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-K for the fiscal year ended June 30, 2009 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 is focused on providing wireless high-speed broadband Internet in rural markets, and presently serves 8,100 wireless broadband Internet subscribers. Since the Company's founding in 1995, we have a history of providing an array of Internet services to residential and business subscribers and serve approximately 26,400 total subscribers in Texas as of September 30, 2009. Initially providing primarily dial-up Internet services, the Company grew rapidly to over 150,000 subscribers. In recent years, Internet America has evolved its product offering to include high-speed broadband, and entered the rural wireless broadband market in 2004, incorporating a core competency of managing large numbers of 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. A decline in non-wireless subscribers and revenues is expected and will continue primarily due to our customers migrating to high-speed providers in metropolitan areas.

During 2009, we focused on quality process implementation including investing in infrastructure upgrades, increasing network capacity and simplifying internal systems and procedures. Our efforts improved productivity and customer satisfaction, and also resulted in improved EBITDA and decreases in expenses and headcount last year. We expect our ongoing commitment to defect-free quality services to contribute to our future profitability and productivity. We anticipate no significant negative churn in wireless broadband subscribers, which has increased slightly from approximately 8,000 subscribers at June 30, 2009 to 8,100 at the end of this quarter. Management is disappointed with the slow growth in the rural markets which seems to be related to the changing economic conditions. We continue to expect modest growth rather than large gains in subscribers in our existing network footprint.

During this quarter, the Company entered into an agreement with a third-party service provider to provide Voice over Internet Protocol ("VoIP") and Hosted VoIP PBX services to its embedded customer base throughout Texas and to new residential and business customers nationwide. Providing these customers with bundled broadband Internet access and commercial-grade VoIP services is expected to increase revenue per subscriber during fiscal 2010.

Under the present economic recession, many companies are seeking to reduce travel time and expenses. Also, the quality and availability of internet connectivity is improving and the power of personal computers is growing. Management believes video conferencing presents an opportunity for growth and has identified this as a natural addition to our products and services in existing and potential markets. Under a reseller agreement, the Company provides one-on-one and multi party high-quality, resilient video conferencing using desktop computers. The Company offers its customers access to this technology in the form of hosted services or direct sale of hardware and software. Hosted video conferencing products may be very attractive to mid-size businesses without long-term capital costs or commitments, and Internet America can provide them with immediate access to new, high performance technology.

During the first quarter of fiscal 2010, the Company devoted substantial time and resources to submitting an application to expand our service area by utilizing funds made available for economic stimulus by The American Recovery and Reinvestment Act ("ARRA") legislation, whose mission includes making high-speed broadband and other technologies available to everyone residing in the United States. A non-recurring increase in general and administrative costs of $120,000 was incurred for the fiscal quarter ended September 30, 2009 for personnel, consulting and other direct costs incurred in completing the application. Overall direct expenses incurred to date as of September 30, 2009 related to the application totaled approximately $162,000. The Company's application includes request for immediate funding of permitted pre-application expenses. These expenses have contributed to the Company's negative cash flow in the quarters ended September 30, 2009 and June 30, 2009. Excluding these non-recurring costs, the Company's general and administrative expenses remained stable for the quarter ended September 30, 2009 compared to the same period last fiscal year, as we maintained efficient operations.

Management awaits further communication regarding the status of its application in order to reasonably project certain future cash flow and operating profits. The grant program requires a minimum of 20% of the project costs to be funded from non-federal sources. If awarded funds, the Company has commitments to obtain the minimum outside capital funding. More information on our proposed project is included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009, recent press-releases and other publicly filed reports.

In addition to our proposed growth detailed in our ARRA application, we believe our continued efforts to improve the quality and efficiency of our operations over the last few years, as well as additional service offerings such as desktop video conferencing and VoIP may lead to a more rapid rate of growth and revenue per subscriber. This should contribute to improvements in profitability and cash flow from operations.

Management is uncertain about positive cash flow and operating profits in the near future; accordingly, the Company will be dependent on reducing certain discretionary spending to provide financing to support its operations and for any capital expenditures. We can provide no assurance that we will be successful in achieving any or all of our initiatives, that the achievement or existence of such initiatives will result in positive cash flow or profit improvements, or that other factors will not arise that would adversely affect future profits and our ability to achieve our intended business objectives.

