Table of Contents





UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





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


SECURITIES
EXCHANGE ACT OF 1934





FOR THE
QUARTERLY PERIOD ENDED DECEMBER 31, 2008





OR





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


SECURITIES
ACT OF 1934





FOR THE
TRANSITION PERIOD FROM _________ TO _________





COMMISSION
FILE NUMBER   000-25147





INTERNET
AMERICA, INC.


(Exact
name of registrant as specified in its charter)





TEXAS
            86-0778979(State
      or other jurisdiction of
            (I.R.S.
      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
o





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





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





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


Yes o               No
x





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





Transitional
Small Business Disclosure Format (check one).


Yes o  No x









Table of Contents
  TABLE OF CONTENTS





PART I - FINANCIAL INFORMATIONITEM 1.
            FINANCIAL STATEMENTS
            2CONDENSED CONSOLIDATED BALANCE SHEETS
            2CONDENSED CONSOLIDATED STATEMENTS OF
      OPERATIONS
            3CONDENSED CONSOLIDATED STATEMENTS OF CASH
    FLOWS
            4NOTES TO CONDENSED CONSOLIDATED FINANCIAL
      STATEMENTS
            5ITEM 2.
            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS
            9ITEM 3.
            QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
            19ITEM 4T.
            CONTROLS AND PROCEDURES
            19PART II - OTHER INFORMATIONITEM 6.
            EXHIBITS
            20SIGNATURES
            21





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PART I - FINANCIAL INFORMATION





ITEM 1 - FINANCIAL STATEMENTS




INTERNET
AMERICA, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED
BALANCE SHEETS




December
      31,
            
            
            June
      30,2008
            
            
            2008(unaudited)
            
            
            (audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            3,045,630
            
            
            $
            3,911,680Restricted
      cash
            
            
            6,432
            
            
            
            6,432Accounts
      receivable, net of allowance for uncollectible accounts of $5,798 and
      $5,863as
      of December 31, 2008 and June 30, 2008, respectively
            
            
            142,790
            
            
            
            170,231Inventory
            
            
            300,592
            
            
            
            285,410Prepaid
      expenses and other current assets
            
            
            704,196
            
            
            
            610,865Total
      current assets
            
            
            4,199,640
            
            
            
            4,984,618Property
      and equipment---Net
            
            
            2,143,963
            
            
            
            2,328,954Goodwill---Net
            
            
            3,533,127
            
            
            
            3,533,127Subscriber
      acquisition costs---Net
            
            
            1,061,407
            
            
            
            1,310,537Other
      assets---Net
            
            
            13,518
            
            
            
            38,087TOTAL
            
            $
            10,951,655
            
            
            $
            12,195,323LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Trade
      accounts payable
            
            $
            262,270
            
            
            $
            204,056Accrued
      liabilities
            
            
            383,740
            
            
            
            654,187Deferred
      revenue
            
            
            1,118,776
            
            
            
            1,271,901Current
      portion of long-term debt
            
            
            658,163
            
            
            
            620,585Total
      current liabilities
            
            
            2,422,949
            
            
            
            2,750,729Long-term
      debt, net of current portion
            
            
            1,007,089
            
            
            
            1,331,096Minority
      interest in subsidiary
            
            
            5,639
            
            
            
            5,696Total
      liabilities
            
            
            3,435,677
            
            
            
            4,087,521COMMITMENTS
      AND CONTINGENCIES
            
            
            —
            
            
            
            —SHAREHOLDERS'
      EQUITY:Preferred
      stock 10% cumulative, convertible, $.01 par value: 5,000,000 shares
      authorized, 2,889,076issued
      and outstanding as of December 31, 2008 and June 30, 2008,
      respectively
            
            
            28,891
            
            
            
            28,891Common
      stock, $.01 par value: 40,000,000 shares authorized,
      16,857,031issued
      and outstanding as of  December 31, 2008 and June 30,
      2008
            
            
            168,571
            
            
            
            168,571Additional
      paid-in capital
            
            
            63,633,146
            
            
            
            63,588,884Accumulated
      deficit
            
            
            (56,314,630
            )
            
            
            (55,678,544
            )Total
      shareholders' equity
            
            
            7,515,978
            
            
            
            8,107,802TOTAL
            
            $
            10,951,655
            
            
            $
            12,195,323






See
accompanying notes to condensed consolidated financial statements.




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Financial
Statements - Continued




INTERNET
AMERICA, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)




Three
      Months Ended
            
            
            Six
      Months EndedDecember
      31,
            
            
            December
      31,2008
            
            
            2007
            
            
            2008
            
            
            2007REVENUES:Internet
      services
            
            $
            1,930,332
            
            
            $
            2,154,708
            
            
            $
            3,885,047
            
            
            $
            4,249,166Other
            
            
            57,585
            
            
            
            115,299
            
            
            
            107,723
            
            
            
            191,132Total
            
            
            1,987,917
            
            
            
            2,270,007
            
            
            
            3,992,770
            
            
            
            4,440,298OPERATING
      COSTS AND EXPENSES:Connectivity
      and operations
            
            
            1,339,613
            
            
            
            1,394,726
            
            
            
            2,690,791
            
            
            
            2,846,410Sales
      and marketing
            
            
            72,832
            
            
            
            172,878
            
            
            
            142,845
            
            
            
            311,286General
      and administrative
            
            
            613,377
            
            
            
            1,186,169
            
            
            
            1,201,306
            
            
            
            1,847,316Provision
      for (recoveries of) bad debt
            
            
            (1,152
            )
            
            
            (7,460
            )
            
            
            (65
            )
            
            
            3,895Depreciation
      and amortization
            
            
            277,307
            
            
            
            304,232
            
            
            
            573,104
            
            
            
            570,655Total
            
            
            2,301,977
            
            
            
            3,050,545
            
            
            
            4,607,981
            
            
            
