UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





(X)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE


SECURITIES
EXCHANGE ACT OF 1934





FOR THE
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008





OR





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


SECURITIES
ACT OF 1934





FOR THE
TRANSITION PERIOD FROM _________ TO _____





COMMISSION
FILE NUMBER   000-25147





INTERNET
AMERICA, INC.


(Exact
name of registrant as specified in its charter)








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





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





(713)
968-2500


(Registrant's
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.




Yes [
      x ]
            
            No
      [   ]





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





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).




Yes [  
      ]
              
              No
      [ x ]
 As of
October 24, 2008, registrant had 16,857,031 shares of Common Stock at $.01 par
value, outstanding.





--------------------------------











PART
I - FINANCIAL INFORMATION





ITEM
1 - FINANCIAL STATEMENTS





INTERNET
AMERICA, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED BALANCE
SHEETS





September
      30,
            
            
            June
      30,2008
            
            
            2008(unaudited)
            
            
            (audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            3,469,974
            
            
            $
            3,911,680Restricted
      cash
            
            
            6,432
            
            
            
            6,432Accounts
      receivable, net of allowance for uncollectible accounts of $6,951 and
      $5,863as
      of September 30, 2008 and June 30, 2008, respectively
            
            
            188,915
            
            
            
            170,231Inventory
            
            
            327,341
            
            
            
            285,410Prepaid
      expenses and other current assets
            
            
            640,668
            
            
            
            610,865Total
      current assets
            
            
            4,633,330
            
            
            
            4,984,618Property
      and equipment---net
            
            
            2,190,013
            
            
            
            2,328,954Goodwill---net
            
            
            3,533,127
            
            
            
            3,533,127Subscriber
      acquisition costs---net
            
            
            1,181,503
            
            
            
            1,310,537Other
      assets---net
            
            
            37,232
            
            
            
            38,087TOTAL
            
            $
            11,575,205
            
            
            $
            12,195,323LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Trade
      accounts payable
            
            $
            244,340
            
            
            $
            204,056Accrued
      liabilities
            
            
            500,733
            
            
            
            654,187Deferred
      revenue
            
            
            1,193,604
            
            
            
            1,271,901Current
      portion of long-term debt
            
            
            645,450
            
            
            
            620,585Total
      current liabilities
            
            
            2,584,127
            
            
            
            2,750,729Long-term
      debt
            
            
            1,165,424
            
            
            
            1,331,096Minority
      interest in subsidiary
            
            
            5,727
            
            
            
            5,696Total
      liabilities
            
            
            3,755,278
            
            
            
            4,087,521COMMITMENTS
      AND CONTINGENCIES
            
            
            -
            
            
            
            -SHAREHOLDERS'
      EQUITY:Preferred
      stock $.01 par value: 5,000,000 shares authorized,
    2,889,076issued
      and outstanding as of September 30, 2008 and June 30, 2008,
      aggregateliquidation
      preference of $1,693,000
            
            
            28,891
            
            
            
            28,891Common
      stock, $.01 par value: 40,000,000 shares authorized,
      16,857,031issued
      and outstanding as of September 30, 2008 and June 30, 2008
            
            
            168,571
            
            
            
            168,571Additional
      paid-in capital
            
            
            63,611,873
            
            
            
            63,588,884Accumulated
      deficit
            
            
            (55,989,408
            )
            
            
            (55,678,544
            )Total
      shareholders' equity
            
            
            7,819,927
            
            
            
            8,107,802TOTAL
            
            $
            11,575,205
            
            
            $
            12,195,323





See
accompanying notes to condensed consolidated financial statements.





2


Financial
Statements - Continued





INTERNET
AMERICA, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)




Three
      Months EndedSeptember
      30,2008
            
            
            2007REVENUES:Internet
      services
            
            $
            1,954,715
            
            
            $
            2,095,028Other
            
            
            50,138
            
            
            
            77,166Total
            
            
            2,004,853
            
            
            
            2,172,194OPERATING
      COSTS AND EXPENSES:Connectivity
      and operations
            
            
            1,351,178
            
            
            
            1,414,780Sales
      and marketing
            
            
            70,013
            
            
            
            138,409General
      and administrative
            
            
            587,928
            
            
            
            699,952Provision
      for bad debt expense
            
            
            1,088
            
            
            
            11,355Depreciation
      and amortization
            
            
            295,797
            
            
            
            266,423Total
            
            
            2,306,004
            
            
            
            2,530,919LOSS
      FROM OPERATIONS
            
            
            (301,151
            )
            
            
            (358,725
            )INTEREST
      INCOME
            
            
            (15,722
            )
            
            
            (9,829
            )INTEREST
      EXPENSE
            
            
            25,404
            
            
            
            25,276Minority
      interest in (income) loss of consolidated subsidiary
            
            
            (31
            )
            
            
            191NET
      LOSS
            
            $
            (310,864
            )
            
            $
            (373,981
            )NET
      LOSS PER COMMON SHARE:BASIC
            
            $
            (0.02
            )
            
            $
            (0.03
            )DILUTED
            
            $
            (0.02
            )
            
            $
            (0.03
            )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:BASIC
            
            
            16,857,031
            
            
            
            12,545,871DILUTED
            
            
            16,857,031
            
            
            
            12,545,871




See
accompanying notes to condensed consolidated financial statements.