Statement of Operations

Internet services revenue is derived from dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, wireless access, bulk dial-up access, web hosting services, and value-added services, such as multiple e-mail boxes, personalized e-mail addresses and Fax-2-Email services. In addition to miscellaneous revenue, other revenue includes 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 (recoveries) consists primarily of customer accounts that have been deemed uncollectible and will potentially be written off in future periods, net of recoveries. Historically, the expense has been based on the aging of customer accounts whereby all customer accounts that are 90 days or older have been provided for as a bad debt expense.

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

Our business is not subject to any significant seasonal influences.

Results of Operations

Three Months Ended September 30, 2009 Compared to Three Months Ended September
30, 2008

The following table sets forth certain unaudited financial data for the three
months ended September 30, 2009 and 2008. Operating results for any period are
not indicative of results for any future period. Dollar amounts are shown in
thousands (except per share data, shares and subscriber counts).

                                                               Three Months Ended September 30,
                                               2009           % of Revenues           2008           % of Revenues
STATEMENT OF OPERATIONS DATA:
REVENUES:
Internet services                          $      1,798                 98.0 %    $      1,955                 97.5 %
Other                                                38                  2.0 %              50                  2.5 %
Total                                             1,836                100.0 %           2,005                100.0 %
OPERATING COSTS AND EXPENSES:
Connectivity and operations                       1,320                 71.9 %           1,351                 67.4 %
Sales and marketing                                  78                  4.2 %              70                  3.5 %
General and administrative                          701                 38.2 %             588                 29.3 %
Provisions for (recoveries of) bad debt              (3 )               (0.2 )%              1                  0.0 %
Depreciation and amortization                       247                 13.5 %             296                 14.8 %
Total                                             2,343                127.6 %           2,306                115.0 %
OPERATING LOSS                                     (507 )              (27.6 )%           (301 )              (15.0 )%
INTEREST INCOME                                       4                  0.2 %              15                  0.8 %
INTEREST EXPENSE                                    (19 )               (1.1 )%            (25 )               (1.3 )%
NET LOSS                                   $       (522 )              (28.5 )%   $       (311 )              (15.5 )%
LESS: NET LOSS ATTRIBUTABLE TO
NONCONTROLLING INTEREST                    $         (0 )                0.0 %    $         (0 )                0.0 %
NET LOSS ATTRIBUTABLE TO INTERNET
AMERICA, INC.                              $       (522 )              (28.5 )%   $       (311 )              (15.5 )%
NET LOSS PER COMMON SHARE:
BASIC AND DILUTED                          $      (0.03 )                         $      (0.02 )
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:
BASIC AND DILUTED                            16,646,405                             16,857,031
OTHER DATA:
Subscribers at end of period (1)                 26,400                                 29,000
EBITDA(loss)(2)                            $       (260 )                         $         (5 )
EBITDA margin(3)                                  (14.1 )%                                (0.3 )%
CASH FLOW DATA:
Cash flow used in operations               $       (372 )                         $       (267 )
Cash flow used in investing activities     $       (140 )                         $        (34 )
Cash flow used in financing activities     $       (153 )                         $       (141 )
Reconciliation of net loss to EBITDA
(loss):
Net loss                                   $       (522 )                         $       (311 )
Add:
Depreciation and amortization                       247                                    296
Interest income                                       4                                     15
Interest expense                                    (19 )                                  (25 )
EBITDA (loss)(2)                           $       (260 )                         $         (5 )

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

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

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

Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008 (Continued)

Total revenue. Total revenue decreased by $169,000, or 8.4%, to $1,836,000 for the three months ended September 30, 2009, from $2,005,000 for the three months ended September 30, 2008. The Company's total subscriber count decreased by 2,600, or 9.0%, to 26,400 as of September 30, 2009 compared to 29,000 as of September 30, 2008. The Company's wireless broadband Internet subscriber count increased slightly to 8,100 as of September 30, 2009, compared to 7,900 as of September 30, 2008. Wireless broadband Internet revenue increased by $75,000 to $1,116,000 as of September 30, 2009 compared to $1,041,000 as of September 30, 2008. This increase was primarily due to the stability of the subscriber base and customers migrating to upgraded service levels upon completion of infrastructure upgrades in certain areas as well as purchasing additional services during the quarter ended September 30, 2009. Presently stable revenues derived from wireless broadband Internet subscribers were offset by the decrease in other types of Internet service revenues of $232,000. This is attributed to the expected decline of dial-up customers who may move to other providers' broadband service. In connection with the acquisition of TeleShare, the Company derives other revenues from providing telex messaging services. Messaging revenues decreased by $12,000, or 24.0%, to $38,000 as of September 30, 2009, compared to $50,000 as of September 30, 2008.