            5,579,562LOSS
      FROM OPERATIONS
            
            
            (314,060
            )
            
            
            (780,538
            )
            
            
            (615,211
            )
            
            
            (1,139,264
            )INTEREST
      INCOME
            
            
            11,803
            
            
            
            24,524
            
            
            
            27,525
            
            
            
            34,354INTEREST
      EXPENSE
            
            
            (23,052
            )
            
            
            (31,672
            )
            
            
            (48,457
            )
            
            
            (56,948
            )Minority
      interest in loss of consolidated subsidiary
            
            
            87
            
            
            
            204
            
            
            
            57
            
            
            
            395NET
      LOSS
            
            $
            (325,222
            )
            
            $
            (787,482
            )
            
            $
            (636,086
            )
            
            $
            (1,161,463
            )NET
      LOSS PER COMMON SHARE:BASIC
            
            $
            (0.02
            )
            
            $
            (0.06
            )
            
            $
            (0.04
            )
            
            $
            (0.09
            )DILUTED
            
            $
            (0.02
            )
            
            $
            (0.06
            )
            
            $
            (0.04
            )
            
            $
            (0.09
            )WEIGHTED
      AVERAGE COMMON SHARESOUTSTANDING:BASIC
            
            
            16,857,031
            
            
            
            13,682,584
            
            
            
            16,857,031
            
            
            
            13,120,749DILUTED
            
            
            16,857,031
            
            
            
            13,682,584
            
            
            
            16,857,031
            
            
            
            13,120,749






See
accompanying notes to condensed consolidated financial statements.





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Financial
Statements - Continued




INTERNET
AMERICA, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




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






See
accompanying notes to condensed consolidated financial statements.




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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 and six months ended
December 31, 2008 and 2007.  During the three and six months ended
December 31, 2008 and 2007, options to purchase 585,278 and 331,141 shares of
common stock, respectively, were not included in the computation of diluted EPS
because the options were not “in the money” as of December 31, 2008 and 2007,
respectively.  There were no options “in the money” at December 31,
2008 and 2007.  There were no options exercised to purchase shares of
common stock during the three and six months ended December 31, 2008 or
2007.




4.
            Use
      of Estimates





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




5.
            Goodwill
      and Subscriber Acquisition Costs





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





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






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6.
            Income
      Taxes





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





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




7.
            Long-Term
      Debt




Long-term
debt consists of:






December
      31,
            
            
            June
      30,2008
            
            
            2008Note
      payable due July 19, 2009, payable in quarterly payments of $7,751
      with interest imputed at 9% (net of unamortized discount of
      $4,570)
            
            $
            49,623
            
            
            $
            62,452Note
      payable due January 23, 2011 payable in bi-annual installments of
      $13,917 with interest imputed at 8% (net of unamortized discount of
      $3,033)
            
            
            23,106
            
            
            
            23,106Note
      payable due February 12, 2009 payable in monthly installments of
      $1,261
            
            
            2,521
            
            
            
            10,084Note
      payable due August 28, 2010, payable in monthly installments of $1,033
      with interest imputed at 9% (net of unamortized discount of
      $877)
            
            
            19,614
            
            
            
            21,219Note
      payable due June 20, 2012, payable in monthly installments of $2,088 with
      interest imputed at 9% (net of unamortized discount of
      $12,707)
            
            
            74,982
            
            
            
            83,900Note
      payable due July 20, 2010, payable in monthly installments of $1,818 with
      interest imputed at 6.5% (net of unamortized discount of
      $1,802)
            
            
            32,733
            
            
            
            42,392Note
      payable due July 20, 2010, payable in monthly installments of $1,409 with
      interest imputed at 6.5% (net of unamortized discount of
      $1,396)
            
            
            25,370
            
            
            
            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
            
            
            93,991
            
            
            
            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
      $33,121)
            
            
            595,665
            
            
            
            735,083Loan
      and Security Agreement with United States Department of Agriculture Rural
      Utilities Service
            
            
            747,647
            
            
            
            845,2661,665,252
            
            
            
            1,951,681Less
      current portion
            
            
            (658,163
            )
            
            
            (620,585
            )Long-term
      debt, net of current portion
            
            $
            1,007,089
            
            
            $
            1,331,096





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


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8.
            Related
      Parties





The
following table shows amounts paid to four non-employee directors for serving on
the Company’s board of directors and payments made to Cynthia Ocker, former
owner of TeleShare, for contract services during the six months ended December
31, 2008 and 2007:




Six
      Months EndedDecember 31,2008
            
            
            2007Troy
      LeMaile Stovall
            
            $
            8,676
            
            
            $
            11,500Justin
      McClure
            
            
            8,250
            
            
            
            11,500John
      Palmer
            
            
            9,073
            
            
            
            16,662Steven
      Mihaylo
            
            
            8,893
            
            
            
            4,378Cindy
      Ocker
            
            
            76,834
            
            
            
            56,623$
            111,726
            
            
            $
            100,663





9.
            New
      Accounting Pronouncements




In
September 2006, the FASB issued SFAS No. 157 “Fair Value
Measurements,” which provides guidance for using fair value to measure assets
and liabilities. SFAS No. 157 establishes a definition of fair value,
provides a framework for measuring fair value and expands the disclosure
requirements about fair value measurements. SFAS No. 157 as issued is
effective for fiscal years beginning after November 15, 2007. Early
adoption is permitted. On February 12, 2008, FASB Staff Position
No. FAS 157-2 was issued which delays the effective date to fiscal years
beginning after November 15, 2008 for certain non-financial assets and
liabilities. Adoption
of the pronouncement as it relates to our financial assets and liabilities had
no impact on our consolidated financial position or results of operations and
the Company is currently evaluating the impact of SFAS No. 157
on our non-financial assets and liabilities.


