SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**Form
      10-KSB**


**x**


**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(** d **)
      OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**





**For
      The Fiscal Year Ended June 30, 2006**


**o**


**TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(** d **)
      OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


**For
      the transition period from to**





**Commission
      file number 000-25147**





**Internet
      America, Inc.**


(Name
      of
      registrant as specified in its charter)





**Texas**
            **86-0778979**(State
                or other jurisdiction of
            (I.R.S.
                Employerincorporation
                or organization)
            Identification
                No.)**10930
                W. Sam Houston Pkwy.,N.**
              **Suite
                200**
            **77064****Houston,
                Texas**
            (Zip
                Code)(Address
                of principal executive offices)





Registrant’s
      telephone number: **(214)
      861-2500**





Securities
      registered pursuant to Section 12(b) of the Exchange Act:


**(Not
      applicable)**





Securities
      registered pursuant to Section 12(g) of the Exchange Act:





**Common
      Stock, Par Value $.01 Per Share**


**(Title
      of Class)**





Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act. o





Check
      whether the registrant (1) filed all reports required to be filed by Section
      13
      or 15(d) of the Exchange Act during the past 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





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of registrant's knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this Form 10-KSB. x





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





The
      issuer’s revenues for its most recent fiscal year were $9,909,385.





Based
      on
      the closing price of the registrant’s Common Stock on September 1, 2006, the
      aggregate market value of the Common Stock held by non-affiliates of the
      registrant is $3,146,439. Solely for the purposes of this calculation, all
      executive officers and directors of the registrant and all shareholders
      reporting beneficial ownership of more then 5% of the registrant’s Common Stock
      are considered to be affiliates.





The
      number of shares of Common Stock outstanding as of September 30, 2006 was
      12,508,914.





**DOCUMENTS
      INCORPORATED BY REFERENCE**





Portions
      of the definitive proxy statement for the Annual Meeting of Shareholders to
      be
      held in December 2006 to be filed within 120 days after the end of our fiscal
      year, are incorporated by reference into Part III, Items 9 through 12 and 14
      of
      this Form 10-KSB.








**TABLE
      OF CONTENTS**





**Page**PART
                I
            Item
                1.
            Description
                of Business
            3Item
                2.
            Description
                of Properties
            7Item
                3.
            Legal
                Proceedings
            8Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            8PART
                II
            Item
                5.
            Market
                for Common Stock, Related Stockholder Matters and Issuer Purchases
                of
                Equity Securities
            9Item
                6.
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            9Item
                7.
            Financial
                Statements
            16Item
                8.
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            16Item
                8A.
            Controls
                and Procedures
            16Item
                8B.
            Other
                Information
            16PART
                III
            Item
                9.
            Directors,
                Executive Officers, Promoters and Control Persons; Compliance with
                Section
                16(a) of the Exchange Act
            17Item
                10.
            Executive
                Compensation
            17Item
                11.
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            17Item
                12.
            Certain
                Relationships and Related Transactions
            17Item
                13.
            Exhibits
            17Item
                14.
            Principal
                Accountant Fees and Services
            17SIGNATURES
            18INDEX
                TO FINANCIAL STATEMENTS
            F-1


2





*This
      Report on Form 10-KSB contains forward-looking statements that involve risks
      and
      uncertainties. Actual results, performance or achievements, or industry results,
      may be materially different from those described in the forward-looking
      statements due to a number of risk factors. Such risks and uncertainties include
      those set forth under the caption "Management's Discussion and Analysis of
      Financial Condition and Results of Operations" and elsewhere in this Form
      10-KSB. See also Item 6, “Management’s Discussion and Analysis of Financial
      Condition and Results of Operations - Safe Harbor Statement.”*





**PART
      I**





**Item
      1.** ***Description
      of*** **** ***Business***





**General**





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. As of June 30, 2006, we served approximately 37,000 active
      subscribers. Internet America was incorporated in Texas in 1995 and currently
      has operations only in the state of Texas.





In
      fiscal
      2006 the Company continued to adjust its focus and business away from reliance
      on dialup and wire broadband connectivity in major metropolitan markets to
      providing wireless broadband Internet connectivity to under-served suburban
      and
      rural markets near its wireless operational centers in San Antonio, Stafford
      (a
      suburb of Houston) and Corsicana, Texas. These operational centers provide
      installation, construction and repair services to their surrounding geographic
      areas, and are supported by two additional remote offices in Hillsboro and
      Weimar, Texas. We expect these centers to cover a market area that is larger
      than the town where it is located. We try to locate a center so that one can
      reach any part of its market within an hour and a half’s drive. Initially, three
      of these operational centers also offered computer repair services. However,
      due
      to lack of profitability, these service offerings were discontinued during
      2006.





The
      San
      Antonio wireless operations are a result of two acquisitions made in fiscal
      2006
      and internal growth in that market subsequent to the acquisitions: Top Gun
      Telecommunications, purchased in July of 2005, and 2Fast Communications, Inc.
      purchased in January, 2006. The operations of these two entities were combined
      shortly after the 2Fast acquisition.





The
      Houston area wireless operations have been expanded in a “de-novo” fashion since
      operations commenced in September 2005 in the area west of Houston, roughly
      following Interstate Highway 10. The initial service offerings were provided
      in
      Weimar, Texas and have expanded since then to the towns of Schulenberg, Flatonia
      and Columbus. In February 2006, the Company acquired a small Wireless ISP,
      PowerWeb, in the Fulshear, Texas area near Houston and has used this as a
      platform for expansion of services in that geographic region as
      well.





In
      the
      Corsicana operational center, approximately 50% of the present operations and
      subscriber base are the result of several acquisitions made in fiscal 2005
      and
      the remaining 50% from growth in subscribers since those acquisitions. The
      Corsicana operations provide service coverage to a five county area where some
      residents commute to the Dallas/Fort Worth Metroplex for
      employment.





In
      addition to the growth of the wireless subscriber base through acquisitions,
      in
      the last nine months, the Company has organically expanded its wireless
      subscriber base by focusing on providing services in specifically targeted
      underserved “micro-markets”, consisting primarily of subdivisions and other
      small geographic areas with favorable demographics and population density,
      near
      the operational centers in San Antonio, Houston and Corsicana, Texas. At June
      30, 2006, the Company had approximately 3,200 wireless subscribers.





In
      addition to its focus on wireless broadband Internet access services, the
      Company continues to provide dialup and wire-line broadband Internet access
      services and other services such as co-location of servers, hosting of websites
      and broadband telecommunications to its long-existing base of subscribers.
      However, as previously reported, the Company does not aggressively market these
      services and has seen some decline of the overall number of subscribers using
      these services as wireless service becomes more popular. As of June 30, 2006,
      Internet America had approximately 3,000 wire-line broadband subscribers down
      from 3,200 at June 30, 2005.





In
      January of 2006, the Company announced its intention to relocate its corporate
      headquarters to Houston from Dallas, Texas. That move was completed in March.
      Also in March, the Company ceased operations of its small “computer centers”
which offered computer repair services in some local markets, after a review
      of
      them indicated that they were only marginally profitable and did not provide
      the
      tactical marketing advantages that management had originally
      presumed.





The
      Company is also in the process of relocating its primary data center operations
      from Dallas to Houston. Management anticipates that this will be completed
      by
      the end of calendar 2006.


3




While
      there is no guarantee that we will make significant or numerous acquisitions,
      the management of the Company believes that there are many wireless Internet
      service providers (“WISPS”) who need the sales, marketing and management
      experience that Internet America offers and who 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 ISP’s and
      WISP’s, acquisitions remain attractive as an important method of acquiring
      attractive subscriber bases and good, experienced management. For these reasons,
      as well as the potential financial attractiveness of some acquisitions, the
      Company remains open to blending its expansion to new suburban and rural markets
      in the near term between de novo openings and acquisitions. In addition to
      the
      opportunity for organic growth, some of the larger potential combinations appear
      to be even more attractive because of duplication and redundancy in areas such
      as customer support, accounting, telecom costs and systems. Management believes
      that such combinations could be synergistic in improving sales and marketing
      while saving money by reducing duplicated expenses.





**Services**





We
      offer
      Internet services tailored to meet the needs of both individual and business
      subscribers. Our primary service offerings are broadband and dial-up Internet
      access, as well as related value-added services. For our business subscribers,
      we offer dedicated high speed Internet access, web hosting, co-location and
      other business related services. Our services are offered in several different
      packages to provide subscribers a broad range of choices to satisfy their
      Internet needs. The majority of our consumer subscribers have month-to-month
      subscriptions, and the majority of our business customers are under service
      contracts for a term. We bill most consumer subscribers through automatic
      charges to their credit cards or bank accounts, and we bill most of our business
      customers by monthly invoices. We offer discounts on almost all of our services
      for subscribers who prepay for a longer term.





*High
      Speed Connectivity; DSL Services* .
      We
      offer broadband connectivity for business and consumers, including 64k/128k
      Integrated Service Digital Network (ISDN) access, 1.5M Asymmetrical Digital
      Subscriber Lines (ADSL), fractional to full T-1, DS-3 level connectivity and
      wireless connectivity. Our DSL products provide high-speed Internet access
      over
      existing telephone lines, and may allow subscribers to simultaneously use a
      single telephone line for voice service and for access to the Internet. DSL
      provides an "always on" connection thereby removing wait times associated with
      dialing into a network. The DSL products offer our residential and business
      subscribers a cost-effective way to substantially increase the speed at which
      they access the Internet.





*Dial-Up
      Internet Access* .
      Our
      most popular dial-up Internet access package includes basic Internet access
      and
      related Internet applications such as World Wide Web browsing, e-mail, file
      transfer protocol (FTP), and USENET news access. Available value-added services
      include multiple e-mail mailboxes, national roaming services, personalized
      e-mail addresses, personal web sites and enhanced USENET news
      access.





*Wireless
      Broadband Internet Access* .
      Our
      wireless Internet access package includes basic Internet access and related
      Internet applications such as World Wide Web browsing, e-mail, file transfer
      protocol (FTP), and USENET news access. Available value-added services include
      multiple e-mail mailboxes, national dial-up roaming services, personalized
      e-mail addresses and personal web sites.





**Customer
      Care**





Our
      goal
      of customer satisfaction begins with providing superior systems and network
      performance. In addition to the provision of excellent systems and network
      performance, we emphasize high quality customer care and technical support.
      We
      strive to retain our subscribers by strong responses to customer problems via
      telephone, email and newsgroups.





Individuals
      accessing the Internet have many different operating system, hardware and
      network configurations, coupled with varying levels of computer sophistication.
      Consequently, our customer care department must be able to efficiently and
      effectively address:





•
      Problems affecting a variety of hardware systems;





•
      Start-up or other basic problems of new subscribers or new Internet
      users;





•
Highly
      technical issues that sophisticated users may encounter; and





•
      Operating system defects/workarounds.





4


We
      had
      approximately 28 customer care employees in three different business areas
      (specialized by type of service) at June 30, 2006. Customer care is available
      to
      subscribers during extended business hours, typically until 9 p.m. weekdays
      and
      on limited hours on weekends. These hours were reduced from 24x7 in early 2006
      after careful evaluation of overnight call volumes and the user needs at those
      times. In addition to diagnosing and resolving subscribers' technical problems,
      members of our customer care department answer questions about account status
      and billing information, respond to new product requests and provide
      configuration information.





We
      maintain a comprehensive description of our customer care services on our Web
      site, as well as troubleshooting tips and configuration information. Subscribers
      can also obtain recorded system and network status reports at any time and
      review extensive system and network performance on the World Wide
      Web.





**Marketing**





As
      discussed, our marketing efforts and expenditures are primarily focused on
      expanding our wireless subscriber base in very specific geographic areas that
      are represented by underserved markets whose characteristics meet our
      requirements for specific demographics and population density. We primarily
      use
      door direct marketing to create brand and service awareness in these areas.
      We
      do not use mass-marketing tools or tactics as a result of our focus on very
      specific geographic areas.





**Infrastructure**





Our
      network provides subscribers with local dial-up and broadband (DSL) access
      in
      all major metropolitan areas of Texas, as well as dial-up access in many tier
      2
      and tier 3 cities. Our wireless network is limited to specific areas in which
      we
      have chosen to establish the required network components such as towers and
      network access points.





Our
      systems and network infrastructure are designed to provide reliability and
      speed. Reliability is achieved through redundancy in mission critical systems
      that minimize 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.





