INTERNET AMERICA INC, 424B1, 1998-12-10

INTERNET AMERICA INC
424B1, 1998-12-10
PREPACKAGED SOFTWARE

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<PAGE> 1

FILED PURSUANT TO RULE 424(B)(1)
FILE NUMBER 333-59527
2,300,000 SHARES

Internet America Logo
COMMON STOCK
---------------------

Of the 2,300,000 shares of Common Stock offered hereby, 1,700,000 shares are
being sold by the Company and 600,000 shares are being sold by the Selling
Shareholders. The Company will not receive any of the proceeds from the sale of
shares by the Selling Shareholders. See "Principal and Selling Shareholders."
Prior to this offering (the "Offering"), there has been no public market for the
Common Stock. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price. The Common Stock has been
approved for quotation on the Nasdaq National Market under the symbol "GEEK."

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

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 7.
---------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share................. $13.00 $0.91 $12.09 $12.09
- --------------------------------------------------------------------------------------------------------------
Total(3).................. $29,900,000 $2,093,000 $20,553,000 $7,254,000
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
</TABLE>

(1) The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."

(2) Before deducting estimated expenses of this Offering of $450,000 payable by
the Company.

(3) The Selling Shareholders have granted to the Underwriters a 30-day option to
purchase up to an aggregate of 345,000 additional shares of Common Stock,
solely to cover over-allotments, if any. If such option is exercised in
full, the total Price to Public will be $34,385,000, the total Underwriting
Discount will be $2,406,950 and the total Proceeds to Selling Shareholders
will be $11,425,050. See "Underwriting."

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

The Common Stock is offered by the Underwriters as stated herein, subject to
receipt and acceptance by them and subject to their right to reject any order in
whole or in part. Delivery of such shares will be made through the offices of
Hoak Breedlove Wesneski & Co., Dallas, Texas, or its agent on or about December
15, 1998.

HOAK BREEDLOVE WESNESKI & CO. FERRIS, BAKER WATTS
INCORPORATED

The date of this Prospectus is December 9, 1998.

<PAGE> 2

[GRAPHICS]

- Inside front cover contains a color map of Texas, designating the
counties and cities with populations greater than 50,000 and highlighting
the locations of the Company's POPs. Under the map is the following text:
Internet America has dial-up customers in almost half of the 254 counties
in Texas. The Company's strategy for growth involves building a critical
mass of customers in a given market to take advantage of marketing,
network and operating efficiencies.

- Inside back cover contains screen shots of television and billboard
advertising and the following text: Internet America combines
direct-response television commercials with billboards to attract new
customers and position itself as "The Best Route Along the Information
Highway."

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING THE ENTRY OF STABILIZING BIDS, EFFECTING SYNDICATE COVERING
TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."

Internet America(R), 1-800-BE-A-GEEK(R), Airnews.net, Airmail.net,
Airweb.net and their respective logos are trademarks, trade names and service
marks of the Company. This Prospectus also includes trademarks, trade names and
service marks of companies other than the Company, which are the property of
their respective owners.
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<PAGE> 3

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and Financial Statements, including Notes thereto, appearing
elsewhere in this Prospectus. Except as otherwise indicated, the information
contained in this Prospectus assumes (i) a 2.25-for-1.00 stock split of the
Common Stock effected in the form of a dividend on July 13, 1998, (ii) the
conversion of all outstanding shares of the Company's preferred stock into
shares of Common Stock on a 2.25-for-1.00 basis not more than 30 days after the
completion of the Offering, (iii) an initial public offering price of $13.00 per
share and (iv) the Underwriters' over-allotment option is not exercised. See
"Description of Securities -- Preferred Stock" and "Underwriting." Except where
the context otherwise requires, all references to the "Company" or "Internet
America" include Internet America, Inc., a Texas corporation, and its
predecessor. References to fiscal years by date refer to the fiscal year ended
June 30 of that year. This Prospectus contains certain forward-looking
statements that involve risks and uncertainties. In addition to the other
information in this Prospectus, prospective investors should carefully consider
the information set forth under the heading "Risk Factors." The "Glossary of
Technical Terms" appearing elsewhere in this Prospectus contains definitions of
certain technical terms used herein.

THE COMPANY

Internet America is a leading Internet service provider ("ISP") in the
southwestern United States. The Company provides a wide array of Internet
services tailored to meet the needs of individual and business customers,
including customers with little or no online experience. With more than 50,000
customers, primarily in the North Texas area, the Company believes that it has
achieved one of the highest user densities per point of presence ("POP") of any
ISP in the United States. This user density has enabled the Company to realize
substantial marketing, network and operating efficiencies, which have resulted
in net profit margins in recent periods that are substantially higher than those
of most publicly traded ISPs. The Company realized net profit margins of 10.4%
for the quarter ended September 30, 1998 and 9.5% for the year ended June 30,
1998.

As part of its user density business model, the Company uses television
advertising as its primary marketing tool. The Company's experience is that
television, reinforced with billboard advertising, is substantially more
effective and efficient than radio, print or direct mail in rapidly building a
customer base and creating brand awareness. Through its 1-800-BE-A-GEEK(R)
television campaigns, which emphasize the speed and quality of the Company's
Internet services and its commitment to customer care, the Company has succeeded
in building the brand awareness of Internet America in its existing markets.
This brand awareness, combined with the Company's deep penetration of the North
Texas market, has also resulted in a substantial number of customer referrals.

Internet America's most popular service package includes unlimited dial-up
Internet access for $19.95 a month. The Company also offers value-added services
for additional fees, including multiple e-mail boxes, personalized e-mail
addresses and personal Web sites. The Company's Airnews.net provides access to
Internet America's news services for customers of other Internet services and on
a wholesale basis to other businesses and ISPs. The Company also provides
business customers with a full range of services, including dedicated high-speed
access, Web hosting, server co-location and domain name registration and
hosting. Although the Company's customers are primarily individuals, these
business services represent approximately 10% of the Company's fiscal 1998 total
revenue.

Outstanding service and customer care are crucial to customer acquisition
and retention in the ISP industry. The Company's goal of 100% customer
satisfaction begins with providing superior systems and network performance, and
emphasizes high quality customer service and technical support. The Company's
customer care department is available to customers 24-hours-a-day,
7-days-a-week, and is structured to provide effective, friendly support to each
customer, whether a novice or an experienced Internet user.

The Company's systems and network infrastructure, which can be expanded
rapidly to accommodate customer growth, is designed to provide fast, highly
reliable performance. The Company's primary operations

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center and largest POP is located in Dallas. Additional physical POPs,
incorporating modems, terminal servers and routers are located in four other
Texas cities. To expand its geographic coverage and upgrade to new technology,
the Company has also implemented a "Virtual POP" architecture with various
telecommunications providers. Through its Virtual POP architecture, the Company
can provide local access services without deploying physical infrastructure. The
benefits of this architecture include substantially reduced capital
expenditures, lower operating costs and reduced exposure to technological
obsolescence. At September 30, 1998, approximately 50% of the Company's
customers were serviced by Virtual POPs.

Unlike many other ISPs, the Company believes that at the current stage of
the ISP industry's development, the highest priority should be to rapidly build
profitable market share, not to deploy a large network infrastructure with a
substantial number of underutilized POPs. Therefore, the Company's growth
strategy is focused on (i) acquiring additional customers in its existing
markets and (ii) deploying its user density business model in other selected
markets. The aim of the user density business model is to quickly build in a
given market a "critical mass" of customers that will support profitable
operations.

Elements of the Company's growth strategy include:

Aggressive Use of Advertising to Rapidly Acquire a Critical Mass of
Customers and Build the Internet America Brand. The Company intensively
uses two of the more effective and efficient advertising
media -- television and outdoor billboard displays -- to acquire customers
quickly and build brand awareness.

Strategic and Add-On Acquisitions. The Company intends to pursue
strategic acquisitions that will jump-start its entry into new markets, as
well as add-on acquisitions in its existing markets that it believes will
be accretive to earnings. The Company completed a strategic acquisition in
fiscal 1997 and an add-on acquisition in fiscal 1998, but is not currently
negotiating any acquisitions. The completed acquisitions were purchases of
customer bases and did not constitute business combinations requiring
financial statements of the acquirees to be included herein.

Cost-Effective Development of Network Infrastructure. In deploying
physical infrastructure, the Company will continue to apply its disciplined
approach, which is premised upon the achievement of substantial economies
of scope and scale. The Virtual POP architecture enables the Company to
serve existing markets more efficiently and enter certain new markets more
quickly.

Development of Value-Added Revenue Streams. In addition to growing
value-added revenue streams from its existing services, such as dedicated
high-speed access, news access and Web hosting, the Company continues to
evaluate and develop other value-added service opportunities, such as xDSL
connectivity. The Company believes that a user dense, regionally focused
customer base provides an excellent platform for the introduction of new
value-added services (potentially including Internet telephony) that can
take advantage of brand awareness and economies of scope and scale.

Maintenance of a First-Rate Customer Care Operation. The Company's
sophisticated, high quality customer care operation is designed to assist
both novice and experienced Internet users, to ensure that every customer's
Internet experience is efficient, productive and enjoyable. The Company
believes that this operation is a substantial competitive advantage.

The Company was formed in 1994 and reincorporated in Texas in 1995. The
Company's principal executive office is located at One Dallas Centre, 350 N. St.
Paul, Suite 3000, Dallas, Texas 75201, and its telephone number at that office
is (214) 861-2500. The Company's World Wide Web home page is at
http://www.airmail.net. Information contained in the Company's Web site does not
constitute, and shall not be deemed to constitute, part of this Prospectus.

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<PAGE> 5

THE OFFERING

Common Stock offered by the
Company.......................... 1,700,000 shares

Common Stock offered by the
Selling Shareholders............. 600,000 shares

Common Stock to be outstanding
after the Offering(1)............ 6,285,957 shares

Estimated net proceeds to the

Company(2)..................... $20.1 million

Use of proceeds.................. The Company intends to use the net proceeds
of the Offering as follows: (i)
approximately $8.0 million to fund
potential acquisitions of unaffiliated
persons or entities; (ii) approximately
$6.5 million to fund increased marketing
expenses and incremental capital equipment
and infrastructure expenditures related to
the Company's anticipated growth; (iii)
approximately $2.3 million to repay certain
indebtedness, of which approximately $1.8
million is debt owed to affiliates; and
(iv) the remaining amount for general
corporate purposes.

Proposed Nasdaq National Market
symbol........................... GEEK

SUMMARY FINANCIAL AND OPERATING DATA
(In thousands, except per share and customer data)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED JUNE 30, SEPTEMBER 30,
--------------------------- -------------------
1996 1997 1998 1997 1998
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenue............................ $ 3,777 $ 9,471 $10,643 $ 2,412 $ 3,141
Total operating expenses................. 7,129 12,814 9,042 1,957 2,729
------- ------- ------- ------- -------
Income (loss) from operations............ (3,352) (3,343) 1,601 455 412
Interest expense......................... 77 481 571 135 76
Income tax expense....................... -- -- 24 6 10
------- ------- ------- ------- -------
Net income (loss)........................ $(3,429) $(3,824) $ 1,006 $ 314 $ 326
======= ======= ======= ======= =======
Net income (loss) per share(3):
Basic.................................... $ (1.15) $ (1.12) $ 0.28 $ 0.10 $ 0.09
Diluted.................................. $ (1.15) $ (1.12) $ 0.21 $ 0.07 $ 0.07
Weighted average shares(3):
Basic.................................... 2,981 3,418 3,532 3,418 3,532
Diluted.................................. 2,981 3,418 4,783 4,767 4,783
OTHER DATA:
Approximate number of customers at end of
period................................ 27,900 39,900 48,600 39,800 50,100
EBITDA(4)................................ $(2,804) $(1,725) $ 3,075 $ 818 $ 799
EBITDA margin(4)......................... (74.2)% (18.2)% 28.9% 33.9% 25.4%
Cash flow provided (used) by:
Operating activities.................. $ 390 $(1,430) $ 1,797 $ 451 $ 614
Investing activities.................. (2,981) (1,513) (407) (6) (232)
Financing activities.................. 2,615 2,864 (826) (445) (774)
</TABLE>

See notes on following page

5
<PAGE> 6

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1997 1997 1998 1998 1998
------------- ------------ --------- -------- -------------
<S> <C> <C> <C> <C> <C>
QUARTERLY STATEMENT OF OPERATIONS
DATA:
Total revenue..................... $2,412 $2,534 $2,810 $2,887 $ 3,141
Total operating expenses.......... 1,957 2,159 2,397 2,529 2,729
------ ------ ------ ------ -------
Income from operations............ $ 455 $ 375 $ 413 $ 358 $ 412
====== ====== ====== ====== =======
Net income........................ $ 314 $ 214 $ 242 $ 236 $ 326
====== ====== ====== ====== =======
OTHER QUARTERLY DATA:
Approximate number of customers at
end of period.................. 39,800 44,600 47,600 48,600 50,100
EBITDA(4)......................... $ 818 $ 738 $ 802 $ 717 $ 799
EBITDA margin(4).................. 33.9% 29.1% 28.5% 24.8% 25.4%
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------
ACTUAL AS ADJUSTED(5)
------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 173 $17,695
Working capital........................................... (5,476) 12,046
Total assets.............................................. 3,035 20,557
Long-term debt, net of current portion.................... 331 1
Total shareholders' equity (deficit)...................... (3,441) 16,662
</TABLE>

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

(1) Includes 33,750 shares of Common Stock subject to a warrant granted on March
31, 1996 to M.J. Capital Partners, L.P. (the "Warrant") at an exercise price
of $1.67 per share that the warrant holder has indicated it intends to
exercise contemporaneously with the Offering, and assumes the automatic
conversion of all outstanding shares of the Company's preferred stock into
shares of Common Stock on a 2.25-for-1.00 basis 30 days after completion of
the Offering. Excludes as of September 30, 1998 (i) 225,000 shares of Common
Stock reserved for issuance under the 1996 Incentive Stock Option Plan (the
"1996 Option Plan"), of which options to purchase 67,075 shares were
outstanding at a weighted average exercise price of $1.67 per share, (ii)
400,000 shares of Common Stock reserved for issuance under the 1998
Nonqualified Stock Option Plan (the "1998 Option Plan"), of which no options
were outstanding and (iii) 1,212,476 shares of Common Stock issuable upon
exercise of other outstanding options at a weighted average exercise price
of $2.18 per share. See "Management -- 1996 Incentive Stock Option Plan,"
"-- Nonqualified Stock Options Issued to Officers and Directors," and
"-- 1998 Nonqualified Stock Option Plan."

(2) After deducting the underwriting discount and other estimated expenses of
the Offering.

(3) See Notes 1 and 10 of Notes to Financial Statements for information
concerning the calculation of basic and diluted net income (loss) per share.

(4) EBITDA (earnings before interest, taxes, depreciation and amortization)
consists of total revenue less connectivity and operations expense, sales
and marketing expense, general and administrative expense and impairment of
equipment expense. EBITDA is provided because it is a measure commonly used
by investors to analyze and compare companies on the basis of operating
performance. EBITDA is presented to enhance an understanding of the
Company's operating results and is not intended to represent cash flows or
results of operations in accordance with generally accepted accounting
principles ("GAAP") for the periods indicated. EBITDA is not a measurement
under GAAP and is not necessarily comparable with similarly titled measures
for other companies. EBITDA margin represents EBITDA as a percentage of
total revenue.

(5) Adjusted to give effect to the sale of 1,700,000 shares of Common Stock
offered by the Company hereby at the initial public offering price of $13.00
per share, after deducting the underwriting discount and estimated expenses
of the Offering payable by the Company, the application of the net proceeds
therefrom, the exercise of the Warrant and the conversion of all of the
outstanding shares of preferred stock to Common Stock. See "Use of Proceeds"
and "Capitalization."

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<PAGE> 7

RISK FACTORS

The shares offered hereby involve a high degree of risk. The factors set
forth below, along with the other information contained herein, should be
considered carefully in evaluating an investment in the shares of Common Stock
offered hereby. Further, this Prospectus contains certain forward-looking
statements that involve risks and uncertainties, such as statements of the
Company's plans, goals, objectives, expectations and intentions. The cautionary
statements made in this Prospectus apply to all related forward-looking
statements wherever they appear in this Prospectus. Prospective investors in the
shares of Common Stock offered hereby are cautioned that, while the
forward-looking statements reflect the Company's good faith beliefs, they are
not guarantees of future performance, and involve known and unknown risks and
uncertainties. In addition, the Company's actual results could differ materially
from those discussed herein. Some of the factors that could cause or contribute
to such differences include those discussed below, as well as those discussed
elsewhere in this Prospectus.

LIMITED OPERATING HISTORY; OPERATING LOSSES

The Company was incorporated in December 1994 and commenced offering
Internet access in January 1995. Accordingly, the Company has only a limited
operating history upon which an evaluation of its prospects can be made. Such
prospects must be considered in light of the substantial risks, expenses and
difficulties encountered by new entrants into the Internet services industry.
Moreover, the Company's current management, a number of whom joined the Company
as recently as the first and second quarters of fiscal 1997, is relatively new.
Although the Company had net profits for each of its last five fiscal quarters,
the Company had net losses in every preceding quarter since it commenced
operations. As of September 30, 1998, the Company had an accumulated deficit of
approximately $6.3 million. The Company's ability to maintain profitability and
positive cash flow is dependent upon a number of factors, including the
Company's ability to increase revenues while reducing costs per subscriber and
achieving economies of scale. Based upon current expansion plans, the Company
expects to incur operating losses in future periods as it incurs significant
expenses associated with its entry into new markets. There can be no assurance
that the Company will be successful in increasing or maintaining revenues or
achieving or sustaining economies of scale or positive cash flow in the future,
and any such failure could have a material adverse effect on the Company's
business, financial condition and results of operations. See "-- Factors
Affecting Operating Results; Potential Fluctuations in Quarterly Results,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview" and "-- Selected Quarterly Results of Operations,"
"Business -- Competition" and "Management -- Executive Officers and Directors."

FACTORS AFFECTING OPERATING RESULTS; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS

The Company's future success depends on a number of factors, many of which
are beyond the Company's control. These factors include the rates of and costs
associated with new customer acquisition, customer retention, capital
expenditures and other costs relating to the expansion of operations, the timing
of new product and service announcements, changes in the Company's pricing
policies and those of its competitors, market acceptance of new and enhanced
versions of the Company's services, changes in operating expenses, changes in
the Company's strategy, personnel changes, the introduction of alternative
technologies, the effect of potential acquisitions, increased competition in the
Company's current and prospective markets and other general economic factors.

The Company's operating results, cash flows and liquidity may fluctuate
significantly in the future. The Company's revenues depend on its ability to
attract and retain subscribers. Internet America's monthly customers, who
account for a majority of the Company's revenues, have the option of
discontinuing their service at the end of any given month for any reason. The
percentage of customers discontinuing service on a monthly or other basis is
currently immaterial. The Company's expense levels are based, in part, on its
expectations as to future revenues. Moreover, the Company's operations often
require up-front expenses, but result in trailing revenues. To the extent that
revenues are below expectations, the Company may be unable or unwilling to
reduce expenses proportionately, and operating results, cash flow and liquidity
are likely to be adversely affected. In addition, the Company has in recent
periods experienced increasing customer utilization
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<PAGE> 8

rates, which increases the Company's expenses. To remain competitive from a
pricing standpoint, the Company may not be able to increase customer fees to
match these increasing expenses and therefore could experience deteriorating
profit margins or losses. In addition, the Company's planned entry into new
markets will involve substantial initial expenditures on advertising, customer
care and other operating needs which will result in operating losses in future
periods. Due to these and other factors, in some future quarter the Company's
operating results and/or growth rate may be below the expectations of analysts,
management and investors, which could materially adversely affect the value of
the Common Stock.

RISKS OF TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS

The market for Internet access is characterized by rapidly changing
technology, evolving industry standards, changes in customer needs and frequent
new service introductions. The Company's future success will depend, in part, on
its ability to use leading technologies effectively, to continue to develop its
technical expertise and to enhance its existing services and develop new
services to meet changing customer needs on a timely and cost-effective basis.
There can be no assurance that the Company will be successful in using new
technologies effectively, developing new services or enhancing existing services
on a timely basis or that such new technologies or enhancements will achieve
market acceptance. The Company believes that its ability to compete successfully
is also dependent upon the continued compatibility and interoperability of its
services with products and architectures offered by various vendors. Although
the Company intends to support emerging standards in the market for Internet
services, there can be no assurance that industry standards will be established
or, if they become established, that the Company will be able to conform to
these new standards in a timely fashion and maintain a competitive position in
the market. In addition, there can be no assurance that services or technologies
developed by others will not render the Company's services or technology
uncompetitive or obsolete.

The Company is also at risk to fundamental changes in the way Internet
access is delivered. Currently, Internet services are accessed primarily by
computers connected by telephone lines. There are currently available or under
development a number of alternative methods for users to access the Internet,
including cable television modems, high speed dedicated access, screen based
telephones, satellite technologies, wireless telecommunications technologies and
other consumer electronic devices. The methods have the ability to transmit data
at substantially faster speeds than the modems the Company currently uses. As
the Internet becomes more accessible through these alternative methods, or as
customer requirements change the way Internet access is provided, the Company
will face additional competitive pressures and will have to develop or use new
technology or modify its existing technology, either internally or through
arrangements with third parties, to accommodate these changes. See
"Competition." Adjusting to such technological advances may require substantial
time and expense, and there can be no assurance that the Company will succeed in
addressing these competitive pressures or adapting its business to alternative
access methods.

DEPENDENCE ON NETWORK INFRASTRUCTURE; CAPACITY; RISK OF SYSTEM FAILURE

The future success of the Company's business will depend to a large extent
on the capacity, reliability and security of its network infrastructure. The
Company will be required to expand and adapt its network infrastructure as the
number of customers and the amount and type of information they wish to transfer
increase. Such expansion and adaptation of the Company's network infrastructure
will require substantial financial, operational and management resources. In
order to address anticipated growth in its existing markets, the Company
believes that it will require up to $750,000 for capital expenditures on network
infrastructure during the next twelve months and expects the source of these
funds to be drawn from the proceeds of the Offering. However, there can be no
assurance that the Company will be able to expand or adapt its network
infrastructure to meet additional demand or changing customer requirements on a
timely basis and at a commercially reasonable cost, or at all. See "Use of
Proceeds."

Capacity constraints have occurred and may occur in the future, both at the
level of particular POPs (affecting only customers attempting to use the
particular POP) and in connection with system wide services (such as e-mail and
newsgroup services). From time to time, the Company has experienced delayed
delivery from suppliers of new telephone lines, modems, terminal servers and
other equipment. If delays of this nature
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<PAGE> 9

are severe, all incoming modem lines may become full during peak times,
resulting in busy signals for customers who are trying to connect to the
Internet through the Company. Further, if the Company does not maintain
sufficient bandwidth capacity in its network connections, customers will
perceive a general slowdown of all services on the Internet. Similar problems
can occur if the Company is unable to expand the capacity of its information
servers (for e-mail, news and the World Wide Web) fast enough to keep up with
demand from an expanding subscriber base with increasing utilization rates. If
the capacity of such servers is exceeded, customers will experience delays when
trying to use a particular service. As the majority of the Company's
information traffic flows through the Dallas POP, a capacity constraint,
supplier delay or other slowdown at the Dallas POP or operations infrastructure
would affect a majority of the Company's customers and operations. Any of these
events could cause customers to terminate use of the Company's services.
Accordingly, while the Company's objective is to maintain excess capacity, any
failure of the Company to expand or enhance its network infrastructure on a
timely basis or to adapt it to an expanding subscriber base, changing customer
requirements or evolving industry standards could materially adversely affect
the Company's business, financial condition and results of operations.

The Company's operations and services are dependent on the extent to which
the equipment of the Company is protected against damage from fire, earthquakes,
power loss, telecommunications failures and similar events. A significant
portion of the Company's equipment, including critical equipment dedicated to
its Internet access services, is located at a single facility in Dallas, Texas.
Despite precautions taken by the Company, the occurrence of a natural disaster
or other unanticipated problems at the Company's headquarters, network hub or a
POP could cause interruptions in the services provided by the Company. The
Company does not currently maintain fully redundant or back-up Internet
services, backbone facilities or other computing and telecommunications
facilities. See "Business -- Systems Infrastructure." Any accident, incident or
system failure that causes interruptions in the Company's operations could have
a material adverse effect on the Company's ability to provide Internet services
to its customers and, in turn, on the Company's business, financial condition
and results of operations. See "-- Dependence on Telecommunications Carriers and
Other Suppliers" and "-- Security Risks."

The Company's billing and management information systems are also dependent
on the extent to which the computer equipment and attendant software of the
Company is protected against damage, malfunction or other loss. The Company
bills the majority of its customers by automatic charges to customers' credit
cards or bank accounts each month in advance, while some customers are invoiced.
Any damage to or system failure of the Company's billing and management
information systems could have a material adverse effect on the Company's
business, financial condition and results of operations. See "-- Security
Risks."

DEPENDENCE ON TELECOMMUNICATIONS CARRIERS AND OTHER SUPPLIERS

The Company relies on local telephone companies and other companies to
provide data communications capacity via local telecommunications lines and
leased long-distance lines, usually through contracts effective for terms of one
to three years. The Company has experienced and is subject to disruptions or
capacity constraints in these telecommunications services and may have no means
of replacing these services, on a timely basis or at all, in the event of such
disruption or capacity constraints. The Company has in the past temporarily lost
service in a market area, although these problems are usually cured within 24
hours. In addition, local phone service is sometimes available only from the
local monopoly telephone company in each of the markets served by the Company.

