an increase of $15,000 in amortization. A decrease of $13,000 in depreciation relates to the increase in fully depreciated assets still in use. This is offset by a $15,000 increase in amortization expense due to amortization of companies acquired in fiscal 2007.
 
Interest income and expense. For the six months ended December 31, 2008 and 2007, the Company recorded interest expense of $48,000 and $57,000, respectively.  The $9,000 decrease in interest expense is the result of the reduction in the Company’s long-term debt. For the six months ended December 31, 2008 and 2007, the Company recorded interest income of $28,000 and $34,000, respectively. The $6,000 decrease in interest income is the result of a reduction in the interest rates.

Liquidity and Capital Resources

We have financed our operations to date primarily through (i) cash flows from operations, (ii) public and private sales of equity securities and (iii) loans from shareholders and third parties.
 
Cash used in operating activities is net income or loss adjusted for certain non-cash items and changes in assets and liabilities.  For the six months ended December 31, 2008, cash used in operations was $438,000 compared to cash used in operations of $570,000 for the six months ended December 31, 2007. For the six months ended December 31, 2008, net loss plus non-cash items used cash of $16,000.  Increases in accounts receivable and purchase of other assets were offset by decreases in inventory, prepaid expenses, accounts payable and deferred revenue.  For the six months ended December 31, 2007, net loss plus non-cash items used cash of $527,000. Decreases in accounts receivable, inventory, prepaid expenses and other assets were offset by increases in accounts payable and deferred revenue.
 
Cash used in investing activities totaled $141,000 for the six months ended December 31, 2008, which relates primarily to approximately $152,000 in cash used to purchase new wireless broadband Internet infrastructure, offset by proceeds from the sale of equipment of approximately $11,000.  Cash provided by investing activities totaled $206,000 for the six months ended December 31, 2007, which relates primarily to approximately $655,000 in cash provided by the acquisition of Teleshare, offset primarily by the deployment of new wireless broadband Internet infrastructure of approximately $443,000.
 
Cash used in financing activities for the six months ended December 31, 2008 totaled $286,000 and relates to the principal payments on long-term debt. Cash provided by financing activities, which totaled $5,178,000 for the six months ended December 31, 2007, consisted of the issuance of common and preferred stock resulting in net proceeds of $5,295,000 and borrowings on the RUS loan of $72,000, offset by principal payments on long term-debt totaling $188,000.
 
 
 
Internet America estimates that cash on hand of $3 million at December 31, 2008 along with anticipated cash flow from operations will be sufficient for meeting our working capital needs for the next twelve months for continuing operations in both existing and new markets as well as the planned deployment of additional wireless infrastructure.  Management believes that Internet America will be able to meet the service obligations related to the deferral of revenue and that cash generated from recently acquired operations will be adequate to meet its payment obligations under debt issued and assumed in connection with these acquisitions.  However, additional financing may be required to fund future acquisitions.  Continued decreases in revenues and subscriber count may adversely affect the liquidity of the Company.
 
The focus of Internet America’s acquisition program has been to identify prospective opportunities that would provide us with a larger number of subscribers, larger revenue base and geographic expansion. This will allow us to spread the cost of our well developed systems, superior network performance, high quality customer care and technical support over an increased number of subscribers. Leveraging the efficiencies of Internet America’s operations over a larger subscriber base would provide us with the benefits of larger economies of scale. Expanding operations outside of Texas would also allow us to become a national player in the delivery of wireless internet service, thereby providing geographical diversity and more stability to our subscriber base, as well as the opportunity for cross marketing and selling new products to a larger base. Financing for such an acquisition would likely come from the public issuance of equity securities and/or the private sale of debt or equity securities. If such capital financing arrangements or borrowings from commercial banks are insufficient or unavailable, or if we experience shortfalls in anticipated revenues or increases in anticipated expenses, we will modify our acquisition program to match available funding.
 
Off Balance Sheet Arrangements
 
None.
 
