SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _____
COMMISSION FILE NUMBER 000-25147
INTERNET AMERICA, INC.
(Exact name of registrant as specified in its charter)
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
As of November 12, 2012, the registrant had 16,729,562 shares of Common Stock at $0.01 par value, outstanding.
INTERNET AMERICA, INC.
TABLE OF CONTENTS
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERNET AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying notes to condensed consolidated financial statements.
INTERNET AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to condensed consolidated financial statements.
INTERNET AMERICA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to condensed consolidated financial statements.
INTERNET AMERICA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to Article 8 of Regulation S-X of the Securities and Exchange Commission. The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary to achieve a fair presentation of the consolidated financial position and results of operations of Internet America, Inc. (the “Company” or “Internet America” or "we") for the interim periods presented. All such adjustments are of a normal and recurring nature. These condensed financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for its fiscal year ended June 30, 2012.
The consolidated financial statements include the accounts of the Company and its subsidiary, TeleShare Communication Services, Inc. ("TeleShare"). All material intercompany accounts and transactions have been eliminated.
For the three months ended September 30, 2012 and 2011, common stock equivalent shares totaling 2,718,428 have been added to the weighted average common shares outstanding assuming the shares of preferred stock were converted into shares of common stock as of the first day of each respective period, for the purpose of computing diluted earnings per share ("EPS"). For the three months ended September 30, 2012 and 2011, options to purchase 1,076,526 and 1,508,944 shares of the Company’s common stock, respectively, and warrants to acquire 394,922 shares of common stock were excluded from the computation of diluted EPS as the options and warrants were anti-dilutive.
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these estimates.
On August 1, 2012, the Company completed an acquisition of subscribers (the "Acquisition"). Purchase consideration for the Acquisition consisted of (i) $19,635 in a cash payment made at closing, (ii) a $6,365 credit for certain prepayments for services to be provided by the Company post-closing that were retained by the seller, and (iii) $45,250 in additional purchase consideration determined on November 1, 2012, based on the number of acquired subscribers as of that date, which amount is included in Accrued Liabilities in the accompanying consolidated balance sheet as of September 30, 2012. A note payable for this amount will be issued during the quarter ended December 31, 2012.
Pursuant to Financial Accounting Standards Board (“FASB”) guidance on goodwill and other intangibles, the Company performs an impairment test annually during the fourth quarter of its fiscal year or when events and circumstances indicate goodwill might be permanently impaired. The Company concluded that no impairment of goodwill occurred during the three months ended September 30, 2012 or 2011.
The Company amortizes customer acquisition costs over the estimated life of the acquired customers. The weighted average amortization period for subscriber acquisition costs was 48 months for both dial-up and wireless broadband Internet customers during the three months ended September 30, 2012 and 2011. As of September 30, 2012, unrecognized amortization expense for the remainder of fiscal year ended June 30, 2013 is expected to be $112,000 and unrecognized amortization expense for fiscal years ended June 30, 2014, 2015, 2016 and 2017 is expected to be $149,000, $129,000, $61,000 and $1,000, respectively.
During the three months ended September 30, 2012 and 2011, the Company generated income before income tax expense of $247,636 and $117,012, respectively, and recognized income tax expense of $12,000 and $6,000, respectively, which only consisted of Texas state franchise tax expense. No provision for federal income taxes was recorded for the three months ended September 30, 2012 and 2011 due to the utilization of net operating loss carryforwards.
As of September 30, 2012, the Company had net operating loss carryforwards of approximately $37 million for federal income tax purposes, and the Company's deferred tax assets primarily consisted of assets related to these net operating loss carryforwards. The Company has provided a full valuation allowance for its deferred tax assets and considers all evidence both positive and negative when evaluating the recoverability of its deferred tax assets. As of September 30, 2012, it has been determined that it is more likely than not that these deferred tax assets will not be utilized due to inconsistent earnings in its prior operating history and the lack of expected taxable income in the foreseeable future. The Company will continue to monitor the need for a full valuation allowance in future periods. Should the Company determine that it is more likely than not that a portion of its deferred tax assets will be realized, a reversal of the valuation allowance representing an estimate of what is recoverable will be recorded within income tax expense in the period that the determination is made.
The preparation of various tax returns requires the use of estimates for federal and state income tax purposes. Those estimates may be subject to review by respective taxing authorities. A revision, if any, to an estimate may result in assessment of additional taxes, penalties and interest. The 2008, 2009, 2010 and 2011 tax periods remain subject to examination by various federal and state tax jurisdictions. The Company performed an assessment of its various income tax positions for all periods subject to examination and concluded that no accrual of uncertain tax positions was necessary as of September 30, 2012 and June 30, 2012. The Company will account for interest and penalties related to uncertain tax positions in the current period consolidated statement of operations, as necessary.
As of September 30, 2012 and June 30, 2012, long term debt consisted of:
9. Stock Options and Warrants
As of September 30, 2012, 1,076,526 stock options were outstanding and 923,474 stock options were available for future issuance under the Company’s 2007 Stock Option Plan. During the three months ended September 30, 2012, the Company did not grant any stock options. No stock compensation expense was recognized during the three months ended September 30, 2012. As of September 30, 2012 the total compensation cost related to non-vested awards not yet recognized is zero.