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




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




In
December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests
in Consolidated Financial Statements — an Amendment of ARB No. 51.”
SFAS No. 160 establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be recorded as equity
in the consolidated financial statements. This Statement also requires that
consolidated net income shall be adjusted to include the net income attributed
to the noncontrolling interest. Disclosure on the face of the income statement
of the amounts of consolidated net income attributable to the parent and to the
noncontrolling interest is required. SFAS No. 160 is effective for
fiscal years beginning after December 15, 2008. Earlier adoption is not
permitted. The Company is currently evaluating the impact of SFAS No. 160
on our financial statements.
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10.
            Merger
      Agreement with KeyOn Communications Holdings, Inc. and Subsequent
      Events




On
November 14, 2008, the Company entered into an Agreement and Plan of Merger (the
"Merger Agreement") with KeyOn Communications Holdings, Inc., a Delaware
corporation (“KeyOn”), and IA Acquisition, Inc. (“AcquisitionSub”), a Delaware
corporation wholly owned by Internet America, pursuant to which AcquisitionSub
will be merged with and into KeyOn with KeyOn continuing as the surviving
corporation wholly-owned by Internet America (the “Merger”).




If the
merger is consummated, the Company will issue an aggregate of 16,155,906 shares
of Company common stock to KeyOn shareholders in a stock-for-stock exchange for
all outstanding shares of KeyOn common stock. Upon completion of the Merger,
KeyOn shareholders will own 45%, and Internet America shareholders will own 55%,
of the aggregate number of shares of common and preferred stock of the Company
outstanding. The ratio between the 16,155,906 shares of Internet America common
stock and the number of shares of outstanding KeyOn common stock at the
effective time of the Merger is referred to as the “Exchange
Ratio”.




If the
merger is consummated, Internet America will assume all options to purchase
shares outstanding at July 28, 2008, and warrants to purchase an aggregate of
281,875 shares, of KeyOn common stock, that are not otherwise exercised in
accordance with their terms before the effective time of the Merger. Assumed
options and warrants will become exercisable to purchase shares of Internet
America common stock and will generally retain their same terms and conditions,
except that the number of shares of Internet America common stock subject to
such options and warrants, and the exercise price thereof, will each be adjusted
by the Exchange Ratio.




The
proposed Merger is intended to be a tax-free reorganization under Section 368(a)
of the Internal Revenue Code of 1986, as amended. The Merger was approved by the
holders of a majority of the outstanding shares of KeyOn by written
consent.  The consummation of the Merger is subject to effectiveness
of the Form S-4 Registration Statement filed by the Company with the Securities
and Exchange Commission, the mailing of the Prospectus to KeyOn shareholders,
the completion of certain conditions to closing, and other customary closing
conditions.  Among other obligations, KeyOn is required to reach a
liquidity threshold by reducing or eliminating certain current liabilities
combined with raising additional equity, to meet certain financial covenants and
to restructure its $4,500,000 short-term obligation into a long-term debt
obligation with a 5 year maturity and a ten-year amortization.  Each
party to the Merger Agreement has rights to terminate that agreement if certain
covenants of the other party are not performed or conditions to the closing are
not met. A copy of the Merger Agreement was filed as Exhibit 2.1 to the
Company’s Form 8-K Current Report on November 18, 2008.






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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 28,400 subscribers
in Texas as of December 31, 2008. Of the Company’s 28,400 total subscribers,
approximately 7,900 are wireless broadband Internet subscribers. A subscriber
represents an active, billed service.  One customer account may
represent multiple subscribers depending on the number of active and billed
services for that customer. Wireless revenues continue to grow and totaled
approximately $1,061,000, or 53.4% of total revenues, for the quarter ending
December 31, 2008, compared to approximately $1,036,000, or 45.6% of total
revenues, for the same period last fiscal year.




On
November 14, 2008, the Company entered into a definitive agreement to merge with
KeyOn Communications Holdings, Inc. (“KeyOn”) in a stock-for-stock transaction,
with KeyOn shareholders maintaining 45% of the merged companies. Management
expects the efficiencies derived from scale economies as a result of the merger
will enable the Company to immediately reduce and maintain lower overall
operating expenses.  Operating margins are also expected to be
positively impacted by the cross-selling of existing products and the
introduction of new, related services across the expanded customer
base.  As part of its conditions to closing among other obligations,
KeyOn is required to reach a liquidity threshold by reducing or eliminating
certain current liabilities combined with raising additional equity. The closing
is also subject to, among other customary closing conditions, the
performance of certain financial covenants and the effectiveness of the
registration statement filed with the SEC.  Extensive information
about the merger, including the risks involved, is contained in the Form S-4/A
registration statement of the Company.




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




The
Company is focused on remaining prepared for a more difficult economic
environment.  First, we raised sufficient capital in the fall of 2007
to fund internally our capital needs for 2008.  We then entered into a
nine month process of improving quality and customer satisfaction as well as
simplifying our internal systems and procedures as further discussed
below.  Quality process implementation substantially improved our
productivity, which can be measured in ways such as headcount reduction from 93
total employees in December 2007 to 57 at the end of December
2008.  At the same time we have made investments in our infrastructure
to improve quality and network capacity by investing approximately $1.2 million
in fiscal 2008 and an additional $152,000 in the six months ending December 31,
2008.




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During
calendar 2008, the Company made capital investments to upgrade and expand areas
where our network has been experiencing congestion due to the bandwidth demands
created by the growth of our customer base.  While upgrading, we
restricted the addition of new customers to those areas of the network that did
not have capacity and performance issues.  We created “no sale”
regions for any wireless Broadband coverage areas scheduled for improvement
projects. These “no sale” regions were internally restricted from the addition
of new customers until the upgrades were completed and tested. We experienced a
decline in new customer additions as a direct result of our deliberate actions
during the upgrade and, to a lesser extent, of the challenging present economic
environment.   The Company’s customer count for wireless
broadband Internet services remained relatively stable, decreasing from 8,000
subscribers at June 30, 2008 to approximately 7,900 subscribers through the
first two fiscal quarters of 2009. We believe that customer stability during the
“no sale” period and the beginnings of the recession is a positive sign that we
should be able to maintain a relatively stable wireless customer base during an
economic recession, as some demand may continue to exist in areas previously
covered by our internal “no sale” restrictions. We
continue to remove selling restrictions only on a regional basis, as
improvements are completed.