3


Financial
Statements - Continued





INTERNET
AMERICA, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




Three
      Months EndedSeptember
      30,2008
            
            
            2007OPERATING
      ACTIVITIES:Net
      loss
            
            $
            (310,864
            )
            
            $
            (373,981
            )Adjustments
      to reconcile net income to net cashused
      in operating activities:Minority
      interest
            
            
            31
            
            
            
            (191
            )Depreciation
      and amortization
            
            
            295,797
            
            
            
            266,423Loss
      on disposal of fixed assets
            
            
            5,850
            
            
            
            -Provision
      for bad debt expense
            
            
            1,088
            
            
            
            11,355Non-cash
      stock compensation expense
            
            
            22,989
            
            
            
            17,853Changes
      in operating assets and liabilities (net of effectsof assets acquired, less liabilities assumed):Accounts
      receivable
            
            
            (19,772
            )
            
            
            (45,642
            )Inventory
            
            
            (41,931
            )
            
            
            (43,045
            )Prepaid
      expenses and other current assets
            
            
            (29,803
            )
            
            
            (63,065
            )Other
      assets
            
            
            855
            
            
            
            (21,238
            )Accounts
      payable and accrued liabilities
            
            
            (113,170
            )
            
            
            90,962Deferred
      revenue
            
            
            (78,297
            )
            
            
            16,511Net
      cash used in operating activities
            
            
            (267,227
            )
            
            
            (144,058
            )INVESTING
      ACTIVITIES:Purchases
      of property and equipment, net
            
            
            (35,872
            )
            
            
            (204,662
            )Change
      in restricted cash
            
            
            -
            
            
            
            (32,437
            )Proceeds
      from sale of property and equipment
            
            
            2,200
            
            
            
            -Cash
      provided from acquisitions
            
            
            -
            
            
            
            655,102Net
      cash provided by (used in) investing activities
            
            
            (33,672
            )
            
            
            418,003FINANCING
      ACTIVITIES:Proceeds
      from issuance of long term debt
            
            
            -
            
            
            
            71,787Principal
      payments of long-term debt
            
            
            (140,807
            )
            
            
            (53,404
            )Net
      cash provided by (used in) financing activities
            
            
            (140,807
            )
            
            
            18,383NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (441,706
            )
            
            
            292,328CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            3,911,680
            
            
            
            782,887CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            3,469,974
            
            
            $
            1,075,215SUPPLEMENTAL
      INFORMATION:Cash
      paid for interest
            
            $
            23,668
            
            
            $
            19,971NON-CASH
      INVESTING AND FINANCING ACTIVITIES:Stock
      issued in connection with acquisitions
            
            $
            -
            
            
            $
            770,443Debt
      issued in connection with acquisitions, net
            
            $
            -
            
            
            $
            863,500Minority
      interest liability
            
            $
            -
            
            
            $
            6,420





See
accompanying notes to condensed consolidated financial statements.




4




INTERNET
AMERICA, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





1.
            Basis
      of Presentation




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





2.
            Reclassifications





Certain
reclassifications have been made to the 2007 financial statements to conform to
the 2008 presentation.  These classifications had no effect on 2007
net loss or shareholders’ equity.





3.
            Basic
      and Diluted Net Loss Per Share




There are
no adjustments required to be made to net loss for the purpose of computing
basic and diluted earnings per share (“EPS”) for the three months ended
September 30, 2008 and 2007.  During the three months ended September
30, 2008 and 2007, options to purchase 567,778 and 333,641 shares of common
stock, respectively, were not included in the computation of diluted EPS because
the options were not “in the money” as of September 30, 2008 and 2007,
respectively.  There were no options “in the money” at September 30,
2008 and 2007.  There were no options exercised to purchase shares of
common stock during the three months ended September 30, 2008 or
2007.




4.
            Use
      of Estimates




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




5.
            Goodwill
      and Subscriber Acquisition Costs




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





The Company allocates the purchase price for
acquisitions to acquired subscriber bases and goodwill based on fair value at
the time of acquisition.  Subscriber acquisition costs, net of
amortization, totaled approximately $1,182,000 and $1,311,000, as of September
30, 2008 and June 30, 2008, respectively.  The weighted average
amortization period for subscriber acquisition costs is 48 months for both
dial-up and wireless broadband Internet customers. Amortization expense for the
three months ended September 30, 2008 and 2007 was $129,034 and $103,657,
respectively.  As of September 30, 2008, amortization expense for the
fiscal years ended June 30, 2009, 2010, 2011 and 2012 is expected to be
approximately $485,000, $427,000, $394,000 and $5,000,
respectively.




5




6.
            Income
      Taxes




During the
three months ended September 30, 2008 and 2007, the Company generated a net loss
of $310,864 and $373,981, respectively.  No provision for income taxes
has been recorded for the three months ended September 30, 2008 and 2007, as the
Company has net operating losses generated in the current and prior
periods.  As of September 30, 2008, the Company continues to maintain
a full valuation allowance for its net deferred tax assets of approximately
$13.6 million.  Given its limited history of generating net income,
the Company has concluded that it is not more likely than not that the net
deferred tax assets will be realized.