As of September 30, 2012, the Company had a total of 394,922 warrants issued and outstanding, previously issued in equal amounts to Mr. Mihaylo, a current non-employee director of the Company and Ambassador Palmer, a former director of the Company. No warrants were granted during the three months ended September 30, 2012.
10. Related Parties
During the three months ended September 30, 2012, a total of $6,250 was paid to two non-employee directors for serving on the Company's board of directors. For the three months ended September 30, 2011, a total of $15,000 was paid to four non-employee directors for serving on the Company’s board of directors.
11. Recent Accounting Pronouncements
The Company has reviewed recently issued accounting standards, none of which are expected to have a material impact on the Company’s financial positions or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-Q constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements, identified by words such as "anticipate," "believe," "estimate," "should," "expect" and similar expressions include our expectations and objectives regarding our future financial position, operating results and business strategy. These statements reflect the current views of management with respect to future events and are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from those described in the forward-looking statements. We do not intend to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. Our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 and other publicly filed reports discuss some additional important factors that could cause our actual results to differ materially from those in any forward-looking statements. Some of these factors are also discussed under the heading “Safe Harbor Statement and Risk Factors” later in this Item 2.
The quarter ended September 30, 2012 continued to show improved results of operations and related cash flow. Improving our operating performance through a disciplined focus on managing our costs while laying the foundation for stronger internal revenue growth through an increasing subscriber base will further increase our expected future results. We are also continually evaluating accretive opportunities to secure subscribers through strategic acquisitions of Internet service providers in underserved markets where we can introduce our model for delivering wireless broadband internet services. We anticipate that these efforts should yield a better fiscal 2013 relative to fiscal 2012.
Statement of Operations
Internet services revenue is derived from dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, wireless access, bulk dial-up access, web hosting services, and value-added services, such as multiple e-mail boxes, personalized e-mail addresses and Fax-2-Email services.
A brief description of each element of our operating expenses follows:
Connectivity and operations expenses consist primarily of setup costs for new subscribers, telecommunication costs, merchant processing fees, and wages of network operations and customer support personnel. Connectivity costs include fees paid to telephone companies for subscribers' dial-up connections to our network, fees paid to backbone providers for connections from our network to the Internet, and equipment and tower lease costs for our new wireless networks.
Sales and marketing expenses consist primarily of creative and production costs, costs of media placement, management salaries and call center wages. Advertising costs are expensed as incurred.
General and administrative expenses consist primarily of administrative salaries, professional services, rent and other general office and business expenses.
Bad debt expenses (recoveries) consist primarily of customer accounts that have been deemed uncollectible and will potentially be written off in future periods, net of recoveries. Historically, the expense has been based on the aging of customer accounts whereby all customer accounts that are 90 days or older have been provided for as a bad debt expense.
Depreciation expense is computed using the straight-line or double declining method over the estimated useful lives of the assets or the capital lease term, as appropriate. Data communications equipment, computers, data servers and office equipment are depreciated over five years. Furniture, fixtures and leasehold improvements are depreciated over five years or the lease term. Buildings are depreciated over fifteen years. Amortization expense consists of the amortization of subscriber acquisition costs, which are amortized over four years.
Our business is not subject to any significant seasonal influences.
Results of Operations
Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011
The following table sets forth certain unaudited financial data for the three months ended September 30, 2012 and September 30, 2011. Operating results for any period are not indicative of results for any future period. Dollar amounts are shown in thousands (except per share data, shares and subscriber counts).
(1) Adjusted EBITDA, which as used herein means earnings before the effect of interest, taxes, depreciation, amortization and stock based compensation is not a measurement of financial performance under generally accepted accounting principles (GAAP) and should not be considered an alternative to net income as a measure of performance. Management has consistently used Adjusted EBITDA on a historical basis as a measurement of the Company’s current operating cash income.
(2) Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of total revenue.
Total revenue. Total revenue increased by $76,000, or 4.1%, to $1,912,000 for the three months ended September 30, 2012, from $1,836,000 for the three months ended September 30, 2011. The Company’s total subscriber count increased by 1,800, or 7.2%, to approximately 26,800 as of September 30, 2012 compared to approximately 25,000 as of September 30, 2011. The Company’s wireless broadband Internet subscriber count increased by 1,300 to approximately 9,100 as of September 30, 2012 compared to approximately 7,800 as of September 30, 2011. Wireless broadband Internet revenue increased by $158,000 to $1,491,000 for the three months ended September 30, 2012 compared to $1,333,000 for the three months ended September 30, 2011. This increase was primarily due to the stability of the subscriber base and customers migrating to upgraded service levels during the quarter ended September 30, 2012, as well as a result of successful acquisitions of wireless subscribers completed in the twelve months ended September 30, 2012. Increased revenues derived from wireless broadband Internet subscribers were partially offset by the net decrease in other types of Internet service revenues of $82,000 to $421,000 during the three months ended September 30, 2012 as compared to $503,000 for the prior year period, attributed to the expected decline of dial-up customers who may move to other providers’ broadband service.