In addition, the Company provides Internet access exclusively through
Virtual POPs in some markets. See "Business -- Infrastructure." The inability or
unwillingness of any third-party to provide POP access to the Company's
customers or the Company's inability to secure alternative POP arrangements upon
partial or complete termination of a third-party network provider agreement or
other loss of access to such POPs could significantly limit the Company's
ability to provide Internet access to its customers and could limit the
Company's ability to expand in new markets, which could, in turn, have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that, if access to one or more
Virtual POPs is lost, any alternative arrangements will be available or, if
available, that such arrangements will be on terms acceptable to the Company.
The Company does not currently have any plans or
9
<PAGE> 10

commitments with respect to such alternative POP arrangements. Moreover, while
the third-party providers are contractually obligated to provide commercially
reliable service to the Company's customers with a significant assurance of
accessibility to the Internet, there can be no assurance that such services or
Internet access will meet the Company's requirements, which could materially
adversely affect the Company's business, financial condition and results of
operations.

The Company's operations and services are dependent on the extent to which
the equipment of its third-party network providers (over which the Company has
no control) is protected against damage from fire, earthquakes, power loss,
telecommunications failures and similar events. Any accident, incident, system
failure or discontinuance of operations involving a third-party network that
causes interruptions in the Company's operations could have a material adverse
effect on the Company's ability to provide Internet services to its customers
and, in turn, on the Company's business, financial condition and results of
operations. In addition, failure of the Company's telecommunications providers
to provide the required data communications capacity as a result of a natural
disaster, operational disruption or for any other reason could cause
interruptions in the services provided by the Company.

The Company is dependent on certain third-party suppliers of hardware
components. Expansion of network infrastructure by the Company and others is
placing, and will continue to place, a significant demand on the Company's
suppliers, some of which have limited resources and production capacity. Failure
of the Company's suppliers to adjust to meet such increasing demand may prevent
them from continuing to supply components and products in the quantities, at the
quality levels and at the times required by the Company, or at all. The
Company's inability to develop alternative sources of supply, if required, could
result in delays and increased costs in expanding the Company's network
infrastructure, which could have a material adverse effect on the Company's
business, financial condition and results of operations.

The Company's telecommunications carriers and suppliers also sell, lease or
make available products and services to the Company's competitors and may be, or
in the future may become, competitors of the Company themselves. There can be no
assurance that the Company's telecommunications carriers and suppliers will not
enter into exclusive arrangements with the Company's competitors or stop
selling, leasing or making available their products or services to the Company
at commercially reasonable prices, or at all. See "-- Competition."

RISKS ASSOCIATED WITH GROWTH STRATEGY AND ACQUISITIONS

Although the Company has tested each component of its growth strategy in
its existing markets, the Company has not attempted to introduce its user
density business model to other markets. There can be no assurance that the
Company will be successful in implementing its growth strategy, and any failure
could have a material adverse effect on the Company's business, financial
condition and results of operations. One component of its growth strategy, the
strategic acquisition of businesses and subscriber accounts, involves certain
risks, including, among others, the following: the difficulty of assimilating
the acquired operations and personnel; the potential disruption of the Company's
ongoing business; the possible inability of management to maximize the financial
and strategic position of the Company by the successful incorporation of
acquired technology and rights into the Company's service offerings and to
maintain uniform standards, controls, procedures and policies; the risks of
entering markets in which the Company has little or no direct prior experience;
and the potential impairment of relationships with employees and customers as a
result of changes in management. There can be no assurance that the Company will
be successful in overcoming these risks or any other problems encountered in
connection with future transactions. In addition, any such transaction could
materially adversely affect the Company's operating results due to dilutive
issuances of equity securities, the incurrence of additional debt and the
amortization of expenses related to goodwill and other intangible assets, if
any.

COMPETITION

The market for the provision of Internet access to individuals and small
businesses is extremely competitive and highly fragmented. There are no
substantial barriers to entry, and the Company expects that competition will
continue to intensify. The Company believes that the primary competitive factors
determin-

10
<PAGE> 11

ing success in this market are a reputation for reliability and service,
effective customer support, pricing, creative marketing, easy-to-use software
and geographic coverage. Other important factors include the timing of
introductions of new services and industry and general economic trends. There
can be no assurance that the Company will be able to compete successfully
against current or future competitors or that competitive pressures faced by the
Company will not materially adversely affect its business, financial condition
and results of operations.

The Company's current and prospective competitors include many large
companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company currently
competes or expects to compete with the following types of Internet services
providers: (i) national commercial providers, such as Verio, Inc., Mindspring
Enterprises, Inc. and EarthLink Network, Inc.; (ii) numerous regional and local
commercial providers, which vary widely in quality, service offerings and
pricing, such as Websight Services, Inc. and PDQ Net, Inc.; (iii) established
online commercial information service providers, such as America Online, Inc.;
(iv) computer hardware and software and other technology companies, such as
International Business Machines Corporation, Microsoft Corp. and Gateway, Inc.;
(v) national telecommunications providers, such as AT&T Corp. ("AT&T"), MCI
WorldCom, Inc. ("MCI"), Sprint Corporation ("Sprint") and WinStar
Communications, Inc.; (vi) regional telecommunications providers, such as SBC
Communications and IXC Communications; (vii) cable operators, such as Tele-
Communications, Inc., Time Warner, Inc., TCA Cable, Inc. and Marcus Cable, Inc.;
(viii) wireless communications companies; (ix) satellite companies; and (x)
nonprofit or educational Internet access providers. The Company believes that
new competitors, including large computer hardware and software, media and
telecommunications companies, will continue to enter the Internet services
market, resulting in even greater competition for the Company. In particular,
the Company expects to face increased competition in the future from companies
that provide connections to consumers' homes, including local and long distance
telephone companies, cable companies, electric utility companies and wireless
communications companies. Technologies have been developed that enable cable
television operators to offer Internet access through their cable facilities at
significantly faster rates than existing modem speeds. Such companies can
include Internet access in their basic bundle of services or offer such access
for a nominal additional charge, and could prevent the Company from delivering
Internet access through the wire and cable connections that such companies own.
In addition, as consumer awareness of the Internet grows, existing competitors
are likely to further increase their emphasis on Internet access services,
resulting in even greater competition for the Company. Any such developments
could materially adversely affect the Company's business, financial condition
and results of operations. See "Business -- Competition."

As a result of increased competition in the industry, the Company expects
to encounter significant pricing pressure. Reductions in rates charged by the
Company's competitors could require the Company to reduce prices charged to its
customers, which could cause a decrease in total revenues and revenue per
customer and reduce the likelihood of the Company maintaining positive cash flow
or profitability in the future. Any such reductions in prices could materially
adversely affect the Company's business, financial condition and results of
operations. In addition, telecommunications companies may be able to offer
customers reduced communications costs in connection with their Internet access
services, reducing the overall cost of such services and significantly
increasing price pressures on the Company. Competition could also result in
increased selling and marketing expenses, related customer acquisition costs and
customer attrition, all of which could materially adversely affect the Company's
business, financial condition and results of operations. There can be no
assurance that the Company will be able to offset the effects of any such
increased costs or reductions in the Company's prices through an increase in the
number of its customers, higher revenues from enhanced services, cost reductions
or otherwise, or that the Company will have the resources to continue to compete
successfully.

DEPENDENCE ON AND ABILITY TO ATTRACT KEY PERSONNEL

The Company's success depends upon the continued efforts of its senior
management team and its technical, marketing and sales personnel. Such employees
may voluntarily terminate their employment with the Company at any time, as the
Company has no employment agreements with any of its employees. The

11
<PAGE> 12

Company's success also depends on its ability to attract and retain additional
highly qualified management, technical, marketing and sales personnel. The
process of hiring employees with the combination of skills and attributes
required to carry out the Company's strategy is extremely competitive and
time-consuming. There can be no assurance that the Company will be able to
retain or integrate existing personnel or identify and hire additional qualified
personnel. The loss of the services of key personnel, or the inability to
attract additional qualified personnel, could materially adversely affect the
Company's business, financial condition and results of operations.

SECURITY RISKS

Despite the implementation of security measures, the Company's network
infrastructure may be vulnerable to computer viruses, hacking or similar
disruptive problems caused by customers, customers of other ISPs, other
connected Internet sites, the interconnecting networks and the various telephone
networks. Computer viruses or problems caused by third parties could lead to
interruptions, delays or cessation in service to the Company's customers.
Inappropriate use of the Internet by third parties could also potentially
jeopardize the security of confidential information stored in the computer
systems of the Company or its customers, which may cause losses to the Company
or its customers or deter certain persons from subscribing to the Company's
services. Such inappropriate use of the Internet includes attempting to gain
unauthorized access to information or systems, which is commonly known as
"cracking" or "hacking." Although the Company intends to continue to implement
security measures, such measures have been circumvented in the past, and there
can be no assurance that measures implemented by the Company will not be
circumvented in the future. Alleviating problems caused by computer viruses or
other inappropriate uses or security breaches may require interruptions, delays
or cessation in service to the Company's customers, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the Company expects that its customers will
increasingly use the Internet for commercial transactions in the future. Any
network malfunction or security breach could cause these transactions to be
delayed, not completed at all or completed with compromised security. There can
be no assurance that customers or others will not assert claims of liability
against the Company as a result of any such failure. Further, until more
comprehensive security technologies are developed, the security and privacy
concerns of existing and potential customers may inhibit the growth of the
Internet service industry in general and Internet America's customer base and
revenues in particular.

MANAGEMENT AND RISKS OF GROWTH

The rapid execution necessary for the Company to fully exploit the market
for its services requires an effective planning and management process. The
Company's growth has in the past placed, and may in the future place, a
significant strain on the Company's managerial, operational and financial
resources. In order to effectively manage its operations, the Company will be
required to continue to implement and improve its operational, financial and
management information systems and to identify, attract, train, integrate and
retain qualified personnel. These demands will require the addition of new
management personnel and the development of additional expertise by existing
management. In particular, the successful integration of acquired businesses or
assets and the implementation of an expansion strategy will require close
monitoring of quality of service (particularly through Virtual POPs) and, to the
extent management deems necessary, identification and acquisition of physical
sites, acquisition and installation of necessary equipment and
telecommunications facilities, implementation of marketing efforts in new as
well as existing markets, employment of qualified personnel to provide technical
and marketing support for such sites and continued expansion of the Company's
managerial, operational and financial resources to support such development. The
demands on the Company's customer service and technical support resources will
grow as the Company's customer base expands. There can be no assurance that the
Company's customer service and technical support or other resources will be
sufficient to manage any future growth in the Company's business or that the
Company will be able to implement its expansion program in whole or in part.

12
<PAGE> 13

NEW AND UNCERTAIN MARKET; UNCERTAIN ACCEPTANCE OF THE INTERNET AS A MEDIUM OF
COMMERCE AND COMMUNICATION

The market for Internet access and related products is in an early stage of
growth. The Company's success will depend upon the continuing development and
expansion of the Internet and the market for Internet access. Critical issues
concerning commercial and personal use of the Internet (including practice
standards and protocol, security, reliability, cost, ease of use, access and
quality of service) remain uncertain and may affect the growth of Internet use.
See "-- Potential Liability." The acceptance of the Internet for commerce and
communications, particularly by those individuals and enterprises that have
historically relied upon alternative means of commerce and communication,
generally requires that such users accept a new way of conducting business and
exchanging information, that industry participants continue to provide new and
compelling content and applications and that the Internet provide a reliable and
secure computer platform. It is difficult to predict with any assurance the rate
at which the market will grow, if at all, or at which new or increased
competition will result in market saturation. The novelty of the market for
Internet services may also adversely affect the Company's ability to retain new
customers, as customers unfamiliar with the Internet may be more likely to
discontinue the Company's services after an initial trial period than other
customers. If demand for Internet services fails to continue to grow, grows more
slowly than anticipated or becomes saturated with competitors, the Company's
business, operating results and financial condition will be materially adversely
affected. Conversely, to the extent that the Internet continues to experience
significant growth in the number of users and level of use, there can be no
assurance that the Internet infrastructure will be able to support the demands
placed on it by such growth.

POTENTIAL LIABILITY

The Company has limited control over its customers' online practices and
the information passed through and stored on its systems by its customers. The
law relating to the liability of Internet access providers and online services
companies for incorrect use of the Internet and information carried on or
disseminated through their networks is unsettled. On June 22, 1998, the United
States Supreme Court declined to review a Fourth Circuit Court of Appeals
decision in which a negligence action was brought against an ISP for allegedly
delaying the removal of defamatory messages posted by an Internet user, refusing
to post retractions of those messages and failing to screen for similar postings
thereafter. The Fourth Circuit Court of Appeals affirmed the lower court's
decision that the Communications Decency Act of 1996 bars the claims against the
ISP. Although no such claims or lawsuits have been asserted against the Company
to date, there can be no assurance that such claims will not be asserted in the
future, or if asserted, will not be successful. As the law in this area
develops, the potential imposition of liability upon the Company for information
carried on and disseminated through its network could require the Company to
implement measures to reduce its exposure to such liability, which may require
the expenditure of substantial resources or the discontinuation of certain
service offerings. Any costs that are incurred as a result of contesting any
such asserted claims or the consequent imposition of liability could materially
adversely affect the Company's business, financial condition and results of
operations.

In addition, the Communications Decency Act of 1996 imposes fines on any
entity that: (i) by means of a telecommunications device, knowingly sends
indecent or obscene material to a minor; (ii) by means of an interactive
computer service sends or displays indecent material to a minor; or (iii)
permits any telecommunications facility under such entity's control to be used
for the purposes detailed above. The standard for determining whether an entity
acted knowingly has not yet been established. Certain defenses to liability
under the statute are available but may not apply. Although the Company does not
actively monitor the content of its customers' Internet transmissions, there can
be no assurance that the Company would not be considered to have knowledge of
such content. Although no such claims or lawsuits have been asserted against the
Company to date, there can be no assurance that if the Company were prosecuted
that any defenses to liability would be applicable.

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<PAGE> 14

PROPRIETARY RIGHTS; INFRINGEMENT CLAIMS

The Company's success depends in part upon its technology. The Company
relies upon a combination of copyright, trademark and trade secret laws, and
contractual restrictions to establish and protect its proprietary technology.
There can be no assurance that the steps taken by the Company will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology.

The Company has obtained permission and, in certain cases, licenses from
each manufacturer of software that the Company bundles in its front-end software
product for customers. Although the Company does not believe that the software
or the trademarks it uses infringe on the proprietary rights of any third
parties, and no such claims or lawsuits have been asserted against the Company
to date, there can be no assurance that third parties will not assert such
claims against the Company in the future or that such claims will not be
successful. The Company could incur substantial costs and diversion of
management resources with respect to the defense of any claims relating to
proprietary rights, which could materially adversely affect the Company's
business, financial condition and results of operations. In the event a claim
relating to the proprietary technology or information is asserted against the
Company, the Company may seek licenses to such intellectual property. There can
be no assurance, however, that licenses could be extended or obtained on
commercially reasonable terms, if at all, or that the terms of any offered
licenses will be acceptable to the Company. The failure to obtain the necessary
licenses or other rights could materially adversely affect the Company's
business, financial condition and results of operations. See
"Business -- Proprietary Rights."

THE YEAR 2000 ISSUE

The Year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in system failures or miscalculations, causing disruptions of
operations, including, among others, a temporary inability to process
transactions, send invoices or engage in similar normal business activities. The
Company does not believe that the Year 2000 issue will have a material effect on
its network, computer systems or operations, although it is continuing to
evaluate its information and other systems technology to identify and address
Year 2000 issues. Any failure of the Company to become Year 2000 compliant on a
timely basis could have a material adverse effect on the Company's business,
financial condition and results of operations, including, without limitation, a
complete failure or degradation of the performance of the Company's network or
other systems. The Company is heavily dependent on a significant number of
third-party vendors to provide both network services and equipment. Most of the
Company's critical third-party providers have made representations to the effect
that they are, or will be, Year 2000 compliant. The Company, however, has not
undertaken an in-depth evaluation of its critical or other third-party providers
in relation to the Year 2000 issue, and furthermore the Company has no control
over whether its third-party providers are, or will be, Year 2000 compliant. Any
failure on the part of such third-party providers to become Year 2000 compliant
on a timely basis or in a manner that is compatible with the Company's systems
could have a material adverse effect on the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Year
2000 Compliance."

GOVERNMENT REGULATION

The Company provides Internet access, in part, through transmissions over
public telephone lines. These transmissions are governed by regulatory policies
establishing charges and terms for communications. The Company, as an Internet
access provider, is not currently subject to direct regulation by the Federal
Communications Commission (the "FCC") or any other agency, other than
regulations applicable to businesses generally. In a report to Congress adopted
on April 10, 1998, the FCC reaffirmed that Internet access providers should be
classified as unregulated "information service providers" rather than regulated
"telecommunications providers" under the terms of the 1996 Telecommunications
Act. The consequence of this finding is that the Company is not subject to
regulations applicable to telephone companies and similar carriers merely
because the Company provides its services via telecommunications networks. The
Company

14
<PAGE> 15

also is not required to contribute to the universal service fund, which
subsidizes phone service for rural and low income consumers and supports
Internet access among schools and libraries. The FCC action may also discourage
states from regulating Internet access providers as telecommunications carriers
or imposing similar subsidy obligations.

Nevertheless, Internet-related regulatory policies are continuing to
develop, and it is possible that the Company could be exposed to regulation in
the future. For example, in the same report to Congress, the FCC stated its
intention to consider whether to regulate voice and fax telephony services
provided over the Internet as "telecommunications" even though Internet access
itself would not be regulated. The FCC is also considering whether such
Internet-based telephone services should be subject to the universal service
support obligations discussed above, or should pay carrier access charges on the
same basis as traditional telecommunications companies. Access charges are
assessed by local telephone companies to long distance companies for the use of
the local telephone network to originate and terminate long distance calls,
generally on a per-minute basis. Access charges have been a matter of continuing
dispute, with long distance companies complaining that the rates are
substantially in excess of cost and local telephone companies arguing that
access rates are justified to subsidize lower local rates for end users and
other purposes. Both local and long distance companies, however, contend that
Internet-based telephony should be subject to these charges. The Company
currently does not offer telephony, and so is not directly affected by these
developments, however, should the Company offer telephony in the future, it may
be affected by these issues. Additionally, the Company cannot predict whether
these debates will cause the FCC to reconsider its current policy of not
regulating Internet access providers.

In a notice of proposed rulemaking adopted on August 6, 1998, the FCC
proposed that if an incumbent LEC established a separate affiliate to pursue the
deployment of advanced telecommunications services such as xDSL and that
affiliate interconnected with the LEC's network on the same terms and conditions
as the LEC's competitors did, then the affiliate would not be subject to the
unbundling requirement that applied to the LEC. If the FCC ultimately adopted
this proposal or similar proposals, the Company's access to xDSL and other
high-speed data transmission methods could be curtailed. Such curtailment could
have a material adverse effect on the Company's business, financial condition
and results of operations.

Due to the increasing popularity and use of the Internet, it is possible
that additional federal, state or other laws and regulations may be adopted with
respect to the Internet, covering issues such as content, privacy, pricing,
encryption standards, consumer protection, electronic commerce, taxation,
copyright infringement and other intellectual property issues. See "-- Potential
Liability." The Company cannot predict the impact, if any, that any future
regulatory changes or development may have on its business, financial condition
and results of operations. Changes in the regulatory environment relating to the
Internet access industry, including regulatory changes that directly or
indirectly affect telecommunication costs or increase the likelihood or scope of
competition from regional telephone companies or others, could have a material
adverse effect on the Company's business, financial condition and results of
operations.

NEED FOR ADDITIONAL CAPITAL

Although the Company believes that the net proceeds of the Offering will be
sufficient to enable the Company to implement its business strategies for at
least the next twelve months, there can be no assurance that the net proceeds
will be sufficient for such purposes, either in the near term or thereafter.
Additionally, the Company may have insufficient capital to respond to
unanticipated technological developments or competitive pressures or to take
advantage of unanticipated opportunities, such as special marketing
opportunities, the development of new services or larger than anticipated
acquisitions of complementary businesses or assets. As a result, the Company may
need to raise additional funds through equity or debt financings. There can be
no assurance that such additional financings will be available on terms
acceptable to the Company or at all. Further, any such financings may be upon
terms that are dilutive or potentially dilutive to the Company's shareholders.
If alternative sources of financing are required, but are insufficient or
unavailable, the Company will be required to modify its growth and operating
plans in accordance with the extent of available funding, which could have a
material adverse effect on the Company's business, financial

15
<PAGE> 16

condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition -- Liquidity and Capital Resources."

CONTROL OF COMPANY

After completion of the Offering, the Company's officers, directors and 10%
shareholders will beneficially own, directly or indirectly, approximately 48.8%
of the outstanding voting stock of the Company, (assuming the exercise of all
derivative securities currently outstanding, such persons would beneficially
own, directly or indirectly, approximately 44.7% of the outstanding voting stock
of the Company). As a result, these shareholders, acting together, would be able
to exercise control over substantially all matters requiring approval by the
shareholders of the Company, including the election of directors and certain
change-of-control transactions. See also "-- Anti-Takeover Matters."

ABSENCE OF A PRIOR PUBLIC MARKET

Prior to the Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
or be sustained. The initial public offering price of the Common Stock was
determined through negotiations among the Company, the Selling Shareholders and
the Underwriters and may not be indicative of the market price for the Common
Stock after the Offering. See "Underwriting" for a discussion of the factors
considered in determining the initial public offering price.

STOCK PRICE VOLATILITY

The trading price of the Common Stock may be subject to wide fluctuations
in response to factors such as actual or anticipated variations in the Company's
operating results; announcements of technological innovations by the Company or
its competitors; new services or contracts; developments with respect to
patents, copyrights or proprietary rights; changes in recommendations or
financial estimates by securities analysts; conditions and trends in the
Internet services and technology industries; adoption of new accounting
standards affecting the Company's industry; general market conditions and other
factors. Further, the stock market has experienced in recent months and may
continue in the future to experience extreme price and volume fluctuations that
particularly affect the market prices of equity securities of Internet services
and technology companies and that often are unrelated or disproportionate to the
operating performance of such companies. The trading prices of many Internet
services and technology companies' stocks have recently been at or near
historical highs and reflect price to earnings ratios that are substantially
above historical levels. There can be no assurance that these trading price to
earnings ratios will be sustained. These broad market price fluctuations, as
well as general economic, political and market conditions, may adversely affect
the market price of the Company's Common Stock. In the past, following periods
of volatility in the market price of a company's stock, securities class action
litigation has often been instituted against the issuing company. There can be
no assurance that such litigation will not occur in the future with respect to
the Company. Such litigation could result in substantial costs and would at a
minimum divert management's attention and resources, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Any adverse determination in such litigation could also subject the
Company to significant liabilities.

SHARES ELIGIBLE FOR FUTURE SALE

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<PAGE> 17

registered under the Securities Act pursuant to the terms of agreements between
such holders and the Company. See "Description of Securities -- Registration
Rights." Of those 1,660,769 shares, 769,149 shares are freely tradeable upon
completion of the Offering, subject in certain cases to the 180-day lock-up
period described below and the 90-day information requirement of Rule 144 for
shares held by affiliates or for less than the required two-year period. The
Company, and its executive officers, directors and certain shareholders
(including all those with registration rights) who will hold, collectively,
3,066,017 outstanding shares of Common Stock after the Offering, have agreed not
to offer or sell any shares of Common Stock for a period of 180 days following
the date of this Prospectus without the prior written consent of Hoak Breedlove
Wesneski & Co., except under limited circumstances. If this 180-day lock-up
period is waived by Hoak Breedlove Wesneski & Co., then 2,459,284 of the
3,066,017 shares would be freely tradeable subject to the 90-day information
requirement of Rule 144 for shares held by affiliates or for less than the
required two-year period. The Company intends to file a Registration Statement
on Form S-8 to register 800,000 shares of Common Stock, which is the aggregate
of all shares reserved for issuance pursuant to the 1996 Option Plan and 1998
Option Plan and shares underlying certain nonqualified options granted to
officers and directors. Accordingly, shares issued upon exercise of such options
will be freely tradeable by holders who are not affiliates of the Company and,
subject to volume and other limitations of Rule 144, by holders who are
affiliates of the Company. Sales of substantial amounts of shares of Common
Stock in the public market after the Offering, or the perception that such sales
could occur, may adversely affect the market price of the Common Stock. See
"Shares Eligible for Future Sale."

ANTI-TAKEOVER MATTERS

The Company's Articles of Incorporation, as amended (the "Articles"), and
Bylaws, as amended ("Bylaws"), contain provisions that may have the effect of
delaying, deterring or preventing a potential takeover of the Company that
shareholders purchasing shares in the Offering may consider to be in their best
interests. The Articles and Bylaws prevent shareholders from calling a special
meeting of shareholders, prevent shareholders from amending the Bylaws and
prohibit shareholder action by written consent. The Articles also authorize only
the Board of Directors to fill vacancies, including newly-created directorships,
and state that directors of the Company may be removed only for cause and only
by the affirmative vote of holders of at least two-thirds of the outstanding
shares of the voting stock, voting together as a single class. Article XIII of
the Texas Business Corporation Act, which is applicable to the Company, contains
provisions that restrict certain business combinations with interested
shareholders, which may have the effect of inhibiting a non-negotiated merger or
other business combination involving the Company. See "Description of
Securities -- Texas Anti-Takeover Law and Certain Provisions."

IMMEDIATE AND SUBSTANTIAL DILUTION

Investors purchasing shares of Common Stock in this Offering will incur
immediate and substantial dilution in net tangible book value of the Common
Stock of $10.41 per share on a pro forma basis. If all currently exercisable
derivative securities are exercised, investors will incur total dilution in net
tangible book value of the Common Stock of $10.50 per share on a pro forma
basis. See "Dilution."

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<PAGE> 18

USE OF PROCEEDS

The net proceeds to the Company from the sale of 1,700,000 shares of Common
Stock offered hereby by the Company at the initial public offering price of
$13.00 per share are estimated to be approximately $20.1 million, after
deducting the underwriting discount and estimated offering expenses payable by
the Company. The Company will not receive any of the proceeds from the sale of
shares of Common Stock by the Selling Shareholders.

The principal purposes of the Offering are to increase the Company's equity
capital, to create a public market for the Common Stock, to facilitate the
future access by the Company to public equity markets, to facilitate
acquisitions funded through the issuance of Common Stock, to provide liquidity
for certain of the Company's existing shareholders and to provide increased
visibility of the Company in the marketplace.