On July 1,
2007, the Company adopted Financial Account Standards Board Interpretation No.
48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB
Statement No. 109” (“FIN 48”).  As a result of the implementation of
FIN 48, management assessed its various income tax positions; and this
assessment resulted in no adjustment. The preparation of various tax returns
requires the use of estimates for federal and state income tax
purposes.  Those estimates may be subject to review by respective
taxing authorities.  A revision, if any, to an estimate may result in
assessment of additional taxes, penalties and interest.  At this time,
a range in which our estimates may change is not quantifiable and a change, if
any, is not expected to be material.  The Company will account for
interest and penalties related to uncertain tax positions in the current period
income statement, as necessary.  The 2004, 2005, 2006 and 2007 tax
periods remain subject to examination by various federal and state tax
jurisdictions.




7.
            Long-Term
      Debt


Long-term
debt consists of:





September
      30,
            
            
            June
      30,2008
            
            
            2008Note
      payable due July 19, 2009, payable in quarterly payments of $7,751
      with interest imputed at 9% (net of unamortized discount of
      $5,843)
            
            $
            56,102
            
            
            $
            62,452Note
      payable due January 23, 2011 payable in bi-annual installments of
      $13,917 with interest imputed at 8% (net of unamortized discount of
      $3,495)
            
            
            23,106
            
            
            
            23,106Note
      payable due August 8, 2010, payable in monthly installments of $1,033
      beginning October 8, 2008 with interest imputed at 5% (net of unamortized
      discount of $2,236)
            
            
            21,219
            
            
            
            21,219Note
      payable due June 20, 2012, payable in monthly installments of $2,088 with
      interest imputed at 5% (net of unamortized discount of
      $14,462)
            
            
            79,491
            
            
            
            83,900Note
      payable due July 20, 2010, payable in monthly installments of $1,818 with
      interest imputed at 6.5% (net of unamortized discount of
      $2,387)
            
            
            37,602
            
            
            
            42,392Note
      payable due July 20, 2010, payable in monthly installments of $1,409 with
      interest imputed at 6.5% (net of unamortized discount of
      $1,850)
            
            
            29,142
            
            
            
            32,855Amount
      payable due in equal quarterly installments beginning 120 days from
      issuance of note with interest payable at a rate to be determined by the
      12-month LIBOR rate at date of note issuance
            
            
            95,324
            
            
            
            95,324Note
      payable due December 23, 2010, payable in monthly payments of $26,199 with
      interest imputed at 5.5% (net of unamortized discount of
      $41,554)
            
            
            665,831
            
            
            
            735,083Loan
      and Security Agreement with United States Department of Agriculture Rural
      Utilities Service
            
            
            796,754
            
            
            
            845,266Note
      payable due February 12, 2009 payable in monthly installments of
      $1,261
            
            
            6,303
            
            
            
            10,0841,810,874
            
            
            
            1,951,681Less
      current portion
            
            
            (645,450
            )
            
            
            (620,585
            )Total
      long-term debt
            
            $
            1,165,424
            
            
            $
            1,331,096




The
Company’s long-term debt is unsecured except for approximately $1,626,000 and
$1,681,000 as of September 30, 2008 and June 30, 2008, respectively, which is
secured by certificates of deposit and certain inventory and
equipment.




6
 
  8.
              Related
      Parties


The
following table shows amounts paid to three non-employee directors for serving
on the Company’s board of directors and payments made to Cynthia Ocker, former
owner of TeleShare, for contract services during the three months ended
September 30, 2008 and 2007:




Three
      Months EndedSeptember
      30,2008
            
            
            2007Troy
      LeMaile Stovall
            
            $
            3,000
            
            
            $
            7,000Justin
      McClure
            
            
            3,000
            
            
            
            7,000John
      Palmer
            
            
            3,000
            
            
            
            10,265Steven
      Mihaylo
            
            
            3,893
            
            
            
            -Cindy
      Ocker
            
            
            32,007
            
            
            
            13,825$
            44,900
            
            
            $
            38,090




9.
            New
      Accounting Pronouncements




In
February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities," which provides companies with an option to report selected
financial assets and liabilities at fair value. SFAS No. 159 also
establishes presentation and disclosure requirements designed to facilitate
comparisons between companies that choose different measurement attributes for
similar types of assets and liabilities. SFAS No. 159 is effective as of
the beginning of an entity's first fiscal year beginning after November 15,
2007.  Adoption of this pronouncement had no impact on our
consolidated financial position and results of operations.




In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations,"
which amends SFAS No. 141, and provides revised guidance for recognizing
and measuring identifiable assets and goodwill acquired, liabilities assumed,
and any noncontrolling interest in the acquiree. It also provides disclosure
requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination. SFAS No. 141(R) is
effective for fiscal years beginning after December 15, 2008 and is to be
applied prospectively. The Company is currently evaluating the potential impact
of adopting SFAS No. 141(R) on our consolidated financial position and
results of operations.