Connectivity and operations. Connectivity and operations expense decreased by $31,000, or 2.3%, to $1,320,000 for the three months ended September 30, 2009, from $1,351,000 for the three months ended September 30, 2008. Data and telecommunications expense decreased by $24,000 to $370,000 as of September 30, 2009 compared to $394,000 as of September 30, 2008 due to our renegotiating more favorable terms with telecommunications service providers. Salaries, wages and related personnel decreased by approximately $70,000 to $614,000 as of September 30, 2009 compared to $684,000 as of September 30, 2009 which is attributed to efficiencies gained from quality process initiatives. Other decreases in expense of approximately $3,000 relate to reduction in merchant fees in fiscal 2010.

The decreases in previously discussed expenses were offset by increases in installation expenses, tower leases and one time conversion costs related to transfer email services to a hosted outsource service provider. Non-recurring costs incurred totaled $33,000 for the quarter ended September 30, 2009. Increase in consumable supplies expenses of $14,000 to $148,000 as of September 30, 2009 compared to $134,000 as of September 30, 2008 is primarily due to network improvement activity during this fiscal year. Tower lease expense increased by $19,000 to $115,000 as of September 30, 2009 compared to $96,000 as of September 30, 2008. The increase in tower leases relates to improvements in the Company's wireless broadband infrastructure and increases in tower rental rates.

Sales and marketing. Sales and marketing expense increased by $8,000, or 11.4%, to $78,000 for the three months ended September 30, 2009, compared to $70,000 for the three months ended September 30, 2008. Advertising expense increased by $13,000 to $15,000 as of September 30, 2009 compared to $2,000 as of September 30, 2008. In fiscal 2009 the Company is focusing on direct advertising in all improved or enhanced network areas. The increases in advertising have been offset by decreases in salaries and wages of $5,000 to $57,000 as of September 30, 2009 compared to $62,000 as of September 30, 2008 due to restructuring of department personnel to reduce costs.

General and administrative. General and administrative expense increased by $113,000, or 19.2%, to $701,000 for the three months ended September 30, 2009, from $588,000 for the three months ended September 30, 2008. The increase is primarily due to non-recurring expenses totaling $120,000 in connection with our application for a grant under the ARRA to expand access to broadband into areas in Southeast Texas adjacent to existing operations. Telecommunications expense increased by $17,000 to $55,000 as of September 30, 2009 from $38,000 as of September 30, 2008, due primarily to purchasing increased bandwidth capacity. Other general and administrative costs increased by $28,000 to $84,000 as of September 30, 2009 compared to $56,000 as of September 30, 2008. Stock compensation expense and directors' fees increased slightly by $1,000 to $37,000 as of September 30, 2009.

The above increases and non-recurring expenses were offset by the following decreases. Personnel costs decreased by $8,000 to $228,000 for September 30, 2009 compared to $236,000 as of September 30, 2008, which is attributed to efficiencies gained from quality process initiatives. Professional fees decreased by $16,000 as of September 30, 2009 to $87,000 compared to $103,000 in September 30, 2008 primarily due to declining consulting fees paid to contract labor for telex messaging services. Facilities costs decreased by $15,000 as of September 30, 2009, to $66,000 at September 30, 2009 from $81,000 at September 30, 2008, due to the closing of additional regional field offices. Our insurance expense decreased by $9,000 to $20,000 as of September 30, 2009 compared to $29,000 as of September 30, 2008. Travel expenses decreased by $5,000 to $4,000 as of September 30, 2009 compared to $9,000 as of September 30, 2008.

Provision for bad debt expense (recovery). Provision for bad debt expense increased by $4,000 to $3,000 recovery for the three months ended September 30, 2009, from $1,000 expense for the three months ended September 30, 2008. As of September 30, 2009, we are fully reserved for all customer accounts that are at least 90 days old.