The Company anticipates that the net proceeds of the Offering will be
applied as follows, subject to the qualifications set forth further below:

<TABLE>
<CAPTION>
APPROXIMATE
USE OF PROCEEDS DOLLAR AMOUNT PERCENT
--------------- ------------- -------
<S> <C> <C>
Possible acquisitions of complementary businesses or
expansion in existing and new markets..................... $ 8,000,000 40.0%
Marketing expenses and capital equipment and infrastructure
expenditures related to anticipated growth................ 6,500,000 32.3
Repayment of indebtedness(1)................................ 2,300,000 11.4
General corporate purposes(2)............................... 3,300,000 16.3
----------- ----
Total............................................. $20,100,000 100%
=========== ====
</TABLE>

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

(1) Specifically the following (as of September 30, 1998): (a) indebtedness
owing to Jack T. Smith, a director of the Company, in the aggregate
approximate amount of $272,000, and indebtedness owing to Carl Westcott, a
principal shareholder of the Company, in the aggregate approximate amount of
$1.5 million (collectively, the "Affiliate Debt"); (b) indebtedness owing to
a commercial bank in the aggregate approximate amount of $148,000 (the "Bank
Debt"); (c) indebtedness owing to Webstar, Inc. in connection with the
acquisition of subscribers in the aggregate approximate amount of $352,000
(the "Webstar Debt"); and (d) indebtedness owing to M.J. Capital Partners,
L.P. in connection with a loan for general working capital in the aggregate
approximate amount of $42,000 (the "MJ Debt"). The Affiliate Debt and Bank
Debt both accrue interest at the prime rate. The Webstar Debt accrues
interest at 14% per year, and the MJ Debt accrues interest at 16.5% per
year. The Affiliate Debt and the Bank Debt mature two days after the Company
receives the proceeds of this Offering, while the Webstar Debt matures on
June 30, 1999 and the MJ Debt matures on January 1, 1999. The Bank Debt is
secured by the personal guaranty of William O. Hunt, a director of the
Company, and the pledge of all assets of the Company. See "Certain
Transactions" and Notes 4, 5 and 6 of Notes to Financial Statements.

(2) Such funds could be used for a variety of general corporate purposes,
including, without limitation, further marketing efforts and infrastructure
improvements.

The Company continues to evaluate potential acquisitions, and to identify
and have preliminary discussions with potential acquisition candidates, although
there are, as of the date of this Prospectus, no agreements, arrangements or
understandings between the Company and any party relating thereto.

Pending the above uses of proceeds, the Company intends to invest the net
proceeds of this Offering in short-term bank deposits or investment-grade
securities. The foregoing represents the Company's current intentions with
respect to the allocation of the proceeds of this Offering based upon its
present plans and business conditions. However, changed business conditions and
various other factors could result in the application of the proceeds of this
Offering in a manner other than as described in this Prospectus.

18
<PAGE> 19

DIVIDEND POLICY

To date, the Company has neither declared nor paid any dividends on its
Common Stock nor does the Company anticipate that dividends will be declared or
paid in the foreseeable future. Rather, the Company intends to retain any
earnings to finance the growth and development of its business. Any payment of
cash dividends on its Common Stock in the future will be dependent, among other
things, upon the Company's earnings, financial condition, capital requirements
and other factors which the Board of Directors deems relevant.

CAPITALIZATION

The following table sets forth at September 30, 1998, the capitalization of
the Company: (i) on a historical basis and (ii) as adjusted to reflect the sale
of shares of Common Stock offered hereby at the initial public offering price of
$13.00 per share and the application of the estimated net proceeds therefrom,
the conversion of all outstanding shares of preferred stock into shares of
Common Stock on a 2.25-for-1.00 basis, which will occur not more than 30 days
after completion of the Offering, the exercise of the Warrant and repayment of
substantially all current indebtedness contemporaneously with the Offering. See
"Use of Proceeds" and "Description of Securities -- Preferred Stock." This table
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations," the Company's Financial
Statements and Notes thereto and other financial and operating data included
elsewhere in this Prospectus.

<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Long-term debt, net of current portion...................... $ 331 $ 1
Shareholders' equity (deficit):
Preferred Stock, $0.01 par value; 5,000,000 shares
authorized
Series A Preferred Stock, $0.01 par value; 400,000
shares authorized; 379,672 shares issued and
outstanding; no shares issued and outstanding, as
adjusted.............................................. 4 --
Series B Preferred Stock, $0.01 par value; 300,000
shares authorized; 73,667 shares issued and
outstanding; no shares issued and outstanding, as
adjusted.............................................. 1 --
Common Stock, $0.01 par value; 40,000,000 shares
authorized; 3,532,205 shares issued and outstanding;
6,285,957 shares issued and outstanding, as
adjusted(1)(2)......................................... 35 63
Additional paid-in capital................................ 2,816 22,896
Accumulated deficit....................................... (6,297) (6,297)
------- -------
Total shareholders' equity (deficit).............. (3,441) 16,662
------- -------
Total capitalization.............................. $(1,112) $16,663
======= =======
</TABLE>

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

(1) Excludes (i) 225,000 shares reserved for issuance under the 1996 Option
Plan, of which options to purchase 67,075 shares were outstanding at a
weighted average exercise price of $1.67 per share, (ii) 400,000 shares
reserved for issuance under the 1998 Option Plan, of which no options were
outstanding and (iii) 1,212,476 shares of Common Stock issuable upon
exercise of other outstanding options at a weighted average exercise price
of $2.18 per share. See "Management -- 1996 Incentive Stock Option Plan,"
"-- Nonqualified Stock Options Issued to Officers and Directors" and
"-- 1998 Nonqualified Stock Option Plan."

(2) Reflects the amendment of the Company's Articles of Incorporation in July
1998 to increase the authorized Common Stock from 15,000,000 shares to
40,000,000 shares.

19
<PAGE> 20

DILUTION

The deficit in net tangible book value of the Common Stock as of September
30, 1998 was approximately $3.8 million, or $.84 per share, on a pro forma basis
after giving effect to conversion of all outstanding shares of preferred stock
into shares of Common Stock and exercise of the Warrant. Dilution is determined
by subtracting net tangible book value per share after the Offering from the
amount of cash paid by investors for the shares of Common Stock. Net tangible
book value per share represents the book value of the Company's total tangible
assets less total liabilities, divided by the number of outstanding shares of
Common Stock. After giving effect to the sale of the 1,700,000 shares of Common
Stock offered by the Company hereby (at the initial public offering price of
$13.00 per share), and after deducting the underwriting discount and estimated
expenses of the Offering payable by the Company and the application of the net
proceeds therefrom, and assuming no other changes in the net tangible book value
after September 30, 1998, the Company's pro forma net tangible book value as
adjusted at September 30, 1998 would have been approximately $16.3 million, or
$2.59 per share. This represents an immediate increase in net tangible book
value of $3.43 per share to existing shareholders and an immediate decrease in
net tangible book value to new investors of $10.41 per share. The following
table illustrates the per share dilution:

<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $13.00
Deficit in pro forma net tangible book value per share at
September 30, 1998..................................... $(0.84)
Increase per share attributable to new investors.......... 3.43
------
Pro forma net tangible book value per share after this
Offering.................................................. 2.59
------
Dilution per share to new investors......................... $10.41
======
Percentage dilution......................................... 80.1%
======
</TABLE>

The following table sets forth on a pro forma basis the differences between
the existing shareholders and the investors in this Offering with respect to the
total consideration paid or payable and the average price per share paid or
payable:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION(1)
------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ------------ -------- -------------
<S> <C> <C> <C> <C> <C>
Existing Shareholders(2)(3)..... 4,585,957 73.0% $ 2,634,776 10.7% $ 0.57
New Investors(2)................ 1,700,000 27.0% 22,100,000 89.3% 13.00
--------- ----- ----------- -----
Total................. 6,285,957 100.0% $24,734,776 100.0%
========= ===== =========== =====
</TABLE>

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

(1) These amounts reflect total consideration paid by shareholders and do not
reflect net amounts received by the Company.

(2) Sales by the Selling Shareholders in the Offering will reduce the number of
shares held by existing shareholders to 3,985,957 shares, or 63.4% of the
total shares of Common Stock outstanding after the Offering, and will
increase the number of shares held by new investors to 2,300,000 shares, or
36.6% of the total shares of Common Stock outstanding after the Offering. If
the Underwriters' over-allotment option is exercised in full, the number of
shares held by existing shareholders will further decrease to 3,640,957
shares, or 57.9% of the total shares of Common Stock outstanding after the
Offering, and the number of shares held by new investors will further
increase to 2,645,000 shares, or 42.1% of the total shares of Common Stock
outstanding after the Offering. See "Principal and Selling Shareholders."

(3) Assumes the exercise of the Warrant and conversion of all outstanding shares
of preferred stock into shares of Common Stock.

The foregoing computations assume no exercise of outstanding stock options.
Options to purchase 67,075 shares of Common Stock were outstanding under the
1996 Option Plan at a weighted average exercise price of $1.67 per share as of
September 30, 1998. Additional options to purchase 1,212,476 shares of Common
Stock were outstanding as of September 30, 1998 at a weighted average exercise
price of $2.18 per share. If all currently exercisable options are exercised,
investors purchasing shares in the Offering will incur total dilution of $10.50
per share of Common Stock on a pro forma basis. See "Management -- 1996
Incentive Stock Option Plan," "-- Nonqualified Stock Options Issued to Officers
and Directors" and "-- 1998 Nonqualified Stock Option Plan."

20
<PAGE> 21

SELECTED FINANCIAL AND OPERATING DATA

The following selected historical financial data as of and for the years
ended June 30, 1997 and 1998 has been derived from the Company's financial
statements included elsewhere herein and audited by Deloitte & Touche LLP,
independent auditors as set forth in their report thereon also included herein.
The selected historical financial data of the Company for the year ended June
30, 1996 is derived from the Company's audited financial statements not included
herein. The selected historical financial data as of and for the three months
ended September 30, 1997 and 1998 was derived from the Company's financial
statements, which in the opinion of management reflect all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of results for such periods. Results for the three months ended September 30,
1998 are not necessarily indicative of the results that may be expected for the
full fiscal year. The following selected financial data should be read in
conjunction with, and is qualified in its entirety by, "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the Financial
Statements and Notes thereto included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED JUNE 30, SEPTEMBER 30,
------------------------------ -------------------
1996 1997 1998 1997 1998
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND CUSTOMER DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue
Access............................................... $ 3,052 $ 8,177 $ 9,566 $ 2,150 $ 2,896
Business services.................................... 411 1,045 1,036 259 228
Other................................................ 314 249 41 3 17
------- ------- ------- ------- -------
Total revenue................................. 3,777 9,471 10,643 2,412 3,141
Operating expenses
Connectivity and operations.......................... 2,187 6,185 4,509 1,108 1,186
Sales and marketing.................................. 1,597 1,912 1,140 86 593
General and administrative........................... 2,797 2,748 1,919 400 563
Depreciation and amortization........................ 548 1,618 1,474 363 387
Impairment of equipment.............................. -- 351 -- -- --
------- ------- ------- ------- -------
Total operating expenses...................... 7,129 12,814 9,042 1,957 2,729
------- ------- ------- ------- -------
Income (loss) from operations.......................... (3,352) (3,343) 1,601 455 412
Interest expense....................................... 77 481 571 135 76
Income tax expense..................................... -- -- 24 6 10
------- ------- ------- ------- -------
Net income (loss)...................................... $(3,429) $(3,824) $ 1,006 $ 314 $ 326
======= ======= ======= ======= =======
Earnings (loss) per share(1):
Basic................................................ $ (1.15) $ (1.12) $ 0.28 $ 0.10 $ 0.09
Diluted.............................................. $ (1.15) $ (1.12) $ 0.21 $ 0.07 $ 0.07
Weighted average shares(1):
Basic................................................ 2,981 3,418 3,532 3,418 3,532
Diluted.............................................. 2,981 3,418 4,783 4,767 4,783
OTHER DATA:
Approximate number of customers at end of period..... 27,900 39,900 48,600 39,800 50,100
EBITDA(2)............................................ $(2,804) $(1,725) $ 3,075 $ 818 $ 799
EBITDA margin(2)..................................... (74.2)% (18.2)% 28.9% 33.9% 25.4%
Cash flow provided (used) by:
Operating activities............................... $ 390 $(1,430) $ 1,797 $ 451 $ 614
Investing activities............................... (2,981) (1,513) (407) (6) (232)
Financing activities............................... 2,615 2,864 (826) (445) (774)
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
--------------------------- -----------------
1996 1997 1998 1997 1998
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash................................................. $ 79 $ -- $ 565 $ -- $ 173
Working capital (deficit)............................ (3,462) (6,834) (5,962) (6,315) (5,476)
Total assets......................................... 3,127 3,114 3,150 2,769 3,035
Long-term debt, net of current portion............... 373 684 609 272 331
Total shareholders' equity (deficit)................. (1,063) (4,681) (3,767) (4,368) (3,441)
</TABLE>

See notes on following page

21
<PAGE> 22

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

(1) See Notes 1 and 10 of Notes to Financial Statements for information
concerning the calculation of basic and diluted net income (loss) per share.

(2) EBITDA (earnings before interest, taxes, depreciation and amortization)
consists of revenue less connectivity and operating expense, sales and
marketing expense, general and administrative expense and impairment of
equipment expense. EBITDA is provided because it is a measure commonly used
by investors to analyze and compare companies on the basis of operating
performance. EBITDA is presented to enhance an understanding of the
Company's operating results and is not intended to represent cash flows or
results of operations in accordance with GAAP for the periods indicated.
EBITDA is not a measurement under GAAP and is not necessarily comparable
with similarly titled measures for other companies. EBITDA margin represents
EBITDA as a percentage of total revenue.

22
<PAGE> 23

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

The following discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those discussed in the forward-looking statements as a result of certain
factors including those set forth under "Risk Factors" and elsewhere in this
Prospectus. The following discussion and analysis should be read in conjunction
with "Selected Financial and Operating Data" and the Financial Statements and
Notes thereto appearing elsewhere in this Prospectus.

OVERVIEW

Internet America is a leading ISP in the southwestern United States with
more than 50,000 customers, primarily in the North Texas area. From inception
through fiscal 1997, the Company incurred substantial operating losses while
building its infrastructure and rapidly increasing market share. In response to
these losses, the Company moved to reorganize its management and operations
personnel and implement a comprehensive cost control program. At the end of the
third quarter of fiscal 1997, the Company's Board of Directors accepted the
resignation of the President and Chief Executive Officer of the Company. The
Company's new Chief Executive Officer continued the reorganization of the
Company.

The primary elements of the cost control program involved: (i) selective
reduction in customer care, administrative and marketing personnel (reducing
Company personnel from approximately 220 to 80); (ii) elimination of ineffective
marketing programs and (iii) improved cost efficiencies in the Company's network
infrastructure. As a result of the implementation of the Company's cost control
program, management was able to apply positive cash flow to the orderly
reduction of a substantial amount of past due trade payables, thus allowing the
Company to thereafter direct available cash to marketing efforts. By the end of
the first quarter of fiscal 1998, the Company had completed its reorganization
and implementation of the cost control program, and the Company achieved
sustained profitability for the first time.

The reorganization and cost controls implemented by management were
carefully designed not to compromise quality of customer service or customer
care. In fact, in several key ways, management believes that the changes
improved the Company's overall level of service quality, principally through
reorganization of the Company's customer care operations, improved browser
software and enhanced network performance. The Company's customer base remained
stable from the third quarter of fiscal 1997, when the changes began, through
the second quarter of fiscal 1998, after the changes were substantially
implemented, even though the Company had suspended virtually all advertising
during this period. The Company has continued to apply its disciplined approach
to strict cost controls, proven marketing tools and network operating
efficiencies.

Management believes that the Company's experience in implementing and
maintaining the above changes validated important elements of its user density
business model, and also believes that this model can be effectively applied in
other markets. The Company's user density business model focuses on the rapid
development of a profitable base of customers in selected markets. Upon entry
into a new market, the Company will make a strategic acquisition and/or engage
in substantial direct response marketing to quickly gain a critical mass of
customers. The early phases of entering new markets will involve substantial
initial expenditures on advertising, customer care and other operating needs.
Based upon current expansion plans, the Company expects to incur operating
losses in future periods. The initial expenses associated with entering new
markets will offset the positive margins achieved in established markets. The
Company believes that this offset effect will decrease as its new markets mature
and the Company realizes the marketing, network and operating efficiencies
created by user density in those markets. The Company expects that the overall
significance of the offset effect will diminish as the Company's customer base
and revenues increase. Through application of its user density business model in
selected new markets, the Company believes it will be able to achieve economies
of scope and scale similar to those achieved in the Company's existing markets.

The Company's access revenues are derived primarily from individual dial-up
Internet access, whether analog or ISDN, and revenues derived from value-added
services. Airnews.net as a subscription service also contributes to access
revenues. Both types of access revenues are principally derived from monthly
subscription fees and are therefore primarily determined by the number of
customers. The Company derives
23
<PAGE> 24

business services revenues primarily from dedicated connectivity, bulk dial-up
access and Web services. Business services revenues are also generated from the
sale of Airnews.net to other ISPs on a wholesale basis. While monthly
subscriptions are an important component of business services revenues, these
revenues fluctuate because of the wide range of setup fees associated with
different business services and the mix thereof in any given period. Other
revenues are derived from advertising fees and other miscellaneous sources.

A brief description of each element of the Company's operating expenses
follows:

Connectivity and operations expenses consist primarily of the setup
costs for new customers, telecommunication costs and wages of network
operations and customer support personnel. Setup expenses include one-time
license fees for the right to bundle other software into the Company's
software, cost of diskettes and other media, manuals, packaging and
delivery costs. The Company does not defer customer setup expenses, but
expenses such items as incurred. Telecommunications costs include (i) the
costs of providing local telephone lines into each POP (or fees for Virtual
POP connectivity), (ii) leased lines connecting each POP to the Company's
internal network and (iii) connectivity from the internal network to the
Internet.

Sales and marketing expenses consist primarily of creative, media and
production costs, as well as call center employee wages. These expenses
include the cost of the Company's television and billboard advertising
campaigns, as well as other advertising. The Company does not defer any
advertising costs, but expenses such items as incurred.

General and administrative expenses consist primarily of accounting
and administrative personnel wages, professional services, rent and
non-Internet related telephone costs.

Depreciation is computed using the straight line method over the
estimated useful life of the assets. The Company's data communications
equipment, computers, data server and office equipment are depreciated over
a three-year life. The Company depreciates its furniture, fixtures and
leasehold improvements over a five-year life. The acquisition of customer
accounts is amortized over three years. Management anticipates that further
expansion using the Virtual POP technology will cause depreciation as a
percentage of revenue to decrease, with a corresponding increase in
connectivity and operations expenses, as network equipment that would have
been purchased by the Company will now be provided by selected
telecommunications providers.

24
<PAGE> 25

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain items
from the Company's Statement of Operations as a percentage of total revenue.
Operating results for any period are not necessarily indicative of results for
any future period.

<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
JUNE 30, SEPTEMBER 30
----------------------- --------------
1996 1997 1998 1997 1998
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Revenue:
Access................................. 80.8% 86.3% 89.9% 89.1% 92.2%
Business services...................... 10.9 11.1 9.7 10.8 7.3
Other.................................. 8.3 2.6 0.4 0.1 0.5
----- ----- ----- ----- -----
Total revenue.................. 100% 100% 100% 100% 100%
----- ----- ----- ----- -----
Operating expenses:
Connectivity and operations............ 57.9 65.3 42.4 45.9 37.8
Sales and marketing.................... 42.3 20.2 10.7 3.6 18.9
General and administrative............. 74.1 29.0 18.0 16.7 17.9
Depreciation and amortization.......... 14.5 17.1 13.8 15.0 12.3
Impairment of equipment................ -- 3.7 -- -- --
----- ----- ----- ----- -----
Total operating expenses....... 188.8 135.3 84.9 81.2 86.9
----- ----- ----- ----- -----
Income (loss) from operations............ (88.8) (35.3) 15.1 18.8 13.1
Interest expense......................... (2.0) (5.1) (5.4) (5.6) (2.4)
Income tax expense....................... -- -- (0.2) (0.2) (0.3)
----- ----- ----- ----- -----
Net income (loss)........................ (90.8)% (40.4)% 9.5% 13.0% 10.4%
===== ===== ===== ===== =====
</TABLE>

THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997

Total revenue. Total revenue increased by $730,000, or 30.3%, to $3.1
million for the three months ended September 30, 1998 from $2.4 million for the
three months ended September 30, 1997. Access revenue increased by $746,000, or
34.7%, to $2.9 million for the three months ended September 30, 1998 from $2.2
million for the three months ended September 30, 1997. The increase in access
revenue is attributable to increased subscription and activation fees derived
from an increased number of dial-up access customers which totaled 50,100 at
September 30, 1998, as compared to 39,800 at September 30, 1997. Business
services revenue declined by $31,000, or 11.7%, to $228,000 for the three months
ended September 30, 1998 from $259,000 for the three months ended September 30,
1997. The decrease in business services revenue is attributable to a change in
the mix of services sold to include more web hosting and other lower-priced
business services for the three months ended September 30, 1998.

Connectivity and operations. Connectivity and operations expenses increased
by $78,000, or 7.1%, to $1.2 million in the three months ended September 30,
1998 from $1.1 million in the three months ended September 30, 1997, but
decreased to 37.8% of total revenue for the three months ended September 30,
1998 compared to 45.9% of total revenue for the three months ended September 30,
1997. This decrease in expenses as a percentage of revenue is primarily due to
implementation of the Company's comprehensive cost control program, which
resulted in reduced staffing and lower telephone connectivity costs. Operational
wages for the three months ended September 30, 1998 were 16.5% of total revenue
as compared to 20.3% of total revenue for the three months ended September 30,
1997. Telephone connectivity expenses for the three months ended September 30,
1998 were 13.4% of total revenue as compared to 17.3% of total revenue for the
three months ended September 30, 1997.

Sales and marketing. Sales and marketing expenses increased by $507,000, or
590.4%, to $593,000 for the three months ended September 30, 1998 from $86,000
for the three months ended September 30, 1997. Sales and marketing expenses for
the three months ended September 30, 1997 were primarily call center

25
<PAGE> 26

employee wages for the 1-800-BE-A-GEEK phone number. The Company had suspended
virtually all television and print advertising during the three months ended
September 30, 1997. Sales and marketing expenses for the three months ended
September 30, 1998 included $470,000 in television, print, and billboard
advertising. Approximately $92,000, or 20%, of these advertising expenditures
for the three months ended September 30, 1998 were incurred for the production
of new television commercials to be used in building brand awareness in new
markets.

General and administrative. General and administrative expenses increased
to $563,000, or 40.8%, for the three months ended September 30, 1998, compared
to $400,000 for the three months ended September 30, 1997. This increase of
$163,000 is primarily due to additional payroll costs and professional fees
related to the Company's growth.

Depreciation and amortization. Depreciation and amortization increased by
$24,000, or 6.5%, to $387,000 for the three months ended September 30, 1998 from
$363,000 for the three months ended September 30, 1997, due to routine increases
in property and equipment and an add-on acquisition of a subscriber base in the
Company's existing market in December 1997.

Interest expense. Interest expense decreased by $59,000, or 43.3%, to
$76,000 for the three months ended September 30, 1998 from $135,000 for the
three months ended September 30, 1997. The decrease in interest expense is due
to a restructuring of notes payable to shareholders on June 30, 1998, which
included a reduction in interest rates from 18% to prime rate (8.25% at
September 30, 1998).

YEAR ENDED JUNE 30, 1998 COMPARED TO YEAR ENDED JUNE 30, 1997

Total revenue. Total revenue increased by $1.2 million, or 12.4%, to $10.6
million for fiscal 1998 from $9.5 million for fiscal 1997. Access revenue
increased by $1.4 million, or 17.0%, to $9.6 million for fiscal 1998 from $8.2
million for fiscal 1997. The increase in access revenue is primarily
attributable to increased subscription fees derived from an increased number of
dial-up access customers which totaled 48,600 at June 30, 1998, as compared to
39,900 at June 30, 1997. Business services revenue declined by $9,000, or 1.0%,
to $1,036,000 for fiscal 1998 from $1,045,000 for fiscal 1997. Other revenue
decreased by $208,000, or 83.4%, to $41,000 for fiscal 1998 from $249,000 for
fiscal 1997. The decrease in other revenue is primarily attributable to the
termination of a contract to provide customer care services to another ISP and
the termination of charges for browser software provided to customers.

Connectivity and operations. Connectivity and operations expenses decreased
by $1.7 million, or 27.1%, to $4.5 million for fiscal 1998 from $6.2 million for
fiscal 1997. The majority of the reduction in these expenses is associated with
the cost control program which commenced in the fourth quarter of fiscal 1997,
including (i) a decrease in wages of approximately $1.4 million resulting from
reduced staffing, (ii) a decrease in software costs of $169,000 and (iii) a
decrease in Internet and telephone connectivity costs of $118,000 due to
improved cost efficiencies in the Company's network infrastructure.

Sales and marketing. Sales and marketing expenses decreased by $772,000, or
40.4%, to $1.1 million for fiscal 1998 from $1.9 million for fiscal 1997. For
fiscal 1998, the Company suspended virtually all advertising until a new
television advertising campaign began in January 1998. For fiscal 1998,
marketing payroll and consulting fees declined by $558,000, or 57.3%, and
advertising and promotional costs declined by $202,000, or 21.5%.

General and administrative. General and administrative expenses decreased
by $828,000, or 30.1%, to $1.9 million for fiscal 1998 from $2.7 million for the
same period in the prior year. The decrease in general and administrative
expenses was primarily due to decreased staffing, and decreases in telephone
expenses, professional services and equipment leases in connection with the
Company's cost control program.

Depreciation and amortization. Depreciation and amortization decreased by
$144,000, or 8.9%, to $1.5 million for fiscal 1998 from $1.6 million for fiscal
1997.