*Physical
      and Virtual POPs.* Subscribers dial a local phone number and connect to one of our points of
      presence (POPs), consisting of inbound telephone lines, modems and related
      computer equipment. The POPs are either facilities owned by Internet America
      or
      "Virtual POPs" owned by telecommunication companies. Virtual POP architecture
      allows us to provide local access services without deploying additional physical
      infrastructure. The Virtual POP architecture enables subscribers to dial a
      local
      phone number and connect to a modem owned and housed by a telecommunications
      provider. The subscriber's data call is then routed across leased lines to
      our
      internal network. Unlike simply leasing network capacity from a third-party
      provider, the Virtual POP architecture allows us to maintain substantial control
      over quality of service and capacity. The benefits of this architecture include
      substantially reduced capital expenditures and reduced exposure to technological
      obsolescence. In addition, when entering new markets, the Virtual POP
      architecture allows us to match more precisely capacity needs to actual sales
      in
      that market.





*Internal
      Network Infrastructure* .
      Subscribers enter our network from either the physical POP or Virtual POP.
      Our
      primary internal network is designed to maximize sustained high-speed traffic
      and provide both resiliency to failure and redundancy. Our facilities are
      powered by a computer controlled uninterruptible power supply that provides
      battery backup, surge protection and power conditioning. Automatic onsite diesel
      generators provide power for prolonged power outages.





Our
      network is remotely monitored by using software tools that alert specific
      employees who are responsible for specific functions of the network and various
      applications running on the network. The software tools monitor the status
      of
      all networking facilities, components, applications and equipment deployed
      throughout our infrastructure on a 24 hour/365 days a year basis and transmit
      alerts as issues appear. The employees who receive the alerts are responsible
      for operational communications among internal departments and are also
      responsible for communication with external service providers. Other software
      tools such as statistical analysis software are used by the Company to provide
      data about the quality of service most subscribers are experiencing, as well
      as
      information to help control costs by purchasing additional bandwidth and
      services only when needed.





We
      maintain our applications on a variety of systems from a number of vendors.
      The
      major applications, such as e-mail and newsgroup access services, utilize a
      network of servers which are connected directly to our network backbone through
      high-availability network routers. We deploy 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.





*Management
      Information Systems* .
      Our MIS
      department uses a near real-time customer database, billing and flow-through
      fulfillment system (“CMS”) to handle all customer contact and billing
      information for the services we provide. CMS 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. We continually enhance CMS to provide additional functionality
      for improved financial, marketing and management reporting.





5


**Technology
      and Development**





The
      Company does not focus a material amount of resources on developing new
      technologies. We do however recognize that additional revenue streams and higher
      level of subscriber satisfaction (and thus increased subscriber retention)
      are,
      in many cases, based on deploying new services and technologies as they become
      commercially reliable and economically feasible. Therefore, we are continuously
      evaluating new technologies and applications for possible introduction or
      incorporation into our services.





Additionally,
      we are committed to developing and maintaining strong, stable, resilient low
      latency data-communications networks in order to provide connectivity services
      to our subscribers. As new services are introduced, we believe our customers
      will quickly be able to adopt our new offerings on the infrastructure on which
      our network is deployed.





**Proprietary
      Rights**





We
      believe that our success is more dependent upon technical, marketing and
      customer service expertise than upon our proprietary rights. However, our
      success and ability to compete are dependent in part upon proprietary rights.
      We
      primarily rely on copyright and trademark laws. "Internet America," the Internet
      America logo, "1-800-Be-A-Geek”, “Airmail.net," and "Airnews.net," are
      registered service marks of Internet America or its subsidiaries. In addition,
      as we expand our wireless operations in rural markets and become more entrenched
      and integrated into the communities that we serve through our local offices,
      local staff and internet connectivity, we believe that our brand and our
      presence may create some barriers to entry by others and more loyalty on the
      part of our rural customers.





There
      can
      be no assurance that the steps we take will be adequate to prevent the
      misappropriation of our technology or that our competitors will not
      independently develop technologies and services that are substantially
      equivalent or superior to ours.





**Competition**





The
      Internet services market is extremely competitive in every type of market
      (dialup, wired broadband and wireless).





In
      the
      dialup market, where we have approximately 18,000 subscribers, there are no
      substantial barriers to entry, and we expect that competition will continue
      to
      intensify and, more importantly, dialup subscribers in general will continue
      to
      decline as more subscribers, business and residential, convert to the various
      broadband services available to them.





The
      wired
      broadband services market, such as DSL (where we have over 3,000 subscribers)
      or
      cable-modem, in particular is extremely competitive. The markets we serve have
      been flooded with DSL, cable and wireless offers from our competitors, some
      of
      which have greater resources than we have and are able to offer their products
      at lower prices than we offer. We have to rely on local loop providers with
      whom
      we compete in order to provide DSL services to our customers. These providers
      have been exerting pressure on independent ISPs, including raising prices and
      changing billing relationships, all of which puts us at a competitive
      disadvantage. Many local loop providers have consolidated or failed, causing
      fewer choices for us to offer to our customers. Furthermore, other methods
      of
      broadband delivery which we do not currently offer, such as cable transmission,
      may be more successful than DSL.





In
      the
      wireless market, while there is still significant competition, we are utilizing
      a strategy of focusing on marketing to underserved geographic areas (i.e. those
      areas where there is less competition or technically inferior services
      available).





In
      all of
      these competitive markets, we believe that the primary competitive factors
      determining success include pricing, access speed, a reputation for reliability
      and service, effective customer support and access to capital. Our current
      and
      prospective competitors include many large companies that have substantially
      greater market presence and financial, technical, marketing and other resources
      (including the ability to offer “bundled” packages of services) than we have.
      Increased competition for users of Internet services may result in lower
      subscriber growth rates or continued subscriber loss. Competitors may charge
      less than we do, causing us to reduce or preventing us from raising our fees.
      As
      a result, our business and revenues may suffer. We currently compete or expect
      to compete with the following types of Internet access providers:





•
      national online service providers, such as AOL, the Microsoft Network and
      EarthLink;


•
      national telecommunications providers, such as AT&T, Qwest, MCI and
      Sprint;


•
      numerous regional and local ISPs and WISPs;


•
      computer hardware and software companies, and other technology companies, such
      as Microsoft and
      Dell;


6


•
cable
      operators, such as Time Warner and Comcast;


•
fixed
      wireless communications companies;


•
      satellite companies; and


•
      electric utility companies.





**Government
      Regulation**





Internet
      America is not currently subject to direct regulation by the Federal
      Communications Commission or any other agency, other than regulations applicable
      to businesses and public companies generally. The FCC classifies Internet access
      providers as "information service providers," rather than regulated
      "telecommunications providers" under the 1996 Telecommunications Act. As such,
      we are not subject to regulations that apply to telephone companies and similar
      carriers. However, as we provide Internet access delivered via DSL or wire
      line
      broadband technology, which transmits internet service over public telephone
      lines, these transmissions are governed by regulations and policies of the
      FCC
      establishing charges, terms and conditions.





Changes
      in the FCC's policies relating to the classification of telecommunications
      services and information services could have a material adverse effect on our
      business. The FCC has recently determined that Internet access providers,
      utilizing DSL technology, are “information services functionally integrated with
      a telecommunications component”. In the past, the FCC required that telephone
      companies and similar carriers offer the DSL transmission component separately
      from their own Internet service, as a stand-alone service on a common-carrier
      basis. This regulation was removed effective August 2006, thereby allowing
      telephone companies the flexibility to offer access to affiliated or
      unaffiliated ISPs on a common-carrier basis, a non-common carrier basis, or
      some
      combination of both.





Internet
      America has approximately 3,000 DSL subscribers. After the data center move
      is
      complete at the end of this calendar year, we anticipate entering into
      renegotiation of our contracts to share the DSL transmission component for
      our
      existing DSL service with our telephone service providers. The intended result
      will be a mutually agreeable solution which will allow Internet America to
      continue to provide cost effective DSL service to our customers; however, there
      is no guarantee that we will be successful in renegotiating our contracts with
      the ILEC providers.





Further
      changes in the FCC's policies relating to the classification of
      telecommunications services and information services could have more adverse
      effects on our business. If the FCC were to classify us as a provider of
      telecommunications services, regulations could affect the charges we pay to
      connect to the local telephone network, could impede our ability to compete
      for
      broadband customers and could cause us to have to increase prices for our
      services.





The
      FCC
      also does not currently regulate the use of cable infrastructure for Internet
      access as a telecommunications service or cable service. This classification
      will likely protect cable modem service providers from regulation, including
      regulations requiring open access to cable infrastructure. Although some cable
      operators are voluntarily providing access to competing service providers,
      the
      FCC’s classifications decrease our potential to provide Internet access services
      via the cable television infrastructure.





Due
      to
      the increasing popularity and use of the Internet, it is possible that
      additional laws, regulations or legal precedent may be adopted with respect
      to
      the Internet, covering issues such as content, privacy, pricing, unsolicited
      email, encryption standards, consumer protection, electronic commerce, taxation,
      copyright infringement and other intellectual property issues. We cannot predict
      the impact, if any, that any future legal or regulatory changes or developments
      may have on our business, financial condition and results of operations. Changes
      in the legal or regulatory environment relating to the Internet access industry,
      including changes that directly or indirectly affect telecommunication costs
      or
      increase the likelihood or scope of competition from regional telephone
      companies, cable operators or others, could have a material adverse effect
      on
      our business, financial condition and results of operations.





**Employees**





As
      of
      June 30, 2006, we employed approximately 67 people, 58 of whom were full-time
      and 9 of whom were part time employees. None of our current employees are
      represented by a labor organization, and we consider employee relations to
      be
      good.





**Item
      2.** ***Description
      of*** **** ***Properties***





Our
      corporate headquarters are located in Houston, Texas at 10930 W. Sam Houston
      Pkwy., N., Suite 200, where all executive functions exist. We do not own any
      real estate. We believe that all of our facilities are adequately maintained
      and
      suitable for their present use. We lease office space in the following locations
      for the purposes indicated:


7





**Location**
            **Square
                footage**
            **Purpose**Houston
            4,100
            Corporate
                headquartersHillsboro
            1,500
            Field
                officeDallas
            19,000
            Call
                centerStafford
            5,600
            Call
                center/Field officeCorsicana
            2,000
            Field
                officeSan
                Antonio
            1,700
            Field
                office








**Item
      3.** ***Legal
      Proceedings***





We
      are
      involved from time to time in routine disputes and legal proceedings occurring
      in the ordinary course of business. Management believes these matters,
      individually and in the aggregate, are immaterial to our financial condition,
      results of operations and cash flows.





**Item
      4.** ***Submission
      of Matters to a Vote of Security Holders***





No
      matters were submitted to a vote of our security holders during the fourth
      quarter of fiscal 2006.





8





**PART
      II**





**Item
      5.** ***Market
      for Common Stock, Related Stockholder Matters and Issuer Purchases of Equity
      Securities***





Our
      common stock trades on the OTC Bulletin Board under the symbol GEEK.OB. The
      following table shows the high and low bid quotations per share of the common
      stock for the periods indicated as reported on the OTC Bulletin Board. These
      over-the-counter market quotations reflect inter-dealer prices, without retail
      mark-up, mark-down or commission and may not necessarily represent actual
      transactions.





**High**
            
            **Low**Fiscal
                Year Ended June 30, 2006:Fourth
                Quarter
            
            $
            0.40
            
            $
            0.29Third
                Quarter
            
            
            0.55
            
            
            0.38Second
                Quarter
            
            
            0.64
            
            
            0.40First
                Quarter
            
            
            0.78
            
            
            0.46Fiscal
                Year Ended June 30, 2005:Fourth
                Quarter
            
            
            1.17
            
            
            0.67Third
                Quarter
            
            
            1.54
            
            
            0.87Second
                Quarter
            
            
            1.54
            
            
            0.66First
                Quarter
            
            
            0.80
            
            
            0.51





At
      September 30, 2006, there were 252 holders of record of our common stock. The
      last reported sale price of the common stock on the OTC Bulletin Board on
      September 28, 2006 was $0.28 per share.





We
      have
      neither declared nor paid any cash dividends on our capital stock and do not
      anticipate paying cash dividends in the foreseeable future. Our current policy
      is to retain any earnings in order to finance the expansion of our operations.
      Our board of directors will determine future declaration and payment of
      dividends, if any, in light of the then-current conditions they deem
      relevant.





For
      information regarding securities authorized for issuance under the Company’s
      equity compensation plans, please see Item 10 of this Form 10-KSB, which
      incorporates by reference a section of the Company’s definitive proxy
      statement.





**Item
      6.** ***Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations***





The
      following is a discussion of the financial condition and results of operations
      of Internet America, Inc. for the years end ed
      June
      30, 2006 and 2005. This discussion should be read in conjunction with the
      consolidated financial statements and notes thereto included elsewhere in this
      report.





**Safe
      Harbor Statement**





Certain
      statements contained in this Form 10-KSB constitute "forward-looking statements"
      within the meaning of Section 27A of the Securities Act of 1933, as amended
      (the
      "Securities Act"), and Section 21E of the Exchange Act. 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 and worse than those described in the
      forward-looking statements. Such risks and uncertainties include those set
      forth
      in this section and elsewhere in this Form 10-KSB.