The
Company experienced significant reductions in headcount as it adopted quality
processes.  Staffing was previously increased during the first and
second quarters of the year ended June 30, 2008, with the highest headcount
being 93 employees in December 2007.  As our productivity has
increased due to quality initiatives, we have reduced headcount by more than
one-third to 57 people at the date of this filing. There was a corresponding
decrease in salaries and wages of approximately $126,000 to $920,000 as of
December 31, 2008 compared to $1,046,000 as of December 31, 2007.




During
2008 we experienced increases in telecommunications cost per subscriber by
increasing network capacity to provide higher quality service to our customers
as we increased our wireless broadband footprint. This cost increase is offset
partially by entering into more favorable agreements with telecommunications
service providers.  Overall, decreases in telecommunications costs
from the six months ended December 31, 2008 compared to the same period in the
previous year, totaled approximately $293,000.




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




While
there is no guarantee that we will make significant or numerous acquisitions,
the management of the Company believes that there are many WISPS that are not in
a strong financial position today and that have not made efforts
similar  to Internet America’s to improve quality and
systems.  We believe other WISPs are impacted by recent economic
conditions and will now be more interested in combinations which offer the
management experience that Internet America offers and that also need access to
the systems and capital that will be necessary to grow their
businesses.  The Company is focusing on markets that enhance its
geographic and strategic plans.  As we have gained experience in both
opening de novo markets and acquiring smaller ISPs and WISPs, acquisitions
remain attractive as an important method of acquiring substantial subscriber
bases that we can enlarge and to which we can provide qualified, experienced
management. The Company is currently focused on larger acquisitions that will be
accretive after completing integration and that will not materially drain our
cash resources. Larger
acquisitions with geographic expansion would provide us with an opportunity to
spread the cost of our well developed systems, superior network performance,
high quality customer care and technical support over an increased number of
subscribers. Financing for such an acquisition would likely come from the public
issuance of equity securities and/or the private sale of debt or equity
securities.




Over the
past year, Company management has actively addressed the declining subscriber
base and decrease in its total revenues and the related impact on profitability
while preparing for an economic turndown.  We completed the sale of
additional securities in private placements to provide ample capital to make
investments in infrastructure and withstand temporary operating
losses.  We invested capital in quality process improvements that have
substantially improved our productivity. For the six months ended December 31,
2008, net loss plus non-cash items used cash of $16,000, compared to cash used
of $527,000 for the same period last year, which is a measurement of the results
of our efficiency and cost reduction measures.  We will continue these
efforts of improvement, stabilization and growth possibilities, and management
believes we are in a fortunate position today, able better to withstand an
economic slowdown or to capitalize on growth
possibilities.  Additionally these continued efforts may yield
improvements in profitability and cash flow from operations. Today, Internet
America is a leaner, more efficient organization that is better prepared to
sustain more challenging economic times.  We believe that we have
sufficient capital resources and cash on hand to withstand a short or prolonged
economic downturn, and we are in a strong position to grow internally and
through additional acquisitions should the economy strengthen.






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




Statement
of Operations




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





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





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




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




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




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




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




Our
business is not subject to any significant seasonal influences.







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Results
of Operations





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




The
following table sets forth certain unaudited financial data for the three months
ended December 31, 2008 and 2007.  Operating results for any period
are not indicative of results for any future period.  Amounts are
shown in thousands (except share, per share and subscriber count
data).




Three
      Months Ended December 31,2008
            
            
            % of
              Revenues
            
            
            2007
            
            
            % of
              RevenuesSTATEMENT
      OF OPERATIONS DATA:REVENUES:Internet
      services
            
            $
            1,931
            
            
            
            97.1
            %
            
            $
            2,155
            
            
            
            94.9
            %Other
            
            
            58
            
            
            
            2.9
            %
            
            
            115
            
            
            
            5.1
            %Total
            
            
            1,989
            
            
            
            100.0
            %
            
            
            2,270
            
            
            
            100.00
            %OPERATING
      COSTS AND EXPENSES:Connectivity
      and operations
            
            
            1,340
            
            
            
            67.4
            %
            
            
            1,395
            
            
            
            61.5
            %Sales
      and marketing
            
            
            73
            
            
            
            3.7
            %
            
            
            172
            
            
            
            7.6
            %General
      and administrative
            
            
            614
            
            
            
            30.8
            %
            
            
            1,186
            
            
            
            52.3
            %Recoveries
      of bad debt
            
            
            (1
            )
            
            
            (0.1
            )%
            
            
            (7
            )
            
            
            (0.3
            )%Depreciation
      and amortization
            
            
            277
            
            
            
            13.9
            %
            
            
            304
            
            
            
            13.3
            %Total
            
            
            2,303
            
            
            
            115.7
            %
            
            
            3,050
            
            
            
            134.4
            %OPERATING
      LOSS
            
            
            (314
            )
            
            
            (15.7
            )%
            
            
            (780
            )
            
            
            (34.4
            )%INTEREST
      INCOME
            
            
            12
            
            
            
            0.6
            %
            
            
            25
            
            
            
            1.1
            %INTEREST
      EXPENSE
            
            
            (23
            )
            
            
            (1.2
            )%
            
            
            (32
            )
            
            
            (1.4
            )%Minority
      interest in loss of consolidated subsidiary
            
            
            (0
            )
            
            
            0.0
            %
            
            
            (0
            )
            