26
<PAGE> 27

Interest expense. Interest expense increased by $90,000, or 18.7%, to
$571,000 for fiscal 1998 from $481,000 for fiscal 1997. This increase in
interest expense relates primarily to interest on certain indebtedness accruing
at a default rate of 18%. See "Certain Transactions."

YEAR ENDED JUNE 30, 1997 COMPARED TO YEAR ENDED JUNE 30, 1996

Total revenue. Total revenue increased by $5.7 million, or 151%, to $9.5
million for fiscal 1997 from $3.8 million for fiscal 1996. Access revenue
increased by $5.1 million, or 168%, to $8.2 million for fiscal 1997 from $3.1
million for fiscal 1996. The increase in access revenue is primarily
attributable to increased subscription fees derived from an increased number of
dial-up access customers, which totaled 39,900 at June 30, 1997 as compared to
27,900 at June 30, 1996. During fiscal 1997, the Company introduced its
Airnews.net service, which resulted in an increase in access revenue of
approximately $141,000. Business services revenue increased by $634,000, or
154%, to approximately $1.0 million in fiscal 1997 from $411,000 in fiscal 1996.
In fiscal 1997 business services revenue increased as a result of the addition
of new business customers and price increases. Other revenue decreased by
$65,000, or 20.7%, to $249,000 in fiscal 1997 from $314,000 in fiscal 1996. The
decrease in other revenue is primarily attributable to a decline in fees charged
under a contract to provide customer services to another ISP.

Connectivity and operations. Connectivity and operations expenses increased
by $4.0 million, or 183%, to approximately $6.2 million in fiscal 1997 from $2.2
million in fiscal 1996. These expenses increased as a result of increased
customer support wages and increased connectivity expenses related to the
increase in the number of customers and excessive staffing during fiscal 1997
prior to the Company's reorganization and implementation of its cost control
program.

Sales and marketing. Sales and marketing expenses increased by $315,000, or
19.7%, to $1.9 million for fiscal 1997 from $1.6 million for fiscal 1996. This
increase was primarily a result of increased staffing in sales and marketing and
the cost of providing promotional kits to customers.

General and administrative. General and administrative expenses of $2.7
million remained relatively constant from fiscal 1996 to fiscal 1997.

Depreciation and amortization. Depreciation and amortization expenses
increased by $1.1 million, or 195%, to $1.6 million in fiscal 1997 from $548,000
in fiscal 1996 as the Company's fixed assets continued to grow with subscriber
growth. In fiscal 1997, the Company also recognized amortization expenses
related to the acquisition of an ISP located in San Angelo, Texas.

Impairment of equipment. Operating expenses for fiscal 1997 include an
impairment loss recognized for certain modem and telecommunication equipment.
Due to the emergence of a new standard in modem speeds, management deemed these
assets to be fully impaired by the fourth quarter of fiscal 1997, and the
Company recognized an impairment loss of $351,000.

Interest expense. Interest expense increased by $404,000, or 528%, to
$481,000 for fiscal 1997 from $77,000 in fiscal 1996. The increase was due to
the issuance of promissory notes in fiscal 1997 to shareholders for working
capital and notes issued in connection with the acquisition of an ISP located in
San Angelo, Texas. See "Certain Transactions."

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<PAGE> 28

SELECTED QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain quarterly financial information of
the Company for each quarter of fiscal 1997 and 1998 and the first quarter of
fiscal 1999. The information has been derived from the quarterly financial
statements of the Company which are unaudited but which, in the opinion of
management, have been prepared on the same basis as the audited Financial
Statements and Notes thereto included herein and include all adjustments
(consisting only of normal recurring items) necessary for a fair presentation of
the financial results for such periods. This information should be read in
conjunction with the Company's Financial Statements and Notes thereto and the
other financial and operating information appearing elsewhere in this
Prospectus. The operating results for any quarter are not necessarily indicative
of results for any future period.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------------------------------
FISCAL 1997 FISCAL 1998 FISCAL 1999
------------------------------------------ ----------------------------------------- -----------
SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30 DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
1996 1996 1997 1997 1997 1997 1998 1998 1998
--------- -------- -------- -------- -------- -------- -------- -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Access................... $ 1,762 $ 2,185 $2,098 $2,132 $2,150 $2,242 $2,566 $2,608 $2,896
Business services........ 194 304 299 248 259 289 229 259 228
Other.................... 93 85 31 40 3 3 15 20 17
------- ------- ------ ------ ------ ------ ------ ------ ------
Total revenue...... 2,049 2,574 2,428 2,420 2,412 2,534 2,810 2,887 3,141
------- ------- ------ ------ ------ ------ ------ ------ ------
Operating expenses:
Connectivity and
operations............. 1,696 1,796 1,555 1,138 1,108 1,151 1,112 1,138 1,186
Sales and marketing...... 909 648 233 122 86 199 388 467 593
General and
administrative......... 733 848 648 519 400 446 508 565 563
Depreciation and
amortization........... 351 430 426 411 363 363 389 359 387
Impairment of
equipment.............. -- -- -- 351 -- -- -- -- --
------- ------- ------ ------ ------ ------ ------ ------ ------
Total operating
expenses......... 3,689 3,722 2,862 2,541 1,957 2,159 2,397 2,529 2,729
------- ------- ------ ------ ------ ------ ------ ------ ------
Income (loss) from
operations............... (1,640) (1,148) (434) (121) 455 375 413 358 412
Interest expense........... (47) (121) (136) (177) (135) (155) (165) (116) (76)
Income tax expense......... -- -- -- -- (6) (6) (6) (6) (10)
------- ------- ------ ------ ------ ------ ------ ------ ------
Net income (loss).......... $(1,687) $(1,269) $ (570) $ (298) $ 314 $ 214 $ 242 $ 236 $ 326
======= ======= ====== ====== ====== ====== ====== ====== ======
</TABLE>

<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------------------------------
FISCAL 1997 FISCAL 1998 FISCAL 1999
------------------------------------------ ----------------------------------------- -----------
SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30 DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
1996 1996 1997 1997 1997 1997 1998 1998 1998
--------- -------- -------- -------- -------- -------- -------- -------- -----------
(AS A PERCENTAGE OF TOTAL REVENUE)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Access................... 86.0% 84.9% 86.4% 88.1% 89.1% 88.5% 91.3% 90.3% 92.2%
Business services........ 9.5 11.8 12.3 10.2 10.8 11.4 8.2 9.0 7.3
Other.................... 4.5 3.3 1.3 1.7 0.1 0.1 0.5 0.7 0.5
------- ------- ------- ------- ------- ------ ------ ------ ------
Total revenue...... 100% 100% 100% 100% 100% 100% 100% 100% 100%
------- ------- ------- ------- ------- ------ ------ ------ ------
Operating expenses:
Connectivity and
operations............. 82.8 69.8 64.0 47.0 45.9 45.4 39.6 39.4 37.8
Sales and marketing...... 44.4 25.2 9.6 5.0 3.6 7.9 13.8 16.2 18.9
General and
administrative......... 35.8 32.9 26.7 21.4 16.7 17.6 18.1 19.6 17.9
Depreciation and
amortization........... 17.1 16.7 17.5 17.0 15.0 14.3 13.8 12.4 12.3
Impairment of
equipment.............. -- -- -- 14.5 -- -- -- -- --
------- ------- ------- ------- ------- ------ ------ ------ ------
Total operating
expenses......... 180.1 144.6 117.8 104.9 81.2 85.2 85.3 87.6 86.9
------- ------- ------- ------- ------- ------ ------ ------ ------
Income (loss) from
operations............... (80.1) (44.6) (17.8) (4.9) 18.8 14.8 14.7 12.4 13.1
Interest expense........... (2.3) (4.7) (5.6) (7.3) (5.6) (6.1) (5.9) (4.0) (2.4)
Income tax expense......... -- -- -- -- (0.2) (0.2) (0.2) (0.2) (0.3)
------- ------- ------- ------- ------- ------ ------ ------ ------
Net income (loss).......... (82.4)% (49.3)% (23.4)% (12.2)% 13.0% 8.5% 8.6% 8.2% 10.4%
======= ======= ======= ======= ======= ====== ====== ====== ======
</TABLE>

28
<PAGE> 29

From the last quarter of fiscal 1997 through the first quarter of fiscal
1998, the Company was in the process of reorganizing its management and
operations personnel and implementing a comprehensive cost control program. In
future periods, the Company expects to incur substantial advertising, customer
care and other operating costs as it enters new markets. See "-- Overview."

The Company's business is not subject to any significant seasonal
influences. Sales during the third fiscal quarter of a given year, however, have
historically been slightly higher due to new users who get personal computers
during the holiday season of the prior year.

LIQUIDITY AND CAPITAL RESOURCES

The Company's principal capital and liquidity needs have historically
consisted of funds required for (i) customer care and sales personnel, (ii)
marketing expenditures and (iii) telecommunication costs incurred in connecting
customers to the Internet. These outflows have been funded through a combination
of cash generated from existing operations, shareholder loans and other credit
facilities from various third parties.

Cash used in operating activities of $1.4 million during fiscal year 1997
was primarily attributable to marketing expenditures, the building of the
customer care operations and the expansion of the Company's network
infrastructure, partially offset by increases in deferred revenue. For the year
ended June 30, 1998, cash provided by operations was $1.8 million, which
resulted largely from cost controls implemented just prior to and during this
period. Cash provided by operating activities for the three months ended
September 30, 1998 was approximately $614,000, which resulted from continued
cost controls and normal operations. See "-- Overview."

Cash used in investing activities during fiscal 1997 was $1.5 million, and
was primarily related to the purchase of customers from a regional ISP in San
Angelo, Texas and purchases of property and equipment. Cash used in investing
activities for the year ended June 30, 1998 was $407,000, and was primarily
related to the acquisition of an ISP's customer base located in the Dallas-Fort
Worth area and purchases of property and equipment. Cash used in investing
activities for the three months ended September 30, 1998 was approximately
$232,000, and was related to purchases of property and equipment in the Dallas
and San Angelo POPs.

During fiscal 1997, cash provided by financing activities was $2.9 million,
which consisted primarily of $2.0 million of Affiliate Debt, $225,000 of Bank
Debt and $106,000 of MJ Debt. During fiscal 1998, cash used in financing
activities was $826,000, which consisted primarily of $420,000 of payments under
capital leases and $314,000 of payments on long term debt. Cash used in
financing activities for the three months ended September 30, 1998 was
approximately $774,000 and consisted of $346,000 of payments on long term debt,
$331,000 of payments for initial public offering costs, and $96,000 of payments
under capital leases. The Company intends to repay the Affiliate Debt, the Bank
Debt and the MJ Debt with the net proceeds of this Offering. See "Use of the
Proceeds" and "Certain Transactions." Following the Offering, the Company
intends to seek a new line of credit.

The Company expects to spend approximately $8.0 million for possible
acquisitions of complementary businesses, approximately $6.5 million to fund the
growth strategy in new and existing markets, primarily for marketing expenses
and incremental capital equipment and infrastructure expenditures, and, as
indicated above, approximately $2.3 million to repay substantially all current
indebtedness. See "Use of Proceeds." The Company believes that the net proceeds
of the Offering, together with existing cash resources, cash flows from
operations and any financing obtained through a new line of credit, will be
sufficient to fund the Company's operations for at least the next twelve months.
After such period, depending on its financial condition and results of
operations, the Company may require additional equity or debt financing. There
can be no assurance that additional financing will be available when required.
The Company is currently in discussions with various lenders concerning a
possible credit facility, but there can be no assurance that the Company will
enter into any credit facility, and if so, on what terms.

29
<PAGE> 30

YEAR 2000 COMPLIANCE

State of Readiness

In order to address Year 2000 issues, the Company has developed and is
implementing a plan for the Company to become Year 2000 ready (the "Year 2000
Plan"). The Year 2000 Plan covers: (i) software products which are supplied by
the Company to its customers and (ii) the Company's information and other
systems technology. In addition, the Year 2000 Plan calls for the Company to
identify and assess the systems and services of the Company's major vendors,
third party network service providers and other material service providers
("Third Party Systems"), and take appropriate remedial actions and develop
contingency plans where appropriate in connection with such Third Party Systems.

The Company supplies its customers with a software package that, among
other things, allows its customers to access the Company's services. The
software package consists of internally developed software which is bundled with
third party software (collectively, the "Installation Package"). The Company
believes that the current shipping version of its software package is Year 2000
ready. In addition, the Company believes that substantially all of its customer
base is presently using a version of the Installation Package that is Year 2000
ready.

The Company continues to evaluate its information and other systems
technology to identify and eliminate Year 2000 issues in order to timely achieve
Year 2000 readiness. The Company has performed a review of its more critical
Third Party Systems and has surveyed the publicly available statements issued by
vendors of such systems. Most of the Company's critical third-party providers
have made representations to the effect that they are, or will be, Year 2000
compliant. The Company, however, has not undertaken an in-depth evaluation of
its critical or other third-party providers in relation to the Year 2000 issue,
and furthermore the Company has no control over whether its third-party
providers are, or will be, Year 2000 compliant.

Costs

There are no significant historical costs associated with the Company's
Year 2000 readiness efforts and the magnitude of any future costs will depend
upon the nature and extent of any problems that are identified.

Risks

The failure by the Company to correct a material Year 2000 problem could
result in a complete failure or degradation of the performance of the Company's
network or other systems, including the disruption of operations, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities. Presently, however, the Company believes that its most
reasonably likely worst case scenario related to the Year 2000 is associated
with potential concerns with third-party services or products. Specifically, the
Company is heavily dependent on a significant number of third-party vendors to
provide both network services or equipment. A significant Year 2000-related
disruption of the network services or equipment provided to the Company by
third-party vendors could cause customers to consider seeking alternate
providers or cause an unmanageable burden on customer service and technical
support, which in turn could materially and adversely affect the Company's
results of operations, liquidity and financial condition. The Company is not
presently aware of any vendor-related Year 2000 issue that is likely to result
in such a disruption. Although there is inherent uncertainty in the Year 2000
issue, the Company expects that as it progresses with its Year 2000 Plan, the
level of uncertainty about the impact of the Year 2000 issue on the Company will
be reduced and the Company should be better positioned to identify the nature
and extent of material risk to the Company as a result of any Year 2000
disruptions.
30
<PAGE> 31

Contingency Plans

Due to the current stage of the Company's Year 2000 Plan, the Company is
currently unable to fully assess its risks and determine what contingency plans,
if any, need to be implemented. As the Company progresses with its Year 2000
Plan and identifies specific risk areas, the Company intends to timely implement
appropriate remedial actions and contingency plans.

The estimates and conclusions herein contain forward-looking statements and
are based on management's best estimates of future events. The Company's
expectations about risks, future costs, and the timely completion of its Year
2000 efforts are subject to uncertainties that could cause actual results to
differ materially from what has been discussed above. Factors that could
influence risks, amount of future costs and the effective timing of remediation
efforts include the Company's success in identifying and correcting potential
Year 2000 issues and the ability of third parties to appropriately address their
Year 2000 issues. See "Risk Factors -- The Year 2000 Issue."

CHANGE IN INDEPENDENT AUDITORS

On June 1, 1998, the Company's Board of Directors made the decision to
replace Farmer, Fuqua, Hunt & Munselle, P.C., Accountants and Consultants
("FFHM"), with Deloitte & Touche LLP as its independent auditor. The report of
FFHM on the financial statements of the Company as of and for the fiscal year
ended June 30, 1997 contained no adverse opinion or disclaimer of opinion and
was not qualified or modified as to uncertainty, audit scope or accounting
principles. In connection with FFHM's audit for the fiscal year ended June 30,
1997, there were no disagreements with FFHM on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure which, if not resolved to the satisfaction of FFHM, would have caused
it to make reference thereto in its report on the Company's financial statements
for such year. During the same period, the Company did not consult Deloitte &
Touche LLP regarding the application of accounting principles to a specified
transaction or the type of audit opinion that might be rendered on the Company's
financial statements.

RECENT ACCOUNTING PRONOUNCEMENTS

In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 129, "Disclosure of
Information about Capital Structure," which establishes standards for disclosing
information about an entity's capital structure and is effective for financial
statements for periods ending after December 15, 1997. In June 1997, the FASB
issued SFAS No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in the financial statements for fiscal years beginning after December 15, 1997.
The FASB also issued, in June 1997, SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
public companies disclose information about operating segments, products and
services, geographic areas and major customers. SFAS No. 131 is effective for
financial statements for periods beginning after December 15, 1997. The Company
has determined that the impact on its financial statements of adopting SFAS Nos.
129, 130 and 131 is not material. In June 1998, the FASB issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for fiscal quarters ending after June 15, 1999. The Company does not
expect the adoption of SFAS No. 133 to have a material impact on its financial
statements.

31
<PAGE> 32

BUSINESS

GENERAL

Internet America is a leading ISP in the southwestern United States. The
Company provides a wide array of Internet services tailored to meet the needs of
individual and business customers, including customers with little or no online
experience. With more than 50,000 customers, primarily in the North Texas area,
the Company believes that it has achieved one of the highest user densities per
POP of any ISP in the United States. This user density has enabled the Company
to realize substantial marketing, network and operating efficiencies, which have
resulted in profit margins in recent periods that are substantially higher than
those of most publicly traded ISPs.

INDUSTRY OVERVIEW

Internet access and related value-added services ("Internet services")
represent one of the fastest growing segments of the telecommunications services
marketplace. According to industry estimates, the number of Internet users in
the United States who access the World Wide Web reached approximately 29.2
million in 1997 and is projected to grow to approximately 72.1 million by the
year 2000. In addition, total ISP revenues in the United States are projected to
grow from $4.6 billion in 1997 to $18.3 billion in 2000. Declining prices in the
PC market, continuing improvements in Internet connectivity, advancements in
Internet navigation technology, and the proliferation of services, applications,
information and other content on the Internet have attracted a rapidly growing
number of users.

Numerous companies have moved to enter the Internet services market, such
as (i) telecommunications services providers, including national and regional
interexchange carriers, incumbent local exchange carriers ("LECs") and
competitive LECs, (ii) online commercial information service providers, (iii)
computer hardware and software providers, (iv) cable television operators and
(v) national, regional and local companies that focus primarily on providing
Internet services. These companies pursue a wide variety of business strategies.
For example, cable television operators, who are not required to grant third
party ISPs access to their local networks, are deploying high-speed cable modems
among their subscribers. Incumbent and competitive LECs, which generally provide
third party ISPs access to their local networks, are deploying high-speed data
transmission technologies such as xDSL to support the provision of Internet
services.

There are more than 4,000 national, regional and local ISPs. Some of these
ISPs have chosen to focus on business customers, others on individual customers.
Most national ISPs have made a major investment in network infrastructure in
anticipation of future high subscriber growth. As a result, the average national
ISP has been experiencing an extended period of losses as it works to build a
profitable base of customers in each of the many markets it serves. In addition
to these losses, national ISPs are exposed to a high level of technological
obsolescence risk as Internet access technology continues to evolve. At the
other end of the spectrum, many regional and local ISPs, which have a much lower
investment in network infrastructure, lack the marketing skills and resources to
build a critical mass of customers.

STRATEGY

Unlike many other ISPs, the Company believes that at the current stage of
the ISP industry's development, the highest priority should be to rapidly build
profitable market share, not to deploy a large network infrastructure with a
substantial number of underutilized owned or leased POPs. Therefore, the
Company's growth strategy is focused on (i) acquiring additional customers in
its existing markets and (ii) deploying its user density business model in other
selected markets. The aim of the user density business model is to quickly build
in a given market a critical mass of customers that will support profitable
operations.

Elements of the Company's growth strategy include:

Aggressive Use of Advertising to Rapidly Acquire a Critical Mass of
Customers and Build the Internet America Brand. The Company extensively
uses two of the more effective and efficient advertising
media -- television and outdoor billboard displays -- to highlight its
high-speed, quality

32
<PAGE> 33

services and strong customer care. The Company believes these media are
particularly effective in quickly acquiring customers, particularly new
Internet users, and building brand awareness. The Company is currently
preparing aggressive advertising campaigns for new target markets. See
"-- Marketing and Sales."

Strategic and Add-On Acquisitions. Because of the fragmented nature of
the ISP industry and the difficulty that many ISPs have encountered in
growing to a size where they can realize economies of scale and achieve
profitability, the Company expects to be able to make a significant number
of acquisitions in new and existing markets. The Company is currently
investigating strategic acquisition opportunities that would jump-start the
Company's entry into new markets, enabling the Company to more quickly
achieve the critical mass necessary to support profitable operations. The
Company also continues to evaluate add-on acquisitions in existing markets
that it believes would be accretive to earnings. The Company has already
made add-on acquisitions, successfully transitioning two smaller ISPs'
customers to the Internet America infrastructure and brand while
eliminating duplicative facilities and operations.

Cost-Effective Development of Network Infrastructure. The Company
seeks to ensure that its deployment of physical infrastructure,
particularly POPs, is accompanied with the rapid development of a
substantial customer base. Through this disciplined approach, the Company
has been able to achieve economies of scope and scale more quickly than
most other ISPs. The Virtual POP architecture that the Company is now
deploying with the participation of various telecommunications providers
enables the Company to enter new markets more quickly with a smaller
commitment of long-term capital resources, lower operating costs and less
exposure to technological obsolescence. See "-- Network Infrastructure."

Development of Value-Added Revenue Streams. The Company provides a
number of value-added services, such as dedicated high-speed access, news
access, Web hosting and server co-location. The Company continues to
evaluate and develop potential new value-added services, seeking to
leverage its current sales, marketing and network capabilities to create
additional revenue opportunities. These revenue streams may arise from
technological changes, such as the introduction of high-speed xDSL
connectivity technology, or other factors. The Company believes that a user
dense, regionally focused customer base provides an excellent platform for
the introduction of new value-added services that can take advantage of
brand awareness and economies of scope and scale, potentially including
Internet telephony and video and audio programming distribution.

Maintenance of a First-Rate Customer Care Operation. The Company's
sophisticated, high-quality customer care operation is designed to make
every customer's Internet experience efficient, productive and enjoyable,
whether that customer is a novice or an experienced Internet user. The
Company believes that this operation is a substantial competitive
advantage. See "-- Customer Care."

SERVICES

The Company offers Internet services tailored to meet the needs of both its
individual and business customers. The Company's primary service offering is
dial-up Internet access and value-added services for its individual customers.
The Company's business customers take advantage of dedicated high speed Internet
access, Web hosting and other services. The Company's services are offered in
various prices and packages so that customers may customize their subscription
with services that meet their particular requirements.

The majority of the Company's customers have month-to-month subscriptions.
The Company offers a 30-day money-back satisfaction guarantee for new customers.
Customers can subscribe by calling the 1-800-BE-A-GEEK phone number, e-mailing
the Company or enrolling through the Company's Web site. The majority of
customers are billed through automatic charges to their credit cards or bank
account, although some customers are invoiced. The Company offers discounts
ranging from 10% to 20% on most of its services for customers who prepay.

Internet Access. The Company's primary service is a dial-up Internet access
package, which includes unlimited Internet access and various Internet
applications such as World Wide Web, e-mail, Internet relay chat ("IRC"), file
transfer protocol ("FTP") and Usenet news access. The package costs $19.95 per
month

33
<PAGE> 34

plus a $29.95 activation fee. Value-added services available for an additional
fee include multiple e-mail mailboxes, personalized e-mail addresses and
personal Web sites. The Company also offers individual dedicated analog
connections for $79 a month plus a $79 setup fee.

Airnews.net. The Company's Airnews.net, provides access to Internet
America's news services for customers of other Internet services and on a
wholesale basis to other businesses or ISPs. The service has approximately 3,800
customers in 35 countries and provides access to millions of articles. The
service is included in the Company's dial-up access package and costs $10 per
month for other retail customers.

High Speed Connectivity. In addition to offering dial-up and dedicated
analog access, the Company also offers its business customers dedicated ISDN
access and full and partial T-1 connectivity, which can service hundreds of
users at once. Internet America offers numerous services related to a customer's
T-1 connection, including hardware configuration and local loop installation. In
addition, the Company provides 24-hour network monitoring to alert customers of
any circuit trouble. T-1 connections have a setup fee of $995 and monthly fees
ranging from $470 to $1295, depending on the type of services purchased. Fees
for dedicated ISDN access are $540 for setup and $300 to $400 per month
depending on the speed of the circuit.

Web Services. The Company offers Web hosting through its Airweb.net service
for businesses and other organizations that wish to create their own World Wide
Web sites without maintaining their own Web servers and high-speed Internet
connections. With this "virtual Web server" service, Web hosting customers can
use their own domain names in their World Wide Web addresses. Web hosting
customers are responsible for building their own Web sites and then uploading
the pages to an Internet America Web server. The Company's Web hosting service
features state-of-the-art Web servers for high speed and reliability, a high-
quality connection to the Internet, specialized customer support and advanced
services features, such as secure transactions and site usage reports. The
Company currently offers various price plans for Web hosting customers beginning
at $20 per month. Internet America had approximately 350 Web hosting customers
as of September 30, 1998.

The Company offers Web server co-location services at its headquarters in
Dallas for customers who want to maintain their own Web servers in Internet
America's state-of-the-art data telecommunications environment and receive a
high-speed, full-time connection to the Internet. Internet America's co-location
services include 24-hour security monitoring, uninterruptible power (battery and
generator), climate control and after-hours access for the customer. The Company
also offers domain name registration and hosting to protect the use of the name
of a customers's Web site address.

CUSTOMER CARE

The Company's goal of 100% customer satisfaction begins with providing
superior systems and network performance. The Company focuses on scalability,
reliability and speed in the technical design and maintenance of its systems.
See "-- Systems Infrastructure." In addition to the provision of superior
systems and network performance, the Company emphasizes high quality customer
care and technical support. The Company strives to retain its customers by
prioritizing fast response to customer problems. Individuals accessing the
Internet have many different hardware configurations and varying levels of
computer sophistication. Consequently, Internet America's customer care
department must be able to efficiently and effectively address (i) problems
affecting a variety of hardware systems, (ii) start-up or other basic problems
of new customers or new Internet users and (iii) more technical issues that
sophisticated users may encounter. Internet America is committed to providing
the best technical support in the industry, especially for new users, while
maintaining the ability to resolve the most difficult problems that a
sophisticated user may present.