In
September 2006, the FASB issued SFAS No. 157 “Fair Value
Measurements,” which provides guidance for using fair value to measure assets
and liabilities. SFASNo.157 establishes a definition
of fair value, provides a framework for measuring fair value and expands the
disclosure requirements about fair value measurements. SFAS No. 157 as
issued is effective for fiscal years beginning after November 15, 2007.
Early adoption is permitted. On February 12, 2008, FASB Staff Position
No. FAS 157-2 was issued which delays the effective date to fiscal years
beginning after November 15, 2008 for certain nonfinancial assets and
liabilities. The Company is currently evaluating the impact ofSFASNo.157 on its financial statements.


In
December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests
in Consolidated Financial Statements — an Amendment of ARB No. 51.”
SFAS No. 160 establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be recorded as equity
in the consolidated financial statements. This Statement also requires that
consolidated net income shall be adjusted to include the net income attributed
to the noncontrolling interest. Disclosure on the face of the income statement
of the amounts of consolidated net income attributable to the parent and to the
noncontrolling interest is required. SFAS No. 160 is effective for
fiscal years beginning after December 15, 2008. Earlier adoption is not
permitted. The Company is currently evaluating the impact of SFAS No. 160
on its financial statements.





7





ITEM
2.





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





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





Overview





Internet
America, Inc. (the “Company” or “Internet America”) is an Internet service
provider ("ISP") that provides an array of Internet services to residential and
business subscribers and is currently serving approximately 29,000 subscribers
in Texas as of September 30, 2008. Of the Company’s 29,000 total subscribers,
approximately 7,900 are wireless broadband Internet subscribers. A subscriber
represents an active, billed service.  One customer account may
represent multiple subscribers depending on the number of active and billed
services for that customer. Wireless revenues continue to grow and totaled
approximately $1,041,000, or 51.9% of total revenues, for the quarter ending
September 30, 2008, compared to approximately $886,000, or 40.8% of total
revenues, for the same period last fiscal year.





The
Company continues to experience an attrition of dial-up Internet service
customers. The loss of these customers is primarily attributable to their moving
to broadband connectivity with other service providers. The largest
competitors in broadband access are the cable companies and regional Bell
operating companies.  We operate in a highly competitive market for each of
our non-wireless service offerings.  The competitive environment impacts
the churn rates we experience. Near the end of October 2008, the Company entered
into an agreement with an aggregator that allows the Company to resell DSL
broadband internet service over most of the metropolitan and suburban areas of
the United States where it is currently available.  Management does
not anticipate this arrangement adding significant profits in the near term but
we anticipate it helping us to offset the attrition of dial-up customers to
other broadband providers and allowing us to fulfill additional demand for this
service.





Over the
past twelve months, we took steps to better prepare the Company for a more
difficult economic environment.  First, we raised sufficient capital
in the fall of 2007 to fund internally our capital needs for 2008.  We
then entered into a nine month process of improving quality and customer
satisfaction as well as simplifying our internal systems and
procedures.  Quality process implementation substantially improved our
productivity, which can be measured in ways such as headcount reduction from 93
total employees in December 2007 to fewer than 60 at the end of October
2008.  At the same time we have made investments in our infrastructure
to improve quality and network capacity by investing approximately $1.2 million
in fiscal 2008 and an additional $36,000 in the quarter ending September 30,
2008.  With the ongoing completion of the capacity and infrastructure
upgrades, we are now returning to marketing to increase new subscribers. We
anticipate no significant negative churn in wireless Broadband subscribers and
instead modest growth, before any acquisitions are taken into
account.





During
most of calendar 2008, we focused on system simplification, on infrastructure
improvements, and on the quality process, all of which we expect to contribute
to our future profitability and productivity.  The Company upgraded
and expanded areas where our network has been experiencing congestion due to the
bandwidth demands created by the growth of our customer base.  During
this upgrade process, we restricted the addition of new customers to those areas
of the network that did not have capacity and performance issues.  We
created “no sale” regions for any wireless Broadband coverage areas scheduled
for improvement projects. These “no sale” regions were internally restricted
from the addition of new customers until the upgrades were completed and
tested.  Because we restricted sales in many areas, we decreased sales
and marketing expenses by 49.6% for the quarter ended September 30, 2008
compared to 2007. We recognized that the potential benefit of advertising would
occur only after systems were upgraded.





8




During “no
sale” periods in many of our market areas, we experienced a reduction in the
rate of growth of the Company’s wireless customer count, and in some areas a
slight decrease in the existing customer base. Our decline in new customer
additions is a direct result of our deliberate actions during the upgrade; and,
to a lesser extent, of the challenging present economic
environment.   The Company’s customer count for wireless
broadband Internet services remained relatively stable, decreasing from 8,000
subscribers at June 30, 2008 to approximately 7,900 subscribers as of September
30, 2008. We believe that customer stability during the “no sale” period and the
beginnings of the recession is a positive sign that we should be able to
maintain a relatively stable wireless customer base during an economic
recession, as some demand may continue to exist in areas previously covered by
our internal “no sale” restrictions.





The
Company experienced significant reductions in headcount as it adopted quality
processes.  Staffing was previously increased during the first and
second quarters of the year ended June 30, 2008, with the highest headcount
being 93 employees in December 2007.  As our productivity has
increased due to quality initiatives, we have reduced headcount by more than
one-third to fewer than 60 people at the date of this filing. The increases in
personnel costs in the second and third quarters of fiscal 2008 are not expected
to continue in fiscal 2009.





