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##### Index to Financial Statements

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-K



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

SECURITIES EXCHANGE ACT
OF 1934



For The Fiscal Year Ended June 30, 2003



 ̈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



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Internet America, Inc.

(Name of registrant as specified in its charter)



|Texas                                                          |  | 86-0778979                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|350 N. St. Paul, Suite 3000 Dallas, Texas                      |  | 75201                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



Registrants
telephone number: (214) 861-2500



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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)



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



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein,
and will not 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-K or any amendment to this Form 10-K. x



Indicate by check mark whether the registrant is an
accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ̈No x



Based on the closing price of the registrants Common Stock on December
31, 2002, the aggregate market value of the Common Stock held by non-affiliates of the registrant is $2,368,450.70. 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 22, 2003 was 10,379,938.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the definitive proxy statement for the Annual Meeting of Shareholders to be held on November 12, 2003, to be
filed within 120 days after the end of our fiscal year, are incorporated by reference into Part III, Items 10-14 of this Form 10-K.



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TABLE OF CONTENTS



|                              |  |          |  |                                                                                                |  | Page
|----------------------------- |  | -------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|PART I                        |  | Item 1.  |  | Business                                                                                       |  | 3   
|                              |  | Item 2.  |  | Properties                                                                                     |  | 7   
|                              |  | Item 3.  |  | Legal Proceedings                                                                              |  | 7   
|                              |  | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                            |  | 8   
|PART II                       |  | Item 5.  |  | Market for Registrants Common Stock and Related Stockholder Matters                           |  | 8   
|                              |  | Item 6.  |  | Selected Financial Data                                                                        |  | 9   
|                              |  | Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  | 10  
|                              |  | Item 7a. |  | Quantitative and Qualitative Disclosure About Market Risk                                      |  | 16  
|                              |  | Item 8.  |  | Financial Statements and Supplementary Data                                                    |  | 16  
|                              |  | Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | 16  
|                              |  | Item 9A. |  | Controls and Procedures                                                                        |  | 16  
|PART III                      |  | Item 10. |  | Directors and Executive Officers                                                               |  | 17  
|                              |  | Item 11. |  | Executive Compensation                                                                         |  | 17  
|                              |  | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 17  
|                              |  | Item 13. |  | Certain Relationships and Related Transactions                                                 |  | 17  
|                              |  | Item 14. |  | Principal Accountant Fees and Services                                                         |  | 17  
|PART IV                       |  | Item 15. |  | Exhibits and Reports on Form 8-K                                                               |  | 17  
|                              | 
|SIGNATURES                    |  | 19      
|INDEX TO FINANCIAL STATEMENTS |  | F-1     



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##### Index to Financial Statements

This Report on Form 10-K 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-K. See also Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations
 Safe Harbor Statement.



PART I



Item 1.Business



General



Internet America is an Internet service provider (ISP) that
provides a wide array of Internet services tailored to meet the needs of individual and business subscribers. As of June 30, 2003, we served approximately 82,000 subscribers. Internet America was incorporated in Texas in 1995 and currently has
operations in Texas and Louisiana. Our business model is to create high user density in each geographic area we serve, which allows us to realize substantial marketing and operating efficiencies. Our growth strategy focuses on growth in revenues
while maintaining reasonable cash flow. We will maintain our focus on the high user density model.



Elements of our growth strategy include:



Creative Use of Advertising to Maintain the Internet America Brand. We have used primarily outdoor billboard, radio and print media advertising. We
are currently developing marketing using billboards and print media.



Cost-Effective Development of Network Infrastructure. We deploy network infrastructure in a disciplined manner to achieve substantial economies of scope and scale. We have been consolidating our Texas operations and have realized
substantial efficiencies from this consolidation. With our Virtual POP architecture, we can provide local access services quickly and efficiently without investing in additional physical infrastructure. See
Infrastructure, below.



Development of
Value-Added Revenue Streams. We continue to develop value-added revenue streams such as dedicated broadband connectivity, news access and Web hosting. In addition, we continue to evaluate other value-added service opportunities such as Internet
telephony. We believe that a user dense, regional customer base provides an excellent platform for the introduction of new value-added services, taking advantage of existing brand awareness and economies of scale.



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, colocation 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, and DS-3
level 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.



USENET. Our Airnews.net product provides access to Internet Americas newsgroup services for subscribers of other Internet services and on a
wholesale basis to other businesses or ISPs.



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##### Index to Financial Statements

Web Services. We offer Web hosting through our Airweb.net service for businesses and other
organizations that wish to create their own World Wide Web sites without maintaining their own Web servers and high-speed Internet connections. Web hosting subscribers are responsible for building their own Web sites and then uploading the pages to
an Internet America server. This Web hosting service features state-of-the-art servers for high speed and reliability, a high quality connection to the Internet, specialized customer support and advanced services features, such as secure
transactions and site usage reports.



Customer Care



Our goal of 100% customer satisfaction begins with providing superior
systems and network performance. We focus on scalability, reliability and speed in the technical design and maintenance of our systems. In addition to the provision of superior systems and network performance, we emphasize high quality customer care
and technical support. We strive to retain our subscribers by prompt response 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
| | - |  | --------------------------------------------------------------



| |  |  | Operating system defects/workarounds.
| | - |  | -------------------------------------



We had approximately 69 customer care employees at June 30, 2003. Customer care is available to subscribers 24-hours-a-day, 7-days-a-week. The customer
care department is organized in tiers designed to respond to varying types of support needs. In addition to diagnosing and resolving subscribers technical problems, our customer care department answers questions about account status and
billing information, provisions new product requests and provides configuration information.



We maintain a comprehensive description of our customer care services on our Web site, as well as troubleshooting tips and configuration information. Additionally, we offer our subscribers free educational classes,
which are held monthly in our Dallas office. 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



Our marketing strategy focuses on penetration of high density urban markets in order to acquire a critical mass of
subscribers to support profitable operations. Our approach focuses on brand building advertising. In the past, we have used primarily outdoor billboard, radio and print media advertising. We believe that the demand for our services in the future
will be more application based, and we currently are evaluating many value-added services for existing and new customers.



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 systems and network infrastructure is designed to provide reliability and speed. Reliability is achieved through redundancy in mission critical systems that minimizes the number of single points of failure. Speed is
achieved through clustered systems, diverse network architecture, multi-peered Internet backbone connections and aggressive load balancing.



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 more precisely match capacity needs to actual sales
in that market.



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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.



We also maintain a Network Operations Control Center (NOCC) in Dallas, which is staffed 24 hours a day. The NOCC is responsible for monitoring
the status of all networking facilities, components, applications and equipment deployed throughout our infrastructure. The NOCC is responsible for operational communications among internal departments and is also responsible for communication with
external service providers. Sophisticated historical and statistical analysis software used in the NOCC provides 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 to handle all customer contact and billing information for the services we provide. The system
maintains access controls for the authentication servers and various applications. The system also creates customer invoices and automatically processes credit card charges and automatic check handling. Our PDQ subsidiary uses a similar system,
while our NeoSoft subsidiary uses a database to manage customer information but provisions services manually. We are transitioning to an integrated financial and information reporting system that will include all subsidiaries, automate many
additional functions and provide financial, marketing and management reports.



Technology and Development



Although we do not
focus a significant amount of resources on creating new technologies, we continuously evaluate new technologies and applications for possible introduction or incorporation into our services. High-speed connectivity is essential to the commercially
viable deployment of new, value-added services such as Internet telephony, particularly VoIP, video and audio programming distribution and other high-bandwidth, low-latency applications. We believe that we are well positioned to efficiently market
and deploy our broadband products and other new, value-added services due to the high density of our subscriber base.



Proprietary Rights



General. 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, PDQ.Net,
ExpressLane DSL, Airmail.net, Airnews.net and Airweb.net are registered service marks of Internet America or its subsidiaries. We have applied to register Airscreen.net.



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. There are no substantial barriers to entry, and we expect that competition will continue to
intensify. We believe that the primary competitive factors determining success in this market 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 than we have. Increased competition for users of Internet services may result in lower subscriber growth
rates or 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:



| |  |  | commercial online service providers, such as AOL Time Warner and the Microsoft Network;
| | - |  | ---------------------------------------------------------------------------------------

| |  |  | national ISPs, such as EarthLink;
| | - |  | ---------------------------------

| |  |  | national telecommunications providers, such as AT&T, Qwest, MCI and Sprint;
| | - |  | ---------------------------------------------------------------------------



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##### Index to Financial Statements

| |  |  | regional telecommunications providers, such as SBC Communications;
| | - |  | ------------------------------------------------------------------

| |  |  | free and low cost providers, such as United Online;
| | - |  | ---------------------------------------------------

| |  |  | numerous regional and local ISPs;
| | - |  | ---------------------------------

| |  |  | computer hardware and software companies, and other technology companies, such as IBM, Microsoft, Dell and Gateway;
| | - |  | -------------------------------------------------------------------------------------------------------------------

| |  |  | cable operators, such as Time Warner and Comcast;
| | - |  | -------------------------------------------------

| |  |  | fixed wireless communications companies; and
| | - |  | --------------------------------------------

| |  |  | satellite companies.
| | - |  | --------------------



The market for broadband services 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 which we compete 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 or wireless transmission, may be more successful than DSL.



We expect to continue to experience competition from numerous
telecommunications providers, including the traditional telecommunications carriers, local exchange carriers and traditional long-distance companies, many of which have greater coverage and market presence, as well as substantial financial,
technical and marketing resources. These telecommunications providers may have the ability to bundle Internet access with basic voice services, which may make it difficult for us to compete effectively. We also face competition from companies that
provide connections to consumers homes, including national and regional telecommunications providers, cable companies, electric utility companies and terrestrial and satellite wireless communications companies. For example, cable television
operators offer Internet access through their cable facilities at significantly faster rates than existing analog modem speeds. These companies include Internet access in the basic bundle of services, or offer such access for a nominal additional
charge, and could prevent us from delivering Internet access through wire and cable connections owned by these competitors.



Our competition is likely to continue increasing, especially as diversified telecommunications and media companies begin providing Internet services, ISPs
consolidate into larger more competitive companies and new competitors enter the Internet services market. The ability of these competitors or others to enter into business combinations, strategic alliances or joint ventures or to bundle services
and products with Internet access could put us at a significant competitive disadvantage.



Government Regulation



We are 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, we provide Internet access through transmissions over public telephone lines, which 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. If we became classified 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.