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 a rate that exceeds the loss of metropolitan area customers, (2) we
      will
      not improve EBITDA, profitability or product margins, (3) we will not continue
      to achieve operating efficiencies, (4) we will not be competitive with existing
      or new competitors, (5) we will not keep up with industry pricing or
      technological developments impacting the Internet, (6) needed financing will
      not
      be available to us if and as needed, (7) we will be adversely affected by
      dependence on network infrastructure, telecommunications providers and other
      vendors, by regulatory changes and by general economic and business conditions;
      (8) service interruptions or impediments could harm our business; (9) we may
      not
      be able to protect our proprietary technologies or successfully defend
      infringement claims and may be required to enter licensing arrangements on
      unfavorable terms; (10) 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; (11) government regulations
      could force us to change our business practices; (12) we may be unable to
      continually develop effective business systems, processes and personnel to
      support our business; (13) we may be unable to hire and retain qualified
      personnel, including our key executive officers; (14) provisions in our
      certificate of incorporation, bylaws and shareholder rights plan could limit
      our
      share price and delay a change of management; (15) our stock price has been
      volatile historically and may continue to be volatile; and (16) some other
      unforeseen difficulties may occur. 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 cautionary statements included in our other publicly filed
      reports and documents.


9





**Overview**





Internet
      America is an ISP serving approximately 37,400 subscribers in Texas as of June
      30, 2006. 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.  The Company derives substantially all
      revenues from services, primarily Internet access services, and related fees,
      and such revenues represented more than 94.5% of our revenue for the year ended
      June 30, 2005.  For the year ended June 30, 2006, Internet access services
      accounted for 89.5% of total revenue, with the remaining revenues related
      primarily to wireless reseller revenues.





The
      Company continues to experience an attrition of dial-up 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 service offerings. 
The competitive environment impacts the churn rates we experience as well as
      the
      number of new customers we are able to add.





The
      Company has undertaken several initiatives to address the declining subscriber
      base and decrease in its total revenues and the related impact on profitability
      including:





·
            *Change
                in focus to under served
                markets;*


·
            *Acquiring
                Wireless Internet Service Providers in strategic geographic areas;
                and*


·
            *Continuing
                to identify opportunities to improve
                profitability.*





As
      more
      fully described in Part I, Item 1. Description of Business, the Company’s
      strategy is to focus on providing wireless Internet connectivity to customers
      in
      under-served markets.  During the fiscal year ended June 30, 2006, we
      expanded in the suburban and rural markets near San Antonio and Houston, Texas,
      through acquisitions and in all three of our major wireless markets we deployed
      new infrastructure to enable additional growth within markets we presently
      serve. The Company is pursuing additional growth within markets we presently
      serve and acquisition opportunities in non-metropolitan markets where
      competition is less intense and the demand for Internet connectivity may be
      under-served.. In pursuing this strategy, the Company is narrowing its focus
      to
      products and developments that contribute directly to its implementation.





Management
      continues to evaluate overall profitability. During 2006, we reduced
      telecommunications cost per subscriber by optimizing network capacity and
      entering into more favorable agreements with telecommunications service
      providers. The Company also reduced head count in fiscal 2006 through a
      reduction-in-force (“RIF”) carried out by management in January 2006. Although a
      certain number of staff has been added since then and we incurred severance
      costs related to the RIF, the Company still experienced an approximate 13%
      decrease in total salaries and wages, excluding severance costs of approximately
      $83,000 in 2006 and $132,000 in 2005.





In
      fiscal
      2006 the Company continued as a wireless equipment reseller (“WER”). Our WER
      business involves purchasing wireless infrastructure equipment and wireless
      customer premise equipment in bulk for both internal purchases and for resale
      to
      other WISP’s. Bulk purchases allow the Company to maximize its cost savings for
      the deployment of wireless. Included in other revenues during fiscal 2006 is
      revenue of approximately $963,000 related the Company’s WER revenues. Due to
      lower profit margins, the Company discontinued this business in March 2006.
      Remaining inventories were sold prior to March or are being utilized in our
      wireless internet provider business.





Co mpany
      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.


10





**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 includes Neo server revenue, which was
      discontinued in November 2004, and wireless equipment reseller revenues, which
      was discontinued in March 2006.





Prior
      to
      fiscal 2005, the Company operated primarily out of its corporate headquarters
      in
      Dallas, Texas. In fiscal 2005, in addition to the corporate office, the Company
      began operating out of local offices including computer centers in Corsicana,
      Hillsboro and Stafford, Texas. In March 2006, the corporate headquarters were
      moved to Houston, Texas. Operating expenses for the Company includes operating
      expenses for both the corporate office and the local computer
      centers.





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 (recoveries) 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.





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 three years. We depreciate furniture, fixtures and leasehold
      improvements over five years. Amortization expense consists of the amortization
      of subscriber acquisition costs.





Our
      business is not subject to any significant seasonal influences.





11


**Results
      of Operations**





**Year
      Ended June 30, 2006 Compared to June 30, 2005**





The
      following table shows financial data for the years ended June 30, 2006 and
      2005.
      Operating results for any period are not necessarily indicative of results
      for
      any future period. Dollar amounts are shown in thousands (except per share
      data).


**Year
                  Ended**
                **June
                  30, 2006**
              
              **Year
                  Ended**
                **June
                  30, 2005****(000’s,
                  except share and per****share
                  data)**
              
              **%
                  of**
                **Revenues**
              
              **(000’s,
                  except share and per****share
                  data)**
              
              **%
                  of**
                **Revenues**STATEMENT
                  OF OPERATIONS DATA:REVENUES:Internet
                  services
              
              $
              8,874
              
              
              89.6
              %
              $
              10,063
              
              
              94.5
              %Other
              
              
              1,035
              
              
              10.4
              %
              
              584
              
              
              5.5
              %Total
              
              
              9,909
              
              
              100.0
              %
              
              10,647
              
              
              100.0
              %OPERATING
                  COSTS AND EXPENSES:Connectivity
                  and operations
              
              
              6,080
              
              
              61.4
              %
              
              6,518
              
              
              61.2
              %Sales
                  and marketing
              
              
              229
              
              
              2.3
              %
              
              607
              
              
              5.7
              %General
                  and administrative
              
              
              3,288
              
              
              33.2
              %
              
              2,887
              
              
              27.1
              %(Recoveries
                  of) provision for bad debt expense
              
              
              56
              
              
              .6
              %
              
              (1
              )
              
              .0
              %Depreciation
                  and amortization
              
              
              859
              
              
              8.7
              %
              
              602
              
              
              5.7
              %Total
              
              
              10,512
              
              
              106.1
              %
              
              10,613
              
              
              99.7
              %OPERATING
                  INCOME (LOSS)
              
              
              (603
              )
              
              (6.1
              )%
              
              34
              
              
              0.3
              %INTEREST
                  (EXPENSE) INCOME, NET
              
              
              (33
              )
              
              (.3
              )%
              
              (15
              )
              
              (.1
              )%NET
                  INCOME (LOSS)
              
              $
              (636
              )
              
              (6.4
              )%
              $
              19
              
              
              0.2
              %NET
                  INCOME (LOSS) PER COMMON SHARE:BASIC
              
              $
              (0.05
              )
              
              
              
              $
              0.00DILUTED
              
              $
              (0.05
              )
              
              
              
              $
              0.00WEIGHTED
                  AVERAGE COMMONSHARES
                  OUTSTANDING:BASIC
              
              
              12,473,635
              
              
              
              
              
              10,771,571DILUTED
              
              
              12,473,635
              
              
              
              
              
              10,835,249OTHER
                  DATA:Subscribers
                  at end of period (1)
              
              
              37,400
              
              
              
              
              
              53,000Number
                  of employees at end of period
              
              
              67
              
              
              
              
              
              64EBITDA(2)
              
              $
              256
              
              
              
              
              $
              636EBITDA
                  margin(3)
              
              
              2.6
              %
              
              
              
              
              6.0
              %CASH
                  FLOW DATA:Cash
                  flow used in operations
              
              $
              (475
              )
              
              
              
              $
              (266
              )Cash
                  flow used in investing activities
              
              $
              (685
              )
              
              
              
              $
              (335
              )Cash
                  flow provided by (used in) financing activities
              
              $
              (267
              )
              
              
              
              $
              1,096Reconciliation
                  of net income (loss) to EBITDA:Net
                  income (loss)
              
              $
              (636
              )
              
              
              
              $
              19Add:Depreciation
                  and amortization
              
              
              859
              
              
              
              
              
              602Interest
                  income
              
              
              (43
              )
              
              
              
              
              (29
              )Interest
                  expense
              
              
              76
              
              
              
              
              
              44EBITDA
                  (2)
              
              $
              256
              
              
              
              
              $
              636


__________





(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.





12


*Total
      revenue.* Total
      revenue decreased by $738,000, or 6.9%, to $9.9 million in fiscal 2006 from
      $10.6 million in fiscal 2005. The Company’s subscriber count decreased by
      15,600, or 29.4%, to 37,400 as of June 30, 2006 compared to 53,000 as of June
      30, 2005. The net decrease in revenue is the direct result of the decrease
      in
      subscriber counts offset by increased revenue related primarily to dial-up
      and
      wireless access revenue from acquisitions and wireless equipment reseller
      revenue. Revenue from wireless equipment reseller revenue was approximately
      $963,000 and $615,000, respectively, for the year ended June 30, 2006 and 2005.
      The Company became a wireless access provider in September 2004, and in November
      2004 became a wireless equipment reseller. In March 2006, the Company
      discontinued its wireless equipment reseller business due to low profit margins.
      The decrease in subscriber count is primarily attributed to the loss of dial-up
      customers.





*Connectivity
      and operations.* Connectivity and operations expenses decreased by approximately $438,000, or
      6.7%, to $6.08 million for fiscal 2006 from $6.52 million for fiscal 2005.
      Due
      to reductions-in-force carried out in fiscal 2005 and fiscal 2006, labor costs
      decreased by $782,000 or 30.0%, from $2.6 million in fiscal 2005. A decrease
      of
      approximately $630,000 in connectivity costs was due to the consolidation of
      internet and telephone connections and circuits to more closely align with
      demand, as well as the renegotiation of contracts with several of our major
      telecom vendors. Additional decreases in merchant processing fees of
      approximately $62,000 are directly related to the decreases in internet services
      revenue.





These
      cost reductions of approximately $1.5 million are offset by increases in costs
      of equipment in the wireless equipment reseller business of $296,000, or 59%,
      from $500,000 in fiscal 2005. Additionally, as the Company has expanded its
      wireless access provider business, costs associated with this service have
      increased by $794,000 to $1.1 million in fiscal 2006.





As
      a
      percentage of total revenue, connectivity and operations expense was consistent
      at 61.4% for fiscal 2006 compared to 61.2% for fiscal 2005, due to increases
      in
      costs in the wireless access provider business offsetting significant cost
      reduction measures.





*Sales
      and marketing.* Sales
      and marketing expenses decreased by $378,000, or 62.3%, to $229,000 for fiscal
      2006 from $607,000 for the prior fiscal year. The net change relates to
      approximately $322,000 in decreased payroll and consulting costs as well as
      approximately $55,000 in decreased advertising expenses. In fiscal 2005, payroll
      costs included two new sales and marketing staff members including a new
      wireless equipment reseller manager and the Vice President - Marketing and
      Sales
      (“VP-M&S”) hired in August 2004 and severance costs of approximately $6,000.
      The VP-M&S resigned in April 2005. The decrease in advertising expenses
      relates to reductions in printed promotions and a focus on direct mail
      marketing, which is less expensive and focuses on areas where wireless access
      service is offered.





*General
      and administrative.* General
      and administrative (“G&A”) expenses increased by $401,000, or 13.9%, to $3.3
      million for fiscal 2006 from $2.9 million for fiscal 2005. The increase relates
      primarily to increases in personnel costs, contract labor, office expenses
      for
      the additional field offices, and loss on disposal of property and equipment,
      offset by decreases in G&A related to lower professional fees. G&A
      salaries and wages and related taxes increased by $306,000, or 20.7%, to $1.5
      million for the year ended June 30, 2006, compared to $1.2 million for the
      year
      ended June 30, 2005, primarily as a result of the addition of managers for
      newly
      established or acquired field offices as well as redundant accounting staff
      during the transition of the corporate office to Houston, offset by Company’s
      staff reductions. Contract labor increased by $62,000 from $15,000 in fiscal
      2005 to $77,000 for fiscal 2006 primarily as a result of the outsourcing the
      human resource management position during fiscal 2006.





Office
      expenses and utilities increased by $73,000 from $273,000 in fiscal 2005 to
      $346,000 in fiscal 2006, as a result of additional field offices in the San
      Antonio and Weimar markets as well as rising utility costs from our providers.
      Also included in office expense is approximately $24,000 in costs associated
      with relocating the corporate headquarters in fiscal 2006. Additionally, during
      fiscal 2006, the Company disposed of certain property and equipment including
      computer equipment which was considered obsolete for a net loss on disposal
      of
      $50,000.