            
            (0.0
            )%NET
      LOSS
            
            $
            (325
            )
            
            
            (16.3
            )%
            
            $
            (787
            )
            
            
            (34.7
            )%NET
      LOSS PER COMMON SHARE:BASIC
      AND DILUTED
            
            $
            (0.02
            )
            
            
            
            
            
            $
            (0.06
            )WEIGHTED
      AVERAGE COMMONSHARES
      OUTSTANDING:BASIC
      AND DILUTED
            
            
            16,857,031
            
            
            
            
            
            
            
            13,682,584OTHER
      DATA:Subscribers
      at end of period (1)
            
            
            28,400
            
            
            
            
            
            
            
            33,200EBITDA(loss)(2)
            
            $
            (37
            )
            
            
            
            
            
            $
            (476
            )EBITDA
      margin(3)
            
            
            (1.9
            %)
            
            
            
            
            
            
            (21.0
            %)Reconciliation
      of net loss to EBITDA (loss):Net
      loss
            
            $
            (325
            )
            
            
            
            
            
            $
            (787
            )Add:Depreciation
      and amortization
            
            
            277
            
            
            
            
            
            
            
            304Interest
      income
            
            
            (12
            )
            
            
            
            
            
            
            (25
            )Interest
      expense
            
            
            23
            
            
            
            
            
            
            
            32EBITDA
      (loss)(2)
            
            $
            (37
            )
            
            
            
            
            
            
            (476
            )





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


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


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


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





Total
revenue.Total revenue decreased by $281,000, or 12.4%, to
$1,989,000 for the three months ended December 31, 2008, from $2,270,000 for the
three months ended December 31, 2007.  The Company’s total subscriber
count decreased by 4,800, or 14.5%, to 28,400 as of December 31, 2008 compared
to 33,200 as of December 31, 2007.  The Company’s wireless broadband
Internet subscriber count increased slightly to 7,900 as of December 31, 2008,
compared to 7,800 as of December 31, 2007. Wireless broadband Internet revenue
increased by $25,000 to $1,061,000 as of December 31, 2008 compared to
$1,036,000 as of December 31, 2007.  During the Company’s upgrade
process in calendar 2008, we restricted the addition of new customers while
improvements were made. The slight increase in wireless broadband Internet
revenues was offset by the decrease in dial-up Internet subscriber counts and
related revenue of $249,000, which is attributed to the loss of dial-up
customers moving to other providers’ broadband service. In connection with the
acquisition of TeleShare, the Company derives other revenues from providing
telex messaging services since July 27, 2007.  Messaging revenues for
the three months ended December 31, 2008 totaled $58,000 and varies based on
customer demand.




Connectivity and operations.Connectivity and operations expense decreased by $55,000, or 3.9%, to
$1,340,000 for the three months ended December 31, 2008, from $1,395,000 for the
three months ended December 31, 2007. Data and telecommunications expense
decreased by $134,000 to $373,000 as of December 31, 2008 compared to $507,000
as of December 31, 2007.  The decrease in data and telecommunications
expense is due to our renegotiating more favorable terms with telecommunications
service providers. The remaining decrease in expense relates primarily to a
$5,000 decrease in travel and other costs and a $7,000, or 14%, decrease in
merchant fees as a result of a 12.4% decrease in revenues.




The
decreases in the previously discussed expenses were offset by an increase in
consumable supplies and installation and repair expenses of $71,000 to $160,000
as of December 31, 2008 compared to $89,000 as of December 31, 2007. This
increase is due to significant increase in service calls in the Greater Houston
Texas region after the natural disaster, Hurricane Ike.  Additionally,
in an effort to reduce capital expenditures and to make best use of resources,
the Company aggressively increased its repair and recycle program for customer
premise equipment.  The costs of refurbishing equipment are currently
expensed as incurred. Tower lease expense increased by $11,000 to $105,000 as of
December 31, 2008 compared to $94,000 as of December 31, 2007. The increase in
tower leases relates to the growth of the Company’s wireless broadband Internet
subscriber operations and to a lesser extent due to increases in tower rental
rates. Salaries, wages and related personnel costs increased approximately
$9,000 to $627,000 as of December 31, 2008 compared to $618,000 as of December
31, 2007.




Sales and marketing.Sales
and marketing expense decreased by $99,000, or 57.6%, to $73,000 for the three
months ended December 31, 2008, compared to $172,000 for the three months ended
December 31, 2007.  Salaries and wages decreased $68,000 to $49,000 as
of December 31, 2008 compared to $117,000 as of December 31, 2007 due to ongoing
efforts to enhance efficiency and reduce headcount, including the present
vacancy of the position of Vice President of Marketing.  A decrease in
advertising, travel and consulting expenses by $37,000 to $18,000 as of December
31, 2008 compared to $55,000 as of December 31, 2007 is the result of a
non-recurring expense of approximately $50,000 during fiscal year 2008 for
reselling municipal Wi-Fi in Corpus Christi, offset by an increase in direct
mail campaign costs during the three months ended December 31,
2008.  The above decreases were offset by a $6,000 increase in
facilities expense for the three months ended December 31, 2008.




General and
administrative.General and administrative expense (G&A)
decreased by $572,000, or 48.2%, to $614,000 for the three months ended December
31, 2008, from $1,186,000 for the three months ended December 31,
2007.  The decreases were related primarily to decreases in rent
expense and professional and consulting fees as well as overall decreases in all
G&A costs as a result of our ongoing cost reduction measures.




Rent
expenses decreased by $324,000 to $66,000 as of December 31, 2008 compared to
$390,000 as of December 31, 2007. In December 2007, the Company closed all
operations at its downtown Dallas office resulting in $296,000 of additional
expenses in the quarter ended December 31, 2007. The remaining decrease of
$28,000 relates to the closing of additional field offices in late fiscal year
2008.