For example, Internet access providers currently are not required to pay carrier access charges. If Internet communications
become regulated by the FCC in the same manner as traditional telecommunications services, access fees similar to those paid by long distance telephone carriers could be imposed on Internet access providers. Access fees could increase the cost of
the Internet to users, most of whom currently enjoy unlimited, flat-fee usage. This in turn could slow the growth of the Internet and cause an adverse effect on our business. The FCC also does not currently require ISPs to contribute to the
Universal Service Fund (although most telecommunications providers charge these fees to their customers, including us). Telecommunications carriers are actively seeking reconsideration or reversal of the FCC decisions regarding universal service as
well as carrier access fees. In addition, a reclassification of Internet services as telecommunications services would jeopardize Internet access providers current right to nondiscriminatory access to the telephone lines owned by incumbent
local telephone companies for use for broadband services. We cannot predict the outcome of FCC proceedings or other federal legislation, but if adopted, these and other regulatory actions could have a material adverse effect on our business,
financial condition and results of operation. Finally, any change in the FCCs policy of not regulating Internet access providers may cause states to regulate aspects of our business as telecommunications 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,



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##### Index to Financial Statements

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, 2003, we employed approximately 119 people, almost all of whom are full-time employees. None of our current employees are represented by a
labor organization, and we consider employee relations to be good.



Executive Officers (as of September 22, 2003)



The following table sets forth certain information concerning our executive officers as of September 22, 2003.



|Name                  |  | Age |  | Position                                           
|--------------------- |  | --- |  | ---------------------------------------------------
|William E. Ladin, Jr. |  | 62  |  | Chief Executive Officer and Chairman of the Board  
|David E. Allard       |  | 45  |  | Executive Vice President  Strategic Implementation
|Elizabeth P. Daane    |  | 37  |  | Vice President, General Counsel and Secretary      



William E. Ladin,
Jr. Mr. Ladin became CEO and Chairman of the Board of Directors in September 2003 after serving as Vice Chairman of the Board since January 2000. He joined us in connection with our acquisition of PDQ.Net, a Houston-based Internet service
provider that Mr. Ladin formed in 1997. Mr. Ladin served as chief executive officer of PDQ.Net until its acquisition by Internet America. Ladin was instrumental in growing PDQ.Net into Houstons largest independent Internet service provider,
known for providing quality connectivity at an affordable price. Prior to forming PDQ.Net, Ladin was a successful entrepreneur having been involved with founding and/or operating a number of publicly held companies, including The ForeFront Group, a
Houston based Internet company; ComputerCraft, a chain of micro-computer retail stores that grew to 65 stores during his management; Mobil Communications Corporation, known as MobilCom, a national paging company that was sold to Bell South in 1988;
Lifemark, a hospital company that merged with AMI in 1984; and First of Texas Incorporated, a Houston based investment banking firm.



David E. Allardjoined us in April 2003 as Executive Vice PresidentStrategic Implementation. Mr. Allard previously was employed by Primedia
Workplace Learning, where as Chief Operating Officer, he created and managed new products and strategies to increase revenue and EBITDA. As Executive Vice President and Chief Financial Officer of E-Train from 1997 to 2000, Mr. Allard administered
major business combinations and developed a business turnaround plan to create significant savings. From 1992 to 1996, Mr. Allard was Senior Vice President  Business Development of Westcott Communications, Inc., where he managed product lines
and business combinations. Mr. Allard is a certified public accountant and a former partner of Farmer and Allard, P.C.



Elizabeth Palmer Daane joined us in August 1999 as Vice President, General Counsel and Secretary. Prior to joining us, Ms. Daane was an attorney at
the law firm of Jackson Walker LLP, where she specialized in corporate and securities law.



Item 2.Properties



Our
corporate headquarters are located in downtown Dallas, Texas at One Dallas Center, 350 N. St. Paul, Suite 3000, where all executive functions exist. We lease approximately 30,000 square feet in Dallas, Texas and approximately 5,600 square feet in
Houston, Texas. All systems, sales and technical support functions take place in our Dallas and Houston facilities. We do not own any real estate. We believe that all of our facilities are adequately maintained and suitable for their present use.



Item 3.Legal Proceedings



On
May 6, 2003, the Company paid $3.25 million to settle the claims of a former employee which resulted in a judgment against the Company and two former directors. The case was filed in the Dallas County District Court on November 12, 1999. The case
had been on appeal by the plaintiff and defendants since July 2001, with the plaintiff asking the court to increase the amount of the judgment to approximately $5.5 million, plus post judgment interest. The plaintiff, Cindy Carradine, is a former
employee who asserted claims for fraud in connection with her sale of options to the Company in 1998. Pursuant to indemnification agreements, the Company has agreed to indemnify the individual defendants for losses incurred by them in connection
with this lawsuit.



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##### Index to Financial Statements

On August 29, 2003, the Company filed a lawsuit in Dallas County District Court against a former
director, William O. Hunt, in connection with his attempt to sell a controlling interest in the company. Mr. Hunt held an option to purchase 9,428,571 shares of the companys common stock, which he obtained in connection with the financing of
an appeal bond in 2001. Mr. Hunts stock and option, if exercised, would have constituted 51% of the companys outstanding shares. The lawsuit alleged breaches of Mr. Hunts fiduciary duties in connection with his actions since the
option became exercisable. On September 3, 2003, the Company purchased the option from Mr. Hunt for $150,000 and subsequently dismissed the lawsuit.



On July 16, 2003, the District Court of Harris County, Texas issued a summary judgment in favor of Internet America in a lawsuit filed on September 12,
2002 by William E. Ladin, Jr., then the Vice Chairman of the Board and now CEO and Chairman of the Board. In the lawsuit, Mr. Ladin alleged that Internet America breached an employment agreement when it terminated his employment in November 2001,
and sought damages, interest and attorneys fees. The judgment was final on August 15, 2003.



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 2003.



PART II



Item 5.Market For Registrants Common Stock and Related Stockholder Matters



Our common stock began trading on the Nasdaq National Market on December 10, 1998 under the symbol GEEK. Before that date, there was no
established public trading market for our common stock. Our common stock was delisted effective August 15, 2001 and currently trades on the OTC Bulletin Board. The following table shows the high and low bid quotations per share of the common stock
for the periods indicated. 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, 2003: |  |      |      |    
|First Quarter                    |  | $    | 0.38 |    
|Second Quarter                   |  |      | 0.38 |    
|Third Quarter                    |  |      | 0.44 |    
|Fourth Quarter                   |  |      | 0.20 |    
|Fiscal Year Ended June 30, 2002: |  |      |      |    
|First Quarter                    |  | $    | 0.66 |    
|Second Quarter                   |  |      | 0.38 |    
|Third Quarter                    |  |      | 0.45 |    
|Fourth Quarter                   |  |      | 0.40 |    



At September 22, 2003,
there were 247 holders of record of our common stock. The last reported sale price of the common stock on the OTC Bulletin Board on September 22, 2003 was $0.96 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.



Information regarding securities
authorized for issuance under the Companys equity compensation plans is incorporated by reference to Item 12 of this Form 10-K, which in turn incorporated by reference a section of the Companys definitive proxy statement.



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##### Index to Financial Statements

Item 6.Selected Financial Data



|                                               |  | Year Ended June 30,                   |           
|---------------------------------------------- |  | ------------------------------------- | ----------
|                                               |  | 2003                                  |           
|                                               |  | (in thousands, except per share data) |           
|STATEMENT OF OPERATIONS DATA REVENUES:         |  |                                       |           
|Internet Services                              |  | $                                     | 17,493    
|Other                                          |  |                                       | 30        
|                                               |  |                                       |           
|Total                                          |  |                                       | 17,523    
|                                               |  |                                       |           
|OPERATING COSTS AND EXPENSES:                  |  |                                       |           
|Connectivity and operations                    |  |                                       | 8,736     
|Sales and marketing                            |  |                                       | 487       
|General and administrative                     |  |                                       | 4,333     
|Provision for bad debt Expense                 |  |                                       | 703       
|Depreciation and Amortization                  |  |                                       | 669       
|Gain on vendor settlement                      |  |                                       |          
|Accrued lawsuit (gain) expense                 |  |                                       | (321      
|                                               |  |                                       |           
|Total                                          |  |                                       | 14,607    
|                                               |  |                                       |           
|INCOME (LOSS) FROM OPERATIONS                  |  |                                       | 2,916     
|INTEREST INCOME                                |  |                                       | 22        
|INTEREST EXPENSE                               |  |                                       | (636      
|                                               |  |                                       |           
|NET INCOME (LOSS) BEFORE INCOME TAX BENEFIT    |  |                                       | 2,302     
|                                               |  |                                       |           
|INCOME TAX BENEFIT                             |  |                                       |          
|                                               |  |                                       |           
|NET INCOME (LOSS)                              |  | $                                     | 2,302     
|                                               |  |                                       |           
|NET INCOME (LOSS) PER COMMON SHARE:            |  |                                       |           
|BASIC                                          |  | $                                     | 0.22      
|                                               |  |                                       |           
|DILUTED                                        |  | $                                     | 0.22      
|                                               |  |                                       |           
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:    |  |                                       |           
|BASIC                                          |  |                                       | 10,255,671
|                                               |  |                                       |           
|DILUTED                                        |  |                                       | 10,268,296
|                                               |  |                                       |           
|BALANCE SHEET DATA:                            |  |                                       |           
|Cash and cash equivalents                      |  | $                                     | 1,968     
|Other assets, net                              |  |                                       | 4,381     
|Total assets                                   |  |                                       | 7,275     
|Accrued lawsuit liability                      |  |                                       |          
|Long-term debt                                 |  |                                       |          
|Total stockholders equity                     |  |                                       | 2,924     
|OTHER DATA:                                    |  |                                       |           
|EBITDA (1)                                     |  |                                       | 3,585     
|Cash flows related to:                         |  |                                       |           
|Operating activities                           |  |                                       | (762      
|Investing activities                           |  |                                       | (143      
|Financing activities                           |  | $                                     | (29       
|Reconciliation of net income (loss) to EBITDA: |  |                                       |           
|Net income (loss)                              |  | $                                     | 2,302     
|Add:                                           |  |                                       |           
|Depreciation and Amortization                  |  |                                       | 669       
|Interest income                                |  |                                       | (22       
|Interest expense                               |  |                                       | 636       
|Income tax benefit                             |  |                                       |          
|                                               |  |                                       |           
|EBITDA (1)                                     |  | $                                     | 3,585     
|                                               |  |                                       |           

|(1) |  | 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.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



9



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##### Table of Contents

##### Index to Financial Statements

Item 7.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 ending June 30, 2003, 2002 and
2001. 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-K 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-K. We do not intend to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. We
intend the forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the Private Securities Litigation Reform Act of 1995.



These risks include, without limitation, that the Company (1) will not increase revenues or improve EBITDA, profitability or
product margins, (2) will not retain or grow its customer base, including its broadband and commercial services customers, (3) will not continue to achieve operating efficiencies, and (4) will be adversely affected by dependence on network
infrastructure, telecommunications carriers and other suppliers, by regulatory changes and by general competitive, economic and business conditions.



Overview



Internet America is an Internet service provider (ISP) that provides a wide array of Internet services tailored to meet the needs of
individual and business subscribers. We afford our subscribers a high quality Internet experience with fast, reliable service and responsive customer care. As of June 30, 2003, we served approximately 82,000 subscribers in the southwestern United
States, primarily in Texas.