The Company's customer care department includes approximately one-half of
all employees, or approximately 48 employees as of September 30, 1998. Customer
care is available to subscribers 24-hours-a-day, 7-days-a-week. The department
is organized in three-tiers designed to respond to varying types of support
needs. The three tiers are staffed with knowledgeable and experienced support
technicians able to diagnose customer problems and prescribe corrective
measures. Each call is routed to the appropriate tier of the department for
response. Internet America's customer care department answers approximately
5,000 calls per week. The average "hold" time is less than 45 seconds, and
approximately 65% of all calls are resolved within
34
<PAGE> 35

four minutes of the caller's initial contact with the technician. In addition to
diagnosing and resolving customers' technical problems, Internet America's
customer care department answers customer account questions, responds to
software requests and provides configuration information.

Customers can access customer support services through a local telephone
number or e-mail. The Company maintains on its Web site a comprehensive
description of its customer care services, as well as troubleshooting tips and
configuration information. Additionally, the Company offers to its customers
free educational classes, which are held weekly at the Company's Dallas
location. Customers can also obtain recorded system and network status reports
at any time and review extensive system and network performance via the World
Wide Web.

MARKETING

The Company's marketing approach is designed to further its user density
business model, which focuses on rapid penetration of a given market to acquire
a critical mass of customers to support profitable operations. The Company's
approach combines direct response with brand building advertising. Unlike most
other ISPs, the Company makes extensive use of television and outdoor billboard
displays, rather than print, radio or direct mail.

The Company continually evaluates the effectiveness of its marketing
methods, primarily by analyzing sales statistics such as call volumes, sales
volumes, media mix and incentive offer response, so that it can refine its
marketing campaign. The Company also uses input from focus groups and other
customer contacts to determine what marketing methods and incentives will be
most effective.

The Company reinforces the customer's purchase decision and stimulates
referral business by sending the customer a welcome letter with the start-up
package. The Company also sends all customers quarterly e-mail newsletters
containing information and updates on the Company services, as well as reminders
about the Company's referral incentive programs.

Since the Company's inception, its marketing message has evolved
substantially. Its early television campaigns were directed at early technology
adopters. The Company's current advertising campaign focuses on young, middle
and upper income families that are seeking the "best route" to the information
highway and access to the Web's increasingly diverse information, entertainment,
educational, product and service resources.

Once the Company's advertising has saturated a given market and the Company
has acquired a critical mass of customers, it begins to reap the benefits of
word of mouth communication about the quality and reliability of its services.
Such communication not only results in a significant number of referrals, but
also reinforces brand awareness of Internet America. At this point, the
Company's advertising expense per acquired customer drops significantly.

The Company's integrated marketing and sales approach includes the
following elements:

Direct Response Television Advertising. The Company believes that
television is the most effective and efficient way of reaching potential
customers, particularly first-time Internet users whose numbers are growing
as personal computers continue to penetrate the home and business markets.
Through a sophisticated and intensive broadcast and cable television
advertising campaign that emphasizes the quality and reliability of the
Company's Internet services and its responsiveness to customer needs and
problems, the Company is able to elicit a strong response from potential
customers, who are asked to contact the Company through a telephone call to
1-800-BE-A-GEEK. Television advertising also helps to reinforce brand
awareness of Internet America.

Outdoor Advertising and Other Media. Billboard campaigns are used by
the Company to establish and reinforce brand awareness of Internet America.
The Company uses other media to reach customers or potential customers only
under special circumstances. For example, the Company has used alternative
print media to reach Internet "power users."

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<PAGE> 36

Value-Added Resellers (VARs). The Company recently initiated a VAR
program that enables smaller personal computer retailers to sell the
Company's start-up package. The Company waives its usual activation fee so
the ultimate cost to the consumer is the same. Initial results from the
program are promising.

The Company has made preparations to begin intensive advertising campaigns
in other markets in the southwestern United States. The Company believes that
its approach to marketing and sales can be successfully introduced into those
markets without major revision.

INFRASTRUCTURE

The Company's current network provides customers with local dial-up access
in all the major metropolitan areas of Texas, as well as several smaller
communities. The Company's systems and network infrastructure are designed to
provide customers with reliability and speed. Reliability is primarily achieved
through redundancy in mission critical systems that minimizes the number of
single points of failure. Speed is achieved through clustered systems, diverse
network architecture, multi-peered Internet backbone connections and aggressive
load balancing.

Network Infrastructure. The Company's primary internal network consists of
Fiber Distributed Data Interface networks that incorporate FDDI Full Duplex
Technology, coupled with a Dual Redundant Digital GIGASwitch. This internal
backbone solution is superior in its ability to handle sustained high-speed
traffic, resilience to failure and redundancy. The internal backbone's level of
redundancy substantially reduces potential data loss and avoids congestion
common with other backbone architectures. The technology incorporated into the
GIGASwitch is capable of operating under extreme loads and is fault-tolerant.
This design and backbone network system is similar to that deployed at most of
the more advanced Internet switching centers worldwide.

The Company's network system incorporates safety features to separate
internal data from external sources, as well as provides a redundant network in
case of catastrophic network failure. The Company's facilities are powered by a
computer controlled uninterruptible power supply that provides company wide
battery backup, surge protection and power conditioning. An automatic onsite
diesel generator provides power for prolonged power outages.

The Company also maintains a Network Operations and Control Center ("NOCC")
with a full-time staff. This continually staffed facility is responsible for
monitoring the status of all networking facilities, components, applications and
equipment deployed throughout the Company's infrastructure. The NOCC is
responsible for all operational communications between the internal departments
of the Company as well as external providers of services to the Company. The
NOCC utilizes software which provides real-time monitoring of each component or
application and is responsible for notifications of quality of service problems
as well as failures. Sophisticated historical and statistical analysis software
used in the NOCC provides data to management about the quality of service the
Company's customers are experiencing, as well as information to help control
costs by purchasing additional bandwidth and services only when needed.

The Company maintains its applications on a variety of systems from a
number of vendors. The major applications, such as e-mail and news access
services, utilize a network of servers connected directly to the Company's FFDT
backbone. These systems are also connected, via another FFDT network, to the
Company's high-availability network file server. This direct connection
minimizes latency for customers accessing these applications. The Company
deploys PC style hardware in clusters for distributing the load of other
applications and providing fault-tolerance against application failure. These
distributed applications are housed on low cost, easily obtainable components
with minimal interdependency. Utilizing lower cost hardware has resulted in
significantly reduced operations expense and high reliability. The Company
expects to minimize its future use of high cost equipment by employing multiple
lower cost hardware components as it develops and applies new technologies.
Notwithstanding the attributes of the Company's network, it is subject to
malfunctions and other limitations, any of which could have a material adverse
effect on the Company's

36
<PAGE> 37

business, financial condition and results of operations. See "Risk
Factors -- Dependence on Network Infrastructure; Capacity; Risk of System
Failure."

Physical POPs. The Company's physical POPs are located in leased space
containing inbound local telephone lines, modems and related communications
equipment. The Company serves the San Angelo, Denison, Corsicana and
Weatherford, Texas markets with these POPs. Traffic from these POPs is routed to
the Company's internal network over leased lines. The Company also maintains a
physical POP in Dallas, but is currently in the process of migrating these
customers in Dallas to the Virtual POP architecture. The Company's intent is to
transition these customers in these markets to the Virtual POP architecture as
soon as services, capacity and reliability are available at reasonable costs.

Virtual POPs. Historically, ISPs have invested heavily in inbound local
telephone lines, modems, related equipment and facilities. The Company, however,
is implementing a "Virtual POP" architecture, which allows the Company to
provide local access services without deploying physical infrastructure. The
benefits of this architecture include substantially reduced capital
expenditures, lower operating costs and reduced exposure to technological
obsolescence. In addition, when entering new markets, the Virtual POP
architecture allows the Company to more precisely match capacity needs to actual
sales in that market.

The Virtual POP architecture enables customers to dial a local phone number
and connect to a modem owned by and housed at a telecommunications provider. The
customer's data call is then routed across leased lines to the Company's
internal network. Currently, Internet America has deployed this Virtual POP
architecture with various telecommunications providers in Dallas, Ft. Worth,
Houston, Austin, San Antonio and Denton, Texas. At September 30, 1998,
approximately 50% of the Company's customers were serviced by Virtual POPs.

Unlike simply leasing network capacity from a third-party provider, the
Virtual POP architecture allows the Company to maintain substantial control over
quality of service and capacity. Other regional ISPs commonly use leased network
capacity, which can result in their customers' Internet experiences being almost
entirely outside of the ISPs' control. In fact, utilizing a leased network may
cause the customer to compete with customers of other ISPs for access and
bandwidth. In contrast, the Company's Virtual POP architecture uses private
networks to carry customer data calls back to the Company's network and
application servers. In this manner, the Company maintains strict quality
control over its customers' Internet experiences, leading to higher levels of
customer satisfaction.

The Company's Virtual POP architecture and user density business model
position the Company to quickly take advantage of emerging high-speed
technologies such as xDSL, wireless and other Internet delivery methods.
Leveraging a dense customer base should enable the Company to economically offer
other emerging technologies, such as Internet telephony, particularly Voice Over
Internet Protocol ("VoIP"), video and audio distribution and other
high-bandwidth, low latency technologies.

Management Information Systems. The Company's MIS department uses a near
real-time customer database, billing and flow-through fulfillment system. This
system handles all customer contact and billing information for the Company's
dial-up access, Airnews.net and Airmail.net services. The system maintains
access controls for the authentication servers and various applications. The
system also creates customer invoices and automatically processes credit card
charges and automatic check handling. The Company is currently transitioning to
an integrated financial and information reporting system that will automate many
additional functions inside the Company and provide financial, marketing and
management reports.

TECHNOLOGY AND DEVELOPMENT

The Company continuously evaluates new technology and applications for
possible introduction. In particular, the Company is preparing to deploy a
high-speed connectivity technology, xDSL, in its established markets. xDSL uses
existing twisted copper pair wires running from a LEC's central office to a
customer's home or office to provide high-speed connectivity. Initially,
provisioning of xDSL service is expected to be difficult and time-consuming,
requiring close coordination between the provisioning LEC, the ISP and the ISP's
customer. The Company believes that because of its user density business model,
it is well positioned to

37
<PAGE> 38

market and deploy xDSL. The Company expects that it will be able to spread the
personnel, hardware, marketing and other costs of such deployment over a
sufficiently large base of customers in a specific local market.

High-speed connectivity is essential to the commercially viable deployment
of new, value-added services such as Internet telephony, particularly VoIP,
video and audio programming distribution and other high-bandwidth, low-latency
applications. Again, the Company believes that its user density business model
is particularly well suited to the marketing and deployment of these services.
The Company continues to stay abreast of developments in these and other areas.

PROPRIETARY RIGHTS

General. Although the Company believes that its success is more dependent
upon its technical, marketing and customer service expertise than its
proprietary rights, the Company's success and ability to compete are dependent
in part upon its proprietary rights. The Company relies on a combination of
copyright, trademark and trade secret laws. "Internet America" and
"1-800-BE-A-GEEK" are registered service marks of Internet America. Service mark
applications are pending for the registration of "Airnews.net," "Airmail.net,"
"Airweb.net," their respective logos and the Internet America logo. There can be
no assurance that the steps taken by the Company will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology. See "Risk Factors -- Proprietary Rights;
Infringement Claims."

Licenses. The Company has obtained authorization to use the products of
each manufacturer of software that the Company bundles in its front-end software
product for Windows and Macintosh subscribers. The particular applications
included in the Internet America start-up package have, when necessary, been
licensed. The Company currently intends to maintain or negotiate renewals of all
existing software licenses and authorizations as necessary. The Company may also
want or need to license other applications in the future. Other applications
included in the Internet America start-up package are shareware that the Company
has obtained permission to distribute or that are from the public domain and are
freely distributable.

COMPETITION

The market for the provision of Internet access to individuals is extremely
competitive and highly fragmented. There are no substantial barriers to entry,
and the Company expects that competition will continue to intensify. The Company
believes that the primary competitive factors determining success in this market
are a reputation for reliability and service, access speed, effective customer
support, pricing, creative marketing, easy-to-use software and geographic
coverage. Other important factors include the timing of introductions of new
products and services and industry and general economic trends. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not materially adversely affect its business, financial condition and results of
operations.

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<PAGE> 39

The Company believes that new competitors, including large computer
hardware and software, media and telecommunications companies, will continue to
enter the Internet services market, resulting in even greater competition for
the Company. Telecommunications providers, such as MCI, AT&T and Sprint, have
also recently entered the Internet access market. In addition, as consumer
awareness of the Internet grows, existing competitors are likely to further
increase their emphasis on Internet access services, resulting in even greater
competition for the Company. The ability of these competitors or others to enter
into business combinations, strategic alliances or joint ventures or to bundle
services and products with Internet access could put the Company at a
significant competitive disadvantage.

Moreover, the Company expects to face competition in the future from
companies that provide connections to consumers' homes, including national and
regional telecommunications providers, cable companies, electric utility
companies and terrestrial and satellite wireless communications companies. For
example, technologies have been developed that enable cable television operators
to offer Internet access through their cable facilities at significantly faster
rates than existing analog modem speeds. Such companies include Internet access
in their basic bundle of services or offer such access for a nominal additional
charge, and could prevent the Company from delivering Internet access through
the wire and cable connections that such companies own. Any such developments
could materially adversely affect the Company's business, financial condition
and results of operations. See "Risk Factors -- Competition."

GOVERNMENT REGULATION

Nevertheless, Internet-related regulatory policies are continuing to
develop, and it is possible that the Company could be exposed to regulation in
the future. For example, in the same report to Congress, the FCC stated its
intention to consider whether to regulate voice and fax telephony services
provided over the Internet as "telecommunications" even though Internet access
itself would not be regulated. The FCC is also considering whether such
Internet-based telephone services should be subject to the universal service
support obligations discussed above, or should pay carrier access charges on the
same basis as traditional telecommunications companies. Access charges are
assessed by local telephone companies to long distance companies for the use of
the local telephone network to originate and terminate long distance calls,
generally on a per-minute basis. Access charges have been a matter of continuing
dispute, with long distance companies complaining that the rates are
substantially in excess of cost and local telephone companies arguing that
access rates are justified to subsidize lower local rates for end users and
other purposes. Both local and long distance companies, however, contend that
Internet-based telephony should be subject to these charges. The Company
currently does not offer telephony, and so is not directly affected by these
developments. However, should the Company offer telephony in the future, it may
be affected by these issues. Additionally, the Company cannot predict whether
these debates will cause the FCC to reconsider its current policy of not
regulating Internet access providers.

LEC's competitors did, then the affiliate would not be subject to the unbundling
requirement that applied to the LEC. If the FCC ultimately adopted this proposal
or similar proposals, the Company's access to xDSL and other high-speed data
technology could be curtailed. Such curtailment could have a material adverse
effect on the Company's business, financial condition and results of operations.

Due to the increasing popularity and use of the Internet, it is possible
that additional laws and regulations may be adopted with respect to the
Internet, covering issues such as content, privacy, pricing, encryption
standards, consumer protection, electronic commerce, taxation, copyright
infringement and other intellectual property issues. The Company cannot predict
the impact, if any, that any future regulatory changes or development may have
on its business, financial condition and results of operations. Changes in the
regulatory environment relating to the Internet access industry, including
regulatory changes that directly or indirectly affect telecommunication costs or
increase the likelihood or scope of competition from regional telephone
companies or others, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Risk
Factors -- Government Regulation."

PROPERTIES

Internet America's corporate office is located in downtown Dallas at One
Dallas Centre, 350 N. St. Paul, Suite 3000, where all executive, systems, sales
and technical support functions exist. The Company leases approximately 31,000
square feet under multiple leases that terminate November 1, 2001. Aggregate
monthly rental payments under such leases are approximately $33,000. The Company
also has leased small equipment room facilities for each of its other physical
POPs in Corsicana, Denison, Weatherford and San Angelo, Texas. The Company does
not own any real estate. The Company believes that all of its facilities are
adequately maintained and suitable for their present use.

EMPLOYEES

As of September 30, 1998, the Company had approximately 90 employees, which
includes 48 customer care employees. The Company anticipates that the
development of its business will require the hiring of additional employees.
None of the Company's current employees are represented by a labor organization,
and the Company's management considers its employee relations to be good. See
"Risk Factors -- Dependence on and Ability to Attract Key Personnel."

LEGAL PROCEEDINGS

The Company is not involved in any material pending legal proceeding.

40
<PAGE> 41

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The names, ages and positions of the executive officers and directors of
the Company, are:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Michael T. Maples.................... 42 President, Chief Executive Officer and Director
Douglas L. Davis..................... 32 Executive Vice President and Chief Operating Officer
James T. Chaney...................... 43 Vice President, Chief Financial Officer, Secretary and
Treasurer
John James Stewart III............... 38 Vice President -- Customer Care
Douglas G. Sheldon................... 39 Vice President -- Marketing and Director
William O. Hunt(1)(2)................ 65 Chairman of the Board
Jack T. Smith(1)(2).................. 45 Director
Gary L. Corona(1)(2)................. 47 Director
</TABLE>

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

(1) Member of the Compensation Committee.

(2) Member of the Audit Committee.

Directors are elected to hold office until the next annual meeting of the
shareholders or until their successors are duly elected and qualified. Officers
serve at the discretion of the Board of Directors.

MICHAEL T. MAPLES has served as President and Chief Executive Officer of
the Company since March 1997 and has served as a director since April 1997. Mr.
Maples joined the Company in September 1996. Prior to joining the Company, Mr.
Maples was Vice President of Westcott Communications, Inc. ("Westcott
Communications"), a provider of educational, motivational and instructional
programming for various industries via satellite delivered television or
videotape. From 1988 to 1996, Mr. Maples was the General Manager of the
Automotive and Government Services business units of Westcott Communications.

DOUGLAS L. DAVIS has served as Executive Vice President and Chief Operating
Officer of the Company since July 1996, and served as Chief Technology Officer
of the Company from January to July 1996. Mr. Davis joined the Company as the
head of R&D in November 1995. From 1991 to October 1995, Mr. Davis was the
Director of Computer Operations for the School of Engineering and Applied
Science at Southern Methodist University, where he was in charge of developing
and supporting the school's technological infrastructure and also contributed to
and published several papers on Internet matters. From 1989 to 1991, Mr. Davis
was a software engineer for Dallas-based Logic Process, Inc., a company that
manufactures single and multi-processor Unix systems.

JAMES T. CHANEY joined the Company in December 1997 as Chief Financial
Officer, and has served as Vice President, Chief Financial Officer, Secretary
and Treasurer of the Company since February 1998. Prior to joining the Company,
Mr. Chaney was Tax Manager at Judd, Thomas, Smith & Co., CPA's, Dallas, Texas,
where he managed the tax department and performed tax and financial planning for
clients in the real estate and oil and gas industries. From 1990 to 1994, he was
self-employed as a Certified Public Accountant.

JOHN JAMES STEWART III has served as Vice President -- Customer Care since
May 1997. Mr. Stewart joined the Company in September 1995 as the Director of
Technical Support, and has also served as Director of Training and Customer
Retention Officer. From February 1993 until joining the Company, Mr. Stewart was
employed by Toys R Us. While at Toys R Us, he served as Assistant Store Director
and Department Manager.

DOUGLAS G. SHELDON has served the Company as Vice President -- Marketing
since September 1997 and as a director since June 1996. From 1986 through May
1996, Mr. Sheldon served in a managerial capacity with the combined companies of
the American Broadcasting Co., Capital Cities/ABC, Inc. and The Disney Company.
He has also served as a director of FuturDallas, Dallas Advertising League,
American Women in Radio and Television and President and director of D/FW Radio
Marketing Association.

41
<PAGE> 42

WILLIAM O. HUNT has served as Chairman of the Board and a director of the
Company since May 1995. Mr. Hunt is currently Chairman of the Board and director
of Intellicall, Inc., a diversified telecommunications company providing
products and services to pay telephone networks on a worldwide basis. From
December 1992 to May 1998, Mr. Hunt served as Chief Executive Officer of
Intellicall, Inc. From August 1990 to March 1996, Mr. Hunt served as Chairman or
Vice Chairman of the Board and director of Hogan Systems, Inc., a designer of
integrated online application software products for financial institutions. He
is also a director of American Homestar Corporation, Dr. Pepper Bottling
Holdings, Inc., The Allen Group, Inc., DSC Communications Corporation and OpTel,
Inc.

JACK T. SMITH has served as a director of the Company since November 1995.
Mr. Smith is currently the President and Chief Operating Officer of Jayhawk
Acceptance Corporation ("Jayhawk"), a specialized financial services company,
and has served as a director of Jayhawk since its inception. From June 1996 to
September 1997, Mr. Smith was employed as an independent business consultant.
From 1989 until its acquisition by Primedia, Inc., in June 1996, Mr. Smith was
President and Chief Operating Officer of Westcott Communications. He is also a
director of First Extended Service Corporation and FFG Insurance Company.

GARY L. CORONA has served as a director of the Company since May 1998. Mr.
Corona is currently the General Manager of the Automotive Division of Jayhawk.
From July 1996 to July 1997, Mr. Corona served as a business consultant for Carl
Westcott LLC. From July 1990 until its acquisition by Primedia, Inc., in June
1996, Mr. Corona was Vice President, New Business Development of Westcott
Communications. Mr. Corona is a director of First Extended Service Corporation
and FFG Insurance Company.

BOARD COMMITTEES

The Compensation Committee currently consists of Messrs. Hunt, Smith and
Corona. The Compensation Committee recommends compensation for all executive
officers and administers incentive compensation and benefit plans.

The Audit Committee currently consists of Messrs. Hunt, Smith and Corona.
The Audit Committee will meet periodically with management and the Company's
independent auditors and will review the results and scope of the audit and
other services provided by the Company's independent auditors, the Company's
accounting procedures and the adequacy of the Company's internal controls.

COMPENSATION OF DIRECTORS

Upon consummation of the Offering, directors who are not employees of the
Company ("Independent Directors") will receive an annual retainer upon election
to the Board of $6,000 (pro rata for existing Independent Directors for the
first partial year) and an additional $750 for each Board meeting attended. All
directors of the Company will be reimbursed for travel, lodging and other
out-of-pocket expenses in connection with their attendance at Board and
committee meetings. After consummation of the Offering, each Independent
Director, upon election to the Board of Directors will receive a non-qualified
option to purchase 22,500 shares of Common Stock (which will be immediately
exercisable), and following his initial term, if reelected, and every fourth
year thereafter, if reelected, such director will receive a non-qualified option
to purchase 20,000 shares of Common Stock (with such options vesting 25%
annually, commencing on the date of issuance and continuing on the first, second
and third anniversaries of the date of issuance, subject to such director's
continued reelection to the Board of Directors). Each Independent Director
holding office at the time of consummation of this Offering will receive such
options as if he had been initially elected as of such date. All options issued
after consummation of the Offering to Independent Directors will be issued
pursuant to the 1998 Option Plan. See "-- 1998 Nonqualified Stock Option Plan."

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Board of Directors has a Compensation Committee, which currently is
comprised of Messrs. Hunt, Smith and Corona. None of the executive officers of
the Company currently serves on the compensation committee of another entity or
any other committee of the board of directors of another entity performing
similar functions.
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<PAGE> 43

EXECUTIVE COMPENSATION

The following table sets forth the information regarding compensation (on
an annualized basis) for the Chief Executive Officer and the Company's other
most highly compensated executive officer for the period indicated. No other
executive officers of the Company were compensated over $100,000 in fiscal 1998.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION ------------
----------------------- SECURITIES
OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY COMPENSATION OPTIONS
- --------------------------- ---- -------- ------------ ------------
<S> <C> <C> <C> <C>
Michael T. Maples,
Chief Executive Officer................. 1998 $108,333 -- 157,500(1)
Douglas L. Davis,
Chief Operating Officer................. 1998 110,000 -- --
</TABLE>

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

(1) Mr. Maples was granted an option to purchase 157,500 shares of Common Stock
at an exercise price of $1.67 per share on March 24, 1998.

The following table sets forth the information regarding option grants
during the last fiscal year for the Chief Executive Officer and the Company's
other executive officers.

OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS

<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO
OPTIONS EMPLOYEES IN EXERCISE PRICE
NAME GRANTED FISCAL YEAR ($/SHARE) EXPIRATION DATE
- ---- ---------- ------------- -------------- ---------------
<S> <C> <C> <C> <C>
Michael T. Maples............... 157,500 40% $1.67 March 24, 2008
Douglas L. Davis................ -- -- -- --
James T. Chaney................. 78,750 20% $1.67 March 24, 2008
John James Stewart, III......... 56,250 14% $1.67 March 24, 2008
Douglas G. Sheldon.............. 67,500 17% $1.67 March 24, 2008
</TABLE>

The following table sets forth the information regarding the Company's
aggregate option exercises in the last fiscal year and fiscal year-end option
values for the Chief Executive Officer and the Company's other executive
officers.

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FY END(#) AT FY END($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Michael T. Maples........ -- -- 67,500 157,500 $ 764,775 $1,784,475
Douglas L. Davis......... -- -- 112,500 -- 1,274,625 --
James T. Chaney.......... -- -- -- 78,750 -- 892,238
John James Stewart, -- -- 59,202 670,759
III.................... 743 8,418
Douglas G. Sheldon....... -- -- 22,500 67,500 254,925 764,775
</TABLE>

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

(1) The value of the options is based on the difference between the option
exercise price of $1.67 per share for all options and the initial public
offering price of $13.00 per share of Common Stock multiplied by the number
of shares of Common Stock underlying the option. No public market existed
for the Common Stock at the fiscal year ended June 30, 1998.