Professional
and consulting fees decreased by approximately $123,000, to $135,000 as of
December 31, 2008 compared to $258,000 as of December 31, 2007 primarily due to
non-recurring expenses incurred in 2007.  During the quarter ended
December 31, 2007, the Company incurred $51,000 in expenses related to investor
relations, professional fees and costs incurred related to the annual meeting in
December 2007. Additionally, during the quarter ended December 31, 2007, the
Company expensed non-recurring legal fees of $38,000 related to ongoing
litigation against a former landlord, in which the Company was the plaintiff and
which was settled.  Consulting expenses related to outsource
management fees for telex messaging customers acquired from TeleShare in July
2007 decreased by $34,000 for the three months ended December 31, 2008 compared
to the three months ended December 31, 2007.






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Telecommunications
expense decreased by $30,000 to $44,000 as of December 31, 2008 compared to
$74,000 as of December 31, 2007. The decrease in data and telecommunications
expense is due to our renegotiating more favorable terms with telecommunications
service providers.  Salaries and wages decreased $28,000 to $244,000
as of December 31, 2008 compared to $272,000 as of December 31, 2007 due to
ongoing efforts to enhance efficiency and reduce headcount. The expense related
to the issuance of stock options and directors fees decreased by $14,000 to
$41,000 as of December 31, 2008 compared to $55,000 as of December 31, 2007 due
to the continued vesting. Insurance expenses decreased by $13,000 primarily due
to the renegotiation of commercial insurance rates. Travel expenses were
consistent with only a slight decrease of $1,000 to $6,000 as of December 31,
2008 from $7,000 as of December 31, 2007.




Provision for bad debt expense
(recovery).Provision for bad debt expense increased by $6,000
to ($1,000) recovery for the three months ended December 31, 2008, from ($7,000)
recovery for the three months ended December 31, 2007. As of December 31, 2008,
we are fully reserved for all customer accounts that are at least 90 days
old.




Depreciation and
amortization.  Depreciation and amortization decreased by
$27,000, or 8.9%, to $277,000 for the three months ended December 31, 2008, from
$304,000 for the three months ended December 31, 2007.  The decrease
in depreciation totaling $17,000 relates to the increase in fully depreciated
assets still in use, offset by the improvement of the Company’s wireless
broadband Internet network. The decrease in amortization expense totaling
$10,000 for acquired subscriber costs is the result of early wireless
acquisitions in fiscal 2005 becoming fully amortized.




Interest income and expense.For the three months ended December 31, 2008 and 2007, the Company
recorded interest expense of $23,000 and $32,000, respectively.  The
$9,000 decrease in interest expense is due to the reduction of the Company’s
long-term debt.  For the three months ended December 31, 2008 and
2007, the Company recorded interest income of $12,000 and $25,000, respectively.
The $13,000 decrease in interest income is due tochanges
in cash on hand  and declining interest rates.





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





The
following table sets forth certain unaudited financial data for the six months
ended December 31, 2008 and 2007.  Operating results for any period
are not indicative of results for any future period.  Amounts are
shown in thousands (except share, per share and subscriber count
data).




Six
      Months Ended December 31,2008
              
              
              % of
                Revenues
              
              
              2007
              
              
              % of
                RevenuesSTATEMENT
      OF OPERATIONS DATA:REVENUES:Internet
      services
              
              $
              3,885
              
              
              
              97.3
              %
              
              $
              4,249
              
              
              
              95.7
              %Other
              
              
              108
              
              
              
              2.7
              %
              
              
              192
              
              
              
              4.3
              %Total
              
              
              3,993
              
              
              
              100.0
              %
              
              
              4,441
              
              
              
              100.0
              %OPERATING
      COSTS AND EXPENSES:Connectivity
      and operations
              
              
              2,691
              
              
              
              67.4
              %
              
              
              2,846
              
              
              
              64.1
              %Sales
      and marketing
              
              
              143
              
              
              
              3.6
              %
              
              
              311
              
              
              
              7.0
              %General
      and administrative
              
              
              1,202
              
              
              
              30.1
              %
              
              
              1,847
              
              
              
              41.6
              %Provision
      for (recoveries of ) bad debt
              
              
              (0
              )
              
              
              0.0
              %
              
              
              4
              
              
              
              0.1
              %Depreciation
      and amortization
              
              
              573
              
              
              
              14.3
              %
              
              
              571
              
              
              
              12.9
              %Total
              
              
              4,609
              
              
              
              115.4
              %
              
              
              5,579
              
              
              
              125.7
              %OPERATING
      LOSS
              
              
              (616
              )
              
              
              (15.4
              )%
              
              
              (1,138
              )
              
              
              (25.7
              )%INTEREST
      INCOME
              
              
              28
              
              
              
              0.7
              %
              
              
              34
              
              
              
              0.8
              %INTEREST
      EXPENSE
              
              
              (48
              )
              
              
              (1.2
              )%
              
              
              (57
              )
              
              
              (1.3
              )%Minority
      interest in loss of consolidated subsidiary
              
              
              (0
              )
              
              
              0.0
              %
              
              
              (0
              )
              
              
              0.0
              %NET
      LOSS
              
              $
              (636
              )
              
              
              (15.9
              )%
              
              $
              (1,161
              )
              
              
              (26.2
              )%NET
      LOSS PER COMMON SHARE:BASIC
      AND DILLUTED
              
              $
              (0.04
              )
              
              
              
              
              
              $
              (0.09
              )WEIGHTED
      AVERAGE COMMONSHARES
      OUTSTANDING:BASIC
      AND DILLUTED
              
              
              16,857,031
              
              
              
              
              
              
              
              13,120,749OTHER
      DATA:Subscribers
      at end of period (1)
              
              
              28,400
              
              
              
              
              
              
              
              33,200EBITDA
      (loss)(2)
              
              $
              (42
              )
              
              
              
              
              
              $
              (567
              )EBITDA
      margin(3)
              