The growth of the Internet has
resulted in increased competition for existing services and increased demand for new products and services. Increases in demand and a surge in Internet users have fostered an increase in the number of ISPs providing access to the Internet. Our
competitors advertise in our existing markets with aggressive new promotions or offers of free Internet access. We believe we are well positioned to deal with these competitive forces by continuing to build high user density and maintaining a
rational business plan.



High user density is the cornerstone
of our business strategy. We will continue to pursue an ambitious growth strategy, but in a controlled manner. Our goal is to rapidly create high user density in specific markets to achieve and maintain positive operating results.



Recent technological developments have facilitated the increased adoption of
broadband access via mechanisms such as cable, fixed/mobile wireless, and copper pair allowing voice, video, and data to occur simultaneously over one connection. The emergence of low-cost broadband solutions will significantly impact the ability of
many ISPs to compete. We are committed to offering cost effective broadband solutions to individuals and businesses. We believe it is essential to offer commercially viable, new, value-added services such as Internet telephony, particularly Voice
Over Internet Protocol (VoIP), video and audio programming distribution and other applications. We believe we are well positioned to efficiently market and deploy these new products due to the high density of our subscriber base. In addition, we are
well positioned to offer add on services to new and existing dial-up customers, such as increased speed, help-desk services, virus protection, desk top video conferencing, spam filtering and other applications.



Given the high level of competition in the industry for new subscribers, we
will be more selective with investing in direct response advertising. We plan to concentrate our direct response advertising more heavily in markets where we have established branding than in new markets.



Our amortization expense increased through fiscal year 2002 as the costs of
purchased subscriber bases were written off. No amortization expense was recorded for the twelve months ended June 30, 2003 and no amortization expense will be recorded for future periods because all of the Companys intangible assets,
excluding goodwill, were fully amortized by June 30, 2002 and, in addition, the adoption of Statement of Financial Accounting Standards Board No. 142, Goodwill and Other Intangible Assets, SFAS No. 142 related to intangible
assets as of July 1, 2002 and our test for impairment in June 2003 resulted in no impairment related to goodwill.



10



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##### Table of Contents

##### Index to Financial Statements

We have an accumulated deficit of $52.8 million at June 30, 2003 and have had annual operating losses
since inception until the current fiscal year as a result of building network infrastructure and rapidly increasing market share.



Statement of Operations



Internet services revenue is derived from individual dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, bulk
dial-up access, Web hosting services, and value-added services, such as multiple e-mail boxes and personalized e-mail addresses.



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, 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 and (ii) fees paid to backbone providers for connections
from our network to the Internet.



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 business expenses.



Depreciation and amortization are computed using the straight line method over the estimated useful lives of the assets. Data communications equipment, computers, data servers and office equipment are depreciated over three years. We
depreciate furniture, fixtures and leasehold improvements over five years. For fiscal years prior and ending June 30, 2002, purchased subscriber bases and related goodwill were amortized over 30 to 36 months. Effective July 1, 2002, it was
determined that the Companys goodwill would not be amortized due to the adoption of SFAS No. 142.



Our business is not subject to any significant seasonal influences.



11



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##### Table of Contents

##### Index to Financial Statements

Results of Operations



Year Ended June 30, 2003 Compared to June 30, 2002



The following table shows financial data for the years ended June 30, 2003 and 2002. 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, 2003 |            |   | Year Ended June 30, 2002 |      
|------------------------------------------- |  | ------------------------ | ---------- | - | ------------------------ | -----
|                                            |  | (000s)                  |            |   | % ofRevenues             |      
|STATEMENT OF OPERATIONS DATA:               |  |                          |            |   |                          |      
|REVENUES:                                   |  |                          |            |   |                          |      
|Internet services                           |  | $                        | 17,493     |   |                          | 99.8 
|Other                                       |  |                          | 30         |   |                          | 0.2  
|                                            |  |                          |            |   |                          |      
|Total                                       |  |                          | 17,523     |   |                          | 100.0
|                                            |  |                          |            |   |                          |      
|OPERATING COSTS AND EXPENSES:               |  |                          |            |   |                          |      
|Connectivity and operations                 |  |                          | 8,736      |   |                          | 49.9 
|Sales and marketing                         |  |                          | 487        |   |                          | 2.8  
|General and administrative                  |  |                          | 4,333      |   |                          | 24.7 
|Provision for bad debt expense              |  |                          | 703        |   |                          | 4.0  
|Depreciation and amortization               |  |                          | 669        |   |                          | 3.8  
|Accrued lawsuit gain                        |  |                          | (321       | ) |                          | (1.8 
|                                            |  |                          |            |   |                          |      
|Total                                       |  |                          | 14,607     |   |                          | 83.4 
|                                            |  |                          |            |   |                          |      
|OPERATING INCOME (LOSS)                     |  |                          | 2,916      |   |                          | 16.6 
|INTEREST EXPENSE, NET                       |  |                          | (614       | ) |                          | (3.5 
|                                            |  |                          |            |   |                          |      
|NET INCOME (LOSS)                           |  | $                        | 2,302      |   |                          | 13.1 
|                                            |  |                          |            |   |                          |      
|NET INCOME (LOSS) PER COMMON SHARE:         |  |                          |            |   |                          |      
|BASIC                                       |  | $                        | 0.22       |   |                          |      
|                                            |  |                          |            |   |                          |      
|DILUTED                                     |  | $                        | 0.22       |   |                          |      
|                                            |  |                          |            |   |                          |      
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |  |                          |            |   |                          |      
|BASIC                                       |  |                          | 10,255,671 |   |                          |      
|DILUTED                                     |  |                          | 10,268,296 |   |                          |      
|OTHER DATA:                                 |  |                          |            |   |                          |      
|Subscribers at end of period                |  |                          | 82,000     |   |                          |      
|Number of employees at end of period        |  |                          | 119        |   |                          |      
|EBITDA(1)                                   |  | $                        | 3,585      |   |                          |      
|EBITDA margin(2)                            |  |                          | 20.5       | % |                          |      
|CASH FLOW DATA:                             |  |                          |            |   |                          |      
|Cash flow from operations                   |  | $                        | (762       | ) |                          |      
|Cash flow used in investing activities      |  | $                        | (143       | ) |                          |      
|Cash flow used in financing activities      |  | $                        | (29        | ) |                          |      
|Reconciliation of net loss to EBITDA:       |  |                          |            |   |                          |      
|Net income (loss)                           |  | $                        | 2,302      |   |                          |      
|Add:                                        |  |                          |            |   |                          |      
|Depreciation and amortization               |  |                          | 669        |   |                          |      
|Interest expense, net                       |  |                          | 614        |   |                          |      
|                                            |  |                          |            |   |                          |      
|EBITDA(1)                                   |  | $                        | 3,585      |   |                          |      
|                                            |  |                          |            |   |                          |      



(1) 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.



(2) EBITDA margin represents EBITDA as a percentage of total revenue.



Total revenue. Total revenue, which primarily consists of dial-up internet access revenue, decreased by $8.0 million,
or 31.4%, to $17.5 million in fiscal 2003 from $25.5 million in fiscal 2002. The Companys subscriber count decreased by 43,000, or 34.4%, to 82,000 as of June 30, 2003 compared to 125,000 as of June 30, 2002. The decrease in the subscriber
count is attributable to tightened credit policies and procedures, normal customer attrition exceeding our rate of new sales, and the loss of DSL customers due to the bankruptcy of one of our DSL providers. Our subscriber count also decreased due to
the consolidation of several billing systems which eliminated counting multiple products sold to one customer, which did not impact revenues.



Connectivity and operations. Connectivity and operations expenses decreased by $4.0 million, or 31.5%, to $8.7 million for fiscal 2003 from $12.7
million for fiscal 2002. The decrease is primarily due to the consolidation of internet and telephone connections and



12



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##### Table of Contents

##### Index to Financial Statements

circuits which was a result of decreased revenues. As a percentage of total revenue, connectivity and operations expenses
remained constant at 49.9% for the current fiscal year compared to the prior fiscal year.



Sales and marketing. Sales and marketing expenses decreased by $212,000, or 30.3%, to $487,000 for fiscal 2003 from $699,000 for the prior fiscal year. The majority of the decrease relates to a reduction of
personnel costs. Sales and marketing expense as a percentage of revenue remained fairly constant at 2.8% for the current fiscal year compared to 2.7% for the prior fiscal year. In the future, we plan to increase sales and marketing expenditures to
the extent we can develop cost effective and efficient techniques in the sale of new and existing products.



General and administrative. General and administrative expenses decreased by $1.0 million, or 18.9%, to $4.3 million for fiscal 2003 from $5.3
million for fiscal 2002. The decrease is mainly related to our overall effort in cost reduction including the consolidation of operations. General and administrative expenses as a percentage of total revenue increased to 24.7% in fiscal 2003 from
20.9% in the prior year.



Provision for bad debt
expense. Provision for bad debt expense decreased by $1.6 million, or 69.6%, to $0.7 million for fiscal 2003 from $2.3 million for fiscal 2002. Provision for bad debt expense as a percentage of revenue decreased to 4.0 % in fiscal 2003 from 8.8%
in the prior fiscal year due to tightened credit policies and procedures. As of June 30, 2003, we are fully reserved for all customer accounts that are at least 90 days old.



Depreciation and amortization. Depreciation and amortization expense decreased significantly by $14.8 million, or
95.5%, to $0.7 million for fiscal 2003 from $15.5 million for fiscal 2002. Due to the adoption of SFAS No. 142, we recorded no amortization expense for fiscal 2003. Amortization expense was $14.1 million for fiscal 2002.



Accrued lawsuit gain. The $321,000 gain for fiscal year 2003
represents the excess reserve related to the settlement of the Carradine lawsuit which was offset with legal fees related to the lawsuit. See Item 3, Legal Proceedings.



Interest expense, net.Interest expense increased $76,000, or 14.1%, to $614,000 for fiscal 2003 from $538,000 for
fiscal 2002. We recorded $150,000 in interest expense for fiscal 2003 related to the fair value of the option which was purchased from Mr. Hunt. We recorded post judgment interest related to an adverse judgment in the Carradine litigation of
$240,000 for fiscal year 2003 compared to $320,000 for fiscal year 2002, a decrease of $80,000.