“Safe Harbor” Statement
 
The following "Safe Harbor" Statement is made pursuant to the Private Securities Litigation Reform Act of 1995.  Certain of the statements contained in the body of this Report are forward-looking statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995.  These risks include, without limitation, that (1) we will not be able to increase our rural customer base at the expected rate, (2) we will not improve EBITDA, profitability or product margins, (3) we will not be able to identify and negotiate acquisitions of wireless broadband Internet customers and infrastructure on attractive terms or successfully integrate those acquisitions into our operations, (4) financing will not be available to us if and as needed, (5) we will not be competitive with existing or new competitors, (6) we will not keep up with industry pricing or technological developments impacting the Internet, (7) we will be adversely affected by dependence on network infrastructure, telecommunications providers and other vendors or by regulatory changes, (8) service interruptions or impediments could harm our business; (9) we may be accused of infringing upon the  intellectual property rights of third parties, which is costly to defend and could limit our ability to use certain technologies in the future, (10) government regulations could force us to change our business practices, (11) we may be unable to hire and retain qualified personnel, including our key executive officers, (12) provisions in our certificate of incorporation, bylaws and shareholder rights plan could limit our share price and delay a change of management; and (13) our stock price has been volatile historically and may continue to be volatile.  Additional risks and uncertainties relating specifically to the proposed merger with KeyOn include, without limitation, that (1) the proposed merger will cause disruptions in our business and the business of KeyOn, (2) we may fail to complete the merger, (3) we may fail to integrate successfully and achieve the anticipated benefits of the merger, (4) we have incurred and will incur additional significant costs associated with the merger that may exceed the benefits, (5) as a result of purchase accounting treatment, we will significantly increase amortization expense for intangibles relating to KeyOn which will decrease net income  for the foreseeable future, and (6) we may need to obtain additional financing to service the debt incurred in the merger.  This list is intended to identify certain of the principal factors that could cause actual results to differ materially from those described in the forward-looking statements included elsewhere herein.  These factors are not intended to represent a complete list of all risks and uncertainties inherent in our business, and should be read in conjunction with the more detailed risk factors included in our Form S-4/A Registration Statement.
 
 


QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable

CONTROLS AND PROCEDURES

Our Chief Executive Officer and Chief Financial Officer performed an evaluation of our disclosure controls and procedures, which have been designed to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.  They concluded that the controls and procedures were effective as of December 31, 2008 to provide reasonable assurance that the information required to be disclosed by the Company in reports it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.  While our disclosure controls and procedures provide reasonable assurance that the appropriate information will be available on a timely basis, this assurance is subject to limitations inherent in any control system, no matter how well it may be designed or administered. There were no changes in our internal control over financial reporting during the six months ended December 31, 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


 
 
EXHIBITS
 
Exhibit
  
Description
2.1
  
Agreement and Plan of Merger among Registrant, KeyOn Communications Holdings, Inc. and IA Acquisition, Inc. dated November 14, 2008.(1)
4.3
  
Amendment No. 2 to Rights Agreement dated as of November 24, 2008.(2)
 
Rule 13a-14(a)/15d-14(a) Certification of William E. Ladin, Jr.
 
Rule 13a-14(a)/15d-14(a) Certification of Jennifer S. LeBlanc
 
Section 1350 Certification of William E. Ladin, Jr.
 
Section 1350 Certification of Jennifer S. LeBlanc
     
(1)
Incorporated by reference to exhibit 2.1 to Form 8-K (file no. 0001144204-08-065145) filed November 18, 2008.
(2) 
Incorporated by reference to exhibit 4.3 to Registration Statement on Form S-4 (Reg. No. 333-155886) filed December 3, 2008.
 
 
 
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



INTERNET AMERICA, INC.
(Registrant)

Date:  02/17/09
By:  /s/ William E. Ladin, Jr.
William E. Ladin, Jr.
Chairman and Chief Executive Officer
 
Date:  02/17/09
By:  /s/ Jennifer S. LeBlanc
Jennifer S. LeBlanc
Chief Financial and Accounting Officer



 
INDEX TO EXHIBITS
 
  Exhibit No. Description
     
 
Rule 13a-14(a)/15d-14(a) Certification of William E. Ladin, Jr.

 
Rule 13a-14(a)/15d-14(a) Certification of Jennifer S. LeBlanc

 
Section 1350 Certification of William E. Ladin, Jr.

 
Section 1350 Certification of Jennifer S. LeBlanc
     
     
     
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