During
2008, we experienced increases in telecommunications cost per subscriber by
increasing network capacity to provide higher quality service to our customers
as we increased our wireless broadband footprint. This cost increase is offset
partially by entering into more favorable agreements with telecommunications
service providers.  Overall, decreases in telecommunications costs
from the quarter ended September 30, 2008 compared to the quarter ended
September 30, 2007 totaled approximately $129,000.





The rural
and suburban wireless ISP (“WISP”) industry is fragmented with ample
consolidation opportunity.   The Company estimates that there are
up to 2,500 potential WISP acquisition candidates in the United States,
including approximately 150 in Texas. Although we will continue to consider
development and acquisition opportunities in non-metropolitan markets in Texas,
our current focus is on larger acquisition opportunities outside our current
geographical region which offer greater opportunities for expanding our
subscriber base.





While
there is no guarantee that we will make significant or numerous acquisitions,
the management of the Company believes that there are many WISPS that are not in
a strong financial position today and that have not made efforts
similar  to Internet America’s to improve quality and
systems.  We believe other WISPs are impacted by recent economic
conditions and will now be more interested in combinations which offer the
management experience that Internet America offers and that also need access to
the systems and capital that will be necessary to grow their
businesses.  The Company is focusing on markets that enhance its
geographic and strategic plans.  As we have gained experience in both
opening de novo markets and acquiring smaller ISP’s and WISP’s, acquisitions
remain attractive as an important method of acquiring substantial subscriber
bases that we can enlarge and to which we can provide qualified, experienced
management. The Company is currently focused on larger acquisitions that will be
accretive after completing integration and that will not materially drain our
cash resources.





Over the
past year, Company management has actively addressed the declining subscriber
base and decrease in its total revenues and the related impact on profitability
while preparing for an economic turndown.  We completed the sale of
additional securities in private placements to provide ample capital to make
investments in infrastructure and withstand temporary operating
losses.  We invested capital in quality process improvements that have
substantially improved our productivity. For the three months ended September
30, 2008, net loss plus non-cash items provided cash of $15,000, compared to
cash used of $79,000 for the same period last year.  We will continue these
efforts of improvement, stabilization and growth possibilities, and management
believes we are in a fortunate position today, able to better withstand an
economic slowdown or to capitalize on growth
possibilities.  Additionally these continued efforts may yield
improvements in profitability and cash flow from operations. Today, Internet
America is a leaner, more efficient organization that is better prepared to
sustain more challenging economic times.  We believe that we have
sufficient capital resources and cash on hand to withstand a short or prolonged
economic downturn, and we are in a strong position to grow internally and
through acquisitions should the economy strengthen.




9





Company
management believes the initiatives identified above are instrumental to the
achievement of our goals, but they may be subject to competitive, regulatory,
and other events and circumstances that are beyond our control. We can provide
no assurance that we will be successful in achieving any or all of the
initiatives, that the achievement or existence of such initiatives will result
in profit improvements, or that other factors will not arise that would
adversely affect future profits.




Statement
of Operations




Internet
services revenue is derived from dial-up Internet access, including analog and
ISDN access, DSL access, dedicated connectivity, wireless access, bulk dial-up
access, web hosting services, and value-added services, such as multiple e-mail
boxes, personalized e-mail addresses and Fax-2-Email
services.   In addition to miscellaneous revenue, other revenue
for fiscal year 2009 and 2008 includes telex messaging service
revenues.





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





Connectivity
and operations expenses consist primarily of setup costs for new subscribers,
telecommunication costs, merchant processing fees, and wages of network
operations and customer support personnel. Connectivity costs include (i) fees
paid to telephone companies for subscribers' dial-up connections to our network;
(ii) fees paid to backbone providers for connections from our network to the
Internet; and (iii) equipment and tower lease costs for our new wireless
networks.





Sales and
marketing expenses consist primarily of creative and production costs, costs of
media placement, management salaries and call center wages. Advertising costs
are expensed as incurred.





General
and administrative expenses consist primarily of administrative salaries,
professional services, rent and other general office and business
expenses.





Bad debt
expense consists primarily of customer accounts that have been deemed
uncollectible and will potentially be written off in future periods, net of
recoveries.  Historically, the expense has been based on the aging of
customer accounts whereby all customer accounts that are 90 days or older have
been provided for as a bad debt expense.





Depreciation
expense is computed using the straight-line method over the estimated useful
lives of the assets or the capital lease term, as appropriate.  Data
communications equipment, computers, data servers and office equipment are
depreciated over five years. We depreciate furniture, fixtures and leasehold
improvements over five years or the lease term.  Buildings are
depreciated over fifteen years. Amortization expense consists of the
amortization of subscriber acquisition costs, which are amortized over four
years.





Our
business is not subject to any significant seasonal influences.




10




Results
of Operations





Three
Months Ended September 30, 2008 Compared to Three Months Ended September 30,
2007





The following table sets forth
certain unaudited financial data for the three months ended September 30, 2008
and 2007.  Operating results for any period are not indicative of
results for any future period.