13



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##### Table of Contents

##### Index to Financial Statements

Year Ended June 30, 2002 Compared to June 30, 2001



The following table shows financial data for the years ended June 30, 2002 and 2001. 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, 2002 |            |   | Year Ended June 30, 2001 |      
|------------------------------------------- |  | ------------------------ | ---------- | - | ------------------------ | -----
|                                            |  | (000s)                  |            |   | % of Revenues            |      
|STATEMENT OF OPERATIONS DATA:               |  |                          |            |   |                          |      
|REVENUES:                                   |  |                          |            |   |                          |      
|Internet services                           |  | $                        | 25,417     |   |                          | 99.7 
|Other                                       |  |                          | 73         |   |                          | 0.3  
|                                            |  |                          |            |   |                          |      
|Total                                       |  |                          | 25,490     |   |                          | 100.0
|                                            |  |                          |            |   |                          |      
|OPERATING COSTS AND EXPENSES:               |  |                          |            |   |                          |      
|Connectivity and operations                 |  |                          | 12,719     |   |                          | 49.9 
|Sales and marketing                         |  |                          | 699        |   |                          | 2.7  
|General and administrative                  |  |                          | 5,335      |   |                          | 20.9 
|Provision for bad debt expense              |  |                          | 2,254      |   |                          | 8.8  
|Depreciation and amortization               |  |                          | 15,510     |   |                          | 60.8 
|Gain on vendor settlement                   |  |                          |           |   |                          | 0.0  
|Accrued lawsuit expense                     |  |                          |           |   |                          | 0.0  
|                                            |  |                          |            |   |                          |      
|Total                                       |  |                          | 36,517     |   |                          | 143.3
|                                            |  |                          |            |   |                          |      
|OPERATING LOSS                              |  |                          | (11,027    | ) |                          | (43.3
|INTEREST EXPENSE, NET                       |  |                          | (538       | ) |                          | (2.1 
|                                            |  |                          |            |   |                          |      
|NET LOSS                                    |  | $                        | (11,565    | ) |                          | (45.4
|                                            |  |                          |            |   |                          |      
|100 NET LOSS PER COMMON SHARE:              |  |                          |            |   |                          |      
|BASIC                                       |  | $                        | (1.15      | ) |                          |      
|                                            |  |                          |            |   |                          |      
|DILUTED                                     |  | $                        | (1.15      | ) |                          |      
|                                            |  |                          |            |   |                          |      
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |  |                          |            |   |                          |      
|BASIC                                       |  |                          | 10,049,450 |   |                          |      
|DILUTED                                     |  |                          | 10,049,450 |   |                          |      
|OTHER DATA:                                 |  |                          |            |   |                          |      
|Subscribers at end of period                |  |                          | 125,000    |   |                          |      
|Number of employees at end of period        |  |                          | 160        |   |                          |      
|EBITDA(1)                                   |  | $                        | 4,483      |   |                          |      
|EBITDA margin(2)                            |  |                          | 17.6       | % |                          |      
|CASH FLOW DATA:                             |  |                          |            |   |                          |      
|Cash flow from operations                   |  | $                        | 2,714      |   |                          |      
|Cash flow used in investing activities      |  | $                        | (552       | ) |                          |      
|Cash flow used in financing activities      |  | $                        | (774       | ) |                          |      
|Reconciliation of net loss to EBITDA:       |  |                          |            |   |                          |      
|Net loss                                    |  | $                        | (11,565    | ) |                          |      
|Add:                                        |  |                          |            |   |                          |      
|Depreciation and amortization               |  |                          | 15,510     |   |                          |      
|Interest expense, net                       |  |                          | 538        |   |                          |      
|                                            |  |                          |            |   |                          |      
|EBITDA(1)                                   |  | $                        | 4,483      |   |                          |      
|                                            |  |                          |            |   |                          |      

---



(1) 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.



(2) EBITDA margin represents EBITDA as a percentage of total
revenue.



Total revenue. Total revenue decreased by $9.4
million, or 26.9%, to $25.5 million in fiscal 2002 from $34.9 million in fiscal 2001. The decrease in total revenue is primarily attributable to the sale of DSL customers to Covad as part of a settlement agreement with Covad, tightened credit
policies and normal customer attrition exceeding our rate of new sales. Our subscriber count decreased by 22,000, or 15%, to 125,000 as of June 30, 2002 compared to 147,000 as of June 30, 2001.



Connectivity and operations. Connectivity and operations expenses
decreased by $9.3 million, or 42.3%, to $12.7 million for fiscal 2002 from $22.0 million for fiscal 2001. As a percentage of total revenue, connectivity and operations expenses decreased to 49.9% for the current year from 63.1% for the previous
year. The decrease is primarily due to the costs eliminated as a result of the sale of DSL customers to Covad, our consolidation of operations and a decrease in our per unit connectivity costs.



14



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##### Table of Contents

##### Index to Financial Statements

Sales and marketing. Sales and marketing expenses decreased by $2.6 million, or 78.8%, to $0.7
million for fiscal 2002 from $3.3 million for the prior fiscal year. Sales and marketing expense decreased as a percentage of revenue to 2.7% for the current year from 9.6% for the previous year. The majority of the decrease relates to an
elimination of television advertising in all markets.



General and administrative. General and administrative expenses decreased by $2.4 million, or 31.2%, to $5.3 million for fiscal 2002 from $7.7 million for fiscal 2001. General and administrative expenses as a percentage of total
revenue decreased to 20.9% in fiscal 2002 from 22.1% in the prior year. General and administrative expense for the year ended June 30, 2001 includes $567,500 in non-cash compensation expense related to an officers stock purchase agreement
compared to only $30,000 for the year ended June 30, 2002. The remainder of the decrease is related to consolidation of operations.



Provision for bad debt expense. Provision for bad debt expense decreased by $1.0 million, or 30.3%, to $2.3 million for fiscal 2002 from $3.3
million for fiscal 2001. Provision for bad debt expense as a percentage of revenue decreased to 8.8% in fiscal 2002 from 9.4% in the prior year. As of June 30, 2002, we were fully reserved for all customer accounts that were at least 90 days old.



Depreciation and amortization. Depreciation and
amortization expense decreased by $0.3 million, or 1.9%, to $15.5 million for fiscal 2002 from $15.8 million for fiscal 2001.



Gain on vendor settlement. We recognized a gain of $2.4 million for fiscal year 2001 in connection with the settlement agreement with Covad.



Accrued lawsuit expense. A charge of $3.2 million was
recorded for fiscal year 2001 due to the adverse judgment in the Carradine litigation. See Item 3, Legal Proceedings.



Interest expense, net.Interest expense was $538,000 for fiscal 2002 compared to interest income of $7,000 for fiscal 2001. The interest expense
for fiscal 2002 is mainly due to post judgment interest of approximately $320,000 related to an adverse judgment in the Carradine litigation and $207,000 in interest expense related to a $3.3 million letter of credit agreement with a former
director, William O. Hunt.



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.



Net cash (used in) or provided by operations totaled ($762,000) for fiscal 2003 compared to $2.7 million for fiscal 2002. Net cash used in operating
activities for fiscal 2003 was negatively impacted by the $3.25 million Carradine lawsuit settlement and the $761,000 decrease in deferred revenue. Deferred revenue decreased as a result of the decrease in our subscriber count.



Net cash used in investing activities was $143,000 for fiscal 2003 compared
to $551,000 for fiscal 2002, and consisted of equipment lease buyouts and routine purchases of property and equipment to expand and upgrade our network.



For fiscal 2003, net cash used in financing activities totaled $29,000 compared to $774,000 for fiscal 2002. Net cash used for financing activities for
fiscal 2003 consisted of proceeds of $56,000 from the issuance of common stock related to the employee stock purchase plan offset by payments of $85,000 to service capital lease and long-term debt obligations. Net cash used for financing activities
for fiscal 2002 consisted of proceeds of $37,000 from the issuance of common stock related to the employee stock purchase plan offset by payments of $811,000 to service long-term debt and capital lease obligations.



On September 18, 2001, we entered into an agreement with a former director,
William O. Hunt, in which Mr. Hunt collateralized an appeal bond with a letter of credit in the approximate amount of $3.3 million to appeal a judgment entered against the Company, Mr. Hunt and a former executive officer of the Company. Internet
America initially collateralized a portion of the appeal bond by placing approximately $200,000 in short term certificates of deposit required to be in place for the duration of the appeal. In August 2002, Internet America increased the amount of
these short-term certificates of deposit by approximately $332,000 in order to significantly reduce the annual premium of the appeal bond. There were one time transaction costs to post this appeal bond. Annual recurring financing costs for this bond
were up to $316,000. In connection with this agreement, we granted Mr. Hunt a security interest in our assets other than accounts receivable.



On May 6, 2003, the Company settled the judgment described in the preceding paragraph. As part of the settlement agreement, the Company made a cash
payment of $3.25 million to the plaintiff. The judgment of approximately $3.3 million had been on appeal by both parties since 2001, with the Company seeking to reduce the amount in full and the plaintiff to increase the amount to



15



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##### Table of Contents

##### Index to Financial Statements

approximately $5.5 million, plus post-judgment interest. Just before the settlement, post-judgment interest accruing at a
rate of 10% per annum had increased the liability to over $3.7 million. As a result of the settlement, the appeal bond was released and, under the financing agreement with Mr. Hunt, Mr. Hunt received an option to purchase approximately 9,428,571
shares of common stock. We purchased the option from Mr. Hunt for $150,000 on September 3, 2003. See Note 12  Subsequent Events of the Notes to the Consolidated Financial Statements.



We estimate that cash on hand of $2.0 million at June 30, 2003 along with
anticipated cash flow from operations will be sufficient for meeting our working capital needs for fiscal 2004 with regard to continuing operations in existing markets. Additional financing will be required to fund acquisitions or expansion into new
markets.



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. In such case, it is likely that our advertising expenditures would be downscaled to a level where positive cash flows are generated from operations. We have no long term
advertising commitments.



In addition, the following are
contractual cash obligations due by fiscal year for the Company as of June 30, 2003:



|                       |  | Total |           | 2004 |   | 2005      |  | 2006 |         | 2007
|---------------------- |  | ----- | --------- | ---- | - | --------- |  | ---- | ------- | ----
|Connectivity contracts |  | $     | 1,415,670 |      | $ | 1,364,373 |  | $    | 51,297  |     
|Operating leases       |  |       | 798,160   |      |   | 291,311   |  |      | 225,266 |     
|Capital leases         |  |       | 14,235    |      |   | 14,235    |  |      |        |     
|                       |  |       |           |      |   |           |  |      |         |     
|                       |  | $     | 2,228,065 |      | $ | 1,669,919 |  | $    | 276,563 |     
|                       |  |       |           |      |   |           |  |      |         |     



Item 7A.Quantitative and Qualitative Disclosure About Market Risk



We do not issue or engage in trading of market-risk sensitive instruments. We also do not purchase for investment, hedging or for purposes other
than trading, instruments that are likely to expose the Company to market risk. We have not entered into any forward nor purchased any futures contracts, nor purchased any options or entered into any swaps. We invest in short-term high grade
interest bearing instruments. In this regard, our interest income is most sensitive to changes in the general level of U.S. interest rates.



Item 8.Financial Statements and Supplementary Data



The financial statements of Internet America and Subsidiaries are attached hereto as pages F-1 through F-16 and include our Balance Sheets as of June 30, 2003 and 2002, Statements of Operations for the three years in
the period ended June 30, 2003, Statements of Shareholders Equity for the three years in the period ended June 30, 2003, Statements of Cash Flows for the three years in the period ended June 30, 2003, and the Notes to the Consolidated
Financial Statements.



Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure



Not applicable.



Item 9A.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 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 Securities Exchange Act of 1934) in effect as of June 30, 2003. Based upon that evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that, as of
June 30, 2003, 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. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the conclusion of their evaluation.



16



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##### Index to Financial Statements

PART III



Item 10.Directors and Executive Officers of the Registrant



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 2003 Annual Meeting of Shareholders. Information about Executive Officers of the Company is included in Item 1 of Part I of this Annual Report on Form
10-K.



Item 11.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 2003 Annual Meeting of Shareholders.



Item 12.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 2003 Annual Meeting of Shareholders.



Item 13.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 2003 Annual Meeting of Shareholders.



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 2003 Annual Meeting of
Shareholders.



PART IV



Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K



(a) Documents filed as part of this Report:



Independent Auditors Report

Consolidated Financial Statements of Internet America, Inc.

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Shareholders Equity (Deficit)

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Internet America, Inc.s Articles of Incorporation

Internet America, Inc.s
Bylaws, as amended

Amendment to Letter of Credit Security Commitment Agreement dated April 23, 2003

Redemption Agreement dated September 3, 2003

Consultation Agreement dated September 19, 2003

Statement regarding computation of per
share earnings

Subsidiaries List

Consent of Deloitte & Touche LLP

Rule 13a-14(a)/15d-14(a) Certification of William E. Ladin, Jr.

Rule 13a-14(a)/15d-14(a)
Certification of Mark Novy

Section 1350 Certification of William E. Ladin, Jr.

Section 1350 Certification of Mark Novy



(b) Reports on Form 8-K. No reports on Form 8-K were filed during the fourth quarter of fiscal 2003.



17



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##### Index to Financial Statements

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



|Exhibit |  | Description                                                                                                                                
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|        | 
|3.1     |  | Internet America, Inc.s Articles of Incorporation(1)                                                                                      
|        | 
|3.2     |  | Internet America, Inc.s Bylaws, as amended(2)                                                                                             
|        | 
|10.1    |  | Amendment to Letter of Credit Security Commitment Agreement dated April 23, 2003 by and between Internet America, Inc. and William
O. Hunt*
|        | 
|10.2    |  | Redemption Agreement dated September 3, 2003 by and between Internet America, Inc. and William O. Hunt*                                    
|        | 
|10.3    |  | Consultation Agreement dated September 19, 2003 by and between Internet America, Inc. and Jack T. Smith*                                   
|        | 
|11.1    |  | Statement regarding computation of per share earnings(3)                                                                                   
|        | 
|21.1    |  | Subsidiaries list*                                                                                                                         
|        | 
|23.1    |  | Consent of Deloitte & Touche 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 Mark Novy*                                                                                       
|        | 
|32.1    |  | Section 1350 Certification of William E. Ladin, Jr.*                                                                                       
|        | 
|32.2    |  | Section 1350 Certification of Mark Novy*                                                                                                   

---



*Filed herewith



|(1) |  | Previously filed as an exhibit to Internet Americas Registration Statement on Form SB-2 as amended (file no. 333-59527) initially filed on July 21, 1998, and incorporated
herein by reference.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Previously filed as an exhibit to Internet Americas Registration Statement on Form SB-2, as amended (file no. 333-59527) initially filed on July 21, 1998, and Quarterly Report
on Form 10-QSB filed on November 15, 1999, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | See Note 1 to the Financial Statements.
|--- |  | ---------------------------------------



18



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##### Index to Financial Statements

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 29th day of September, 2003.



INTERNET AMERICA, INC.



/s/ William E. Ladin, Jr.



William E. (Billy) Ladin, Jr.

Chief Executive Officer

and Chairman of the Board



/s/ Mark Novy



Mark Novy

Chief Accounting Officer

and Controller



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 |  | September 29, 2003
|                                                        |  |                                                  
|/s/ Gary L. Corona Gary L. Corona                       |  | Director                                          |  | September 29, 2003



19



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##### Index to Financial Statements

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|Independent Auditors Report                    |  | F-2
|----------------------------------------------- |  | ---
|Consolidated Financial Statements:              |  |    
|Consolidated Balance Sheets                     |  | F-3
|Consolidated Statements of Operations           |  | F-4
|Consolidated Statements of Shareholders Equity |  | F-5
|Consolidated Statements of Cash Flows           |  | F-6
|Notes to Consolidated Financial Statements      |  | F-7



F-1



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##### Table of Contents

##### Index to Financial Statements

INDEPENDENT AUDITORS REPORT



To the Board of
Directors and Shareholders of Internet America, Inc. and Subsidiaries



We have audited the accompanying consolidated balance sheets of Internet America, Inc. and subsidiaries (the Company) as of June 30, 2003 and 2002, and the related consolidated statements of operations, shareholders
equity, and cash flows for each of the three years in the period ended June 30, 2003. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial
statements based on our audits.



We conducted our audits in
accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2003
and 2002, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2003, in conformity with accounting principles generally accepted in the United States of America.



As discussed in Note 4 to the financial statements, the Company changed its
method of accounting for goodwill as of July 1, 2002, as required by SFAS No. 142, Goodwill and Other Intangible Assets.



DELOITTE & TOUCHE LLP



Dallas, TX

September 3, 2003



F-2



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##### Index to Financial Statements

INTERNET AMERICA, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



|                                                                                                                                            |  | June 30, |            
|------------------------------------------------------------------------------------------------------------------------------------------- |  | -------- | -----------
|                                                                                                                                            |  | 2003     |            
|ASSETS                                                                                                                                      |  |          |            
|CURRENT ASSETS:                                                                                                                             |  |          |            
|Cash and cash equivalents                                                                                                                   |  | $        | 1,968,091  
|Restricted cash                                                                                                                             |  |          |           
|Accounts receivable, net of allowance for uncollectible accounts of $1,133,944 and $2,038,054 in 2003 and 2002,
respectively                |  |          | 347,674    
|Prepaid expenses and other current assets                                                                                                   |  |          | 166,557    
|                                                                                                                                            |  |          |            
|Total current assets                                                                                                                        |  |          | 2,482,322  
|PROPERTY AND EQUIPMENT  Net                                                                                                                |  |          | 411,926    
|OTHER ASSETS  Net                                                                                                                          |  |          | 4,380,393  
|                                                                                                                                            |  |          |            
|TOTAL                                                                                                                                       |  | $        | 7,274,641  
|                                                                                                                                            |  |          |            
|                                                                                                                                            |  |         
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                        |  |          |            
|CURRENT LIABILITIES:                                                                                                                        |  |          |            
|Trade accounts payable                                                                                                                      |  | $        | 795,714    
|Accrued liabilities                                                                                                                         |  |          | 1,472,827  
|Deferred revenue                                                                                                                            |  |          | 2,068,404  
|Current portion of capital lease obligations                                                                                                |  |          | 14,096     
|Current maturities of long-term debt                                                                                                        |  |          |           
|                                                                                                                                            |  |          |            
|Total current liabilities                                                                                                                   |  |          | 4,351,041  
|CAPITAL LEASE OBLIGATIONS, net of current portion                                                                                           |  |          |           
|ACCRUED LAWSUIT LIABILITY                                                                                                                   |  |          |           
|                                                                                                                                            |  |          |            
|Total liabilities                                                                                                                           |  |          | 4,351,041  
|COMMITMENTS AND CONTINGENCIES (Note 7)                                                                                                      |  |          |            
|SHAREHOLDERS EQUITY:                                                                                                                       |  |          |            
|Common stock, $.01 par value; 40,000,000 shares authorized, 10,337,476 and 10,105,249 issued and outstanding in 2003 and 2002,
respectively |  |          | 103,375    
|Additional paid-in capital                                                                                                                  |  |          | 55,733,257 
|Note receivable from a shareholder                                                                                                          |  |          | (82,000    
|Accumulated deficit                                                                                                                         |  |          | (52,831,032
|                                                                                                                                            |  |          |            
|Total shareholders equity                                                                                                                  |  |          | 2,923,600  
|                                                                                                                                            |  |          |            
|TOTAL                                                                                                                                       |  | $        | 7,274,641  
|                                                                                                                                            |  |          |            



See notes to
consolidated financial statements.



F-3



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##### Index to Financial Statements

INTERNET AMERICA, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                            |  | Year Ended June 30, |           
|------------------------------------------- |  | ------------------- | ----------
|                                            |  | 2003                |           
|REVENUES:                                   |  |                     |           
|Internet Services                           |  | $                   | 17,493,106
|Other                                       |  |                     | 30,030    
|                                            |  |                     |           
|Total                                       |  |                     | 17,523,136
|                                            |  |                     |           
|OPERATING COSTS AND EXPENSES:               |  |                     |           
|Connectivity and operations                 |  |                     | 8,736,398 
|Sales and marketing                         |  |                     | 486,933   
|General and administrative                  |  |                     | 4,332,879 
|Provision for bad debt expense              |  |                     | 702,580   
|Depreciation and amortization               |  |                     | 669,383   
|Gain on vendor settlement                   |  |                     |          
|Accrued lawsuit (gain) expense              |  |                     | (321,201  
|                                            |  |                     |           
|Total                                       |  |                     | 14,606,972
|                                            |  |                     |           
|INCOME (LOSS) FROM OPERATIONS               |  |                     | 2,916,164 
|INTEREST INCOME                             |  |                     | 21,719    
|INTEREST EXPENSE                            |  |                     | (635,624  
|                                            |  |                     |           
|INCOME (LOSS) BEFORE INCOME TAXES           |  |                     | 2,302,259 
|INCOME TAX EXPENSE                          |  |                     |          
|                                            |  |                     |           
|NET INCOME (LOSS)                           |  | $                   | 2,302,259 
|                                            |  |                     |           
|NET INCOME (LOSS) PER COMMON SHARE:         |  |                     |           
|BASIC                                       |  | $                   | 0.22      
|                                            |  |                     |           
|DILUTED                                     |  | $                   | 0.22      
|                                            |  |                     |           
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |  |                     |           
|BASIC                                       |  |                     | 10,255,671
|                                            |  |                     |           
|DILUTED                                     |  |                     | 10,268,296
|                                            |  |                     |           



See notes to
consolidated financial statements.