43
<PAGE> 44

1996 INCENTIVE STOCK OPTION PLAN

The Company's 1996 Incentive Stock Option Plan (the "1996 Option Plan") was
adopted by the Board of Directors and the Company's shareholders in December
1996. Pursuant to the 1996 Option Plan, the Company may grant incentive and
nonstatutory (nonqualified) stock options to key employees and directors of the
Company. A total of 225,000 shares of Common Stock have been reserved for
issuance under the 1996 Option Plan.

The Compensation Committee has the authority to select the employees and
directors of the Company to whom stock options are granted. Subject to the
limitations set forth in the 1996 Option Plan, the Compensation Committee has
the sole discretion and authority to determine from time to time the persons to
whom options shall be granted and the number of shares covered by each option,
to interpret the 1996 Option Plan, to establish vesting schedules, to specify
the type of consideration to be paid to the Company upon exercise and, subject
to certain restrictions, to specify other terms of the options.

The maximum term of options granted under the 1996 Option Plan is ten
years. The aggregate fair market value of the stock with respect to which
incentive stock options are first exercisable in any calendar year may not
exceed $100,000 per incidence. Options granted under the 1996 Option Plan are in
most cases nontransferable and generally expire within three months after the
termination of the optionee's services to the Company. In general, if an
optionee is disabled, dies or retires from his or her service to the Company,
such option may be exercised up to 12 months following such disability or death,
unless the Compensation Committee determines to allow a longer period for
exercise.

The exercise price of incentive stock options must be not less than the
fair market value of the Common Stock on the date of grant. The exercise price
of incentive stock options granted to any person who at the time of grant owns
stock possessing more than 10% of the total combined voting power of all classes
of stock must be at least 110% of the fair market value of such stock on the
date of grant, and the term of those options cannot exceed five years.

The Company currently has 67,075 options outstanding to its employees under
the 1996 Option Plan. These options are exercisable at $1.67 per share of Common
Stock. The exercise price of 38,619 of such options was adjusted from $3.33 per
share to $1.67 per share on March 24, 1998 by the Board of Directors.

NONQUALIFIED STOCK OPTIONS

Mr. Maples was granted an option to purchase 67,500 shares of Common Stock
at an exercise price of $3.33 per share on October 27, 1996. The exercise price
of this option was adjusted to $1.67 per share by the Board of Directors on
March 24, 1998. Additionally, on March 24, 1998, Mr. Maples was granted an
option to purchase 157,500 shares of Common Stock at an exercise price of $1.67
per share. Mr. Sheldon was granted an option to purchase 22,500 shares of Common
Stock at an exercise price of $3.33 per share (such exercise price was adjusted
to $1.67 per share on March 24, 1998) and an option to purchase 67,500 shares of
Common Stock at an exercise price of $1.67 per share, on June 27, 1996 and March
24, 1998, respectively. On April 5, 1996, Messrs. Hunt and Smith were each
granted an option to purchase 22,500 shares of Common Stock at an exercise price
of $1.67 per share. On December 15, 1995, Mr. Davis was granted an option to
purchase 112,500 shares of Common Stock at an exercise price of $1.67 per share.
Mr. Chaney was granted an option to purchase 78,750 shares of Common Stock at an
exercise price of $1.67 per share on March 24, 1998. Mr. Stewart was granted an
option to purchase 56,250 shares of Common Stock at an exercise price of $1.67
per share on March 24, 1998. All of the options granted to the Company's
directors and officers are nonqualified stock options.

Additionally, on October 27, 1996, 215,026 options were granted to certain
founders of the Company at an exercise price of $3.33 per share in connection
with such founders' pledge of their stock of the Company to guarantee the bridge
loan from First Computer Services Corporation ("First Computer"). The exercise
price of these options was adjusted to $1.67 per share by the Board of Directors
on March 24, 1998. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" and
"Certain Transactions."

44
<PAGE> 45

The Company currently has 1,212,476 nonqualified options outstanding to
certain of its officers, employees and advisors. These options are exercisable
at prices ranging from $0.09 per share of Common Stock to $8.00 per share of
Common Stock.

1998 NONQUALIFIED STOCK OPTION PLAN

The Company's 1998 Nonqualified Stock Option Plan (the "1998 Option Plan")
was adopted by the Board of Directors and the Company's shareholders on July 13,
1998. The purpose of the 1998 Option Plan is to promote the growth and general
prosperity of the Company by permitting the Company to grant to its employees,
directors and advisors options to purchase Common Stock of the Company. Pursuant
to the 1998 Option Plan, the Company may grant nonstatutory (nonqualified) stock
options to employees, directors and advisors of the Company. A total of 400,000
shares of Common Stock have been reserved for issuance under the 1998 Option
Plan. In July 1998, Mr. Corona was issued an option to purchase 22,500 shares of
Common Stock at an exercise price of $8.00 per share pursuant to the 1998 Option
Plan.

The Compensation Committee has the authority to select the employees,
directors and advisors of the Company to whom stock options are granted. Subject
to the limitations set forth in the 1998 Option Plan, the Compensation Committee
has the sole discretion and authority to determine from time to time the persons
to whom options shall be granted and the number of shares covered by each
option, to interpret the 1998 Option Plan, to establish vesting schedules, to
specify the type of consideration to be paid to the Company upon exercise and,
subject to certain restrictions, to specify other terms of the options.

The maximum term of options granted under the 1998 Option Plan is ten
years. Options granted under the 1998 Option Plan are in most cases
nontransferable and generally expire within 30 days after the termination of the
optionee's services to the Company, except in cases when the optionee is
terminated "for cause" (as such term is defined therein). In such cases, the
option typically expires automatically on the date of termination. In general,
if an optionee is disabled or dies, such option may be exercised up to 12 months
following such disability or death, unless the Compensation Committee determines
to allow a longer period for exercise. In general, if an optionee retires from
his or her service to the Company, such option may be exercised up to three
months following such retirement, unless the Compensation Committee determines
to allow a longer period for exercise.

45
<PAGE> 46

CERTAIN TRANSACTIONS

On September 25, 1996, the Company entered into a Securities Purchase
Agreement (the "Purchase Agreement") with First Computer, which is owned by Carl
Westcott, a principal shareholder of the Company. First Computer acted as a
nominee for Jack T. Smith, a director of the Company, Michael T. Maples, the
Chief Executive Officer and a director of the Company, and Carl Westcott. Under
the terms of the Purchase Agreement, in exchange for $2.0 million in cash, First
Computer purchased 544,149 shares of Common Stock and a promissory note from the
Company in favor of First Computer in the original principal amount of
$1,767,713 (the "First Computer Note"). The First Computer Note bore interest at
10% per annum, with a default rate of 18% per annum, and all principal and
interest were originally payable on September 25, 1997. The First Computer Note,
which was in default, was refinanced at prime rate in June 1998 as set forth
below. The First Computer Note was collateralized by the present and future
assets of the Company. The founding shareholders, Robert Maynard, John Nanni and
Tim Martin, pledged their stock in the Company to collateralize the First
Computer Note, and as consideration were granted vested stock options
exercisable at $3.33 per share (subsequently adjusted in March 1998 to $1.67 per
share) and equal to 10% of their stock holdings, or 89,926 options to Mr.
Maynard, 63,562 options to Mr. Nanni, and 61,538 options to Mr. Martin. Under
the Purchase Agreement, First Computer, as nominee for Messrs. Westcott, Maples
and Smith, was granted certain registration rights. See "Description of
Securities -- Registration Rights."

On January 31, 1997, the Company entered into a letter agreement (the
"First Extended Agreement") with First Extended, Inc. (successor in interest to
First Computer) ("First Extended") and William O. Hunt, a director of the
Company. First Extended acted as a nominee for Messrs. Smith, Maples and
Westcott. Under the terms of the First Extended Agreement, the Company made a
promissory note in the original principal amount of $650,000 in favor of First
Extended (the "First Extended Note"). The First Extended Note and First Extended
Agreement provided that the Company could borrow up to $650,000 from First
Extended. All advances under the First Extended Note and First Extended
Agreement were made at First Extended's discretion. The Company had borrowed a
total of $250,000 under the First Extended Note and First Extended Agreement.
The First Extended Note bore interest at 18% per annum, and all principal and
interest were originally payable on April 1, 1997. The First Extended Note,
which was in default, was refinanced at prime rate in June 1998 as set forth
below and was paid off on July 14, 1998.

Mr. Hunt has personally guaranteed payment under a promissory note made by
the Company in the original principal amount of $350,000 payable to NationsBank,
N.A. (the "NationsBank Note"). A total of $225,000 has been borrowed under the
NationsBank Note. The note bears interest at the bank's prime rate. The
NationsBank Note originally matured on July 15, 1997 but has been renewed
through December 15, 1998. A guarantee fee will accrue to Mr. Hunt at 18% minus
the bank's prime rate if the NationsBank Note is in default. The guarantee fee
and all principal are payable upon demand of the guarantor. All advances under
the NationsBank Note require the consent of the guarantor.

On March 24, 1998, Carl Westcott LLC, as nominee for Messrs. Westcott,
Maples, Smith, Corona and others, and Messrs. Hunt and Sheldon entered into a
Stock Purchase Agreement (the "1998 Purchase Agreement"), pursuant to which Carl
Westcott LLC, as nominee, and Messrs. Hunt and Sheldon purchased all of the
1,987,124 shares of Common Stock held by Messrs. Maynard, Nanni and Martin in
exchange for $883,166.

In June 1998, the Company refinanced the First Computer Note and the First
Extended Note pursuant to a Letter Agreement between the Company and Messrs.
Hunt, Smith and Westcott (the "Letter Agreement"). Pursuant to the Letter
Agreement, the Company made the following promissory notes: (i) Amended and
Restated Promissory Note payable to Mr. Smith in the principal amount of
$229,450, (ii) Amended and Restated Promissory Note payable to Mr. Smith in the
principal amount of $77,694, (iii) Amended and Restated Promissory Note payable
to Mr. Westcott in the principal amount of $1,538,263 and (iv) Amended and
Restated Promissory Note payable to Mr. Westcott in the principal amount of
$172,306 (collectively, the "Amended Notes"). All of the Amended Notes bear
interest per annum at the NationsBank of Texas, N.A. prime rate. Pursuant to the
Letter Agreement, the Company must make a monthly payment of $140,000, which
will be applied pro rata to the repayment of the Amended Notes and the
NationsBank Note. In the

46
<PAGE> 47

event of default under any of the Amended Notes, the outstanding indebtedness of
such note is convertible into shares of Common Stock at the price of $0.44 per
share at the option of the noteholders. Under the Amended Notes and the Letter
Agreement, in the event of any offering of the Company's securities pursuant to
a registration statement declared effective by the Securities and Exchange
Commission or the sale or issuance of the Company's securities through which the
Company raises a minimum of $1.0 million, the Company must use all of the
proceeds of such offering, sale or issuance to pay off the Amended Notes and the
NationsBank Note until all such debt is extinguished. The Company intends to use
approximately $2.0 million of the net proceeds of this Offering to prepay the
Amended Notes and the NationsBank Note. Mr. Maples sold his interest in the
Amended Notes to Carl Westcott.

Chase Bank has made available a stand-by letter of credit in the original
principal amount of $150,000. Payment under this letter of credit has been
personally guaranteed by Mr. Hunt. Approximately $66,000 of this letter of
credit has been pledged as collateral under a three year capital lease.

Carl Westcott owns a significant interest in Jayhawk, First Extended
Service Corporation and FFG Insurance Company. Carl Westcott LLC and Westcott
Communications are current and former affiliates of Carl Westcott. The Company
has had no material business transactions with any of these entities.

FUTURE TRANSACTIONS

The Company has adopted a policy providing that all transactions between
the Company and related parties will be subject to approval by a majority of all
disinterested directors and must be on terms no less favorable than those that
could otherwise be obtained from unrelated third parties.

47
<PAGE> 48

PRINCIPAL AND SELLING SHAREHOLDERS

The following table sets forth certain information as of November 1, 1998,
regarding the beneficial ownership of Common Stock of (i) each person or group
known by the Company to beneficially own 5% or more of the outstanding shares of
Common Stock, (ii) each of the directors and the executive officers of the
Company, (iii) all executive officers and directors of the Company as a group
and (iv) each Selling Shareholder. The Company's officers, directors and certain
principal shareholders have agreed not to offer, sell, contract to sell or
otherwise dispose of any shares of Common Stock for a period of 180 days from
the date of this Prospectus without the prior written consent of Hoak Breedlove
Wesneski & Co. Unless otherwise noted, the persons named below have sole voting
and investment power with respect to the shares shown as beneficially owned by
them.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
PRIOR TO THE OFFERING AFTER THE OFFERING
NAME, ADDRESS AND OFFICE --------------------- SHARES ----------------------
OF BENEFICIAL OWNER(1) NUMBER PERCENT OFFERED(4) NUMBER(4) PERCENT(4)
------------------------ ---------- -------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Michael T. Maples(2).............. 242,404 6.4% -- 242,404 3.7%
Douglas L. Davis(2)............... 225,000 5.9% -- 225,000 3.4%
James T. Chaney................... -- -- -- -- --
John James Stewart III(2)......... 1,115 * -- 1,115 *
Douglas G. Sheldon(2)............. 315,002 8.3% -- 315,002 4.8%
William O. Hunt(2)(3)............. 1,432,490 37.7% 200,000(5) 1,232,490 18.8%
Jack T. Smith(2).................. 534,311 14.0% 60,000 474,311 7.2%
Gary L. Corona(2)................. 44,999 1.2% -- 44,999 *
Carl Westcott..................... 1,141,811 30.0% 340,000 801,811 12.2%
All directors and executive
officers as a group (eight
persons)(2)..................... 2,795,321 73.5% 260,000 2,535,321 38.7%
</TABLE>

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

* Less than one percent.

(1) The address of each of the principal and Selling Shareholders is in care of
the Company, One Dallas Centre, 350 North St. Paul, Suite 3000, Dallas,
Texas 75201.

(2) Includes options to purchase 67,500, 112,500, 1,115, 22,500, 22,500, 22,500
and 22,500 shares of Common Stock granted to Messrs. Maples, Davis, Stewart,
Sheldon, Hunt, Smith and Corona, respectively, that are exercisable within
60 days of November 1, 1998.

(3) Includes 497,301 shares of Common Stock owned by BCG Partnership, Ltd., a
limited partnership in which Mr. Hunt and his wife serve as general
partners, 329,304 shares of Common Stock owned by B&G Partnership, Ltd., a
limited partnership in which Mr. Hunt and his wife serve as general
partners, and 583,385 shares of Common Stock owned by the William O. Hunt
Retirement Trust, for which Mr. Hunt serves as trustee.

(4) Messrs. Hunt (through the William O. Hunt Retirement Trust), Smith and
Westcott have granted the Underwriters an over-allotment option, exercisable
not later than 30 days after the date of this Prospectus, to purchase
120,000, 25,000 and 200,000 shares of Common Stock, respectively, at the
initial public offering price set forth on the cover of this Prospectus,
less the underwriting discount. See "Underwriting."

(5) The Selling Shareholder is BCG Partnership, Ltd.

48
<PAGE> 49

DESCRIPTION OF SECURITIES

GENERAL

The Company is a Texas corporation and its affairs are governed by the
Articles, Bylaws and the Texas Business Corporation Act (the "TBCA"). The
following description of the Company's capital stock is qualified in all
respects by the Articles and the Bylaws, which have been filed as exhibits to
the Registration Statement to which this Prospectus forms a part.

The authorized capital stock of the Company consists of 40,000,000 shares
of Common Stock, par value $0.01 per share, and 5,000,000 shares of preferred
stock, par value $0.01 per share (the "Preferred Stock").

COMMON STOCK

As of November 1, 1998, the Company had 34 holders of its Common Stock. The
holders of outstanding shares of Common Stock are entitled to receive dividends
out of assets legally available therefor at such times and in such amounts as
the Board of Directors may, from time to time, determine, subject to any
preferences which may be granted to the holders of Preferred Stock. Holders of
Common Stock do not have cumulative voting rights and are entitled to one vote
per share on all matters on which the holders of Common Stock are entitled to
vote. The Common Stock is not entitled to preemptive rights and is not subject
to redemption or conversion. Upon liquidation, dissolution or winding-up of the
Company, the assets (if any) legally available for distribution to shareholders
are distributable ratably among the holders of Common Stock after payment of all
debts and liabilities of the Company and the liquidation preference of any
outstanding class or series of Preferred Stock. All outstanding shares of Common
Stock are, and the shares of Common Stock to be issued pursuant to this Offering
will be, when issued and delivered, validly issued, fully paid and
nonassessable. The rights, preferences and privileges of holders of Common Stock
will be subject to the preferential rights of any outstanding class or series of
Preferred Stock that the Company may issue in the future.

PREFERRED STOCK

The Board of Directors may, without further action of the shareholders of
the Company, issue shares of Preferred Stock in one or more series and fix or
alter the rights and preferences thereof, including the voting rights,
redemption provisions (including sinking fund provisions), dividend rights,
dividend rates, liquidation preferences, conversion rights and any other rights,
preferences, privileges and restrictions of any wholly unissued series of
Preferred Stock. The rights of holders of Common Stock will be subject to, and
may be adversely affected by, the rights of holders of any Preferred Stock.

On November 10, 1995, the Board of Directors issued a series of Preferred
Stock, which currently consists of 400,000 shares of Preferred Stock (such
amount may from time to time be increased or decreased by the Board of
Directors), designated as Series A Preferred Stock (the "Series A Preferred
Stock"). The Series A Preferred Stock, with respect to rights on liquidation,
winding up and dissolution, ranks senior to all classes and series of Common
Stock and may rank senior to other classes of Preferred Stock. The Series A
Preferred Stock has no specified dividend rate and the holders of Series A
Preferred Stock are entitled to receive the same dividends as the holders of the
Common Stock. The holders of Series A Preferred Stock are entitled to vote in
all matters as to which the holders of the Common Stock are entitled to vote (on
an "as converted" basis) in the same manner and with the same effect as such
holders of Common Stock, voting together with the holders of Common Stock and
Series A Preferred Stock as one class. Each share of Series A Preferred Stock is
convertible at any time into 2.25 shares of Common Stock and shall be
automatically converted, without further action on the part of the Company or
the holder thereof, into 2.25 fully paid and nonassessable shares of Common
Stock on the date 30 days after the successful completion of the Offering.

On May 15, 1996, the Board of Directors issued a series of Preferred Stock,
which currently consists of 300,000 shares of Preferred Stock (such amount may
from time to time be increased or decreased by the Board of Directors),
designated as Series B Preferred Stock (the "Series B Preferred Stock"). The
Series B Preferred Stock, with respect to rights on liquidation, winding up and
dissolution, ranks equally to the Series A Preferred Stock, ranks senior to all
classes and series of Common Stock and may rank senior to other classes
49
<PAGE> 50

of Preferred Stock. The Series B Preferred Stock has no specified dividend rate
and the holders of Series B Preferred Stock are entitled to receive the same
dividends as the holders of the Common Stock. The holders of Series B Preferred
Stock are entitled to vote in all matters as to which the holders of the Common
Stock are entitled to vote, in the same manner and with the same effect as such
holders of Common Stock (on an "as converted" basis), voting together with the
holders of Common Stock, Series A Preferred Stock and Series B Preferred Stock
as one class. Each share of Series B Preferred Stock is convertible at any time
into 2.25 shares of Common Stock and shall be automatically converted, without
further action on the part of the Company or the holder thereof, into 2.25 fully
paid and nonassessable shares of Common Stock on the date 30 days after the
successful completion of the Offering.

As of November 1, 1998, the Company had 30 holders of its Series A
Preferred Stock and 3 holders of its Series B Preferred Stock.

REGISTRATION RIGHTS

Holders of 1,660,769 shares of Common Stock (the "Holders") have certain
rights to have such shares registered under the Securities Act pursuant to the
terms of agreements between such holders and the Company. Specifically, the
Holders have the one-time right to demand that the Company use its best efforts
to register all their shares of Common Stock. Additionally, if at any time the
Company proposes to register its securities under the Securities Act (other than
on a Form S-4 or Form S-8), the Company must notify the Holders of such proposed
offering, and, upon their request the Company must use its best efforts to
register all shares of Common Stock owned by the Holders. In such instances, the
Company is responsible for the expenses related to the registration of such
shares.

LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS

The Articles of Incorporation of the Company provide that to the fullest
extent permitted by applicable law, a director of the Company will not be liable
to the Company or its shareholders for monetary damages for an act or omission
in the director's capacity as a director.

The TBCA permits the indemnification of directors, employees, officers and
agents of Texas corporations. The Company's Articles and Bylaws provide that the
Company shall indemnify any person to the fullest extent permitted by law. Under
the TBCA, an officer or director may be indemnified if he acted in good faith
and reasonably believed that his conduct (i) was in the best interests of the
Company and if he acted in his official capacity or (ii) was not opposed to the
best interests of the Company in all other cases. In addition, the indemnitee
may not have reasonable cause to believe that his conduct was unlawful in the
case of a criminal proceeding. In any case, the indemnitee may not have been
found liable to the Company for improperly receiving a personal benefit or for
willful or intentional misconduct in the performance of his duty to the Company.
The Company (i) must indemnify an officer or director for reasonable expenses if
he is successful, (ii) may indemnify an officer or director for such reasonable
expenses unless he was found liable for willful or intentional misconduct in the
performance of his duty to the Company and (iii) may advance reasonable defense
expenses if the officer or director undertakes to reimburse the Company if he is
later found not to satisfy the standard for indemnification expenses. Insofar as
indemnification for liabilities arising under the Securities Act may be
permitted to directors, officers and controlling persons of the Company pursuant
to the foregoing provisions, or otherwise, the Company has been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. This provision in the Articles does not eliminate the duty of
care, and in appropriate circumstances equitable remedies such as an injunction
or other forms of nonmonetary relief would remain available under Texas law.
This provision also does not affect a director's responsibilities under any
other laws, such as the federal securities laws or state or federal
environmental laws.

For a discussion of provisions of the underwriting agreement with regard to
indemnification of the Underwriters, see "Underwriting."

50
<PAGE> 51

TRADING MARKET, TRANSFER AGENT AND REGISTRAR

The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "GEEK." The Transfer Agent and Registrar for the Common
Stock is ChaseMellon Shareholder Services, L.L.C.

TEXAS ANTI-TAKEOVER LAW AND CERTAIN PROVISIONS

As a Texas corporation, the Company is subject to the provisions of the
Texas Business Combination Law ("TBCL") that became effective on September 1,
1997. In general, the TBCL prohibits a Texas "issuing public corporation" (such
as the Company) from engaging in a "business combination" with any shareholder
who is a beneficial owner of 20% or more of the corporation's outstanding stock
for a period of three years after such shareholder's acquisition of a 20%
ownership interest, unless: (i) the board of directors of the corporation
approves the transaction or the shareholder's acquisition of the shares prior to
the acquisition or (ii) two-thirds of the unaffiliated shareholders of the
corporation approve the transaction at a shareholders' meeting. The TBCL may
have the effect of inhibiting a non-negotiated merger or other business
combination involving the Company. The Company is subject to the terms of the
TBCL, unless its shareholders or directors take action electing not to be
governed by its terms (which action is not currently contemplated).

The Company's Articles and Bylaws prevent shareholders from calling a
special meeting of shareholders, prevent shareholders from amending the Bylaws
and prohibit shareholder action by written consent. The Bylaws also authorize
only the Board of Directors to fill vacancies, including newly-created
directorships and state that directors of the Company may be removed only for
cause and only by the affirmative vote of holders of at least a majority of the
outstanding shares of the voting stock, voting together as a single class.

51
<PAGE> 52

SHARES ELIGIBLE FOR FUTURE SALE

GENERAL

Upon completion of the Offering, the Company will have an aggregate of
6,285,957 shares of Common Stock outstanding. Of these shares, all of the shares
sold in the Offering will be freely transferable without restriction or
limitation under the Securities Act, except for any shares purchased by
"affiliates" (as such term is defined under the Securities Act) of the Company.
The remaining 3,985,957 shares constitute "restricted securities" within the
meaning of Rule 144, and the resale of such shares is restricted for one year
from the date they were acquired. Of these "restricted securities," 1,886,333
shares have been held for the required one-year period and will be freely
tradeable upon completion of the Offering, subject in certain cases to the
180-day lock-up period described below and the 90-day information requirement of
Rule 144 for shares held by affiliates or for less than the required two-year
period. In addition, the holders of 1,660,769 outstanding shares have certain
rights to have shares registered under the Securities Act pursuant to the terms
of agreements between such holders and the Company. See "Description of
Securities -- Registration Rights." Of those 1,660,769 shares, 769,149 shares
are freely tradeable upon completion of the Offering, subject in certain cases
to the 180-day lock-up period described below and the 90-day information
requirement of Rule 144 for shares held by affiliates or for less than the
required two-year period.

In general, under Rule 144, as currently in effect, a person (or persons
whose shares are required to be aggregated) who has beneficially owned, for at
least one year, shares of Common Stock that have not been registered under the
Securities Act or that were acquired from an "affiliate" of the Company is
entitled to sell within any three-month period the number of shares of Common
Stock which does not exceed the greater of one percent of the number of then
outstanding shares or the average weekly reported trading volume during the four
calendar weeks preceding the sale. Sales under Rule 144 are also subject to
certain notice and manner of sale requirements and to the availability of
current public information about the Company and must be made in unsolicited
brokers' transactions or to a market maker. A person (or persons whose shares
are aggregated) who is not an "affiliate" of the Company under the Securities
Act during the three months preceding a sale and who has beneficially owned such
shares for at least two years is entitled to sell such shares under Rule 144
without regard to the volume, notice, information and manner of sale provisions
of such rule. Rule 144 does not require the same person to have held the
securities for the applicable periods.

The Company, its officers, directors and certain shareholders, who will
hold collectively 3,066,017 outstanding shares of Common Stock after the
Offering, have agreed not to offer or sell any shares of Common Stock for a
period of 180 days following the date of this Prospectus without the prior
written consent of Hoak Breedlove Wesneski & Co., subject to certain limited
exceptions. If this 180-day lock-up period is waived by Hoak Breedlove Wesneski
& Co., then 2,459,284 of the 3,066,017 shares would be freely tradeable subject
to the 90-day information requirement of Rule 144 for shares held by affiliates
or for less than the required two-year period.