Three
      Months EndedSeptember 30,
      2008
            
            
            September 30,
      2007(000’s,
      except
              share
      and per
              share
      data)
            
            
            % of
              Revenues
            
            
            (000’s,
      except
              share
      and per
              share
      data)
            
            
            % of
              RevenuesSTATEMENT
      OF OPERATIONS DATA:REVENUES:Internet
      services
            
            $
            1,955
            
            
            
            97.5
            %
            
            $
            2,095
            
            
            
            96.5
            %Other
            
            
            50
            
            
            
            2.5
            %
            
            
            77
            
            
            
            3.5
            %Total
            
            
            2,005
            
            
            
            100.0
            %
            
            
            2,172
            
            
            
            100.0
            %OPERATING
      COSTS AND EXPENSES:Connectivity
      and operations
            
            
            1,351
            
            
            
            67.4
            %
            
            
            1,415
            
            
            
            65.2
            %Sales
      and marketing
            
            
            70
            
            
            
            3.5
            %
            
            
            139
            
            
            
            6.4
            %General
      and administrative
            
            
            588
            
            
            
            29.3
            %
            
            
            700
            
            
            
            32.2
            %Provision
      for bad debt expense
            
            
            1
            
            
            
            0.0
            %
            
            
            11
            
            
            
            0.5
            %Depreciation
      and amortization
            
            
            296
            
            
            
            14.8
            %
            
            
            266
            
            
            
            12.2
            %Total
            
            
            2,306
            
            
            
            115.0
            %
            
            
            2,531
            
            
            
            116.5
            %OPERATING
      LOSS
            
            
            (301
            )
            
            
            (15.0
            )%
            
            
            (359
            )
            
            
            (16.5
            )%INTEREST
      INCOME
            
            
            15
            
            
            
            0.8
            %
            
            
            10
            
            
            
            0.5
            %INTEREST
      EXPENSE
            
            
            (25
            )
            
            
            (1.3
            )%
            
            
            (25
            )
            
            
            (1.2
            )%Minority
      interest in (income) loss of consolidated subsidiary
            
            
            0
            
            
            
            0.0
            %
            
            
            (0
            )
            
            
            0.0
            %NET
      LOSS
            
            $
            (311
            )
            
            
            (15.5
            )%
            
            $
            (374
            )
            
            
            (17.2
            )%NET
      LOSS PER COMMON SHARE:BASIC
            
            $
            (0.02
            )
            
            
            
            
            
            $
            (0.03
            )DILUTED
            
            $
            (0.02
            )
            
            
            
            
            
            $
            (0.03
            )WEIGHTED
      AVERAGE COMMONSHARES
      OUTSTANDING:BASIC
            
            
            16,857,031
            
            
            
            
            
            
            
            12,545,871DILUTED
            
            
            16,857,031
            
            
            
            
            
            
            
            12,545,871OTHER
      DATA:Subscribers
      at end of period (1)
            
            
            29,000
            
            
            
            
            
            
            
            34,400EBITDA(2)
            
            $
            (5
            )
            
            
            
            
            
            $
            (93
            )EBITDA
      margin(3)
            
            
            -0.3
            %
            
            
            
            
            
            
            -4.3
            %CASH
      FLOW DATA:Cash
      flow used in operations
            
            $
            (267
            )
            
            
            
            
            
            $
            (144
            )Cash
      flow provided by (used in) investing activities
            
            $
            (34
            )
            
            
            
            
            
            $
            418Cash
      flow provided by (used in) financing activities
            
            $
            (141
            )
            
            
            
            
            
            $
            18Reconciliation
      of net loss to EBITDA:Net
      loss
            
            $
            (311
            )
            
            
            
            
            
            $
            (374
            )Add:Depreciation
      and amortization
            
            
            296
            
            
            
            
            
            
            
            266Interest
      income
            
            
            (15
            )
            
            
            
            
            
            
            (10
            )Interest
      expense
            
            
            25
            
            
            
            
            
            
            
            25EBITDA
      (2)
            
            $
            (5
            )
            
            
            
            
            
            $
            (93
            )




(1)    
A subscriber represents an active, billed service.  One customer
account may represent multiple subscribers depending on the number of active and
billed services for that customer.




(2)     EBITDA
(earnings before interest, taxes, depreciation and amortization) is not a
measurement of financial performance under generally accepted accounting
principles (GAAP) and should not be considered an alternative to net income as a
measure of performance.  Management has consistently used EBITDA on a
historical basis as a measurement of the Company’s current operating cash
income.




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





11




Three Months Ended September 30,
2008 Compared to Three Months Ended September 30, 2007
(Continued)




Total
revenue.Total revenue decreased by $167,000, or 7.7%, to
$2,005,000 for the three months ended September 30, 2008, from $2,172,000 for
the three months ended September 30, 2007.  The Company’s total
subscriber count decreased by 5,400, or 15.7%, to 29,000 as of September 30,
2008 compared to 34,400 as of September 30, 2007.  The Company’s
wireless broadband Internet subscriber count increased by 400, or 5.3%, to 7,900
as of September 30, 2008, compared to 7,500 as of September 30, 2007. Wireless
broadband Internet revenue increased by $155,000 to $1,041,000 as of September
30, 2008 compared to $886,000 as of September 30, 2007.  The Company
has not completed any acquisitions during the last twelve months, during which
we have focused on network improvements which will increase potential for
organically growing the Company’s subscriber count through increased sales
efforts in the future.  The increase in wireless broadband Internet
revenues was offset by the decrease in dial-up Internet subscriber counts and
related revenue of $183,000.  This decrease is attributed to the loss
of dial-up customers moving to other providers’ broadband service.