Depreciation and amortization. Depreciation and amortization decreased by $49,000, or 16.6%, to $247,000 for the three months ended September 30, 2009, from $296,000 for the three months ended September 30, 2008. The decrease in depreciation totaling $16,000 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 $33,000 for acquired subscriber costs is the result of early wireless acquisitions in fiscal 2005 and 2006 becoming fully amortized.

Interest (expense) income, net. Interest expense decreased by $6,000 or 24.0% to $19,000 from $25,000 for the three months ended September 30, 2009 and 2008, which is related to acquisition debt and the RUS loan outstanding. Interest income decreased by $11,000, or 73.3%, to $4,000 due to changes in cash on hand, declining interest rates, and closing of our interest bearing accounts. As a precautionary measure, in February 2009, the Company transferred all funds from interest bearing accounts during this economic crisis to ensure all funds were covered by the Temporary Guaranty Liquidity Program initiated by the Federal Reserve Board.

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 (loss) adjusted for certain non-cash items and changes in assets and liabilities. For the three months ended September 30, 2009, cash used in operations was $372,000 compared to cash used in operations of $267,000 for the three months ended September 30, 2008. For the three months ended September 30, 2009, net loss plus non-cash items used cash of $244,000. Material decreases in accounts payable and accrued expenses and deferred revenue and purchases of inventory were offset by decreases in accounts receivable and prepaid and other assets. 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.

Cash used in investing activities totaled $140,000 for the three months ended September 30, 2009, which relates primarily to the improvements in existing wireless broadband Internet infrastructure. 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 used in financing activities, which totaled $153,000 for the three months ended September 30, 2009, consisted of principal payments on long term debt including notes related to acquisitions, the RUS loan and capital leases. 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.

Cash on hand declined by $665,000 during the quarter ended September 30, 2009. At September 30, 2009, cash on hand was $1,756,000 compared to $2,421,000 at June 30, 2009. Anticipated cash flow from operations in the near future may not be sufficient for meeting our working capital needs in fiscal 2010 for continuing operations as well as the addition of value-added services to both new and existing subscribers. In addition to our proposed growth detailed in our ARRA application, we believe our continued efforts to improve the quality and efficiency of our operations over the last few years, as well as additional service offerings such as desktop video conferencing and VoIP may lead to a more rapid rate of growth and revenue per subscriber and result in improved cash flow from operations.

However, in the near term the Company will be dependent on reducing certain discretionary spending to provide financing to support its operations and for any capital expenditure in both existing and new markets. Management believes that the Company will be able to meet the service obligations related to the deferral of revenue. Continued decreases in revenues and subscriber count may adversely affect the liquidity of the Company. We can provide no assurance that we will be successful in achieving any or all of our initiatives, or that the achievement or existence of such initiatives will result in positive cash flow. Additional capital financing arrangements, including public or private sales of debt or equity securities, or additional borrowings from commercial banks, shareholders and third parties, may be insufficient or unavailable.

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 receive grant funding sought after in our application to the Broadband Technology Opportunity Program to expand our wireless infrastructure to additional unserved and underserved areas available under The American Recovery and Reinvestment Act, (4) we will not expand our coverage in public-private partnerships with state or local governments, utility providers, or other entities seeking to participate in grant programs or those partnerships may not be successful, (5) Internet revenue in high-speed broadband will continue to increase at a slower pace than the decrease in other Internet services resulting in greater operating losses in future periods, (6) financing will not be available to us if and as needed, (7) we will not be competitive with existing or new competitors, (8) we will not keep up with industry pricing or technological developments impacting the Internet, (9) we will be adversely affected by dependence on network infrastructure, telecommunications providers and other vendors or by regulatory changes, (10) service interruptions or impediments could harm our business, (11) 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, (12) government regulations could force us to change our business practices, (13) we may be unable to hire and retain qualified personnel, including our key executive officers, (14) future acquisitions of wireless broadband Internet customers and infrastructure may not be available on attractive terms and if available we may not successfully integrate those acquisitions into our operations, (15) provisions in our certificate of incorporation, bylaws and shareholder rights plan could limit our share price and delay a change of management, and (16) 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 . . .