F-4



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##### Index to Financial Statements

INTERNET AMERICA, INC. AND ITS SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY



|                                                                |  | Common Stock |   |  | Additional Paid-in Capital |         |   | Note Receivable from Shareholder |   |            | Accumulated Deficit |  |   | Total Shareholders Equity |  
|--------------------------------------------------------------- |  | ------------ | - |  | -------------------------- | ------- | - | -------------------------------- | - | ---------- | ------------------- |  | - | -------------------------- | -
|                                                                |  | Shares       |   |  | Amount                     |         |   |                                  |   |           
|BALANCE, JUNE 30, 2000                                          |  | 9,705,798    |   |  | $                          | 97,059  |   |                                  | $ | 54,743,828 |                     |  | $ |                           |  
|Issuance of common stock                                        |  | 271,480      |   |  |                            | 2,714   |   |                                  |   | 753,434    |                     |  |   |                           |  
|Note receivable from a shareholder for common stock             |  |             |   |  |                            |        |   |                                  |   |           |                     |  |   | (685,500                   | )
|Stock compensation expense                                      |  |             |   |  |                            |        |   |                                  |   | 567,500    |                     |  |   |                           |  
|Net loss                                                        |  |             |   |  |                            |        |   |                                  |   |           |                     |  |   |                           |  
|                                                                |  |              |   |  |                            |         |   |                                  |   |            |                     |  |   |                            |  
|BALANCE, JUNE 30, 2001                                          |  | 9,977,278    |   |  |                            | 99,773  |   |                                  |   | 56,064,762 |                     |  |   | (685,500                   | )
|Issuance of common stock                                        |  | 127,971      |   |  |                            | 1,279   |   |                                  |   | 35,951     |                     |  |   |                           |  
|Put of common stock from a shareholder for note receivable      |  | (200,000     | ) |  |                            | (2,000  | ) |                                  |   | (685,500   | )                   |  |   | 685,500                    |  
|Note receivable from a shareholder for common stock             |  | 200,000      |   |  |                            | 2,000   |   |                                  |   | 82,000     |                     |  |   | (82,000                    | )
|Stock compensation expense                                      |  |             |   |  |                            |        |   |                                  |   | 30,000     |                     |  |   |                           |  
|Net loss                                                        |  |             |   |  |                            |        |   |                                  |   |           |                     |  |   |                           |  
|                                                                |  |              |   |  |                            |         |   |                                  |   |            |                     |  |   |                            |  
|BALANCE, JUNE 30, 2002                                          |  | 10,105,249   |   |  |                            | 101,052 |   |                                  |   | 55,527,213 |                     |  |   | (82,000                    | )
|Issuance of common stock                                        |  | 232,227      |   |  |                            | 2,323   |   |                                  |   | 54,044     |                     |  |   |                           |  
|Stock compensation expense                                      |  |             |   |  |                            |        |   |                                  |   | 2,000      |                     |  |   |                           |  
|Issuance of stock option pursuant to letter of credit agreement |  |              |   |  |                            |         |   |                                  |   | 150,000    |                     |  |   |                           |  
|Net income                                                      |  |             |   |  |                            |        |   |                                  |   |           |                     |  |   |                           |  
|                                                                |  |              |   |  |                            |         |   |                                  |   |            |                     |  |   |                            |  
|BALANCE, JUNE 30, 2003                                          |  | 10,337,476   |   |  | $                          | 103,375 |   |                                  | $ | 55,733,257 |                     |  | $ | (82,000                    | )
|                                                                |  |              |   |  |                            |         |   |                                  |   |            |                     |  |   |                            |  



See notes to
consolidated financial statements



F-5



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##### Index to Financial Statements

INTERNET AMERICA, INC. AND ITS SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                                                         |  | Year Ended June 30, |           
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------- | ----------
|                                                                                                                         |  | 2003                |           
|OPERATING ACTIVITIES:                                                                                                    |  |                     |           
|Net income (loss)                                                                                                        |  | $                   | 2,302,259 
|Adjustments to reconcile net income (loss) to net cash used in operating activities:                                     |  |                     |           
|Depreciation and amortization                                                                                            |  |                     | 669,383   
|Provision for bad debt expense                                                                                           |  |                     | 702,580   
|Non-cash stock compensation expense                                                                                      |  |                     | 2,000     
|Issuance of stock option pursuant to letter of credit agreement                                                          |  |                     | 150,000   
|Gain on vendor settlement                                                                                                |  |                     |          
|Changes in operating assets and liabilities:                                                                             |  |                     |           
|Restricted cash                                                                                                          |  |                     | 200,000   
|Accounts receivable                                                                                                      |  |                     | (377,275  
|Prepaid expenses and other current assets                                                                                |  |                     | 103,275   
|Other assets                                                                                                             |  |                     | 70,651    
|Accounts payable and accrued liabilities                                                                                 |  |                     | (524,106  
|Deferred revenue                                                                                                         |  |                     | (760,989  
|Accrued lawsuit expense                                                                                                  |  |                     | (3,300,000
|                                                                                                                         |  |                     |           
|Net cash (used in) provided by operating activities                                                                      |  |                     | (762,222  
|INVESTING ACTIVITIES:                                                                                                    |  |                     |           
|Purchases of property and equipment, net                                                                                 |  |                     | (142,720  
|FINANCING ACTIVITIES:                                                                                                    |  |                     |           
|Proceeds from issuance of common stock                                                                                   |  |                     | 56,367    
|Principal payments under capital lease obligations                                                                       |  |                     | (78,133   
|Principal payments of long-term debt                                                                                     |  |                     | (6,746    
|                                                                                                                         |  |                     |           
|Net cash used in financing activities                                                                                    |  |                     | (28,512   
|                                                                                                                         |  |                     |           
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                                                     |  |                     | (933,454  
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                                                           |  |                     | 2,901,545 
|                                                                                                                         |  |                     |           
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                                 |  | $                   | 1,968,091 
|                                                                                                                         |  |                     |           
|SUPPLEMENTAL INFORMATION:                                                                                                |  |                     |           
|Cash paid for interest                                                                                                   |  | $                   | 245,624   
|Equipment acquired under capital leases                                                                                  |  | $                   |          
|Issuance of 200,000 shares of common stock in exchange for note receivable from a shareholder and officer of the
company |  | $                   |          
|Conversion of vendor payable to note payable as part of vendor settlement                                                |  | $                   |          



See notes to
consolidated financial statements.



F-6



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##### Index to Financial Statements

INTERNET AMERICA, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended June 30, 2003 and 2002



1.General Information and Summary of Significant Accounting Policies



Basis of Presentation  Internet America,
Inc. is an Internet service provider (ISP) in the southwestern United States. The Company provides a wide array of Internet services tailored to meet the needs of individual and business customers.



The Company has experienced cumulative operating losses, and its operations
are subject to certain risks and uncertainties including, among others, risks associated with technology and regulatory trends, evolving industry standards, dependence on its network infrastructure and suppliers, growth and acquisitions, actual and
prospective competition by entities with greater financial and other resources, the development of the Internet market and need for additional capital or refinancing of existing obligations. There can be no assurance that the Company will be
successful in sustaining profitability and positive cash flow in the future.



Revenue Recognition  Revenues derived from monthly subscribers and set-up charges are recognized as services are provided. The Company bills its subscribers in advance for direct access to the Internet,
but defers recognition of these revenues until the service is provided.



Credit Risk  The Companys accounts receivable potentially subjects the Company to credit risk, as collateral is generally not required.



During the years ended June 30, 2003, 2002 and 2001, the Company has recorded a provision for bad debt expense totaling $0.7
million, $2.3 million, and $3.3 million, 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 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. Cash and cash equivalents are stated at cost, which approximates fair value.



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
three to five years.



Equipment Under Capital Lease
 The Company leases certain of its data communication and other equipment under agreements accounted for as capital leases. The assets and liabilities under capital leases are recorded at the lesser of the present value of aggregate future
minimum lease payments, including estimated bargain purchase options, or the fair value of the assets under lease. Assets under capital lease are depreciated over the shorter of their estimated useful lives or the related lease term.



Other Assets  Other assets consist primarily of subscriber
acquisition costs and goodwill related to the acquisition of NeoSoft, Inc. and PDQ.Net, Incorporated. The Company allocates the purchase price to acquired subscriber bases and goodwill based on reasonable allocation methods at the time of
acquisition. Prior to July 1, 2002, amortization of subscriber acquisition costs and goodwill were provided using the straight-line method over three years commencing upon completion of the transaction.



In July 2001, the Financial Accounting Standard Board issued Statement No.
141 (SFAS No. 141), Business Combinations, and Statement No. 142 (SFAS No. 142), Goodwill and Other Intangible Assets. SFAS 142 includes requirements to test goodwill and indefinite lived intangible assets for impairment
rather than amortize them. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of
certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill.



The Company evaluated the impact that SFAS No. 142 would have on its financial statements, and determined that, effective
July 1, 2002, the Companys goodwill would not be amortized.



F-7



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##### Table of Contents

##### Index to Financial Statements

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 August 2001, the FASB issued SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. The provisions of SFAS 144 are generally effective for financial statements issued for fiscal years beginning after December 15, 2001. The Companys
adoption of this standard did not have a material impact on its financial statements.



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 is less than the carrying value, the Company would recognize a loss for the difference between the carrying value and fair market value.



In July 2001, the FASB issued SFAS 143, Accounting for Asset Retirement Obligations. SFAS 143 establishes
standards associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Companys adoption
of this standard did not have a material impact on its financial statements.



Stock-Based Compensation  The Company continues to account for its employee stock based compensation in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB No.
25) and provides pro forma disclosures in the notes to the financial statements, as if the measurement provisions of SFAS No. 123 Accounting for Stock-Based Compensation, had been adopted.



In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002. The Company has adopted the interim disclosure provisions for the quarter ended March 31, 2003. The Company did not elect to change to the fair value based method of
accounting for stock-based employee compensation.



Had
compensation cost for the Companys stock options been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the Companys net income (loss) and income (loss) per share would have been
as indicated below:



|                                          |  |             |  | 2003 |           | 2002 |   |             | 2001 | 
|----------------------------------------- |  | ----------- |  | ---- | --------- | ---- | - | ----------- | ---- | 
|Net income (loss)                         |  | As reported |  | $    | 2,302,259 |      | $ | (11,564,859 | )    | 
|                                          |  | Pro Forma   |  |      | 1,664,910 |      |   | (12,437,266 | )    | 
|Basic and diluted income (loss) per share |  | As reported |  | $    | 0.22      |      | $ | (1.15       | )    | 
|                                          |  | Pro Forma   |  |      | 0.16      |      |   | (1.24       | )    | 



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, 2003, 2002 and
2001 were $135,180, $144,349 and $1,953,810, respectively.



Income Taxes  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amount of existing assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in



F-8



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##### Table of Contents

##### Index to Financial Statements

which those temporary differences are expected to reverse.



Basic and Diluted Net Income (Loss) Per Share  Basic earnings per share is computed using the weighted average
number of common shares outstanding and excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share reflects the potential dilution that could occur upon exercise or conversion of these instruments. Due
to the net losses reported for the fiscal years ended June 30, 2002 and 2001, all of the Companys stock options and warrants were antidilutive for those respective periods, and basic and diluted loss per share amounts were therefore the same
for all periods presented.



|                                 |  | For the Years Ended June 30, |           
|-------------------------------- |  | ---------------------------- | ----------
|                                 |  | 2003                         |           
|Basic earnings per share:        |  |                              |           
|Net income (loss)                |  | $                            | 2,302,259 
|Weighted avg. common shares      |  |                              | 10,255,671
|Basic earnings per share         |  | $                            | 0.22      
|                                 |  |                              |           
|Diluted earnings per share:      |  |                              |           
|Net income (loss)                |  | $                            | 2,302,259 
|Weighted avg. common shares      |  |                              | 10,255,671
|Effect of dilutive stock options |  |                              | 12,625    
|                                 |  |                              |           
|Diluted weighted avg. shares     |  |                              | 10,268,296
|Diluted earnings per share       |  | $                            | 0.22      
|                                 |  |                              |           



During the year ended
June 30, 2003, options to purchase 1,049,557 shares of common stock 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 year ended June
30, 2003.