Connectivity and operations.Connectivity and operations expense decreased by $64,000, or 4.5%, to
$1,351,000 for the three months ended September 30, 2008, from $1,415,000 for
the three months ended September 30, 2007.  Data and
telecommunications expense decreased by $96,000 to $394,000 as of September 30,
2008 compared to $490,000 as of September 30, 2007 by entering into more
favorable agreements with telecommunications service providers.  Other
decreases in expense of approximately $26,000 relate to reductions in merchant
fees and travel expenses in fiscal 2009. These decreases in telecommunications
and other expenses were offset by an increase in contract labor and consumable
supplies expenses of $34,000 to $134,000 as of September 30, 2008 compared to
$100,000 as of September 30, 2007.  The increase was primarily due to
network improvement activity during this fiscal year.  Tower lease
expense increased by $24,000 to $96,000 as of September 30, 2008 compared to
$72,000 as of September 30, 2007.  The increase in tower leases
relates to the growth of the Company’s wireless broadband Internet subscriber
counts and operations and the positioning of our Company for our anticipated
future growth being driven by our wireless broadband Internet
operations.




Sales and marketing.Sales
and marketing expense decreased by $69,000, or 49.6%, to $70,000 for the three
months ended September 30, 2008, compared to $139,000 for the three months ended
September 30, 2007.  During the upgrade process on our network started
in fiscal 2008, we have restricted the addition of new customers to certain
areas of the network until the capacity can be expanded to meet the demand and
provide quality service to our customers.  This has allowed us to
temporarily reduce marketing personnel, advertising, travel and consulting
expenses.




General and
administrative.General and administrative expense (G&A)
decreased by $112,000, or 16.0%, to $588,000 for the three months ended
September 30, 2008, from $700,000 for the three months ended September 30,
2007.  Facilities costs decreased by $86,000 as of September 30, 2008,
to $81,000 at September 30, 2008 from $167,000 at September 30, 2007, due to the
write off of the abandoned corporate headquarters lease in Dallas in the
previous year.   Telecommunications expense decreased by $33,000
to $38,000 as of September 30, 2008 from $71,000 as of September 30, 2007, due
primarily to decreased long distance services by entering into a more favorable
agreement with the telecommunications service provider. These decreases were
offset by a $7,000 increase in other general and administrative costs including
personnel, insurance, stock compensation, professional fees for legal and
accounting services and consulting fees paid to contract labor for telex
messaging services, which totaled $469,000 as of September 30, 2008 compared to
$462,000 as of September 30, 2007.




Provision for bad debt
expense.Provision for bad debt expense decreased to $1,000
for the three months ended September 30, 2008, from $11,000 for the three months
ended September 30, 2007.  This decrease is due primarily to a sales
effort to increase the number of customers enrolled in electronic payment
methods, whereby non-payment for services is decreased.  As of
September 30, 2008, we are fully reserved for all customer accounts that are at
least 90 days old.




Depreciation and
amortization.  Depreciation and amortization increased by
$30,000, or 11.3%, to $296,000 for the three months ended September 30, 2008,
from $266,000 for the three months ended September 30, 2007.  The
increase is primarily related to an increase in amortization of subscriber
acquisition costs derived from acquisitions during first quarter of fiscal
2008.




Interest (expense) income, net.For both the three months ended September 30, 2008 and 2007, the Company
recorded interest expense of $25,000, which is related to acquisition debt and
the RUS loan outstanding.  Interest income increased by $5,000, or
50.0%, to $15,000 due primarily to the increase in cash balances provided by
issuance of Series A Preferred and Common Stock.





12





Liquidity
and Capital Resources




We have
financed our operations to date primarily through (i) cash flows from
operations, (ii) public and private sales of equity securities and (iii) loans
from shareholders and third parties.




Cash used
in operating activities is net income adjusted for certain non-cash items and
changes in assets and liabilities.  For the three months ended
September 30, 2008, cash used in operations was $267,000 compared to cash used
in operations of $144,000 for the three months ended September 30, 2007. For the
three months ended September 30, 2008, net loss plus non-cash items contributed
$15,000 in cash which was then used primarily for purchases of inventory,
payments of accounts payable and accrued expenses and a decrease in deferred
revenue. For the three months ended September 30, 2007, net loss plus non-cash
items used cash of $79,000.  Additional increases in accounts
receivable, purchases of inventory, and purchase of other assets were offset by
increases of accounts payable and an increase in deferred revenue.




Cash used
in investing activities totaled $34,000 for the three months ended September 30,
2008, which relates primarily to the improvements in existing wireless broadband
Internet infrastructure. Cash provided by investing activities totaled $418,000
for the three months ended September 30, 2007, which relates primarily to cash
provided by the acquisition of TeleShare, offset by the deployment of new
wireless broadband Internet infrastructure.




Cash used
in financing activities, which totaled $141,000 for the three months ended
September 30, 2008, consisted of principal payments on long term debt including
notes related to acquisitions and the RUS loan.  Cash provided by
financing activities, which totaled $18,000 for the three months ended September
30, 2007, consisted of principal payments on long term-debt, offset by
borrowings on the RUS loan.