              
              (1.1
              %)
              
              
              
              
              
              
              (12.8
              %)Reconciliation
      of net loss to EBITDA:Net
      loss
              
              $
              (636
              )
              
              
              
              
              
              $
              (1,161
              )Add:Depreciation
      and amortization
              
              
              573
              
              
              
              
              
              
              
              571Interest
      income
              
              
              (28
              )
              
              
              
              
              
              
              (34
              )Interest
      expense
              
              
              48
              
              
              
              
              
              
              
              57EBITDA
      (loss)(2)
              
              $
              (43
              )
              
              
              
              
              
              $
              (567
              )





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


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


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






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





Total
revenue.Total revenue decreased by $448,000, or 10.1%, to
$3,993,000 for the six months ended December 31, 2008, from $4,441,000 for the
six months ended December 31, 2007.  The Company’s total subscriber
count decreased by 4,800, or 14.5%, to 28,400 as of December 31, 2008 compared
to 33,200 as of December 31, 2007.  The Company’s wireless broadband
Internet subscriber count increased slightly to 7,900 as of December 31, 2008,
compared to 7,800 as of December 31, 2007.  Wireless broadband
Internet revenue increased by $181,000 to $2,102,000 as of December 31, 2008
compared to $1,921,000 as of December 31, 2007.  During the Company’s
upgrade process in calendar 2008, we restricted the addition of new customers
while improvements were made. The slight increase in wireless broadband Internet
revenues was offset by the decrease in dial-up Internet subscriber counts and
other internet service related revenue of $544,000, which is attributed to the
loss of dial-up customers moving to other providers’ broadband service. In
connection with the acquisition of TeleShare, the Company derives other revenues
from providing telex messaging services since July 27, 2007, which decreased by
$84,000 to $108,000 for the six months ended December 31, 2008 and varies based
on customer demand.




Connectivity and operations.Connectivity and operations expense decreased by $155,000, or 5.5%, to
$2,691,000 for the six months ended December 31, 2008, from $2,846,000 for the
six months ended December 31, 2007.  There was a decrease in salaries
and wages of approximately $28,000 to $1,278,000 as of December 31, 2008
compared to $1,306,000 as of December 31, 2007.  Data and
telecommunications expense decreased by $230,000 to $767,000 as of December 31,
2008 compared to $997,000 as of December 31, 2007.  The decrease in
data and telecommunications expense is due to our renegotiating more favorable
terms with telecommunications service providers.  The remaining
decrease in expense primarily relates to a decrease in merchant fees by $14,000
and a decrease in travel expenses by $24,000.




The
decreases in the previously discussed expenses were offset by an increase in
installation expenses of $105,000 to $294,000 as of December 31, 2008 compared
to $189,000 as of December 31, 2007. This increase is due to significant
increase in service calls in the Greater Houston Texas region after the natural
disaster, Hurricane Ike, and ongoing network improvement
activity.  Additionally, in an effort to reduce capital expenditures
and to make best use of resources, the Company aggressively increased its repair
and recycle program for customer premise equipment.  The costs of
refurbishing equipment are currently expensed as incurred.  Tower
lease expense increased by $35,000 to $201,000 as of December 31, 2008 compared
to $166,000 as of December 31, 2007. The increase in tower leases relates to the
growth of the Company’s wireless broadband Internet subscriber counts and
operations and the positioning of our Company for our anticipated future growth
being driven by our wireless broadband Internet operations and to a lesser
extent due to increases in tower rental rates. Other miscellaneous costs
increased by $1,000.




Sales and marketing.Sales
and marketing expense decreased by $168,000, or 54.1%, to $143,000 for the six
months ended December 31, 2008, compared to $311,000 for the six months ended
December 31, 2007.  Salaries and wages decreased $85,000 to $111,000
as of December 31, 2008 compared to $196,000 as of December 31, 2007. This
decrease was due to ongoing efforts to enhance efficiency and reduce headcount,
including the elimination of outside sales force and present vacancy of the
position of Vice President of Marketing.   Advertising, travel
and consulting expenses decreased by $95,000 to $20,000 as of December 31, 2008
compared to $115,000 as of December 31, 2007.  Approximately $50,000
of non-recurring advertising was incurred during our initial launch of reselling
municipal Wi-Fi in Corpus Christi, which occurred during the six months ended
December 31, 2007. These decreases were slightly offset by allocation of
facilities expense for inside sales force of $12,000.




General and
administrative.G&A decreased by $645,000, or 34.9%, to
$1,202,000 for the six months ended December 31, 2008 from $1,847,000 for the
six months ended December 31, 2007. Facilities costs decreased by $410,000 to
$147,000 as of December 31, 2008 compared to $557,000 as of December 31, 2007
primarily due to the write off of the abandoned corporate headquarters lease in
Dallas in the previous year and also to the closing of additional regional field
offices.




Professional
and consulting fees decreased by $157,000 to $238,000 as of December 31, 2008
compared to $395,000 as of December 31, 2007 primarily due to non-recurring
expenses incurred in 2007.  During the six months ended December 31,
2007, the Company incurred $85,000 in expenses related to investor relations
consulting fees and costs incurred related to the annual meeting in December
2007. Additionally, during the quarter ended December 31, 2007, the Company
expensed non-recurring legal fees of $38,000 related to ongoing litigation
against a former landlord, in which the Company was the plaintiff and which was
settled.  Consulting expenses related to outsource management fees for
telex messaging customers acquired from TeleShare in July 2007 decreased by
$34,000 for the three months ended December 31, 2008 compared to the three
months ended December 31, 2007.