Use of Estimates  The preparation of
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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these estimates.



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, 2003, 2002 and 2001.



Recently Issued Accounting Pronouncements In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS
No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on
reported results. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. The Company has adopted the interim disclosure provisions for the quarter ended March 31, 2003. The Company did not elect to change to the fair value based method of accounting for
stock-based employee compensation.



Reclassifications Certain prior period amounts have been reclassified to conform to the current period presentation.



2.Covad Settlement



During fiscal 2001, the Company entered into a Purchase and Settlement Agreement with one of its DSL providers, Covad Communications, to resolve certain disputes and settle outstanding claims and liabilities between
the companies. Under this agreement, the Company satisfied approximately $3.6 million in liabilities by transferring to Covad its Digital Subscriber Line (DSL) accounts then currently serviced by Covad, making an immediate payment to Covad of
$300,000 and entering into a promissory note in the principal amount of $650,000. These DSL customers had the option to be migrated to Covad.net or to one of Covads Internet service providers. The Company continued to render services to those
customers during the transition of accounts. In addition, the two companies released all claims in connection with their prior relationship. The total impact on the statement of operations of this transaction of approximately $2.7 million has been
recorded against connectivity and operations expense ($0.3 million) and as a separate line item as a gain on vendor settlement ($2.4 million).



F-9



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##### Table of Contents

##### Index to Financial Statements

3.Property and Equipment



Property and equipment consist of:



|                                               |  | June 30, |           
|---------------------------------------------- |  | -------- | ----------
|                                               |  | 2003     |           
|Data communications and office equipment       |  | $        | 5,060,200 
|Leasehold improvements                         |  |          | 632,390   
|Furniture and fixtures                         |  |          | 252,562   
|Computer software                              |  |          | 717,348   
|                                               |  |          |           
|                                               |  |          | 6,662,400 
|Less accumulated depreciation and amortization |  |          | (6,250,474
|                                               |  |          |           
|                                               |  | $        | 411,926   
|                                               |  |          |           



Depreciation expense
charged to operations was $669,383, $1,363,077 and $1,567,298 for the years ended June 30, 2003, 2002 and 2001, respectively.



4.Other Assets



Other assets consist of:



|                             |  | June 30, |            
|---------------------------- |  | -------- | -----------
|                             |  | 2003     |            
|Goodwill                     |  | $        | 26,023,407 
|Accum. amortization-goodwill |  |          | (21,721,395
|Acquired subscribers         |  |          |           
|Other                        |  |          |           
|Accum. amortization-other    |  |          |           
|                             |  |          |            
|Total intangible assets, net |  |          | 4,302,012  
|Deposits                     |  |          | 78,381     
|                             |  |          |            
|Total other assets, net      |  | $        | 4,380,393  
|                             |  |          |            



Other assets consist
primarily of subscriber acquisition costs and goodwill related to the acquisition of NeoSoft, Inc. and PDQ.Net, Incorporated. The Company allocates the purchase price to acquired subscriber bases and goodwill based on reasonable allocation methods
at the time of acquisition. Prior to July 1, 2002, amortization of subscriber acquisition costs and goodwill were provided using the straight-line method over three years commencing upon completion of the transaction.



Acquired subscribers were fully amortized as of June 30, 2002. Upon adoption
of SFAS No. 142 on July 1, 2002, no further amortization expense was recorded. Amortization expense for the years ended June 30, 2002 and 2001 was $14.1 million and $14.2 million, respectively.



In connection with the adoption of SFAS No.142, goodwill as of June 30, 2003
was evaluated and tested to determine if there was any impairment of goodwill. The evaluation was based on undiscounted cash flow projections of the Company. An excess of carrying value over projected undiscounted cash flows would result in
recognition of an impairment loss. As of June 30, 2003, no impairment loss was recorded based on the evaluation. Goodwill will be evaluated and tested for any impairment on an annual basis as of June 30.



The Company adopted SFAS No. 142 effective July 1, 2002. If the Company had
adopted SFAS No. 142 on July 1, 2001, the Companys results of operations would have been as follows:



|                                      |  | For the Years Ended June 30, |           |      | 2001 |            
|------------------------------------- |  | ---------------------------- | --------- | ---- | ---- | -----------
|                                      |  | 2003                         |           | 2002 |      |            
|Reported net income (loss)            |  | $                            | 2,302,259 |      | $    | (11,564,859
|Add back amortization expense         |  |                              |          |      |      | 8,800,000  
|                                      |  |                              |           |      |      |            
|Pro forma net income (loss)           |  | $                            | 2,302,259 |      | $    | (2,764,859 
|                                      |  |                              |           |      |      |            
|Reported net income (loss) per share  |  | $                            | 0.22      |      | $    | (1.15      
|Add back amortization expense         |  |                              |          |      |      | 0.87       
|                                      |  |                              |           |      |      |            
|Pro forma net income (loss) per share |  | $                            | 0.22      |      | $    | (0.28      
|                                      |  |                              |           |      |      |            



F-10



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##### Table of Contents

##### Index to Financial Statements

5. Accrued Liabilities



Accrued liabilities consists of:



|                                           |  | June 30,
|------------------------------------------ |  | --------
|                                           |  | 2003    
|Telecommunications expenses                |  | $       
|Employee wages and benefits                |  |         
|Acquisition fees                           |  |         
|Accrued interest                           |  |         
|Deferred rent                              |  |         
|Reserve for settlement expense             |  |         
|Property, franchise and sales tax expenses |  |         
|Other                                      |  |         
|                                           |  |         
|                                           |  | $       
|                                           |  |         



6.Long-Term
Debt



Long-term debt consists of:



|                                                                                                            |  | June 30, |  
|----------------------------------------------------------------------------------------------------------- |  | -------- | -
|                                                                                                            |  | 2003     |  
|Other notes payable due from March 2000 through July 2002, with interest ranging from the prime rate to 16% |  |          | 
|                                                                                                            |  |          |  
|                                                                                                            |  |          | 
|Less current portion                                                                                        |  |          | 
|                                                                                                            |  |          |  
|                                                                                                            |  | $        | 
|                                                                                                            |  |          |  



7.Commitments and
Contingencies



The Company leases certain of
its facilities under operating leases. Rental expense under these leases was approximately $584,966, $1,085,958 and $1,113,830 for the years ended June 30, 2003, 2002 and 2001, respectively. At June 30, 2003, future minimum lease payments on capital
and operating leases were approximately as follows:



|                                                    |  | Capital Leases |         |   | Operating Leases
|--------------------------------------------------- |  | -------------- | ------- | - | ----------------
|2004                                                |  | $              | 14,235  |   |                 
|2005                                                |  |                |        |   |                 
|2006                                                |  |                |        |   |                 
|2007                                                |  |                |        |   |                 
|Thereafter                                          |  |                |        |   |                 
|                                                    |  |                |         |   |                 
|Total minimum lease payments                        |  |                | 14,235  |   |                 
|                                                    |  |                |         |   |                 
|Less amounts representing interest                  |  |                | (139    | ) |                 
|                                                    |  |                |         |   |                 
|Present value of minimum capitalized lease payments |  |                | 14,096  |   |                 
|Less current portion                                |  |                | (14,096 | ) |                 
|                                                    |  |                |         |   |                 
|Long-term capitalized lease obligations             |  | $              |        |   |                 
|                                                    |  |                |         |   |                 



In the normal course
of business, the Company enters into telephone and internet backbone connectivity contracts with various vendors. The Company currently has minimum annual obligations as follows: $1,364,373 for the fiscal year ended 2004, $51,297 for the fiscal year
ended 2005 and $0 thereafter.



In July 2001, a District Court
of Dallas County, Texas entered a judgment against the Company and two former directors in the approximate amount of $3.2 million, plus post judgment interest. The plaintiff is a former employee who asserted claims for fraud in connection with her
sale of options to the Company in 1998. The Company agreed to indemnify the individual defendants for losses incurred by them in connection with this lawsuit. The plaintiff had also filed an appeal to increase the amount of the judgment to
approximately $5.5 million, plus post judgment interest. The Company accrued $3.3 million (including $100,000 of prepaid post-judgment interest) during fiscal 2001 in the event the judgment was not overturned. The Company recorded the judgment and
charged operations in the fiscal year ended June 30, 2001.



On
September 18, 2001, the company entered into a Letter of Credit Security Commitment Agreement with William O. Hunt, one of the individual defendants and then the Companys Chairman, to finance an appeal bond in the approximate amount of $3.3
million in connection with the judgment entered against the Company. Under this agreement, Mr. Hunt collateralized a letter of credit in the



F-11



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##### Table of Contents

##### Index to Financial Statements

amount of $3.3 million and the Company paid Mr. Hunt a commitment fee of 8% per annum, paid quarterly. The Company paid
the commitment fee to Mr. Hunt through June 6, 2003, the date the court released the appeal bond.



On May 6, 2003, the Company entered into a settlement agreement with the plaintiff and made a cash payment of $3.25 million to the plaintiff. Prior to the
settlement, post-judgment interest accruing at a rate of 10% per annum had increased the liability to over $3.7 million. As a result of the settlement of the judgment, the Company notified Mr. Hunt that it reduced the collateral in full.
Accordingly, under the Letter of Credit Security Commitment Agreement, the Company issued to Mr. Hunt a transferable option to purchase 9,428,571 shares of common stock of the Company at a price of $0.35 per share. On September 3, 2003, the Company
purchased the option from Mr. Hunt for $150,000. The estimated fair value of the option of $150,000 was recorded as interest expense and additional paid in capital in May 2003.



On July 16, 2003, the District Court of Harris County, Texas issued a summary judgment in favor of Internet America in a
lawsuit filed by William E. Ladin, Jr., then the Vice Chairman of the Board and now CEO and Chairman of the Board. In the lawsuit, Mr. Ladin alleged that Internet America breached an employment agreement when it terminated his employment in November
2001, and sought damages, interest and attorneys fees. The judgment was final on August 15, 2003.



The Company is involved in various other claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the Companys financial position, results of operations and cash flows.



8.Shareholders Equity



Earnings Per Share  Potentially dilutive securities have been excluded from the computation of earnings per share (EPS) for the
years ended June 30, 2002 and 2001 as their effect is antidilutive. For the year ended June 30, 2003, options to purchase 58,000 shares of common stock were included in the computation of diluted EPS because the options were in the money
as of June 30, 2003 and it resulted in 12,625 common stock equivalents to be added to the weighted average shares for the year ended June 30, 2003 (determined using the treasury stock method at the estimated average fair value).