We
estimate that cash on hand of $3.5 million at September 30, 2008 along with
anticipated cash flow from operations will be sufficient for meeting our working
capital needs for the next twelve months for continuing operations in both
existing and new markets as well as the planned deployment of additional
wireless infrastructure.  Management believes that the Company will be
able to meet the service obligations related to the deferral of revenue and that
cash generated from recently acquired operations will be adequate to meet its
payment obligations under debt issued and assumed in connection with these
acquisitions.  However, additional financing may be required to fund
future acquisitions.  Continued decreases in revenues and subscriber
count may adversely affect the liquidity of the Company.




The
current focus of our acquisition program is to identify prospective
opportunities that would provide us with a larger number of subscribers, larger
revenue base and geographic expansion. Such an acquisition would allow us to
spread the cost of our well developed systems, superior network performance,
high quality customer care and technical support over an increased number of
subscribers. Leveraging the efficiencies of our operations over a larger
subscriber base would provide us with the benefits of larger economies of scale.
Acquisition opportunities with operations outside of Texas would also allow us
to become a national player in the delivery of wireless internet service,
thereby providing geographical diversity and more stability to our subscriber
base. Financing for such an acquisition would likely come from the public
issuance of equity securities and/or the private sale of debt or equity
securities. If such capital financing arrangements or borrowings from commercial
banks are insufficient or unavailable, or if we experience shortfalls in
anticipated revenues or increases in anticipated expenses, we will modify our
acquisition program to match available funding.




13





Off
Balance Sheet Arrangements




None.





“Safe
Harbor” Statement




The
following "Safe Harbor" Statement is made pursuant to the Private Securities
Litigation Reform Act of 1995.  Certain of the statements contained in
the body of this Report are forward-looking statements (rather than historical
facts) that are subject to risks and uncertainties that could cause actual
results to differ materially from those described in the forward-looking
statements. With respect to such forward-looking statements, we seek the
protections afforded by the Private Securities Litigation Reform Act of
1995.  These risks include, without limitation, that (1) we will not
be able to increase our rural customer base at the expected rate, (2) we will
not improve EBITDA, profitability or product margins, (3) we will not be able to
identify and negotiate acquisitions of wireless broadband Internet customers and
infrastructure on attractive terms or successfully integrate those acquisitions
into our operations, (4) financing will not be available to us if and as needed,
(5) we will not be competitive with existing or new competitors, (6) we will not
keep up with industry pricing or technological developments impacting the
Internet, (7) we will be adversely affected by dependence on network
infrastructure, telecommunications providers and other vendors or by regulatory
changes, (8) service interruptions or impediments could harm our business; (9)
we may be accused of infringing upon the  intellectual property rights
of third parties, which is costly to defend and could limit our ability to use
certain technologies in the future, (10) government regulations could force us
to change our business practices, (11) we may be unable to hire and retain
qualified personnel, including our key executive officers, (12) provisions in
our certificate of incorporation, bylaws and shareholder rights plan could limit
our share price and delay a change of management; and (13) our stock price has
been volatile historically and may continue to be volatile.  This list
is intended to identify certain of the principal factors that could cause actual
results to differ materially from those described in the forward-looking
statements included elsewhere herein.  These factors are not intended
to represent a complete list of all risks and uncertainties inherent in our
business, and should be read in conjunction with the more detailed cautionary
statements included in our other publicly filed reports.





Item
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Not
applicable





ITEM
4T. CONTROLS AND PROCEDURES




An
evaluation was carried out under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial and
Accounting Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934) in effect as of September 30,
2008.  Based upon that evaluation, the Chief Executive Officer and
Chief Financial and Accounting Officer concluded that, as of September 30, 2008,
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 changes in our internal control
over financial reporting during the three months ended September 30, 2008 that
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.





14




PART
II - OTHER INFORMATION





ITEM
6. EXHIBITS







Exhibit
            
            Description31.1
            
            Rule
      13a-14(a)/15d-14(a) Certification of William E. Ladin,
  Jr.31.2
            
            Rule
      13a-14(a)/15d-14(a) Certification of Jennifer S.
LeBlanc32.1
            
            Section
      1350 Certification of William E. Ladin, Jr.32.2
            
            Section
      1350 Certification of Jennifer S.
LeBlanc









15






SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.








INTERNET
      AMERICA, INC.(Registrant)Date:  10/28/08
              By:   /s/
      William E. Ladin, Jr.William
      E. Ladin, Jr.Chairman
      and Chief Executive OfficerDate:  10/28/08
              By:   /s/
      Jennifer S. LeBlancJennifer
      S. LeBlancChief
      Financial and Accounting Officer







16







INDEX
TO EXHIBITS









Exhibit
      No.
              Description31.1
              Rule
      13a-14(a)/15d-14(a) Certification of William E. Ladin,
  Jr.31.2
              Rule
      13a-14(a)/15d-14(a) Certification of Jennifer S.
LeBlanc32.1
              Section
      1350 Certification of William E. Ladin, Jr.32.2
              Section
      1350 Certification of Jennifer S.
LeBlanc








17