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Property
taxes and insurance expenses decreased by $13,000 to $61,000 as of December 31,
2008 from $74,000 as of December 31, 2007 due to the renegotiation of insurance
contracts.Telecommunications
expense decreased by $63,000 to $82,000 as of December 31, 2008 compared to
$145,000 as of December 31, 2007 due primarily to decreased long distance
services by entering into a more favorable agreement with the telecommunications
service provider. A net decrease in stock compensation and director fees of
$8,000 to $77,000 as of December 31, 2008 compared to $85,000 as of December 31,
2007 was due to the continued vesting of stock options.  Salaries and
wages were relatively consistent totaling $480,000 as of December 31, 2008
compared to $473,000 as of December 31, 2007. The remaining net decrease of
$1,000 was primarily a result of various cost saving measures implemented during
fiscal 2009.




Provision for bad debt
expense.Provision for bad debt expense decreased by $4,000
for the six months ended December 31, 2008.  This decrease is due
primarily to a sales effort to increase the number of customers enrolled in
electronic payment methods, whereby non-payment for services is
decreased.  As of December 31, 2008, we are fully reserved for all
customer accounts that are at least 90 days old.




Depreciation and
amortization.  Depreciation and amortization increased by
$2,000, or 0.4%, to $573,000 for the six months ended December 31, 2008 from
$571,000 for the six months ended December 31, 2007.  The net increase
relates to a decrease of $13,000 in depreciation and an increase of $15,000 in
amortization. A decrease of $13,000 in depreciation relates to the increase in
fully depreciated assets still in use. This is offset by a $15,000 increase in
amortization expense due to amortization of companies acquired in fiscal
2007.




Interest income and expense.For the six months ended December 31, 2008 and 2007, the Company recorded
interest expense of $48,000 and $57,000, respectively.  The $9,000
decrease in interest expense is the result of the reduction in the Company’s
long-term debt. For the six months ended December 31, 2008 and 2007, the Company
recorded interest income of $28,000 and $34,000, respectively. The $6,000
decrease in interest income is the result of a reduction in the interest
rates.





Liquidity
and Capital Resources





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




Cash used
in operating activities is net income or loss adjusted for certain non-cash
items and changes in assets and liabilities.  For the six months ended
December 31, 2008, cash used in operations was $438,000 compared to cash used in
operations of $570,000 for the six months ended December 31, 2007. For the six
months ended December 31, 2008, net loss plus non-cash items used cash of
$16,000.  Increases in accounts receivable and purchase of other
assets were offset by decreases in inventory, prepaid expenses, accounts payable
and deferred revenue.  For the six months ended December 31, 2007, net
loss plus non-cash items used cash of $527,000. Decreases in accounts
receivable, inventory, prepaid expenses and other assets were offset by
increases in accounts payable and deferred revenue.




Cash used
in investing activities totaled $141,000 for the six months ended December 31,
2008, which relates primarily to approximately $152,000 in cash used to purchase
new wireless broadband Internet infrastructure, offset by proceeds from the sale
of equipment of approximately $11,000.  Cash provided by investing
activities totaled $206,000 for the six months ended December 31, 2007, which
relates primarily to approximately $655,000 in cash provided by the acquisition
of Teleshare, offset primarily by the deployment of new wireless broadband
Internet infrastructure of approximately $443,000.




Cash used
in financing activities for the six months ended December 31, 2008 totaled
$286,000 and relates to the principal payments on long-term debt. Cash provided
by financing activities, which totaled $5,178,000 for the six months ended
December 31, 2007, consisted of the issuance of common and preferred stock
resulting in net proceeds of $5,295,000 and borrowings on the RUS loan of
$72,000, offset by principal payments on long term-debt totaling
$188,000.






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Internet
America estimates that cash on hand of $3 million at December 31, 2008
along with anticipated cash flow from operations will be sufficient for meeting
our working capital needs for the next twelve months for continuing operations
in both existing and new markets as well as the planned deployment of additional
wireless infrastructure.  Management believes that Internet America
will be able to meet the service obligations related to the deferral of revenue
and that cash generated from recently acquired operations will be adequate to
meet its payment obligations under debt issued and assumed in connection with
these acquisitions.  However, additional financing may be required to
fund future acquisitions.  Continued decreases in revenues and
subscriber count may adversely affect the liquidity of the Company.




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




Off
Balance Sheet Arrangements




None.




“Safe
Harbor” Statement




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






- 18
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ITEM 3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Not
applicable





ITEM 4T.
            CONTROLS
      AND PROCEDURES





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





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-
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PART II - OTHER INFORMATION




ITEM 6.
            EXHIBITS




Exhibit
            
            Description2.1
            
            Agreement
      and Plan of Merger among Registrant, KeyOn Communications Holdings, Inc.
      and IA Acquisition, Inc. dated November 14, 2008.(1)4.3
            
            Amendment
      No. 2 to Rights Agreement dated as of November 24,
  2008.(2)31.1
            
            Rule
      13a-14(a)/15d-14(a) Certification of William E. Ladin,
  Jr.31.2
            
            Rule
      13a-14(a)/15d-14(a) Certification of Jennifer S.
LeBlanc32.1
            
            Section
      1350 Certification of William E. Ladin, Jr.32.2
            
            Section
      1350 Certification of Jennifer S. LeBlanc





(1)
            Incorporated
      by reference to exhibit 2.1 to Form 8-K (file no. 0001144204-08-065145)
      filed November 18, 2008.


(2)
            Incorporated
      by reference to exhibit 4.3 to Registration Statement on Form S-4 (Reg.
      No. 333-155886) filed December 3,
2008.






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-
 Table of Contents




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: 
02/17/09


By: 
/s/ William E. Ladin, Jr.


William
E. Ladin, Jr.


Chairman
and Chief Executive Officer




Date: 
02/17/09


By: 
/s/ Jennifer S. LeBlanc


Jennifer
S. LeBlanc


Chief
Financial and Accounting Officer








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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.
  LeBlanc





32.1
            Section
      1350 Certification of William E. Ladin,
Jr.





32.2
            Section
      1350 Certification of Jennifer S. LeBlanc