After the Offering, the Company intends to file a Registration Statement on
Form S-8 to register 800,000 shares of Common Stock, which is the aggregate of
all shares reserved for issuance pursuant to the 1996 Option Plan and the 1998
Option Plan and shares underlying certain nonqualified options granted to
officers and directors. Accordingly, shares issued upon exercise of such options
will be freely tradeable by holders who are not affiliates of the Company and,
subject to the volume and other limitations of Rule 144 and the lock-up
agreements, by holders who are affiliates of the Company.

Prior to the Offering, there has been no market for the Common Stock. No
predictions can be made of the effect, if any, that market sales of shares of
Common Stock or the availability of such shares for sale will have on the market
price prevailing from time to time. Nevertheless, sales of significant amounts
of Common Stock could adversely affect the prevailing market price of the Common
Stock, as well as impair the ability of the Company to raise capital through the
issuance of additional equity securities. See "Risk Factors -- Shares Eligible
for Future Sale."

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<PAGE> 53

UNDERWRITING

The Underwriters named below, represented by Hoak Breedlove Wesneski & Co.
and Ferris, Baker Watts, Incorporated (the "Representatives"), have severally
agreed, subject to the terms and conditions contained in the underwriting
agreement (the "Underwriting Agreement"), by and between the Company and the
Underwriters, to purchase from the Company and the Selling Shareholders the
number of shares of Common Stock indicated below opposite their respective
names, at the initial public offering price less the underwriting discount set
forth on the cover page of this Prospectus. The Underwriting Agreement provides
that the obligations of the Underwriters are subject to certain conditions
precedent and that the Underwriters are committed to purchase all of the shares
of Common Stock if they purchase any.

<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Hoak Breedlove Wesneski & Co................................ 627,500
Ferris, Baker Watts, Incorporated........................... 627,500
Donaldson, Lufkin & Jenrette Securities Corporation......... 75,000
Painwebber Incorporated..................................... 75,000
Warburg Dillon Read LLC..................................... 75,000
Advest, Inc................................................. 40,000
J.C. Bradford & Co.......................................... 40,000
Everen Securities, Inc...................................... 40,000
Fahnestock & Co., Inc....................................... 40,000
Friedman, Billings, Ramsey & Co., Inc....................... 40,000
Gerard Klauer Mattison & Co., Inc........................... 40,000
Jefferies & Company, Inc.................................... 40,000
Laidlaw Global Securities, Inc.............................. 40,000
Morgan Keegan & Company, Inc................................ 40,000
Needham & Company, Inc...................................... 40,000
Raymond James & Associates, Inc............................. 40,000
The Robinson-Humphrey Company, LLC.......................... 40,000
Scott & Stringfellow, Inc................................... 40,000
Southwest Securities, Inc................................... 40,000
C.E. Unterberg, Towbin...................................... 40,000
Wheat First Union........................................... 40,000
Auerbach Pollak & Richardson Inc............................ 20,000
Barington Capital Group, L.P................................ 20,000
First Southwest Company..................................... 20,000
Harris, Webb & Garrison, Inc................................ 20,000
Kaufman Bros., L.P.......................................... 20,000
Pacific Crest Securities, Inc............................... 20,000
Sanders Morris Mundy, Inc................................... 20,000
Sands Brothers & Co., Ltd................................... 20,000
Southcoast Capital, L.L.C................................... 20,000
---------
Total............................................. 2,300,000
=========
</TABLE>

The Representatives have advised the Company that the Underwriters propose
initially to offer the shares of Common Stock to the public on the terms set
forth on the cover page of this Prospectus. The Underwriters may allow to
selected dealers a concession of not more than $0.55 per share; and the
Underwriters may allow, and such dealers may reallow, a concession of not more
than $0.10 per share to certain other dealers. After the initial public
distribution of the Offering, the public offering price and other selling terms
may be changed by the Representatives. The Common Stock is offered subject to
receipt and acceptance by the Underwriters, and to certain other conditions,
including the right to reject orders in whole or in part.

53
<PAGE> 54

The Selling Shareholders have granted an option to the Underwriters,
exercisable during the 30-day period after the date of this Prospectus, to
purchase up to a maximum of 345,000 additional shares of Common Stock, to cover
over-allotments, if any, at the same price per share as the initial shares to be
purchased by the Underwriters. To the extent that the Underwriters exercise this
option, the Underwriters will be committed, subject to certain conditions, to
purchase such additional shares in approximately the same proportion as set
forth in the above table. The Underwriters may purchase such shares only to
cover over-allotments made in connection with this Offering.

The Underwriting Agreement provides that the Company and the Selling
Shareholders will indemnify the Underwriters against certain liabilities,
including civil liabilities under the Securities Act, or will contribute to
payments the Underwriter may be required to make in respect thereof.

The Company, its officers, directors and certain principal shareholders, as
well as the Selling Shareholders, have agreed not to offer, sell or otherwise
dispose of any shares of Common Stock, options to acquire shares of Common Stock
or any other securities convertible into shares of Common Stock for a period of
180 days from the date of this Prospectus without the prior written consent of
Hoak Breedlove Wesneski & Co., subject to certain limited exceptions.

The Representatives have informed the Company that the Underwriters do not
expect to make sales of Common Stock offered by this Prospectus to accounts over
which they exercise discretionary authority in excess of 5% of the shares of
Common Stock offered hereby.

Prior to the Offering, there has been no public market for the Common
Stock. The initial public offering price for the Common Stock was determined by
negotiations between the Company, the Selling Shareholders and the
Representatives. Among the factors considered in determining the initial public
offering price were prevailing market and economic conditions, revenues and
earnings of the Company, market valuations of other companies engaged in
activities similar to the Company, estimates of the business potential and
prospects of the Company, the present state of the Company's business
operations, the Company's management and other factors deemed relevant.

Certain persons participating in this Offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
Common Stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids, effecting syndicate covering
transactions or imposing penalty bids. A stabilizing bid means the placing of
any bid or effecting of any purchase, for the purpose of pegging, fixing or
maintaining the price of the Common Stock. A syndicate covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
the Offering. A penalty bid means an arrangement that permits the Underwriters
to reclaim a selling concession from a syndicate member in connection with the
Offering when shares of Common Stock sold by the syndicate member are purchased
in syndicate covering transactions. Such transactions may be effected on the
Nasdaq National Market, or otherwise. Such stabilizing, if commenced, may be
discontinued at any time.

Hoak Breedlove Wesneski & Co. was formed in 1996 by the combination of two
investment banks. The founders and senior professionals of Hoak Breedlove
Wesneski & Co. have substantial backgrounds in investment banking, principal
investing and corporate management. Hoak Breedlove Wesneski & Co. has served as
a co-manager of several other public offerings. Hoak Breedlove Wesneski & Co.
has also been engaged as financial advisor to the Company to arrange a credit
facility. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Jackson Walker L.L.P., Dallas, Texas. Richard F. Dahlson, a partner
of Jackson Walker L.L.P., beneficially owns 5,333 shares of Series A Preferred
Stock. Locke Purnell Rain Harrell (A Professional Corporation), Dallas, Texas,
is acting as counsel for the Underwriters in connection with certain legal
matters relating to the Offering.

54
<PAGE> 55

EXPERTS

The Financial Statements as of June 30, 1997 and 1998 and for the years
then ended included in this Prospectus have been audited by Deloitte & Touche
LLP, independent auditors, as stated in their report appearing herein, and have
been so included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.

AVAILABLE INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form SB-2 (the "Registration
Statement"), pursuant to the Securities Act with respect to the Common Stock
offered by this Prospectus. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits thereto.
THE STATEMENTS CONTAINED IN THIS PROSPECTUS AS TO THE CONTENTS OF ANY CONTRACT
OR OTHER DOCUMENT IDENTIFIED AS EXHIBITS IN THIS PROSPECTUS ARE NOT NECESSARILY
COMPLETE, AND IN EACH INSTANCE, REFERENCE IS MADE TO A COPY OF SUCH CONTRACT OR
DOCUMENT FILED AS AN EXHIBIT TO THE REGISTRATION STATEMENT, EACH STATEMENT BEING
QUALIFIED IN ANY AND ALL RESPECTS BY SUCH REFERENCE. For further information
with respect to the Company and the Common Stock offered hereby, reference is
made to the Registration Statement and exhibits which may be inspected without
charge at the Commission's principal office at Judiciary Plaza, 450 Fifth
Street, N.W., Washington, DC 20549.

Upon consummation of this Offering, the Company will become subject to the
reporting requirements of the Exchange Act and in accordance therewith will file
reports, proxy statements and other information with the Commission. Such
reports, proxy statements and other information can be inspected and copied at
the public reference facilities of the Commission at 450 Fifth Street, N.W.,
Washington, DC 20549 and at its New York Regional Office, Room 1300, 7 World
Trade Center, New York, New York 10048; and at its Chicago Regional Office,
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511. Copies of such material may also be obtained from the
Public Reference Section of the Commission at prescribed rates. The Company's
Registration Statement as well as any reports to be filed under the Exchange Act
can also be obtained electronically after the Company has filed such documents
with the Commission through a variety of databases, including among others, the
Commission's Electronic Data Gathering, Analysis And Retrieval ("EDGAR")
program, Knight-Ridder Information, Inc., Federal Filings/ Dow Jones and
Lexis/Nexis. Additionally, the Commission maintains a Web site (at
http://www.sec.gov) that will contain such information regarding the Company.

The Company intends to furnish its shareholders with annual reports
containing audited financial statements and such other reports as the Company
deems appropriate or as may be required by law.

55
<PAGE> 56

GLOSSARY OF TECHNICAL TERMS

ADSL Asymmetric Digital Subscriber Line. A new
technology that allows more data to be sent over
existing copper telephone lines (POTS). ADSL
supports data rates of from 1.5 to 9.0 Mbps when
receiving data (known as the downstream rate) and
from 16 to 640 Kbps when sending data (known as the
upstream rate). ADSL requires a special ADSL modem.

ANSI American National Standards Institute. Founded in
1918, ANSI is a voluntary organization composed of
over 1,300 members (including all the large
computer companies) that creates standards for the
computer industry. ANSI sets standards for a wide
range of technical areas, from electrical
specifications to programming languages to
communications protocols.

BACKBONE A high-speed network that connects smaller,
independent networks.

BANDWIDTH The number of bits of information that can move
over a communications medium in a given amount of
time.

BROADBAND A transmission facility that has a bandwidth
greater than a voice grade line of 3 kHz and which
may carry numerous voice, video and data channels
simultaneously.

CENTRAL OFFICE A switching unit in a telecommunications system
which provides service to the general public,
having the necessary equipment and operating
arrangements for terminating and interconnecting
customer lines and trunks or trunks only.

DOMAIN NAME Part of the official name of a computer on the
Internet.

DUAL REDUNDANT A device which contains a backup or spare part
which is automatically put into service when a
primary part fails.

ELECTRONIC MAIL OR
E-MAIL An application that allows a user to send or
receive messages to or from any other user with an
Internet address, commonly termed an e-mail
address.

FDDI Fiber Distributed Data Interface Network. A set of
ANSI protocols for sending digital data over fiber
optic cable. FDDI networks are token-passing
networks, and support data rates of up to 100 Mbps
(100 million bits) per second. FDDI networks are
typically used as backbones for wide-area network
extensions to FDDI, called FDDI-2, supports the
transmission of voice and video information as well
as data.

FFDT FDDI Full Duplex Technology. Another variation of
FDDI-2 that uses the same network infrastructure
but can potentially support data rates up to 200
Mbps.

FTP File Transfer Protocol. A protocol that allows file
transfer between a host and a remote computer.

GRAPHICAL USER
INTERFACE A means of communicating with a computer by
manipulating icons and windows rather than using
text commands.

INTERNET An open global network of interconnected
commercial, educational and governmental computer
networks that utilize a common communications
protocol, TCP/IP.
56
<PAGE> 57

INTERNET BACKBONE The Internet backbone consists of high-speed
networks that link the smaller, independent
networks of the Internet.

IRC Internet Relay Chat. A system that enables
individuals on the Internet to talk to each other
in real time (rather than after a delay, as with
e-mail messages).

ISDN Integrated Services Digital Network. A digital
network that combines voice and digital network
services through a single medium, making it
possible to offer subscribers digital data services
as well as voice connections.

ISP Internet Service Provider. A company that provides
access to the Internet. For a monthly fee, the
service provider gives you a software package,
username, password and access phone number.
Equipped with a computer and modem, you can then
connect to the Internet and browse the World Wide
Web and USENET, and send and receive e-mail.

LEC Local Exchange Carrier. A telecommunications
utility that has been granted either a certificate
of convenience and necessity or a certificate of
operating authority to provide local exchange
telephone service, basic local telecommunications
service, or switched access service within the
state. A local exchange carrier is also referred to
as a local exchange company.

LOCAL EXCHANGE TELEPHONE
SERVICE Telecommunications service provided within an
exchange to establish connections between customer
premises within the exchange, including connections
between a customer premises and a long distance
provider serving the exchange. The term includes
tone dialing, service connection charges, and
directory assistance services when offered in
connection with basic local telecommunications
service and interconnection with other service
providers. Local exchange telephone service may
also be referred to as local exchange service.
However, a competitive exchange service is not
local exchange telephone service. This fact, and
the definition of competitive exchange service,
shall be liberally construed to encourage a
competitive marketplace.

MODEM A piece of equipment that connects a computer to a
data transmission line (typically a telephone
line).

NEWSGROUP Same as forum, an on-line discussion group. On the
Internet, there are literally tens of thousands of
newsgroups covering every conceivable interest. To
view and post messages to a newsgroup, you need a
news reader, a program that runs on your computer
and connects you to a news server on the Internet.

ON-LINE SERVICES Commercial information services that offer a
computer user access through a modem to specific
menus of information, entertainment and
communications data. These services are generally
closed systems and many offer limited, if any,
Internet access.

POP Point of Presence. The Company defines a POP as a
local geographic point of presence where
subscribers can access the Company's services via a
local telephone call. To the Company's knowledge,
there is no industry-wide definition of an Internet
access POP, and other companies may define a POP
differently.

57
<PAGE> 58

ROUTER A device that receives and transmits data packets
between segments in a network or different
networks.

SDSL Symmetric Digital Subscriber Line. A new technology
that allows more data to be sent over existing
copper telephone lines (POTS). SDSL supports data
rates up to 3 Mbps. SDSL works by sending digital
pulses in the high-frequency area of telephone
wires. Since these high frequencies are not used by
normal voice communications, SDSL can operate
simultaneously with voice connections over the same
wires. SDSL requires a special SDSL modem. SDSL is
called symmetric because it supports the same data
rates for upstream and downstream traffic.

SERVER Software that allows a computer to offer a service
to another computer. Other computers contact the
server program by means of matching client
software. In addition, such term means the computer
on which server software runs.

T-1 A data communications line capable of transmission
speeds of 1.54 Mbps.

TERMINAL SERVER A specialized computer that supports multiple
communications connections.

USENET A worldwide bulletin board system that can be
accessed through the Internet or through many
online services. The USENET contains tens of
thousands of forums, called newsgroups, that cover
every imaginable interest group. It is used daily
by millions of people around the world.

VIRTUAL POP Modems without a geographically specific location
typically housed or co-located at central offices
inside of a LEC Network. Private networks connect
these facilities with the Company.

VoIP Voice Over Internet Protocol. A category of
hardware and software that enables people to use
the Internet as the transmission medium for voice
telephone calls or faxes.

WINDOWS A computer operating system developed by Microsoft
Corporation that provides a graphical user
interface and multitasking capabilities.

WORLD WIDE WEB A network of computer servers that uses a special
communications protocol to link different servers
throughout the Internet and permits communication
of graphics, video and sound.

xDSL An abbreviation that refers collectively to all
types of digital subscriber lines, the two main
categories being ADSL and SDSL. Two other types of
xDSL technologies are High-data-rate DSL ("HDSL")
and symmetric digital subscriber lines ("SDSL").
DSL technologies use sophisticated modulation
schemes to pack data onto copper wires. They are
sometimes referred to as last-mile technologies
because they are used only for connections from a
telephone switching station to a home or office,
not between switching stations. xDSL is similar to
ISDN inasmuch as both operate over existing copper
telephone lines (POTS) and both require the short
runs to a central telephone office (usually less
than 20,000 feet). However, xDSL offers much higher
speeds -- up to 32 Mbps for downstream traffic.

58
<PAGE> 59

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Independent Auditors' Report................................ F-2
Financial Statements:
Balance Sheets............................................ F-3
Statements of Operations.................................. F-4
Statements of Shareholders' Equity (Deficit).............. F-5
Statements of Cash Flows.................................. F-6
Notes to Financial Statements............................. F-7
</TABLE>

F-1
<PAGE> 60

INDEPENDENT AUDITORS' REPORT

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

We have audited the accompanying balance sheets of Internet America, Inc.
(the "Company") as of June 30, 1997 and 1998, and the related statements of
operations, shareholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at June 30, 1997 and 1998, and
the results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.

DELOITTE & TOUCHE LLP

Dallas, Texas
August 12, 1998

F-2
<PAGE> 61

INTERNET AMERICA, INC.

BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
JUNE 30,
------------------------- SEPTEMBER 30,
1997 1998 1998
----------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................... $ -- $ 565,182 $ 173,398
Accounts receivable, net of allowance for
uncollectible accounts of $126,707 and $198,155
in 1997 and 1998, respectively................... 224,180 327,533 448,637
Prepaid expenses and other current assets........... 53,666 30,824 45,462
----------- ----------- -----------
Total current assets........................ 277,846 923,539 667,497
PROPERTY AND EQUIPMENT -- Net......................... 2,510,623 1,625,022 1,540,896
OTHER ASSETS -- Net................................... 325,678 601,298 826,159
----------- ----------- -----------
TOTAL....................................... $ 3,114,147 $ 3,149,859 $ 3,034,552
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
Trade accounts payable.............................. $ 1,451,969 $ 882,246 $ 927,307
Accrued liabilities................................. 673,672 1,069,191 1,019,037
Current portion of capital lease obligations........ 408,251 332,895 266,521
Current maturities of long-term debt................ 419,468 431,898 393,736
Advances under line of credit....................... 243,000 225,000 147,762
Notes payable to shareholders....................... 2,017,713 1,440,091 1,456,073
Bank overdrafts..................................... 226,979 -- --
Deferred revenue.................................... 1,670,392 1,926,979 1,933,229
----------- ----------- -----------
Total current liabilities................... 7,111,444 6,308,300 6,143,665
CAPITAL LEASE OBLIGATIONS, net of current portion..... 375,851 31,192 1,436
LONG-TERM DEBT, net of current portion................ 308,109 577,622 330,728
----------- ----------- -----------
Total liabilities........................... 7,795,404 6,917,114 6,475,829
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (DEFICIT):
Series A convertible preferred stock, $.01 par
value; 400,000 shares authorized, 379,672 issued
and outstanding in 1997 and 1998................. 3,796 3,796 3,796
Series B convertible preferred stock, $.01 par
value, 300,000 shares authorized, 73,667 issued
and outstanding in 1997 and 1998................. 737 737 737
Common stock, $.01 par value; 40,000,000 shares
authorized, 3,560,330 and 3,532,205 issued in
1997 and 1998, respectively, and 3,532,205
outstanding in 1997 and 1998..................... 35,603 35,322 35,322
Additional paid-in capital.......................... 2,920,333 2,816,114 2,816,114
Common stock in treasury, 28,125 shares at cost in
1997............................................. (12,500) -- --
Accumulated deficit................................. (7,629,226) (6,623,224) (6,297,246)
----------- ----------- -----------
Total shareholders' equity (deficit)........ (4,681,257) (3,767,255) (3,441,277)
----------- ----------- -----------
TOTAL....................................... $ 3,114,147 $ 3,149,859 $ 3,034,552
=========== =========== ===========
</TABLE>

See notes to financial statements.

F-3
<PAGE> 62

INTERNET AMERICA, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED JUNE 30, ENDED SEPTEMBER 30,
------------------------- -----------------------
1997 1998 1997 1998
----------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES:
Access................................... $ 8,177,300 $ 9,565,815 $2,150,085 $2,896,294
Business services........................ 1,044,689 1,036,145 258,777 228,395
Other.................................... 248,933 41,312 2,913 16,763
----------- ----------- ---------- ----------
Total............................ 9,470,922 10,643,272 2,411,775 3,141,452
----------- ----------- ---------- ----------
OPERATING COSTS AND EXPENSES:
Connectivity and operations.............. 6,185,100 4,508,781 1,108,075 1,186,292
Sales and marketing...................... 1,912,265 1,140,279 85,824 592,523
General and administrative............... 2,747,225 1,919,325 400,049 563,364
Depreciation and amortization............ 1,618,089 1,473,779 363,446 386,935
Impairment of equipment.................. 350,787 -- -- --
----------- ----------- ---------- ----------
Total............................ 12,813,466 9,042,164 1,957,394 2,729,114
----------- ----------- ---------- ----------
INCOME (LOSS) FROM OPERATIONS.............. (3,342,544) 1,601,108 454,381 412,338
INTEREST EXPENSE 480,985 571,106 134,720 76,360
----------- ----------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES.......... (3,823,529) 1,030,002 319,661 335,978
INCOME TAX EXPENSE......................... -- 24,000 6,000 10,000
----------- ----------- ---------- ----------
NET INCOME (LOSS).......................... $(3,823,529) $ 1,006,002 $ 313,661 $ 325,978
=========== =========== ========== ==========
NET INCOME (LOSS) PER COMMON SHARE:
BASIC.................................... $ (1.12) $ 0.28 $ 0.10 $ 0.09
=========== =========== ========== ==========
DILUTED.................................. $ (1.12) $ 0.21 $ 0.07 $ 0.07
=========== =========== ========== ==========
PRO FORMA (Unaudited).................... $ (0.86) $ 0.21 $ 0.07 $ 0.07
=========== =========== ========== ==========
</TABLE>

See notes to financial statements.

F-4
<PAGE> 63

INTERNET AMERICA, INC.

STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL TREASURY STOCK
---------------- ------------------- PAID-IN ------------------
SHARES AMOUNT SHARES AMOUNT CAPITAL SHARES AMOUNT
------- ------ --------- ------- ---------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JULY 1, 1996......................... 453,339 $4,533 3,001,180 $30,012 $2,707,787 -- $ --
Issuance of common stock:
For cash..................................... -- -- 544,149 5,441 226,846 -- --
For services................................. -- -- 15,001 150 24,850 -- --
Deferred compensation for stock options issued
below deemed fair value...................... -- -- -- -- (39,150) -- --
Purchase of treasury stock at cost............ -- -- -- -- -- 28,125 (12,500)
Net loss...................................... -- -- -- -- -- -- --
------- ------ --------- ------- ---------- ------- --------
BALANCE, JUNE 30, 1997........................ 453,339 4,533 3,560,330 35,603 2,920,333 28,125 (12,500)
Purchase of stock options..................... -- -- -- -- (92,000) -- --
Cancellation of treasury stock................ -- -- (28,125) (281) (12,219) (28,125) 12,500
Net income.................................... -- -- -- -- -- -- --
------- ------ --------- ------- ---------- ------- --------
BALANCE, JUNE 30, 1998........................ 453,339 $4,533 3,532,205 $35,322 $2,816,114 -- $ --
Net income (Unaudited)........................ -- -- -- -- -- -- --
------- ------ --------- ------- ---------- ------- --------
BALANCE, SEPTEMBER 30, 1998 (Unaudited)....... 453,339 $4,533 3,532,205 $35,322 $2,816,114 -- --
======= ====== ========= ======= ========== ======= ========

<CAPTION>
TOTAL
SHAREHOLDERS'
ACCUMULATED EQUITY
DEFICIT (DEFICIT)
----------- -------------
<S> <C> <C>
BALANCE, JULY 1, 1996......................... $(3,805,697) $(1,063,365)
Issuance of common stock:
For cash..................................... -- 232,287
For services................................. -- 25,000
Deferred compensation for stock options issued
below deemed fair value...................... -- (39,150)
Purchase of treasury stock at cost............ -- (12,500)
Net loss...................................... (3,823,529) (3,823,529)
----------- -----------
BALANCE, JUNE 30, 1997........................ (7,629,226) (4,681,257)
Purchase of stock options..................... -- (92,000)
Cancellation of treasury stock................ -- --
Net income.................................... 1,006,002 1,006,002
----------- -----------
BALANCE, JUNE 30, 1998........................ $(6,623,224) $(3,767,255)
Net income (Unaudited)........................ 325,978 325,978
----------- -----------
BALANCE, SEPTEMBER 30, 1998 (Unaudited)....... $(6,297,246) $(3,441,277)
=========== ===========
</TABLE>

See notes to financial statements.