Professional
      fees decreased by approximately $55,000, or 11.5%, to $422,000 for the year
      ended June 30, 2006, compared to $477,000 for the year ended June 30, 2005.
      Approximately $34,000 of the decrease from fiscal 2005 to fiscal 2006 relates
      to
      a decrease in the annual external audit fee. The remaining decrease relates
      to
      legal fees incurred in fiscal 2005 associated with acquisitions, the stock
      rights agreement implemented in the first quarter and the non-employee option
      plan adopted in the second quarter.





The
      remaining net increase in G&A expense from fiscal 2005 to fiscal 2006 was
      approximately $41,000 which is related to costs incurred due to acquisitions.





*Provision
      for bad debt expense.* Provision for bad debt expense increased by $57,000, from a $1,000 credit for
      fiscal 2005 to $56,000 for fiscal 2006. The increase relates primarily to write
      offs of uncollectible wireless reseller accounts receivable in fiscal 2006.
      As
      of June 30, 2006, we are fully reserved for all customer accounts that are
      at
      least 90 days old.


13


*Depreciation
      and amortization.* Depreciation and amortization expense increased by $257,000, or 42.7%, to
      $859,000 for fiscal 2006 from $602,000 for fiscal 2005. Fiscal 2006 depreciation
      increased approximately $106,000 over fiscal 2005 related primarily to
      depreciation of fixed assets acquired through acquisitions as well as capital
      purchases made for the build out of our wireless infrastructure. Amortization
      expense in fiscal 2005 of approximately $466,000 represents the amortization
      of
      subscriber acquisition costs.





*Interest
      (expense) income, net.* Net
      interest expense increased by $18,000, or 120.0 %, to a net interest expense
      of
      $33,000 for fiscal 2006, compared to net interest expense of $15,000 for fiscal
      2005. Net interest in fiscal 2006 includes interest expense of approximately
      $76,000 related primarily to acquisition debt and interest income of
      approximately $43,000 related primarily to interest earned on the Company’s cash
      balances. Net interest in fiscal 2005 includes interest expense of approximately
      $44,000 related primarily to acquisition debt and interest income of
      approximately $29,000 related primarily to interest earned on the Company’s cash
      balances.





**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
      provided by (used in) operating activities is net income adjusted for certain
      non-cash items and changes in assets and liabilities. For fiscal 2006, cash
      used
      in operations was $475,000, compared to $266,000 in fiscal 2005. Net income
      plus
      non-cash items contributed $328,000 in fiscal 2006 and $620,000 in fiscal 2005
      in cash which was then used primarily for purchases of inventory, pay off of
      accounts payable and accrued expenses and a decrease in deferred revenue.
      Inventory increased in fiscal 2006 due to the deployment of wireless access
      equipment in each of the field offices to allow timely activation of new
      customers. Inventory increased in fiscal 2005 primarily due to the Company
      becoming a wireless equipment reseller during November 2004. The decrease in
      deferred revenue from year to year is a result of the decrease in our subscriber
      count and the related decrease in revenue.





Cash
      used
      in investing activities totaled $685,000 and $335,000 for the years ended June
      30, 2006 and 2005, respectively. The increase in cash used for investing
      activities for fiscal 2006 relates primarily to acquisitions and the deployment
      of new wireless infrastructure.





Cash
      used
      in financing activities for fiscal 2006 of $267,000 relates to principal
      payments on debt and capital leases. Cash provided by financing activities
      for
      fiscal 2005 totaled $1.1 million, primarily as a result of $1.5 million in
      proceeds from a private placement completed by the Company in May 2005, offset
      by principal payments on debt and capital leases. Cash was also used in fiscal
      2005 to pay $73,000 to Jack Smith for the purchase of 200,000 shares of
      outstanding Company stock in October 2004.





We
      estimate that cash on hand of $937,000 at June 30, 2006 along with anticipated
      cash flow from operations will be sufficient to meet our working capital needs
      for fiscal 2007 for continuing operations in both existing and new markets
      as
      well as the planned deployment of additional wireless infrastructure. Management
      believes that the Company 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.





If
      additional capital financing arrangements, including public or private sales
      of
      debt or equity securities, or additional 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 operations
      and
      growth strategies to match available funding.


14





In
      addition, the following are contractual cash obligations entered into by the
      Company through June 30, 2006, for the next five fiscal years ending June
      30:





**Payments
                Due By June 30,****Total**
            
            **2007**
            
            **2008**
            
            **2009**
            
            **2010**
            
            **2011**
            
            **Thereafter**Connectivity
                contracts
            
            $
            183,633
            
            $
            178,633
            
            $
            5,000
            
            $
            —
            
            $
            —
            
            **$**
            **—**
            
            $
            —Operating
                leases
            
            
            1,254,606
            
            
            491,698
            
            
            438,738
            
            
            198,406
            
            
            65,748
            
            
            60,016
            
            
            —Long-term
                debt
            
            
            267,252
            
            
            98,208
            
            
            82,341
            
            
            26,233
            
            
            38,906
            
            
            21,564
            
            
            —Capital
                leases
            
            
            211,163
            
            
            70,713
            
            
            54,368
            
            
            54,368
            
            
            31,714
            
            
            —
            
            
            —$
            1,916,654
            
            $
            839,252
            
            $
            580,447
            
            $
            279,007
            
            $
            136,368
            
            $
            81,580
            
            $
            —






**Critical
      Accounting Policies and Estimates**




In
      preparing our consolidated financial statements, we make estimates, assumptions
      and judgments that can have a significant impact on our operating income (loss)
      and net income (loss), as well as on the value of certain assets and liabilities
      on our consolidated balance sheet. The application of our critical accounting
      policies requires an evaluation of a number of complex criteria and significant
      accounting judgments by us. Management bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about the carrying values of assets and liabilities. Senior management
      has discussed the development, selection and disclosure of these estimates
      with
      the audit committee of our board of directors. Actual results may differ, and
      could be material, from these estimates under different assumptions or
      conditions.




An
      accounting policy is deemed to be critical if it requires an accounting estimate
      to be made based on assumptions about matters that are highly uncertain at
      the
      time the estimate is made, and if different estimates that reasonably could
      have
      been used, or changes in the accounting estimates that are reasonably likely
      to
      occur periodically, could materially impact the consolidated financial
      statements. Management believes the following critical accounting policies
      reflect our more significant estimates and assumptions used in the preparation
      of the consolidated financial statements. We have not materially changed our
      methodology for calculating the estimates below in the past three years.




Our
      critical accounting policies and estimates are as follows:




•
            Accounting
                for income taxes; and•
            Valuation
                of goodwill.•
            Useful
                life of Subscriber acquisition
                costs




*Accounting
                for Income Taxes*




As
      part
      of the process of preparing our consolidated financial statements we are
      required to estimate our income taxes. Deferred
      income tax assets and liabilities are determined using the asset and liability
      method in accordance with SFAS No. 109, “Accounting for Income
      Taxes.” This
      process involves estimating our actual current tax exposure together with
      assessing temporary differences resulting from differing treatment of items,
      such as deferred revenue, for tax and accounting purposes. These differences
      result in deferred tax assets, which are included within our consolidated
      balance sheet. We must then assess and make significant estimates regarding
      the
      likelihood that our deferred tax assets will be recovered from future taxable
      income and to the extent we believe that recovery is not likely, we must
      establish a valuation allowance. To the extent we establish a valuation
      allowance or increase this allowance in a period, we must include an expense
      within the tax provision in the statement of income. Estimates related to income
      taxes affect the deferred tax asset and liability line items and accrued
      liabilities in our consolidated balance sheet and our income tax (benefit)
      expense line item in our statement of operations.




The
      net
      deferred tax asset as of June 30, 2006 of $12.3 million is fully reserved due
      to
      continued losses since inception of the Company. Additionally, due to continued
      customer losses, it is unclear whether the Company will be able to generate
      taxable income in the future. The valuation allowance is based on our historical
      and estimates of taxable income and the period over which our deferred tax
      assets will be recoverable. In the event that actual results differ from these
      estimates or we adjust these estimates in future periods we may need to record
      a
      deferred tax benefit which could materially impact our financial position and
      results of operations.




15




*Valuation
                of Goodwill*




We
      account for goodwill in accordance with Statement of Financial Accounting
      Standard (“SFAS”) No. 142.  SFAS
      142
      requires, among other things, the discontinuance of amortization for goodwill
      and at least an annual test for impairment. An impairment review may be
      performed more frequently in the event circumstances indicate that the carrying
      value may not be recoverable.




We
      are
      required to make estimates regarding the undiscounted cash flow projections
      of
      the Company when testing for potential impairment. An excess of carrying value
      over projected undiscounted cash flows would result in recognition of an
      impairment loss. We estimate cash flows for these purposes using internal
      budgets based on recent and historical trends. We base these estimates on
      assumptions we believe to be reasonable, but which are unpredictable and
      inherently uncertain. If an impairment were present, these estimates would
      affect an impairment line item on our consolidated statement of operations
      and
      would affect the other assets line item on our consolidated balance sheet.




Based
      on
      our current impairment test, we concluded no impairment occurred as of June
      30,
      2006 There would have to be a significant change in our cash flow projections
      in
      order for an impairment to occur.




*Useful life of Subscriber acquisition costs*




We
      are
      required to periodically review the estimated useful lives of our intangible
      assets. This review during fiscal 2006 indicated that actual lives for
      subscriber acquisition costs generally were longer than the useful life used
      for
      amortization purposes in the Company’s financial statements. As a result, the
      Company revised the estimated useful life of subscriber acquisition costs from
      24 to 36 months, effective April 1, 2006. The effect of this change in estimate
      was to reduce fiscal 2006 amortization expense by $30,000 and decrease fiscal
      2006 net loss from operations and resulting net loss by $30,000.




**Inflation**




We
      do not
      believe that inflation has had a significant impact on our consolidated
      operations.





**Item
      7.** ***Financial
      Statements***




The
      financial statements of Internet America and Subsidiaries are attached hereto
      as
      pages F-1 through F-19 and include our Balance Sheet as of June 30, 2006,
      Statements of Operations for each of the two years in the period ended June
      30,
      2006 and 2005, Statements of Shareholders' Equity for each of the two years
      in
      the period ended June 30, 2006 and 2005, Statements of Cash Flows for each
      of
      the two years in the period ended June 30, 2006 and 2005, and the Notes to
      the
      Consolidated Financial Statements.





**Item
      8.** ***Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure***




Not
      applicable.





**Item
      8A.** ***Controls
      and Procedures***




An
      evaluation was carried out under the supervision and with the participation
      of
      our management, including our Chief Executive Officer and Chief Financial and
      Accounting Officer, of the effectiveness of the design and operation of our
      disclosure controls and procedures (as defined in Rule 13a-15(e) under the
      Exchange Act) in effect as of June 30, 2006. Based upon that evaluation, the
      Chief Executive Officer and Chief Financial and Accounting Officer concluded
      that, as of June 30, 2006, the design and operation of these disclosure controls
      and procedures were effective in timely alerting them to the material
      information relating to the Company required to be included in its periodic
      filings with the Securities and Exchange Commission. Subsequent to that
      evaluation and through the date of this filing, there were no changes in our
      internal control over financial reporting that materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.




While
      we
      believe existing controls and procedures are effective, we continue to examine,
      refine and formalize our controls and procedures.





**Item
      8B. Other Information**





Not
      applicable.





16





**PART
      III**





**Item
      9.** ***Directors,
      Executive Officers, Promoters and Control Persons; Compliance with Section
      16(a)
      of the Exchange Act***





Information
      required by this Item is incorporated by reference from the sections entitled
      "Election of Directors," and "Section 16(a) Beneficial Ownership Reporting
      Compliance" in the Company's Proxy Statement for its 2006 Annual Meeting of
      Shareholders.





**Item
      10.** ***Executive
      Compensation***





Information
      required by this Item is incorporated by reference from the section entitled
      "Executive Compensation" in the Company's Proxy Statement for its 2006 Annual
      Meeting of Shareholders.





**Item
      11.** ***Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters***





Information
      required by this Item is incorporated by reference from the section entitled
      "Security Ownership of Management and Certain Shareholders" in the Company's
      Proxy Statement for its 2006 Annual Meeting of Shareholders.





**Item
      12.** ***Certain
      Relationships and Related Transactions***





Information
      required by this Item is incorporated by reference from the section entitled
      "Certain Relationships and Related Transactions" in the Company's Proxy
      Statement for its 2006 Annual Meeting of Shareholders.