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



Note Receivable from a
shareholder and officer for common stock  Pursuant to a Stock Purchase Agreement entered into during September 2000, the Company issued 200,000 shares of its common stock to an officer in exchange for cash of $2,000 and a note receivable,
bearing interest at 6.33%, for $685,500. The note provided for payment of interest on a quarterly basis beginning October 1, 2000 with principal due August 29, 2007. The purchase price of the common stock under the Stock Purchase Agreement was based
on the closing price of the common stock on the date the Companys board of directors approved the transaction.



Under the terms of the Stock Purchase Agreement, the officer had the option to put the shares of common stock to the Company during the term (which would
have expired September 5, 2007) of the Stock Purchase Agreement for $3.4375 per share. In connection with the put option, the Company recognized a non-cash compensation expense of $567,500 during the year ended June 30, 2001, which was a result of
the decrease in the price of the Companys common stock between the date of the Stock Purchase Agreement and June 30, 2001. The officer exercised the put agreement on August 6, 2001. In connection with the put option, the Company recognized a
non-cash compensation expense of $30,000 during the year ended June 30, 2002, which was a result of the decrease in the price of the Companys common stock between July 1, 2001 and August 6, 2001.



On August 6, 2001, another stock purchase agreement was entered into between
the officer and the Company. The Company issued 200,000 shares of common stock to the officer in exchange for cash of $2,000 and a note receivable, bearing interest at 6.33%, for $82,000. Under the terms of this Stock Purchase Agreement, the officer
has the option to put the shares of common stock to the Company during the term of the Stock Purchase Agreement for $0.42 per share. In connection with the put option, the Company recognized non-cash compensation expense of $2,000 during the year
ended June 30, 2003, based on the price of the Companys common stock as of June 30, 2003.



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



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##### Table of Contents

##### Index to Financial Statements

2003, 232,227 shares were purchased ranging in price from $0.22 to $0.28 per share. At June 30, 2003, 267,789 shares were
available under the Purchase Plan for future issuance.



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 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 6,890 options outstanding to its employees under the 1996 Option Plan at June 30,
2003. 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, unless the Compensation Committee determines to allow a longer period for exercise. 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. The Company currently has 524,088 options outstanding to its employees under the 1998 Option Plan at June 30, 2003. These options are
exercisable at prices ranging at $0.34 to $13.75 per share of common stock.



During fiscal 2002, 190,000 options to purchase shares of common stock were granted to certain officers and employees of the Company under the 1998 Option Plan at exercise prices ranging from $0.34 to $0.35 per share
which were equal to the fair market values on the dates of grant.



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 and 1,953 were still outstanding at June 30, 2003. These options are exercisable at $2.69 per share of common stock.



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 574,626 options outstanding to its employees that are not related to any plan at June 30, 2003. These options are exercisable at prices ranging at $0.09 to $2.25
per share of common stock. The strike price of these options were equal to the fair market value of the stock on the date of grant.



The Company applies APB No. 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 and preferred 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, 2003, 2002 and 2001 related to stock option plans.



F-13



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##### Table of Contents

##### Index to Financial Statements

A summary of the status of the Companys stock options as of June 30, 2003, 2002, and 2001, and
changes during the years ended on those dates is presented below:



|                                   |  | 2003      |   | 2002 |                                 | 2001 
|---------------------------------- |  | --------- | - | ---- | ------------------------------- | -----
|                                   |  | Shares    |   |      | Weighted Average Exercise Price |      
|Outstanding at beginning of period |  | 1,119,323 |   |      | $                               | 3.88 
|Granted                            |  |          |   |      |                                 |     
|Exercised                          |  |          |   |      |                                 |     
|Forfeited                          |  | (11,766   | ) |      |                                 | 11.43
|Outstanding at end of Period       |  | 1,107,557 |   |      |                                 | 3.80 
|                                   |  |           |   |      |                                 |      
|Options exercisable at year end    |  | 859,807   |   |      |                                 | 4.14 
|                                   |  |           |   |      |                                 |      



The following table
summarizes information about stock options outstanding at June 30, 2003:



|                         |  | Options Exercisable         |  | OptionsOutstanding                                            
|------------------------ |  | --------------------------- |  | --------------------------------------------------------------
|Range of Exercise Prices |  | NumberOutstandingat 6/30/03 |  | Weighted-AverageRemaining ContractualLife as of 6/30/03(Years)
|$  0.09                  |  | 18,000                      |  | 2.2                                                           
|0.34                     |  | 40,000                      |  | 8.5                                                           
|0.35                     |  | 150,000                     |  | 8.1                                                           
|1.12                     |  | 60,588                      |  | 3.8                                                           
|1.67                     |  | 413,516                     |  | 1.7                                                           
|2.25                     |  | 150,000                     |  | 7.3                                                           
|2.69                     |  | 1,953                       |  | 6.0                                                           
|8.00                     |  | 22,500                      |  | 5.0                                                           
|9.25                     |  | 54,000                      |  | 6.5                                                           
|10.00                    |  | 75,000                      |  | 6.4                                                           
|13.00                    |  | 67,500                      |  | 5.4                                                           
|13.19                    |  | 22,500                      |  | 6.5                                                           
|13.75                    |  | 32,000                      |  | 6.1                                                           
|                         |  |                             |  |                                                               
|                         |  | 1,107,557                   |  |                                                               
|                         |  |                             |  |                                                               



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 2 to 10 years, volatility ranging from 80% to 120%, risk-free interest rate of 5.0%, and an expected dividend
yield of zero. The weighted average grant date fair value of options granted was $0.33 and $1.94 for the years ended June 30, 2002 and 2001, respectively. No options were granted during the year ended June 30, 2003.



9.Income Taxes



No provision for federal income taxes has been recognized for the years
ended June 30, 2003, 2002 and 2001. For the years ended June 30, 2003 and 2001, the Company has incurred net operating losses for income tax purposes and has no carryback potential. For the year ended June 30, 2002, the Company incurred taxable
income, and offset such taxable income with net operating losses generated in prior periods.



Deferred tax assets and liabilities as of June 30, 2003 and 2002, consist of:



|                                 |  | June 30, |            
|-------------------------------- |  | -------- | -----------
|                                 |  | 2003     |            
|Deferred tax assets:             |  |          |            
|Net operating loss carryforwards |  | $        | 8,402,000  
|Intangible assets                |  |          | 2,644,000  
|Allowance for doubtful accounts  |  |          | 386,000    
|Property and equipment           |  |          | 228,000    
|Legal settlement reserve         |  |          |           
|Other                            |  |          | 85,000     
|                                 |  |          |            
|Total deferred tax assets        |  |          | 11,745,000 
|Valuation allowance              |  |          | (11,745,000
|                                 |  |          |            
|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.



At June 30, 2003, the Company has net operating loss carryforwards of approximately $24.7 million for federal income tax purposes. These net operating
loss carryforwards may be carried forward in varying amounts until 2023 and may be limited in their use due to significant changes in the Companys ownership.



F-14



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##### Table of Contents

##### Index to Financial Statements

A reconciliation of the income tax provision computed at statutory tax rates to the income tax provision
for the years ended June 30, 2003, 2002 and 2001 is as follows:



|                                             |  | Years ended June 30, |   
|-------------------------------------------- |  | -------------------- | --
|                                             |  | 2003                 |   
|Federal income tax benefit at statutory rate |  | (34                  | )%
|Valuation allowance                          |  | 34                   |   
|Amortization of goodwill                     |  |                     |   
|                                             |  |                      |   
|Total income tax provision                   |  | 0                    | % 
|                                             |  |                      |   



10.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,
2003.



11.Quarterly Financial Data (Unaudited)



|                                            |  | 2003         |       
|------------------------------------------- |  | ------------ | ------
|                                            |  | FirstQuarter |       
|Revenues                                    |  | $            | 4,986 
|Total expenses                              |  |              | 4,270 
|Income from operations                      |  |              | 716   
|Net Income                                  |  |              | 572   
|Net Income Per Common Share:                |  |              |       
|BASIC                                       |  | $            | 0.06  
|                                            |  |              |       
|DILUTED                                     |  | $            | 0.06  
|                                            |  |              |       
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |  |              |       
|BASIC                                       |  |              | 10,168
|                                            |  |              |       
|DILUTED                                     |  |              | 10,173
|                                            |  |              |       
|                                            | 
|                                            |  | 2002         |       
|                                            |  | FirstQuarter |       
|Revenues                                    |  | $            | 7,298 
|Total expenses                              |  |              | 9,766 
|Loss from operations                        |  |              | (2,468
|Net Loss                                    |  |              | (2,565
|Net Loss Per Common Share:                  |  |              |       
|BASIC                                       |  | $            | (0.26 
|                                            |  |              |       
|DILUTED                                     |  | $            | (0.26 
|                                            |  |              |       
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |  |              |       
|BASIC                                       |  |              | 10,002
|                                            |  |              |       
|DILUTED                                     |  |              | 10,002
|                                            |  |              |       
|                                            | 
|                                            |  | 2001         |       
|                                            |  | FirstQuarter |       
|Revenues                                    |  | $            | 8,967 
|Total expenses                              |  |              | 14,001
|Loss from operations                        |  |              | (5,034
|Net Loss                                    |  |              | (5,038
|Net Loss Per Common Share:                  |  |              |       
|BASIC                                       |  | $            | (0.52 
|                                            |  |              |       
|DILUTED                                     |  | $            | (0.52 
|                                            |  |              |       
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |  |              |       
|BASIC                                       |  |              | 9,773 
|                                            |  |              |       
|DILUTED                                     |  |              | 9,773 
|                                            |  |              |       

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1Included in expenses for the fourth quarter 2003 is a $321,000 benefit recognized in connection with the lawsuit settlement discussed in Note 7.

2Included in expenses for the fourth
quarter 2001 are the $2.4 million gain recognized in connection with the Covad settlement discussed in Note 2 and the $3.2 million charge recorded related to the lawsuit judgment discussed in Note 7.



F-15



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##### Table of Contents

##### Index to Financial Statements

12.Subsequent Events



On August 29, 2003, the Company filed a lawsuit in Dallas County District Court against a former director, William O. Hunt,
in connection with his attempt to sell a controlling interest in the company. Mr. Hunt held an option to purchase 9,428,571 shares of the companys common stock, which he obtained in connection with the financing of an appeal bond in 2001 and
which became exercisable on June 6, 2003. Mr. Hunts stock and option, if exercised, would have constituted 51% of the companys outstanding shares. The lawsuit alleged breaches of Mr. Hunts fiduciary duties in connection with his
actions since the option became exercisable. On September 3, 2003, the Company purchased the option from Mr. Hunt for $150,000 and subsequently dismissed the lawsuit.



F-16