F-5
<PAGE> 64

INTERNET AMERICA, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED JUNE 30, SEPTEMBER 30,
------------------------- ---------------------
1997 1998 1997 1998
----------- ----------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss).................................. $(3,823,529) $ 1,006,002 $ 313,661 $ 325,978
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization................... 1,618,089 1,473,779 320,709 316,204
Loss on impairment.............................. 350,787 -- -- --
Provision for allowance for uncollectible
accounts...................................... 57,661 63,448 -- --
Issuance of stock for services.................. 25,000 -- -- --
Deferred compensation........................... (39,150) -- -- --
Changes in operating assets and liabilities:
Accounts receivable........................... (114,796) (166,801) 3,884 (121,104)
Prepaid expenses and other current assets..... 55,715 22,842 (15,606) (14,638)
Other assets.................................. (12,625) (44,841) 42,409 106,510
Accounts payable and accrued liabilities...... (545,877) (401,183) (190,196) (5,093)
Deferred revenue.............................. 998,715 (155,835) (23,604) 6,250
----------- ----------- --------- ---------
Net cash provided by (used in) operating
activities............................... (1,430,010) 1,797,411 451,257 614,107
----------- ----------- --------- ---------
INVESTING ACTIVITIES:
Purchases of property and equipment, net........... (1,177,894) (356,535) (6,243) (232,078)
Purchase of subscribers............................ (356,670) (50,000) -- --
Proceeds from sale of equipment.................... 21,500 -- -- --
----------- ----------- --------- ---------
Net cash used in investing activities...... (1,513,064) (406,535) (6,243) (232,078)
----------- ----------- --------- ---------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock............. 232,287 -- -- --
Purchase of treasury stock......................... (12,500) -- -- --
Purchase of stock options.......................... -- (92,000) -- --
Payments for initial public offering costs......... -- -- -- (331,371)
Proceeds from sale and leaseback................... 422,302 -- -- --
Proceeds from issuance of long-term debt........... 2,905,288 -- -- --
Principal payments of long-term debt............... (361,666) (295,679) (328,664) (346,312)
Principal payments under capital lease
obligations..................................... (358,119) (420,015) (116,350) (96,130)
Proceeds (payments) on line of credit.............. 93,000 (18,000) -- --
Loan origination fees.............................. (56,289) -- -- --
----------- ----------- --------- ---------
Net cash provided by (used in) financing
activities............................... 2,864,303 (825,694) (445,014) (773,813)
----------- ----------- --------- ---------
NET INCREASE (DECREASE) IN CASH...................... (78,771) 565,182 -- (391,784)
CASH, BEGINNING OF PERIOD............................ 78,771 -- -- 565,182
----------- ----------- --------- ---------
CASH, END OF PERIOD.................................. $ -- $ 565,182 $ -- $ 173,398
=========== =========== ========= =========
SUPPLEMENTAL INFORMATION:
Cash paid for interest............................. $ 285,070 $ 628,920 $ 71,851 $ 166,859
Equipment acquired under capital leases............ $ 816,235 $ -- $ -- $ --
Subscriber purchase assumption of service
obligations..................................... $ -- $ 412,422 $ -- $ --
</TABLE>

See notes to financial statements.

F-6
<PAGE> 65

INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS

1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General -- Internet America, Inc. (the "Company") was incorporated in
Arizona on December 13, 1994, commenced operations on January 13, 1995 and
reincorporated on July 21, 1995 as a Texas corporation. The Company is a
provider of Internet access, serving both individual and corporate customers in
the North Texas area.

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

Interim Financial Statements -- The balance sheet as of September 30, 1998,
and the statements of operations, shareholders' equity (deficit) and cash flows
for the three months ended September 30, 1997 and 1998, have been prepared by
the Company without audit. In the opinion of management, all adjustments (which
included only normal, recurring adjustments) necessary to present fairly the
financial position, at September 30, 1998 and the results of operations and cash
flows for the three months ended September 30, 1997 and 1998, have been made.
The results of operations for the three months ended September 30, 1998, are not
necessarily indicative of the results to be expected for the full year.

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

Credit Risk -- The Company's accounts receivable potentially subjects the
Company to credit risk, as collateral is generally not required. The Company's
risk of loss is limited due to advance billings to customers for services, the
use of preapproved charges to customer credit cards, and the ability to
terminate access on delinquent accounts. The large number of customers
comprising the customer base mitigates the concentration of credit risk.

Financial Instruments -- The carrying amounts of cash, accounts receivable,
accounts payable and accrued liabilities approximate fair value because of the
short maturity of these instruments. The floating interest rate on the Company's
lines of credit reflects current market rates and, accordingly, their carrying
values approximate fair value. The fair values for other debt and lease
obligations, which have fixed interest rates, do not differ materially from
their carrying values.

Property and Equipment -- Property and equipment are recorded at cost.
Depreciation and amortization are provided using the straight-line method over
the estimated useful lives of the assets, ranging from one to five years.

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

Acquired Subscriber Base -- The Company capitalizes specific costs incurred
for the purchase of subscriber bases from other Internet Service Providers
("ISPs"). The subscriber acquisition costs include the actual fee paid to the
selling ISPs as well as the assumption of deferred service obligations and legal
expenses specifically related to the transactions. Amortization is provided
using the straight line method over three years commencing when the subscriber
base is received.

F-7
<PAGE> 66
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Long-Lived Assets -- On an annual basis, the Company reviews the values
assigned to long-lived assets, such as property and equipment to determine if
any impairments are other than temporary. Provisions for asset impairments are
based on discounted cash flow projections in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and such
assets are written down to their estimated fair values. Management believes that
the long-lived assets in the accompanying balance sheets are properly valued. An
impairment loss of $350,787 related to the write down of modem equipment was
recognized during the year ended June 30, 1997.

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

Advertising Expenses -- The Company accounts for advertising costs as
expenses in the period in which they are incurred. Advertising expenses for the
years ended June 30, 1997 and 1998 were $728,404 and $736,222, respectively.

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

Net Earnings Per Share -- Share and per share amounts have been adjusted
retroactively for the 2.25-to-1.00 stock split which was effected in July 1998.
Basic earnings per share is computed using the weighted average number of common
shares outstanding and excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share reflects the potential
dilution that could occur upon exercise or conversion of these instruments.

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

Recent Accounting Pronouncements -- In February 1997, the FASB issued SFAS
No. 129, "Disclosure of Information about Capital Structure," which establishes
standards for disclosing information about an entity's capital structure and is
effective for financial statements for periods ending after December 15, 1997.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components in the financial statements for fiscal years beginning after
December 15, 1997. The FASB also issued, in June 1997, SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
establishes standards for the way public companies disclose information about
operating segments, products and services, geographic areas and major customers.
SFAS No. 131 is effective for financial statements for periods beginning after
December 15, 1997. The Company has determined that the impact on its financial
statements of adopting SFAS Nos. 129, 130 and 131 is not material. In June 1998,
the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities," which is effective for fiscal quarters ending after June 15, 1999.
The Company does not expect the adoption of SFAS No. 133 to have a material
impact on its financial statements.

Certain Reclassifications -- Certain reclassifications have been made to
prior period amounts to conform to the fiscal 1998 presentation.
F-8
<PAGE> 67
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

2. PROPERTY AND EQUIPMENT

Property and equipment consist of:

<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
------------------------- -------------
1997 1998 1998
----------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Data communications and office equipment...... $ 3,327,224 $ 3,557,646 $ 3,739,381
Leasehold improvements........................ 453,937 450,360 455,714
Furniture and fixtures........................ 255,787 255,787 261,508
Computer software............................. 88,757 219,440 258,708
----------- ----------- -----------
4,125,705 4,483,233 4,715,311
Less accumulated depreciation and
amortization................................ (1,615,082) (2,858,211) (3,174,415)
----------- ----------- -----------
$ 2,510,623 $ 1,625,022 $ 1,540,896
=========== =========== ===========
</TABLE>

Property under capital lease, primarily data communications equipment
included above, amounted to $1,084,809 at June 30, 1997 and 1998. Included in
accumulated depreciation and amortization are amounts related to property under
capital lease of $379,486 and $729,865 at June 30, 1997 and 1998, respectively.
Depreciation expense charged to operations was $1,485,782 and $1,242,138 for the
years ended June 30, 1997 and 1998, respectively, and included $300,312 and
$350,379, respectively, pertaining to property under capital lease.

3. OTHER ASSETS

Other assets consist of:

<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
--------------------- -------------
1997 1998 1998
--------- --------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Acquired subscriber base......................... $ 356,670 $ 819,092 $ 819,092
Loan origination fees............................ 61,289 20,353 8,802
Deposits......................................... 40,331 35,172 43,041
Deferred costs................................... -- 50,000 331,371
--------- --------- ----------
458,290 924,617 1,202,306
Less accumulated amortization.................... (132,612) (323,319) (376,147)
--------- --------- ----------
$ 325,678 $ 601,298 $ 826,159
========= ========= ==========
</TABLE>

In July 1996 the Company acquired approximately 900 subscribers of Webstar,
Inc. for approximately $357,000. On November 26, 1997, the Company acquired
approximately 4,600 subscribers of WHY? Telecommunications, Inc. for a cash
payment of $50,000 and the assumption of deferred service obligations of
approximately $412,000 and certain contingent consideration. Management does not
anticipate any additional consideration to be paid related to this transaction.

Deferred costs consists of costs incurred in connection with the Company's
proposed initial public offering of common stock.

4. LINE OF CREDIT AGREEMENTS

The Company may borrow up to $150,000 under a revolving credit agreement
that matured September 30, 1998. The credit agreement automatically renewed to
mature on March 31, 1999. Borrowings under the agreement bear interest at the
bank's prime rate plus 2% (10.5% at June 30, 1997 and 1998) and are
collateralized by substantially all assets of the Company, and by the guarantees
of a director and shareholder.
F-9
<PAGE> 68
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The outstanding borrowings at June 30, 1997 and 1998 were $18,000 and $0;
respectively, with approximately $66,000 (unaudited) at September 30, 1998
committed to a standby letter of credit securing a lease.

Also, the Company may borrow, subject to the approval of a director of the
Company, up to $350,000 under a revolving credit agreement that matures December
15, 1998 or upon the effective date of a defined securities registration.
Borrowings under the agreement bear interest at the bank's prime rate (8.5% at
June 30, 1997 and 1998) and are guaranteed by a Director. The Director receives
guaranty fees, payable on demand, equal to 18% of the outstanding borrowings,
less interest paid to the bank. The outstanding borrowings at June 30, 1997 and
1998 were $225,000.

5. NOTES PAYABLE AND LONG-TERM DEBT

Long-term debt consists of:

<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
------------------------ -------------
1997 1998 1998
---------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Notes payable to shareholders, $1,767,713
bearing interest at 10% and $250,000 at 18%
and were due September 25, 1997 and April 1,
1997, respectively. In the event of default,
the borrowings convert to common stock at the
price of $0.44 per share at the option of the
noteholder. The assets of the Company
collateralized the notes. On June 30, 1998,
the loan agreements, which were in default,
were renewed at the prime rate (8.5% as of
June 30, 1998), with borrowings due in
monthly payments approximating $129,000 or
upon the effective date of a defined
securities registration or sale. The notes
mature on November 30, 1999.................. $2,017,713 $ 2,017,713 $ 1,786,801
Note payable to an unrelated third party,
bearing interest at 16.5%, payable in equal
monthly installments of $10,266, including
interest, through January 1999. The note is
collateralized by substantially all of the
assets of the Company and contains, among
other things, a restriction on the payment of
dividends on common stock. In connection with
this note, the Company issued detachable
warrants during March 1996 to purchase 33,750
shares of common stock at $1.67 per share.
The fair value of the warrants have not been
reflected in the financial statements as the
amount was immaterial. The warrants are
exercisable from January 1, 1998 through
December 31, 1999............................ 191,482 79,773 41,611
Notes payable to vendors maturing through
February 1998, bearing interest at 6% to
18%.......................................... 183,970 -- --
</TABLE>

F-10
<PAGE> 69
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
------------------------ -------------
1997 1998 1998
---------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Note payable in connection with acquisition of
Webstar, Inc. subscriber base, due June 30,
1999 or upon the effective date of a defined
securities registration, bearing interest at
14%, payable monthly. Prior to the end of any
calendar quarter, the lender may demand a
principal payment of up to $50,000........... 352,125 352,125 352,125
---------- ----------- -----------
2,745,290 2,449,611 2,180,537
Less current portion........................... (419,468) (1,871,989) (1,849,809)
---------- ----------- -----------
$ 308,109 $ 577,622 $ 330,728
========== =========== ===========
</TABLE>

6. COMMITMENTS AND CONTINGENCIES

The Company leases certain of its facilities under operating leases. Rental
expense under these leases was approximately $373,000 and $574,000 for the years
ended June 30, 1997 and 1998, respectively. At June 30, 1998, future minimum
lease payments on capital and operating leases were approximately as follows:

<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
--------- ----------
<S> <C> <C>
1999...................................................... $ 361,423 $ 563,756
2000...................................................... 55,082 522,337
2001...................................................... -- 441,572
--------- ----------
Total minimum lease payments.............................. 416,505 $1,527,665
==========
Less amounts representing interest........................ (52,418)
---------
Present value of minimum capitalized lease payments....... 364,087
---------
Less current portion...................................... (332,895)
---------
Long-term capitalized lease obligations................... $ 31,192
=========
</TABLE>

In August 1997, the Company entered into a network services agreement for
telecommunications services with a competitive local exchange carrier ("CLEC")
that commits the Company to the CLEC's services through December 31, 1998. The
Company is in the process of converting customers to this service and estimates
that the monthly recurring commitment will be approximately $50,000.

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

7. SHAREHOLDERS' EQUITY (DEFICIT)

Common Stock -- The Company has authorized 40,000,000 shares of $0.01 par
value common stock. During the year ended June 30, 1997, the Company issued
544,149 shares of its common stock in exchange for cash of $232,287. The Company
also issued 15,001 shares of common stock in exchange for services provided by
one of the Company's employees. The shares issued were recorded at $25,000, the
value of the services provided.

F-11
<PAGE> 70
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

During March 1998, three former shareholders of the Company sold 1,987,124
shares of common stock to an entity acting as nominee for current shareholders
in exchange for $883,166.

Preferred Stock -- The Company has authorized 5,000,000 shares of preferred
stock issuable in series. The Company has authorized 400,000 shares of $0.01 par
value Series A Preferred Stock. Each share of the Series A Preferred Stock is
convertible at any time into 2.25 shares of the Company's common stock and has
the same dividend rights as the common stock. Each share of the Series A
Preferred Stock will automatically be converted into 2.25 shares of the
Company's common stock 30 days following the successful completion of a public
offering of shares of common stock of the Company. In order for the shares to
convert, the gross proceeds from such public offering must exceed $5 million and
the per share price of the common stock must be at least $2.22 per share. In the
event of liquidation of the Company, whether voluntary or involuntary, the
holders of the Series A Preferred Stock then outstanding shall be entitled to be
paid out of the assets of the Company available for distribution to its
shareholders, an amount in cash equal to the purchase price for each share of
the Series A Preferred Stock outstanding, prior to any distributions to common
shareholders.

The Company has authorized 300,000 shares of $0.01 par value Series B
Preferred Stock. Each share of Series B Preferred Stock is convertible at any
time into 2.25 shares of the Company's common stock. The Series B Preferred
Stock automatically converts to common stock 30 days following the successful
completion of a public offering of shares of the Company's common stock. In
order for the shares to convert, the gross proceeds from the public offering
must be at least $5 million and the per share price of the common stock offered
must be at least $3.33 per share. In the event of liquidation of the Company,
whether voluntary or involuntary, the holders of Series B Preferred Stock are
entitled to receive an amount in cash equal to the purchase price for each share
of Series B Preferred Stock outstanding, prior to any distributions to common
shareholders. The liquidation preference payable to holders of Series A and
Series B Preferred Stock shall be made based on the aggregate purchase price for
the shares of the Series A Preferred Stock and Series B Preferred Stock,
respectively. The Series A and Series B Preferred Stock have no specific
dividend rate and the holders of each class of preferred stock are entitled to
receive the same dividends as holders of common stock.

The Company has agreed with the holders of Series A Preferred Stock that
the Company will not issue common stock, or securities convertible into or
exchangeable for shares of common stock, or any options, warrants or other
rights to acquire shares of common stock at a price per share less than $1.67.
However, as noted above, the Company issued common stock at a price of $0.44 per
share, with the express permission of the holders of Series A Preferred Stock.

Stock Option Plan -- The Company's 1996 Incentive Stock Option Plan (the
"1996 Option Plan") was adopted by the Board of Directors and the Company's
shareholders in December 1996. Pursuant to the 1996 Option Plan, the Company may
grant incentive and nonqualified stock options to key employees of the Company.
A total of 225,000 shares of common stock have been reserved for issuance under
the 1996 Option Plan.

The maximum term of options granted under the 1996 Option Plan is ten
years. The aggregate fair market value of the stock with respect to which
incentive stock options are first exercisable in any calendar year may not
exceed $100,000 per incidence. The exercise price of incentive stock options
must be equal or greater than the fair market value of common stock on the date
of grant. The exercise price of incentive stock options granted to any person
who at the time of grant owns stock possessing more than 10% of the total
combined voting power of all classes of stock must be at least 110% of the fair
market value of such stock on the date of grant, and the term of these options
cannot exceed five years. The Company currently has 67,075 options outstanding
to its employees under the 1996 Option Plan. These options are exercisable at
either $1.67 per share of common stock or $3.33 per share of common stock.

F-12
<PAGE> 71
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

In October 1996, 67,500 stock options at an exercise price of $3.33 per
share were granted to an officer of the Company and 215,026 nonqualified stock
options at an exercise price of $3.33 per share were granted to certain founders
of the Company in connection with such founders' pledge of their stock of the
Company to guarantee a bridge loan. The Board of Directors adjusted the exercise
price of these options to $1.67 per share in March 1998.

In March 1998, 393,750 options to purchase shares of common were granted to
certain officers and employees of the Company at an exercise price of $1.67 per
share.

During May 1998, outstanding options to purchase 258,750 shares of common
stock with an exercise price of $0.09 per share were repurchased from former
employees for $0.36 per share.

At September 30, 1998, the Company has 1,212,476 (unaudited) nonqualified
options outstanding to certain of its officers, employees and advisors. These
options are exercisable at prices ranging from $0.09 per share of common stock
to $8.00 per share of common stock.

The Company applies APB No. 25 and related Interpretations in accounting
for its plans. The estimated fair value of each option grant was determined by
reference to recent private arm's length sales of common and preferred stock. In
cases where these were no arm's length transactions on or around the date of an
option grant, the value was determined by the Board of Directors. There was no
compensation cost charged against operations for the stock options during the
years ended June 30, 1997 and 1998, respectively.

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

<TABLE>
<CAPTION>
1997 1998
----------- ----------
<S> <C> <C>
Net income (loss)
As reported............................................... $(3,823,529) $1,006,002
Pro Forma................................................. (3,843,651) 991,540
Basic income (loss) per share
As reported............................................... $ (1.12) $ 0.28
Pro Forma................................................. (1.12) 0.28
Diluted income (loss) per share
As reported............................................... $ (1.12) $ 0.21
Pro Forma................................................. (1.12) 0.21
</TABLE>

A summary of the status of the Company's stock options as of June 30, 1998
and 1997, and changes during the years ended on those dates is presented below:

<TABLE>
<CAPTION>
1997 1998
-------------------------- --------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Outstanding at beginning of period 1,206,765.. $1.37 1,260,364 $1.85
Granted............................ 563,778 3.30 393,750 1.67
Exercised.......................... -- -- -- --
Forfeited.......................... (510,179) 2.30 (205,388) 2.43
Purchased.......................... -- -- (258,750) 0.09
--------- ---------
Outstanding at end of period......... 1,260,364 1.85 1,189,976 1.59
========= =========
Options exercisable at year end...... 1,002,845 1.62 733,793 1.55
========= =========
</TABLE>

F-13
<PAGE> 72
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information about stock options outstanding
at June 30, 1998:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- -------------------------
NUMBER WEIGHTED-AVERAGE NUMBER NUMBER
RANGE OF OUTSTANDING REMAINING CONTRACTUAL EXERCISABLE EXERCISABLE
EXERCISE PRICES AT 6/30/98 LIFE AS OF 6/30/98 (YEARS) AT 6/30/97 AT 6/30/98
--------------- ----------- -------------------------- ----------- -----------
<S> <C> <C> <C> <C>
$0.09......................... 78,750 7.4 337,500 78,750
1.67......................... 1,088,726 8.8 371,570 632,543
3.33......................... 22,500 8.6 293,775 22,500
</TABLE>

All options granted during the years ended June 30, 1997 and 1998 were
granted above the market price. The weighted average grant date fair value of
options granted during the year ended June 30, 1997 and 1998 was $0. During
March 1998, the exercise price of a total of 343,645 options to purchase shares
of common stock was adjusted from $3.33 per share to $1.67 per share, of which
310,541 options were exercisable at June 30, 1998. The adjustment of the
exercise price of these options decreased the weighted-average exercise price of
the outstanding options as of June 30, 1998 by $0.48 per share.

During July 1998, the Company's Board of Directors authorized an initial
public offering of the Company's common stock, changed the number of authorized
shares of common stock to 40,000,000, approved and effected a 2.25-to-1.00 stock
split in the form of a dividend and adopted the 1998 Nonqualified Stock Option
Plan providing for the issuance of up to 400,000 stock options exercisable for
shares of common stock.

During July 1998, options to purchase 22,500 shares of common stock were
granted to a director of the Company under the 1998 Nonqualified Stock Option
Plan. Such options are immediately exercisable at $8.00 per share and expire in
10 years.

8. INCOME TAXES

No provision for income taxes was recognized for the year ended June 30,
1997 as the Company incurred net operating losses for income tax purposes. A
current tax provision of $24,000 was recognized for the year ended June 30, 1998
related to federal corporate alternative minimum tax.

Deferred tax assets and liabilities as of June 30, 1997 and 1998, consist
of:

<TABLE>
<CAPTION>
JUNE 30,
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards......................... $ 2,005,000 $ 1,672,000
Stock options granted at a discount...................... 142,000 31,000
Deferred revenue......................................... 141,000 44,000
Impairment of equipment.................................. 119,000 74,000
Allowance for doubtful accounts.......................... 43,000 67,000
Depreciation and amortization............................ 67,000 234,000
Other.................................................... 55,000 44,000
----------- -----------
Total deferred tax assets........................ 2,572,000 2,166,000
Deferred tax liabilities................................... -- --
----------- -----------
Net deferred tax asset..................................... 2,572,000 2,166,000
Valuation allowance........................................ (2,572,000) (2,166,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>

F-14
<PAGE> 73
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The Company has provided a valuation allowance for net deferred tax assets,
as it is more likely than not that these assets will not be realized.

At June 30, 1998, the Company has net operating loss carryforwards of
approximately $5 million for income tax purposes. These net operating loss
carryforwards may be carried forward in varying amounts until 2012 and may be
limited in their use due to significant changes in the Company's ownership.

The differences between the Company's effective tax rate and the federal
statutory rate of 34% for the fiscal years ended June 30, 1997 and 1998 are as
follows:

<TABLE>
<CAPTION>
YEARS ENDED
JUNE 30,
-----------
1997 1998
---- ----
<S> <C> <C>
Income tax expense (benefit) at statutory rate.............. (34)% (34)%
State tax benefit, net of federal benefit................... (3)% (3)%
Valuation allowance......................................... 37% 37%
Alternative minimum tax..................................... 0% 2%
--- ---
Total income tax expense.......................... 0% 2%
=== ===
</TABLE>

9. EMPLOYEE BENEFIT PLAN

The Company has established a 401(k) plan for the benefits of its
employees. Employees may contribute to the plan up to 15% of their salary,
pursuant to a salary reduction agreement, upon meeting age requirements. The
Company made no discretionary contributions to the Plan through June 30, 1998.

10. NET EARNINGS PER SHARE

A reconciliation of shares used in calculation of basic and diluted and
unaudited pro forma net earnings per share follows:

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------
1997 1998
----------- ----------
<S> <C> <C>
Net income (loss)........................................... $(3,823,529) $1,006,002
=========== ==========
Net income (loss) per common share:
Basic..................................................... $ (1.12) $ 0.28
=========== ==========
Diluted................................................... $ (1.12) $ 0.21
=========== ==========
Pro forma (unaudited)..................................... $ (0.86) $ 0.21
=========== ==========
Reconciliation of weighted average shares:
Shares used in computing basic net income (loss) per
share.................................................. 3,417,808 3,532,221
Adjusted to reflect the assumed conversion of preferred
stock and certain option exercises..................... -- 1,251,098
----------- ----------
Shares used in computing diluted net income (loss) per
share.................................................. 3,417,808 4,783,319
----------- ----------
Adjusted to reflect assumed conversion of preferred
stock.................................................. 1,020,002
Shares used in computing unaudited pro forma net income
(loss) per share....................................... 4,437,810 4,783,319
=========== ==========
</TABLE>

Potentially dilutive securities have been excluded from the computation for
the year ended June 30, 1997 as their effect is antidilutive. Certain options
have been excluded for the year ended June 30, 1998 as their

F-15
<PAGE> 74
INTERNET AMERICA, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

exercise prices are equal to or exceed the average estimated fair value of the
common shares during that period.

Had the Company been in a net income position for the year ended June 30,
1997, diluted earnings per share would have included an additional 319,500
shares related to outstanding options and warrants, (determined using the
treasury stock method at the estimated average fair value) and for 1,020,002
shares convertible preferred stock for the year ended June 30, 1997.

During July 1998, the board of directors authorized the filing of a
registration statement with the Securities and Exchange Commission permitting
the Company to issue shares of its common stock in an initial public offering
early in fiscal 1999. Conversion of 453,339 shares of preferred stock to common
stock will automatically occur 30 days after completion of an offering and is
considered in the calculation of unaudited pro forma net income (loss) per
share.

F-16
<PAGE> 75

- Inside back cover contains photographs of the Company's television and
billboard advertisements.
<PAGE> 76

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

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING SHAREHOLDERS
OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR
SOLICITATION OF AN OFFER TO BUY ANY OF THE COMMON STOCK OFFERED HEREBY IN ANY
JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER IN SUCH
JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.

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TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 7
Use Of Proceeds....................... 18
Dividend Policy....................... 19
Capitalization........................ 19
Dilution.............................. 20
Selected Financial and Operating
Data................................ 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 23
Business.............................. 32
Management............................ 41
Certain Transactions.................. 46
Principal and Selling Shareholders.... 48
Description of Securities............. 49
Shares Eligible for Future Sale....... 52
Underwriting.......................... 53
Legal Matters......................... 54
Experts............................... 55
Available Information................. 55
Glossary of Technical Terms........... 56
Index to Financial Statements......... F-1
</TABLE>

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UNTIL JANUARY 4, 1999 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.

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2,300,000 SHARES

INTERNET AMERICA LOGO

COMMON STOCK
------------------------
PROSPECTUS
------------------------
HOAK BREEDLOVE WESNESKI & CO.

FERRIS, BAKER WATTS
INCORPORATED

December 9, 1998

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