**Item
      13.** ***Exhibits***





The
      following exhibits are either provided with this Report or are incorporated
      herein by reference:





**Exhibit**
            
            **Description**3.1
            
            Articles
                of Incorporation (1)3.2
            
            Bylaws,
                as amended (2)4.1
            
            Rights
                Agreement dated as of August 9, 2004, between Registrant and American
                Stock Transfer & Trust Company, as Rights Agent (3)10.1
            
            Asset
                Purchase Agreement between Registrant and 2FAST Communications, Inc.
                dated
                January 14, 2006 (4)21.1
            
            Subsidiaries
                list (5)23.1
            
            Consent
                of UHY LLP*31.1
            
            Rule
                13a-14(a)/15d-14(a) Certification of William E. Ladin,
                Jr.*31.2
            
            Rule
                13a-14(a)/15d-14(a) Certification of Jennifer S.
                LeBlanc*32.1
            
            Section
                1350 Certification of William E. Ladin, Jr.*32.2
            
            Section
                1350 Certification of Jennifer S.
                LeBlanc*


__________


*Filed
      herewith


(1)
              Incorporated
                  by reference to exhibits 3.1 and 3.2 to Registration Statement
                  on Form
                  SB-2 as amended (file no. 333-59527) initially filed on July 21,
                  1998.
 (2)
              Incorporated
                  by reference to exhibits 3.3 and 3.4 to Registration Statement
                  on Form
                  SB-2, as amended (file no. 333-59527) initially filed on July 21,
                  1998,
                  and to exhibit 3.3 to Form 10-QSB filed on November 15,
                  1999.
 (3)
                Incorporated
                    by reference to exhibit 1 to Registration Statement on Form 8-A
                    (file no.
                    001-32273) filed on August 11,
                    2004.
 (4)
              Incorporated
                  by reference to exhibit 2.1 to Form 10-QSB filed May 16,
                  2006.
 (5)
              Incorporated
                  by reference to exhibit 21.1 to Form 10-K for the fiscal year ended
                  June
                  30, 2005 filed October 11,
                  2005.





**Item
      14.** ***Principal
      Accountant Fees and Services***





Information
      required by this Item is incorporated by reference from the section entitled
      “Principal Accountant Fees and Services” in the Company’s Proxy Statement for
      its 2006 Annual Meeting of Shareholders.





17


**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized as of the 6 day of October, 2006.





INTERNET
                AMERICA, INC./s/William
                E. Ladin, Jr.William
                E. (Billy) Ladin, Jr.*Chief
                Executive Officer and Director*/s/
                Jennifer S. LeBlancJennifer
                S. LeBlanc*Chief
                Financial Officer and Chief Accounting
                Officer*








In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.





**Signatures**
            
            **Title**
            
            **Date**/s/
                William E. Ladin, Jr.
              William
                E. (Billy) Ladin, Jr.
            
            Chairman
                of the Board and Chief Executive Officer
            
            October
                6, 2006/s/
                Troy LeMaile-Stovall
              Troy
                LeMaile-Stovall
            
            Director
            
            October
                6, 2006/s/
                Justin McClure
              Justin
                McClure
            
            Director
            
            October
                6, 2006/s/
                John Palmer
              John
                Palmer
            
            Director
            
            October
                6, 2006








18





INDEX
      TO
      CONSOLIDATED FINANCIAL STATEMENTS





Reports
                of Independent Registered Public Accounting Firm
            F-2Consolidated
                Financial Statements:Consolidated
                Balance Sheets
            F-4Consolidated
                Statements of Operations
            F-5Consolidated
                Statements of Shareholders' Equity
            F-6Consolidated
                Statements of Cash Flows
            F-7Notes
                to Consolidated Financial Statements
            F-9


F-1




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**






To
      the
      Board of Directors and Shareholders of


Internet
      America, Inc.


Houston,
      Texas




We
      have
      audited the accompanying consolidated balance sheet of Internet America, Inc.
      and Subsidiaries (the “Company”) as of June 30, 2006, and the related
      consolidated statements of operations, shareholders’ equity, and cash flows for
      the year then ended. These consolidated financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these consolidated financial statements based on our
      audit.




We
      conducted our audit in accordance with standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal control over
      financial reporting. Our audit included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit includes examining,
      on a test basis, evidence supporting the amounts and disclosures in the
      financial statements, assessing the accounting principles used and significant
      estimates made by management, as well as evaluating the overall financial
      statement presentation. We believe that our audit provides a reasonable basis
      for our opinion.




In
      our
      opinion, such consolidated financial statements present fairly, in all material
      respects, the consolidated financial position of Internet America, Inc. and
      Subsidiaries as of June 30, 2006, and the consolidated results
      of their operations and their cash flows for the year then ended, in
      conformity with accounting principles generally accepted in the United States
      of
      America.








**/s/
      UHY LLP**





Houston,
      Texas


October
      6, 2006


F-2





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Shareholders of


Internet
      America, Inc.


Dallas,
      Texas





We
      have
      audited the consolidated statements of operations, shareholders’ equity, and
      cash flows of Internet America, Inc. and subsidiaries (the “Company”) for the
      year ended June 30, 2005. 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 audit.





We
      conducted our audit in accordance with standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal control over
      financial reporting. Our audit included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit includes examining,
      on a test basis, evidence supporting the amounts and disclosures in the
      financial statements, assessing the accounting principles used and significant
      estimates made by management, as well as evaluating the overall financial
      statement presentation. We believe that our audit provides a reasonable basis
      for our opinion.





In
      our
      opinion, such consolidated financial statements present fairly, in all material
      respects, the results of operations and cash flows of the Company for the year
      ended June 30, 2005, in conformity with accounting principles generally
      accepted in the United States of America.








DELOITTE
      & TOUCHE LLP





Dallas,
      Texas


October
      7, 2005





F-3




**INTERNET
      AMERICA, INC. AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEET**





June
                30,
              2006ASSETSCURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            937,401Accounts
                receivable, net of allowance for uncollectible
              accounts
                of $6,996
            
            
            120,208Inventory
            
            
            280,888Prepaid
                expenses and other current assets
            
            
            299,379Total
                current assets
            
            
            1,637,876PROPERTY
                AND EQUIPMENT — Net
            
            
            1,082,590OTHER
                ASSETS — Net
            
            
            4,812,122TOTAL
            
            $
            7,532,588


LIABILITIES
                AND SHAREHOLDERS' EQUITYCURRENT
                LIABILITIES:Trade
                accounts payable
            
            $
            419,766Accrued
                liabilities
            
            
            465,836Deferred
                revenue
            
            
            1,292,430Current
                portion of long-term debt
            
            
            98,208Current
                portion of capital lease obligations
            
            
            57,390Total
                current liabilities
            
            
            2,333,630Other
                long-term liabilities
            
            
            47,320Long-term
                debt, net of current portion
            
            
            169,044Capital
                lease obligations, net of current portion
            
            
            127,344Total
                liabilities
            
            
            2,677,338COMMITMENTS
                AND CONTINGENCIES (Note 8)
            
            
            —SHAREHOLDERS'
                EQUITY:Common
                stock, $.01 par value; 40,000,000 shares authorized,
              12,508,914
                issued and 12,508,914 outstanding
            
            
            125,089Additional
                paid-in capital
            
            
            57,061,952Accumulated
                deficit
            
            
            (52,331,791
            )Total
                shareholders' equity
            
            
            4,855,250TOTAL
            
            $
            7,532,588





See
      notes
      to consolidated financial statements.


F-4





**INTERNET
      AMERICA, INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





Year
                Ended June 30,2006
            
            2005REVENUES:Internet
                services
            
            $
            8,873,795
            
            $
            10,063,538Other
            
            
            1,035,590
            
            
            583,906Total
            
            
            9,909,385
            
            
            10,647,444OPERATING
                COSTS AND EXPENSES:Connectivity
                and operations
            
            
            6,080,457
            
            
            6,518,302Sales
                and marketing
            
            
            229,220
            
            
            606,801General
                and administrative
            
            
            3,288,205
            
            
            2,886,738(Recoveries
                of) provision for bad debt expense
            
            
            55,742
            
            
            (518
            )Depreciation
                and amortization
            
            
            858,769
            
            
            601,956Total
            
            
            10,512,393
            
            
            10,613,279INCOME
                (LOSS) FROM OPERATIONS
            
            
            (603,008
            )
            
            34,165INTEREST
                INCOME
            
            
            42,853
            
            
            28,620INTEREST
                EXPENSE
            
            
            (76,009
            )
            
            (43,940
            )INCOME
                (LOSS)  BEFORE INCOME TAXES
            
            
            (636,164
            )
            
            18,845INCOME
                TAX EXPENSE
            
            
            —
            
            
            —NET
                INCOME (LOSS)
            
            $
            (636,164
            )
            $
            18,845NET
                INCOME (LOSS) PER COMMON SHARE:BASIC
            
            $
            (0.05
            )
            $
            0.00DILUTED
            
            $
            (0.05
            )
            $
            0.00WEIGHTED
                AVERAGE COMMON SHARES OUTSTANDING:BASIC
            
            
            12,473,635
            
            
            10,771,571DILUTED
            
            
            12,473,635
            
            
            10,835,249





See
      notes
      to consolidated financial statements.


F-5





**INTERNET
      AMERICA, INC. AND ITS SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS' EQUITY**


**Common
                  Stock**
              
              **Additional**
                **Paid-in**
              
              **Treasury**
              
              **Note**
                **Receivable**
                **From**
              
              **Accumulated**
              
              **Total**
                **Shareholders'****Shares**
              
              **Amount**
              
              **Capital**
              
              **Stock**
              
              **Shareholder**
              
              **Deficit**
              
              **Equity**BALANCE,
                  JULY 1, 2004
              
              
              10,449,652
              
              $
              104,497
              
              $
              55,622,488
              
              $
              —
              
              $
              (82,000
              )
              $
              (51,714,472
              )
              $
              3,930,513Issuance
                  of common stock
              
              
              147,383
              
              
              1,474
              
              
              110,989
              
              
              —
              
              
              —
              
              
              —
              
              
              112,463Issuance
                  of common stock pursuant to private placement
              
              
              2,000,000
              
              
              20,000
              
              
              1,425,000
              
              
              —
              
              
              —
              
              
              —
              
              
              1,445,000Purchase
                  of stock pursuant to settlement agreement
              
              
              —
              
              
              —
              
              
              —
              
              
              (160,000
              )
              
              82,000
              
              
              —
              
              
              (78,000
              )Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              18,845
              
              
              18,845BALANCE,
                  JUNE 30, 2005
              
              
              12,597,035
              
              
              125,971
              
              
              57,158,477
              
              
              (160,000
              )
              
              —
              
              
              (51,695,627
              )
              
              5,428,821Retirement
                  of treasury stock
              
              
              (200,000
              )
              
              (2,000
              )
              
              (158,000
              )
              
              160,000
              
              
              —
              
              
              —
              
              
              —Issuance
                  of common stock
              
              
              111,879
              
              
              1,118
              
              
              57,033
              
              
              —
              
              
              —
              
              
              —
              
              
              58,151Adjustment
                  of issuance of common stock pursuant to private placement
              
              
              —
              
              
              —
              
              
              4,442
              
              
              —
              
              
              —
              
              
              —
              
              
              4,442Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (636,164
              )
              
              (636,164
              )BALANCE,
                  JUNE 30, 2006
              
              
              12,508,914
              
              $
              125,089
              
              $
              57,061,952
              
              $
              —
              
              $
              —
              
              $
              (52,331,791
              )
              $
              4,855,250


See
      notes
      to consolidated financial statements


F-6





**INTERNET
      AMERICA, INC. AND ITS SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





Year
                Ended June 30,2006
            
            2005OPERATING
                ACTIVITIES:Net
                income (loss)
            
            $
            (636,164
            )
            $
            18,845Adjustments
                to reconcile net income (loss) to net cashused
                in operating activities:Depreciation and amortization
            
            
            858,769
            
            
            601,956Loss on disposal of property and equipment
            
            
            49,605
            
            
            —(Recoveries of) provision for bad debt expense
            
            
            55,742
            
            
            (518
            )Changes
                in operating assets and liabilities (net of effects of
              assets
                acquired, less liabilities assumed):Accounts receivable
            
            
            7,003
            
            
            22,263Inventory
            
            
            (346,768
            )
            
            (194,079
            )Prepaid expenses and other current assets
            
            
            (215,635
            )
            
            (7,269
            )Other assets
            
            
            38,241
            
            
            (2,454
            )Other long-term liabilities
            
            
            47,320
            
            
            —Accounts payable and accrued liabilities
            
            
            (195,079
            )
            
            (313,417
            )Deferred revenue
            
            
            (137,541
            )
            
            (391,291
            )Net
                cash used in operating activities
            
            
            (474,507
            )
            
            (265,964
            )INVESTING
                ACTIVITIES:Purchases
                of property and equipment, net
            
            
            (460,399
            )
            
            (226,039
            )Proceeds
                from sale of property and equipment
            
            
            23,768
            
            
            —Cash
                paid for acquisitions
            
            
            (248,371
            )
            
            (109,250
            )Net
                cash used in investing activities
            
            
            (685,002
            )
            
            (335,289
            )FINANCING
                ACTIVITIES:Proceeds
                from issuance of common stock
            
            
            10,093
            
            
            1,502,883Purchase
                of treasury stock, net of note and accrued interest
                forgiven
            
            
            —
            
            
            (72,661
            )Principal
                payments under capital lease obligations
            
            
            (71,714
            )
            
            (33,946
            )Principal
                payments of long-term debt
            
            
            (205,756
            )
            
            (300,486
            )Net
                cash provided by (used in) financing activities
            
            
            (267,377
            )
            
            1,095,790NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (1,426,886
            )
            
            494,537CASH
                AND CASH EQUIVALENTS, BEGINNING OF YEAR
            
            
            2,364,287
            
            
            1,869,750CASH
                AND CASH EQUIVALENTS, END OF YEAR
            
            $
            937,401
            
            $
            2,364,287SUPPLEMENTAL
                INFORMATION:Cash
                paid for interest
            
            $
            26,651
            
            $
            34,239





See
      notes
      to consolidated financial statements.


F-7





**INTERNET
      AMERICA, INC. AND ITS SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS (CONTINUED)**





**Year
                Ended June 30,****2006**
            
            **2005**NON-CASH
                INVESTING AND FINANCING ACTIVITIES:Forgiveness
                of note receivable and related accrued interest in connection with
                purchase of treasury stock
            
            **$**
            **—**
            
            $
            87,349Transfers
                between property and equipment and inventory
            
            **$**
            **233,161**
            
            $
            62,883Assets
                acquired through accounts payable
            
            **$**
            **32,275**
            
            $
            19,549Assets
                acquired through capital lease obligation
            
            **$**
            **—**
            
            $
            217,070Stock
                issued in connection with acquisitions
            
            **$**
            **52,500**
            
            $
            54,580Debt
                assumed in connection with acquisitions
            
            **$**
            **65,166**
            
            $
            251,463Debt
                issued in connection with acquisitions, net
            
            **$**
            **126,528**
            
            $
            356,327


F-8





**INTERNET
      AMERICA, INC. AND SUBSIDIARIES**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**Years
      Ended June 30, 2006 and 2005**





**1.** ***General
      Information and Summary of Significant Accounting
      Policies***





*Basis
      of Presentation* —
      Internet America, Inc. is an Internet service provider ("ISP") operating in
      Texas. The Company provides a wide array of Internet services tailored to meet
      the needs of individual and business customers.





The
      Company experienced an operating loss for the fiscal year ended June 30, 2006
      and has experienced continued declines in revenue since fiscal 2002. The
      Company’s operations are subject to certain risks and uncertainties, including
      that the rural customer base will not increase at a rate that exceeds the loss
      of metropolitan area customers; competition with existing or new competitors;
      changes in industry pricing or technological developments impacting the
      Internet; dependence on network infrastructure, telecommunications providers
      and
      other vendors; service interruptions or impediments; and the inability to
      continually develop effective business systems and processes and to hire and
      retain qualified personnel. The stock price has been volatile historically
      and
      may continue to be volatile. There can be no assurance that the Company
      will be successful in achieving profitability and positive cash flow in the
      future.





*Basis
      of Consolidation* — ** The
      consolidated financial statements include the accounts of the Company and its
      wholly-owned subsidiaries. All intercompany balances and transactions have
      been
      eliminated on consolidation.





*Revenue
      Recognition* —
      Revenues 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. Revenues from the Company wireless equipment reseller
      business are recognized when the products are shipped.





*Credit
      Risk* —
      Financial instruments that potentially subject the Company to concentrations
      of
      credit risk consist principally of cash equivalents and accounts receivable,
      as
      collateral is generally not required.





During
      the years ended June 30, 2006 and 2005, the Company recorded a provision
      (recovery) for bad debt expense totaling approximately $56,000, and ($500),
      respectively. The charges were recorded as a result of monthly evaluations
      during the year of the collectibility of accounts receivable and as accounts
      became 90 days or older from the date of billing, including consumer accounts.
      Delinquent accounts deemed uncollectible were disconnected and collection
      efforts were continued on such accounts.





*Financial
      Instruments* —
The
      carrying amounts of cash, accounts receivable, accounts payable and accrued
      liabilities approximate fair value because of the short term maturity of these
      instruments. The fair values for debt and lease obligations, which have fixed
      interest rates, do not differ materially from their carrying
      values.





*Cash
      and Cash Equivalents* —
Cash
      and cash equivalents consist of cash on hand and cash deposited in money market
      accounts, occasionally in excess of federally insured limits. Cash and cash
      equivalents are stated at cost, which approximates fair value.





*Inventory* —
The
      Company values inventory at the lower of cost or market using the first-in,
      first-out (“FIFO”) method. Inventory consists primarily of wireless
      internet access equipment and routers.





*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 two to five years.


F-9





*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.





*Other
      Assets* —
Other
      assets consist primarily of goodwill related to the acquisition of NeoSoft,
      Inc.
      and PDQ.Net, Incorporated and subscriber acquisition costs related to
      acquisitions completed during the years ended June 30, 2005 and June 30, 2006.
      The Company allocates the purchase price to acquired subscriber bases and
      goodwill based on fair value at the time of acquisition. Subscriber acquisition
      costs are amortized over the average life of a customer which is estimated
      at 36
      months . During fiscal 2006, the Company revised the estimated useful life
      of
      subscriber acquisition costs from 24 to 36 months, effective April 1, 2006.
      The
      effect of this change in estimate was to reduce fiscal 2006 amortization expense
      by $30,000 and decrease fiscal 2006 net loss from operations and resulting
      net
      loss by $30,000. The Company does not amortize goodwill; however goodwill is
      tested annually for impairment, or sooner if circumstances require, in
      accordance with Statement of Financial Accounting Standard (“SFAS”) No. 142
      (“SFAS 142”), "Goodwill and Other Intangible Assets." The Company has concluded
      that no impairment of goodwill occurred during the year ended June 30, 2006.





*Long-Lived
      Assets* —
The
      Company periodically reviews the values assigned to long-lived assets, such
      as
      property and equipment to determine if any impairments have occurred in
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets” (“SFAS 144”).





The
      Company reviews long-lived assets for impairment whenever events or changes
      in
      circumstances indicate that the carrying amount of an asset may not be
      recoverable. If the undiscounted future cash flows of an asset to be held and
      used in operations are less than the carrying value, the Company would recognize
      a loss for the difference between the carrying value and fair market value.
      The
      Company has concluded that no impairment occurred in the year ended June 30,
      2006.





*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 25") and provides pro forma disclosures in the notes to the financial
      statements, as if the measurement provisions of Statement No. 123 "Accounting
      for Stock-Based Compensation," (“SFAS 123”) had been adopted.





In
      December 2004, the FASB issued SFAS No. 123 (R), “Share-Based Payment,” which
      replaces SFAS No. 123 and supersedes APB 25. SFAS No. 123 (R) requires that
      compensation cost relating to all share-based payment transactions, including
      grants of employee stock options, be recognized in the statement of operations
      based on their fair values. Pro forma disclosures are no longer an alternative.
      In April 2005, the Securities and Exchange Commission (“SEC”) amended the
      effective date of SFAS No. 123 (R) to be the first annual reporting period
      that
      begins after December 15, 2005, for public companies that are small business
      issuers. The Company expects to adopt SFAS No. 123 (R) on July 1, 2006, based
      on
      the new effective date announced by the SEC and expects to apply the modified
      prospective method upon adoption. The modified prospective method requires
      companies to record compensation cost beginning with the effective date (a)
      based on the requirements of SFAS No. 123 (R) for all share-based payments
      granted after the effective date and (b) based on the requirements of SFAS
      No.
      123 for all awards granted to employees prior to the effective date of SFAS
      No.
      123 (R) that remain unvested on the effective date.





The
      impact of the adoption of SFAS No. 123 (R) cannot be predicted at this time
      because it will depend on levels of share-based payments granted in the future.
      However, had the Company adopted SFAS No. 123 (R) in prior periods, the impact
      of that standard would have approximated the impact of SFAS No. 123 as described
      in the disclosure of pro forma net income (loss) and net income (loss) per
      share
      below adjusted for the impact of forfeitures. The Company’s earnings and
      earnings per share could be adversely affected upon adoption of SFAS No. 123
      (R).





F-10


*Stock-Based
      Compensation (continued)*—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 123, the Company's net (loss) income and (loss) income per share would
      have been as indicated below:





**2006**
            
            **2005**Net
                (loss) income
            
            
            As
                reported
            
            $
            (636,164
            )
            $
            18,845Net
                (loss) income
            
            
            Pro
                Forma
            
            
            (684,131
            )
            
            (163,905
            )Basic
                (loss) income per share
            
            
            As
                reported
            
            $
            (0.05
            )
            $
            0.00Diluted
                (loss) income per share
            
            
            As
                reported
            
            $
            (0.05
            )
            $
            0.00Basic
                (loss) income per share
            
            
            Pro
                Forma
            
            $
            (0.05
            )
            $
            (0.02
            )Diluted
                (loss) income per share
            
            
            Pro
                Forma
            
            $
            (0.05
            )
            $
            (0.02
            )








The
      fair
      value of each option granted is estimated using the Black-Scholes pricing model
      with the following assumptions: option term until exercise ranging from 30
      days
      to 10 years, volatility ranging from 200% to 320%, risk-free interest rate
      ranging from 1.9% to 4.0%, and an expected dividend yield of zero. No options
      were granted during the years ended June 30, 2006 and 2005.





*Advertising
      Expenses* —
The
      Company expenses advertising production costs in the period in which the
      advertisement is first aired. All other advertising costs are expensed as
      incurred. Advertising expenses for the years ended June 30, 2006 and 2005 were
      approximately $65,000 and $120,000, respectively.





*Income
      Taxes* — Deferred
      income tax assets and liabilities are determined using the asset and liability
      method in accordance with SFAS No. 109, “Accounting for Income
      Taxes.”  Under this method, deferred tax assets and liabilities are
      established for future tax consequences of temporary differences between the
      financial statement carrying amounts of assets and liabilities and their tax
      basis. 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.





*Basic
      and Diluted Net Income (Loss) Per Share* —
Basic
      earnings (loss) per share is computed using the weighted average number of
      common shares outstanding and excludes any anti-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.




**For
                the Years Ended June 30,****2006**
            
            **2005***Basic
                (loss) earnings per share:*Net
                (loss) income
            
            $
            (636,164
            )
            $
            18,845Weighted
                average common shares
            
            
            12,473,635
            
            
            10,771,571Basic
                (loss) earnings per share
            
            $
            (0.05
            )
            $
            0.00*Diluted
                (loss) earnings per share:*Net
                (loss) income
            
            $
            (636,164
            )
            $
            18,845Weighted
                average common shares
            
            
            12,473,635
            
            
            10,771,571Effect
                of dilutive stock options
            
            
            —
            
            
            63,678Diluted
                weighted average common shares
            
            
            12,473,635
            
            
            10,835,249*Diluted
                (loss) earnings per share*
            
            $
            (0.05
            )
            $
            0.00





During
      the years ended June 30, 2006 and 2005, options to purchase 175,598 and 361,145
      shares of common stock, respectively, were not included in the computation
      of
      diluted earnings per share because the options were not “in the money” based on
      the average market price for the years ended June 30, 2006 and 2005,
      respectively.





*Use
      of Estimates* —
The
      preparation of consolidated financial statements in conformity with accounting
      principles generally accepted in the United States 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 consolidated
      financial statements and the reported amounts of revenues and expenses during
      the reporting period. Actual results could differ significantly from these
      estimates.





*New
      accouting standards* —
In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—a
      replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No.
      154 requires retrospective application to prior periods’ financial statements
      for changes in accounting principle, unless it is impracticable to determine
      either the period-specific effects or the cumulative effect of the change.
      SFAS
      154 also requires that a change in depreciation, amortization, or depletion
      method for long-lived, non-financial assets be accounted for as a change in
      accounting estimate effected by a change in accounting principle. SFAS 154
      is
      effective for accounting changes and corrections of errors made in fiscal years
      beginning after December 15, 2005. The implementation of SFAS No. 154 is not
      expected to have a material impact on the company’s financial
      statements.




In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments - an amendment of FASB Statements No. 133 and 150.” 
SFAS No. 155 (a) permits fair value remeasurement for any hybrid financial
      instrument.




F-11


In
      July
      2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48),
“Accounting for Uncertainty in Income Taxes”, which prescribes a recognition
      threshold and measurement process for recording in the financial statements
      uncertain tax positions taken or expected to be taken in a tax return.
      Additionally, FIN No. 48 provides guidance on the derecognition,
      classification, accounting in interim periods and disclosure requirements for
      uncertain tax positions. The accounting provisions of FIN No. 48 will be
      effective July 1, 2007. The implementation of FIN No. 48 is not expected to
      have a material impact on the company’s financial statements.




In
      September 2006, the FASB issued FASB Statement No. 157 (SFAS 157), “Fair Value
      Measurements”. SFAS 157 proscribes a single definition of fair value as the
      price that would be received to sell an asset or paid to transfer a liability
      in
      an orderly transaction between market participants at the measurement date.
      The
      accounting provisions of SFAS 157 will be effective for the Company beginning
      July 1, 2008. The Company does not believe the adoption of SFAS 157 will have
      a
      material impact on its financial condition or results of
      operations.





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108).
      SAB
      108 addresses how the effects of prior year uncorrected misstatements should
      be
      considered when quantifying misstatements in current year financial statements.
      SAB 108 requires companies to quantify misstatements using a balance sheet
      and
      income statement approach and to evaluate whether either approach results in
      quantifying an error that is material in light of relevant quantitative and
      qualitative factors. When the effect of initial adoption is material, companies
      will record the effect as a cumulative effect adjustment to beginning of year
      retained earnings. SAB 108 will be effective for the Company beginning July
      1,
      2007. The Company is in the process of determining whether the initial adoption
      will have a material impact on its financial condition.





In
      September 2006, the FASB issued FASB Statement No. 158 (SFAS 158 ),
      “ Employers’
      Accounting for Defined Benefit Pension and Other Postretirement
      Plans”. This
      Statement requires an employer to recognize the overfunded or underfunded status
      of a defined benefit postretirement plan (other than a multiemployer plan)
      as an
      asset or liability in its statement of financial position and to recognize
      changes in that funded status in the year in which the changes occur through
      comprehensive income. The implementation of SFAS No. 158 is not expected to
      have
      a material impact on the company’s financial statements.




*Comprehensive
      Income* —
The
      Company has no components of other comprehensive income such that comprehensive
      income is the same as net income for the years ended June 30, 2006 and
      2005.





**2.**
            ***Acquisitions***





During
      the year ended June 30, 2006, the Company completed the acquisition of three
      internet service providers. The combined aggregate purchase price was
      approximately $555,000, including approximately $248,000 in cash and common
      stock valued at approximately $53,000. The remaining consideration included
      the
      issuance of approximately $127,000 in debt, net of approximately $39,000 in
      imputed interest and the assumption of approximately $127,000 in liabilities.
      The value of the 100,000 shares issued in connection with acquisitions was
      determined based on the average market price of the Company’s common shares over
      the 2-day period before and after the terms of the acquisitions were agreed
      to
      and announced. Subscriber acquisition costs recorded in connection with the
      acquisitions totaled approximately $388,000. These acquisitions were accounted
      for as purchases and, accordingly, the operations of the acquired companies
      were
      included in the consolidated financial statements from the date of acquisition.
      Pro forma information for the acquisitions is not presented as the impact is
      not
      material.





F-12


**3.** ***Property
      and Equipment***





Property
      and equipment consist of:





June
                30,
              2006Data
                communications and office equipment
            
            $
            6,068,180Leasehold
                improvements
            
            
            611,325Furniture
                and fixtures
            
            
            233,396Computer
                software
            
            
            773,8957,686,796Less
                accumulated depreciation and amortization
            
            
            (6,604,206
            )$
            1,082,590





Depreciation
      expense charged to operations was $393,000 and $287,000 for the years ended
      June
      30, 2006 and 2005, respectively.





**4.** ***Other
      Assets***





Other
      assets consist of the following:





June
                30,
              2006Goodwill
            
            $
            26,047,266Accum.
                amortization-goodwill
            
            
            (21,734,139
            )Total
                goodwill, net
            
            
            4,313,127Subscriber
                acquisition costs
            
            
            1,244,102Accum.
                amortization-subscriber acquisition costs
            
            
            (774,681
            )Total
                subscriber acquisition costs, net
            
            
            469,421Deposits
            
            
            29,574Total
                other assets, net
            
            $
            4,812,122








Other
      assets consist primarily of goodwill related to the acquisition of NeoSoft,
      Inc.
      (“Neo”) and PDQ.Net Incorporated (“PDQ”) and subscriber acquisition costs
      related to the acquisitions completed during the year ended June 30, 2006,
      as
      more fully described in footnote 2 above. The Company allocates the purchase
      price to acquired subscriber bases and goodwill based on fair value at the
      time
      of acquisition.





The
      weighted average amortization period for subscriber acquisition costs is 36
      months for both dial-up and wireless customers. Prior to April 1, 2006, these
      costs were amortized over 24 months. Amortization expense for the year ended
      June 30, 2006, was approximately $466,000. Subscriber acquisition costs related
      to the Neo and PDQ acquisitions were fully amortized as of June 30, 2002. As
      of
      June 30, 2006, expected amortization expense for the fiscal years ended June
      30,
      2007, 2008 and 2009 is $269,770, $157,011 and $42,640,
      respectively.





In
      connection with the requirements of SFAS 142, goodwill as of June 30, 2006
      was
      evaluated for impairment. As part of the evaluation, the Company compares the
      carrying value of the goodwill of its reporting unit with the fair value to
      determine whether an impairment exists. The Company discounts the reporting
      unit’s estimated cash flow projections to determine if the goodwill can be
      recovered. As of June 30, 2006, no impairment loss was recorded based on this
      evaluation. Goodwill will be evaluated and tested for impairment on an annual
      basis on June 30, or when events and circumstances indicate that an impairment
      has occurred.





F-13


**5** ***.
      Accrued Liabilities***





Accrued
      liabilities consists of:





June
                30,
              2006Property,
                franchise and sales tax expenses
            
            $
            112,966Employee
                wages and benefits
            
            
            192,323Professional
                fees
            
            
            75,000Investor
                relations and communication fees
            
            
            33,454Telecommunications
                expenses
            
            
            7,602Other
            
            
            19,022Deferred
                rent
            
            
            9,263Interest
            
            
            16,206$
            465,836





In
      addition to the property, franchise and sales tax expenses above, $47,320 of
      additional accrued sales tax expense is included in other long-term
      liabilities.





**6** ***.
      Long-Term Debt***





As
      of
      June 30, 2006 long-term debt consists of:


**June 30,
                    2006**Note
                    payable due November 15, 2007, payable in monthly installments of
                    $1,825, bearing interest at prime plus 3%
                
                $
                31,200Note
                    payable due September 22, 2007, payable in annual installments of
                    $41,667 with interest imputed at 8% (net of unamortized discount
                    of
                    $9,031)
                
                
                74,303Note
                    payable due May 30, 2007, payable in monthly installments of
                    approximately $987, bearing interest at prime plus 2%
                
                
                13,201Note
                    payable due July 19, 2009, payable in quarterly payments of $7,751
                    with interest imputed at 9% (net of unamortized discount of
                    $29,409)
                
                
                94,612Note
                    payable due January 23, 2011, payable in bi-annual installments of
                    $13,917 with interest imputed at 8% (net of unamortized discount
                    of
                    $8,770)
                
                
                32,980Credit
                    card line of credit advance, payable on demand, bearing interest
                    at prime
                    plus 6.5%
                
                
                20,956267,252Less
                    current portion
                
                
                (98,208
                )Total
                    long-term debt
                
                $
                169,044




The
      Company’s long-term debt is unsecured except for approximately $21,000 as of
      June 30, 2006, which is secured by certain inventory and equipment. The
      prime rate at June 30, 2006 was 8.25%.





F-14


6 *.
      Long-Term Debt (continued)*




The
      following is a schedule by fiscal years of the principal payments under these
      agreements as of June 30, 2006:





2007
            
            $
            98,2082008
            
            
            82,3412009
            
            
            26,2332010
            
            
            38,9062011
            
            
            21,564Total
                principal payments
            
            $
            267,252






**7** ***.
      Capital Lease Obligations***




The
      Company leases certain phone equipment, wireless equipment and switches under
      leases with bargain purchase options. The following is a schedule by fiscal
      years of the future minimum lease payments under these capital leases, together
      with the present value of the net minimum lease payments as of June 30,
      2006:





2007
            
            $
            70,7132008
            
            
            54,3682009
            
            
            54,3682010
            
            
            31,7142011
            
            
            —Total
                minimum lease payments
            
            
            211,163Less
                amounts representing interest
            
            
            (26,429
            )Present
                value of minimum capitalized payments
            
            
            184,734Less
                current portion
            
            
            (57,390
            )Long-term
                capitalized lease obligations
            
            $
            127,344








**8.** ***Commitments
      and Contingencies***




The
      Company leases certain of its facilities including tower space under operating
      leases. Rental expense under these leases was approximately $503,370 and
      $439,000 for the years ended June 30, 2006 and 2005, respectively. At June
      30,
      2006, future minimum lease payments on operating leases were approximately
      as
      follows:





2007
            
            $
            491,6982008
            
            
            438,7382009
            
            
            198,4062010
            
            
            65,7482011
            
            
            60,016Thereafter
            
            
            —Total
                minimum lease payments
            
            $
            1,254,606





F-15


8. *Commitments
      and Contingencies (continued)*





In
      the
      normal course of business, the Company enters into telephone and internet
      backbone connectivity contracts with various vendors. At June 30, 2006, the
      Company has minimum annual obligations as follows:





2007
            
            $
            178,6332008
            
            
            5,0002009
            
            
            —2010
            
            
            —2011
            
            
            —Total
                minimum obligations
            
            $
            183,633





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
      consolidated financial position, results of operations and cash
      flows.





**9.** ***Shareholders'
      Equity***





*Earnings
      Per Share* —
For
      the
      year ended June 30, 2005, options to purchase 146,448 shares of common stock
      were included in the computation of diluted EPS because the options were “in the
      money” as of June 30, 2005, and it resulted in 12,625 common stock equivalents
      (determined using the treasury stock method at the estimated average fair value)
      to be added to the weighted average shares for the year ended June 30, 2005.
      There were no “in the money” options as of June 30, 2006.





*Common
      Stock* —
The
      Company has authorized 40,000,000 shares of $0.01 par value common stock.





On
      May
      23, 2005, the Company issued 2,000,000 shares of its common stock, $0.01 par
      value per share, pursuant to a Securities Purchase Agreement dated as of May
      20,
      2005, at a price per share of $0.75. Proceeds to the Company from the sale
      of
      the securities were approximately $1.5 million.





In
      October 2004, the Company entered into a release agreement with a former officer
      resulting in a cash payment to the officer of approximately $73,000 and the
      cancellation of a note receivable and related accrued interest, in connection
      with the purchase by the Company of 200,000 shares of common stock from the
      former officer. This transaction resulted in 200,000 shares of treasury stock
      outstanding at June 30, 2005. During the year ended June 30, 2006, the Company
      cancelled the 200,000 shares of treasury stock.





*Shareholder
      Rights Plan* — During
      August 2004, the Board of Directors adopted a shareholder rights plan (the
      “Rights Plan”). In connection with the Rights Plan, the Board of Directors
      declared a dividend of one common share purchase right (a “Right”) for each
      share of common stock, $.01 par value, of the Company outstanding at the close
      of business on August 13, 2004.





Each
      Right entitles the registered holder to purchase from the Company one common
      share at a price of $7.00 per share, upon the terms and subject to the
      conditions set forth in a Rights Agreement dated as of August 9, 2004, between
      the Company and American Stock Transfer & Trust Company, as Rights
      Agent.





*Employee
      Stock Purchase Plan* —
      Effective April 30, 1999, the Company's Board of Directors adopted the Employee
      Stock Purchase Plan (the "Purchase Plan"), which initially provided for the
      issuance of a maximum of 200,000 shares of common stock and was initially
      approved by the Company’s shareholders on November 4, 1999. In fiscal 2002, the
      Board of Directors approved an amendment including the reservation of an
      additional 500,000 shares for issuance under the Purchase Plan, which amendment
      was approved by the shareholders on November 11, 2002. Eligible employees can
      have up to 15% of their earnings withheld, up to certain maximums, to be used
      to
      purchase shares of the Company's common stock on every July 1, October 1,
      January 1 and April 1. The price of the common stock purchased under the
      Purchase Plan will be equal to 85% of the lower of the fair market value of
      the
      common stock on the commencement date of each three-month offering period or
      the
      specified purchase date. During the year ended 2006, 11,879 shares were
      purchased ranging in price from $0.40 to $0.59 per share. At June 30, 2006,
      155,959 shares were available under the Purchase Plan for future issuance.
      During April 2006, the Company temporarily suspended future purchases in the
      Purchase Plan due to lack of employee participation.





F-16


9.
      Shareholders' Equity (continued)





*Stock
      Option Plans* —
The
      Company's 1996 Nonqualified 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 to 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 4,831 options outstanding under the 1996 Option
      Plan at June 30, 2006. These options are exercisable at $1.67 per share of
      common stock.





The
      Company's 1998 Nonqualified Stock Option Plan (the "1998 Option Plan") was
      adopted by the Board of Directors and the Company's shareholders in July 1998.
      A
      total of 1,200,000 shares of common stock have been reserved for issuance under
      the 1998 Option Plan.





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, 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. In general, if an optionee retires from his or her service to us,
      such
      option may be exercised up to three months following such retirement, unless
      the
      Compensation Committee determines to allow a longer period for exercise.





In
      September 2004, the Company issued 200,000 options to employees under the 1998
      Option Plan that contingently vested based upon the Company having 5,000
      wireless subscribers as of September 30, 2005 and approximately $3.5 million
      in
      EBITDA (earnings before interest, taxes and depreciation) for the twelve months
      ended September 30, 2005. The vesting contingency was not met and these options
      were forfeited. The Company has 90,088 options, including 7,000 related to
      the
      September 2004 issuance, outstanding to its employees under the 1998 Option
      Plan
      at June 30, 2006. These options are exercisable at prices ranging from $1.12
      to
      $13.19 per share of common stock.





The
      Company's Employee and Consultant Stock Option Plan (the "Employee and
      Consultant Option Plan") was approved by the Board of Directors in September
      1999 in connection with the acquisition of PDQ. The plan was subsequently
      approved by the shareholders at a special meeting of shareholders in November
      1999. This plan was created in connection with the acquisition of PDQ so that
      each outstanding PDQ incentive stock option could be exchanged for an incentive
      stock option to purchase Internet America common stock. Pursuant to the Employee
      and Consultant Stock Option Plan, the Company may grant incentive and
      nonqualified stock options to our employees, consultants, directors and
      advisors. A total of 260,063 shares of common stock have been reserved for
      issuance under the Employee and Consultant Option Plan. There were no options
      outstanding under this plan at June 30, 2006.





The
      Company also has granted nonqualified stock options to employees that are not
      included under any of the stock option plans noted above. The Company currently
      has 36,826 options outstanding to its employees that are not related to any
      plan
      at June 30, 2006. These options are exercisable at $1.67 per share of common
      stock. The strike price of these options was equal to the fair market value
      of
      the stock on the date of grant. These options, which vested on the date of
      grant, expire on the tenth anniversary of the date of grant.





F-17


9.
      Shareholders' Equity (continued)





On
      October 26, 2004, the Board of Directors adopted the 2004 Non-Employee Director
      Plan (the “2004 Option Plan”). Pursuant to the 2004 Option Plan, non-employee
      directors are granted stock options on the next business day following their
      election to the Board of Directors (“Initial Award Date”) and the next business
      day following their anniversary as a board member (“Annual Award Date”). On both
      the Initial Award Date and the Annual Award Date such director will receive
      an
      option to purchase a number of shares of common stock equal to the lesser of
      (i)
      $20,000 divided by the per share fair market value of the common stock on the
      award date or (ii) 30,000 shares of common stock. Additionally, at the
      discretion of the Board of Directors, directors receive (i) an option to
      purchase up to 50,000 shares of common stock and (ii) a 30-day option to
      purchase a matching number of shares of common stock of the initial and/or
      annual option grant. In the case of an individual who is also appointed or
      elected as the Chairman of the Board for the first time, such Chairman of the
      Board will automatically receive a one-time grant of (A) an option to purchase
      a
      number of shares of common stock equal to the lesser of (i) $50,000 divided
      by
      the per share fair market value of such common stock on the Initial Award Date,
      or (ii) 70,000 shares of common stock.





The
      maximum term of options granted under the 2004 Option Plan is ten years. Options
      granted under the 2004 Option Plan are nontransferable and expire upon the
      termination of the director’s service on the Board of Directors. A total of
      600,000 shares of common stock have been reserved for issuance under the 2004
      Option Plan. The Company currently has 131,556 options outstanding to its
      non-employee directors under the 2004 Option Plan at June 30, 2006. These
      options are exercisable at prices ranging from $0.77 to $1.07 per share of
      common stock.





The
      Company applies APB 25 and related Interpretations in accounting for its
      employee plans. The estimated fair value of each option grant was determined
      by
      reference to quoted market price or recent private, arm's length sales of common
      stock prior to the company's initial public offering. In cases where there
      were
      no arm's length transactions on or around the date of an option grant, the
      Board
      of Directors determined the value. No compensation expense has been charged
      against operations for the years ended June 30, 2006 and 2005 related to stock
      option plans.





A
      summary
      of the status of the Company's stock options as of June 30, 2006 and 2005,
      and
      changes during the years ended on those dates is presented below:





June
                  30,2006
            
            June
                  30,2005Shares
            
            Weighted
              Average
              Exercise
                Price
            
            Shares
            
            Weighted
              Average
              Exercise
                PriceOutstanding
                at beginning of period
            
            
            507,593
            
            $
            1.89
            
            
            288,537
            
            $
            2.93Granted
            
            
            —
            
            
            —
            
            
            611,164
            
            
            .88Exercised
            
            
            —
            
            
            —
            
            
            (49,608
            )
            
            1.05Forfeited
            
            
            (244,292
            )
            
            1.38
            
            
            (342,500
            )
            
            1.09Outstanding
                at end of Period
            
            
            263,301
            
            
            2.37
            
            
            507,593
            
            
            1.89Options
                exercisable at year end
            
            
            175,597
            
            
            3.08
            
            
            281,537
            
            
            2.77








The
      following table summarizes information about stock options outstanding at June
      30, 2006:


Exercise
                  Price
              
              Number
                Outstanding
                at
                  6/30/06
              
              Weighted-Average
                Remaining
                  Contractual
                Life
                  as of 6/30/06 (Years)
              
              Number
                Exercisable
                at
                  6/30/06$
              .77
              
              
              51,948
              
              
              3.8
              
              
              17,3161.02
              
              
              19,608
              
              
              3.6
              
              
              6,5361.07
              
              
              60,000
              
              
              3.3
              
              
              20,0001.12
              
              
              60,588
              
              
              0.8
              
              
              60,5881.67
              
              
              41,657
              
              
              .9
              
              
              41,6579.25
              
              
              7,000
              
              
              3.5
              
              
              7,00013.19
              
              
              22,500
              
              
              3.5
              
              
              22,500263,301
              
              
              
              
              
              175,597





F-18


**10** ***.*** **** ***Income
      Taxes***





No
      provision for federal income taxes has been recognized for the years ended
      June
      30, 2006 and 2005 as the Company incurred a net operating loss for income tax
      purposes in each year and has no present carryback potential.





Deferred
      tax assets and liabilities as of June 30, 2006 and 2005 consist of:





June
                30,2006
            
            2005Deferred
                tax assets:Net
                operating loss carryforwards
            
            $
            9,803,000
            
            $
            9,286,000Intangible
                assets
            
            
            2,383,000
            
            
            2,703,000Allowance
                for doubtful accounts
            
            
            2,000
            
            
            37,000Other
            
            
            97,000
            
            
            65,000Total
                deferred tax assets
            
            
            12,285,000
            
            
            12,091,000Deferred
                tax liabilities:Other
            
            
            (18,000
            )
            
            (54,000
            )Total
                deferred tax liability
            
            
            (18,000
            )
            
            (54,000
            )Total
                net deferred tax asset
            
            
            12,267,000
            
            
            12,037,000Valuation
                allowance
            
            
            (12,267,000
            )
            
            (12,037,000
            )Net
                deferred tax assets
            
            $
            —
            
            $
            —





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. During the year
      ended June 30, 2006, the valuation allowance increased $230,000.





At
      June
      30, 2006, the Company has net operating loss carryforwards of approximately
      $28.8 million for federal income tax purposes. These net operating loss
      carryforwards may be carried forward in varying amounts until 2025 and may
      be
      limited in their use due to significant changes in the Company's
      ownership.





A
      reconciliation of the income tax provision computed at statutory tax rates
      to
      the income tax provision for the years ended June 30, 2006 and 2005 is as
      follows:





Years
                ended June 30,2006
            
            2005Federal
                income tax expense (benefit) at statutory rate
            
            
            (34
            )%
            
            34
            %Change
                in valuation allowance
            
            
            34
            
            
            (34
            )Total
                income tax provision
            
            
            0
            %
            
            0
            %





**11.** ***Employee
      Benefit Plan***





The
      Company has established a 401(k) plan for the benefit 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, 2006.





**12.** ***Related
      Party Transactions***





The
      Company entered into a consulting agreement for a one-year term beginning
      October 1, 2003 with the former Chairman and CEO of the Company, Jack T. Smith.
      The agreement states that a consulting fee is to be paid at a rate of $10,000
      per month. During the year ended June 30, 2005, the Company paid a total of
      $30,000 in consulting fees to Mr. Smith.





F-19


**12.** ***Related
      Party Transactions (continued)***





During
      the year ended June 30, 2005, the Company paid approximately $23,000 in
      marketing consulting fees and related expenses to Marc Ladin Consulting for
      services rendered through July 2004. Marc Ladin is the son of William E. Ladin,
      the CEO of the Company. Marc Ladin became Vice President-Marketing and Sales
      for
      the Company in August 2004 and resigned from the position in April 2005. Wages,
      tax expense and expense reimbursement incurred by the Company related to Marc
      Ladin’s employment with the Company totaled approximately $103,000 during the
      year ended June 30, 2005.





The
      following table shows amounts paid to four non-employee directors for serving
      on
      the Company’s board of directors during the fiscal years ended June 30, 2006 and
      2005:





**Years
                ended June 30,****2006**
            
            **2005**Dave
                Hanna
            
            $
            —
            
            $
            4,491Troy
                LeMaile Stovall
            
            
            17,500
            
            
            15,250Justin
                McClure
            
            
            17,500
            
            
            16,000John
                Palmer
            
            
            16,000
            
            
            4,750Total
                director fees
            
            $
            51,000
            
            $
            40,491





As
      more
      fully described in footnote 9-Shareholders’ Equity, the Company adopted a
      non-employee director stock option plan and completed a private placement during
      the fiscal year ended June 30, 2005 The Company received approximately $32,000
      and $20,000 from Mr. McClure and Mr. Palmer, respectively, during fiscal 2005
      related to the exercise of options under the 2004 Option Plan. Mr. McClure
      and
      Mr. Palmer also participated indirectly in the private placement completed
      by
      the Company in May 2005 when an individual, a partnership and a corporation
      affiliated with Mr. McClure and Mr. Palmer purchased a total of 233,324 shares
      of the Company’s common stock.





**13.** ***Subsequent
      Events***





On
      August
      18, 2006, the Company signed an agreement with Gevity HR, Inc., an employee
      management solution provider. Gevity will bill the Company for all payroll
      amounts, employer’s tax contributions, health and welfare benefits, and 401(k)
      and other retirement plan contributions for all services rendered by employees
      beginning October 1, 2006.





F-20


EXHIBIT
      INDEX





**Exhibit**
            
            **Description**3.1
            
            Articles
                of Incorporation (1)3.2
            
            Bylaws,
                as amended (2)4.1
            
            Rights
                Agreement dated as of August 9, 2004, between Registrant and American
                Stock Transfer & Trust Company, as Rights Agent (3)10.1
            
            Asset
                Purchase Agreement between Registrant and 2FAST Communications, Inc.
                dated
                January 14, 2006 (4)21.1
            
            Subsidiaries
                list (5)23.1
            
            Consent
                of UHY LLP*31.1
            
            Rule
                13a-14(a)/15d-14(a) Certification of William E. Ladin,
                Jr.*31.2
            
            Rule
                13a-14(a)/15d-14(a) Certification of Jennifer S.
                LeBlanc*32.1
            
            Section
                1350 Certification of William E. Ladin, Jr.*32.2
            
            Section
                1350 Certification of Jennifer S.
                LeBlanc*


__________


*Filed
      herewith


(1)
              Incorporated
                  by reference to exhibits 3.1 and 3.2 to Registration Statement
                  on Form
                  SB-2 as amended (file no. 333-59527) initially filed on July 21,
                  1998.
 (2)
              Incorporated
                  by reference to exhibits 3.3 and 3.4 to Registration Statement
                  on Form
                  SB-2, as amended (file no. 333-59527) initially filed on July 21,
                  1998,
                  and to exhibit 3.3 to Form 10-QSB filed on November 15,
                  1999.
 (3)
              Incorporated
                  by reference to exhibit 1 to Registration Statement on Form 8-A
                  (file no.
                  001-32273) filed on August 11,
                  2004.
 (4)
              Incorporated
                  by reference to exhibit 2.1 to Form 10-QSB filed May 16,
                  2006.
 (5)
              Incorporated
                  by reference to exhibit 21.1 to Form 10-K for the fiscal year ended
                  June
                  30, 2005 filed October 11,
                  2005.


F-21