Connectivity and operations. Connectivity and operations expense decreased by $78,000, or 7.3%, to $992,000 for the three months ended September 30, 2012, from $1,070,000 for the three months ended September 30, 2011. Data and telecommunications expense decreased by $78,000 to $248,000 for the three months ended September 30, 2012 compared to $326,000 for the three months ended September 30, 2011 due to our renegotiating more favorable terms with telecommunications service providers. Expensed assets decreased $16,000 to $70,000 for the three months ended September 30, 2012 compared to $86,000 for the three months ended September 30, 2011 due to the decreases in supplies, installation costs, and repairs. Salaries, wages and related personnel expense decreased by $4,000 to $482,000 for the three months ended September 30, 2012 compared to $486,000 for the three months ended September 30, 2011, which is attributed mainly to the reduction in headcount to streamline our efficiencies gained from quality process initiatives. Merchant fees decreased by $3,000 to $41,000 for the three months ended September 30, 2012 compared to $44,000 for the three months ended September 30, 2011.
The above described decreases in expenses were partially offset by an increase in tower leases costs of $23,000 to $151,000 for the three months ended September 30, 2012 compared to $128,000 for the three months ended September 30, 2011, attributed to customer growth in established and new regions requiring additional tower infrastructure.
Sales and marketing. Sales and marketing expense increased by $10,000, or 10.4%, to $106,000 for the three months ended September 30, 2012, compared to $96,000 for the three months ended September 30, 2011. Personnel expense increased $36,000 to $65,000 for the three months ended September 30, 2012 compared to $29,000 for the prior year period due to the addition of sales management and other personnel. The overall increase in sales and marketing expense was partially offset by the decrease in advertising expense of $14,000 to $8,000 for the three months ended September 30, 2012 compared to $22,000 for the three months ended September 30, 2011 due to a reduction in our postcard marketing efforts during the current quarter compared to prior year period. Outside sales expense decreased by $12,000 to $27,000 for the three months ended September 30, 2012 compared to $39,000 for the prior year period, due to utilization of in house sales efforts and increased personnel.
General and administrative. General and administrative expense remained constant at $353,000 for the three months ended September 30, 2012 and 2011. Personnel costs increased by $59,000 to $162,000 for the three months ended September 30, 2012 compared to $103,000 for the three months ended September 30, 2011, attributed to the addition of full time employees and related benefits. Due to the conditions of the economy and expected higher cost of services, minimal increases totaling $12,000 in travel, insurance, facilities and other general and administrative costs were realized for the three months ended September 30, 2012 compared to the prior year period.
The above described increases were partially offset by the decrease in telecom expense of $41,000 to $11,000 for the three months ended September 30, 2012 compared to $52,000 for the three months ended September 30, 2011 primarily due to refunds received from four telecom providers for sales tax billed in error in previous periods. Stock based compensation expense and directors’ fees decreased by $17,000 to $6,000 for the three months ended September 30, 2012 from $23,000 for the three months ended September 30, 2011 due to the decrease in the number of directors and due to the lack of amortization of stock based compensation expense during this quarter. Professional fees decreased by $13,000 for the three months ended September 30, 2012 to $46,000 compared to $59,000 for the three months ended September 30, 2011, due to the payment of recruiting fees in connection with the hiring of a new Controller in the prior year period which did not occur in the three months ended September 30, 2012.
Depreciation and amortization. Depreciation and amortization expense increased by $19,000, or 10.0%, to $209,000 for the three months ended September 30, 2012 from $190,000 for the three months ended September 30, 2011, primarily due to an $18,000 increase in amortization expense of acquired subscriber costs, resulting from four wireless acquisitions completed since September 30, 2011. Depreciation expense also increased slightly by $1,000 to $173,000 for the three months ended September 30, 2012 compared to $172,000 for the prior year period.
Interest (expense) income, net. Interest expense decreased by $6,000, or 54.5%, to $5,000 for the three months ended September 30, 2012, as compared to $11,000 for the three months ended September 30, 2011, primarily resulting from the reduction in the Company's long-term debt. Interest income remained constant at $1,000 for the three months ended September 30, 2012 and September 30, 2011.
Income tax expense. Income tax expense, consisting of Texas franchise tax, increased $6,000, or 100%, to $12,000 for the three months ended September 30, 2012, as compared to $6,000 for the three months ended September 30, 2011. Due to a true up for past years’ franchise tax due, completed in a prior period, the Company has adjusted their monthly accrual rate on a go-forward basis. The Company currently does not provide for Federal income taxes due to the availability of its net operating loss carryforward which is fully reserved at this time due to uncertainty of the Company’s ability to have taxable earnings in the future. The Company continually monitors its valuation allowance considering all evidence both positive and negative. Should the Company determine that it is more likely than not that a portion of its deferred tax assets will be realized, a reversal of the valuation allowance representing an estimate of what is recoverable will be recorded within income tax expense in the period that the determination is made.
Liquidity and Capital Resources
We have historically financed our operations to date primarily through (i) cash flows from operations, (ii) public and private sales of equity securities and (iii) loans from shareholders and third parties. During the three months ended September 30, 2012, the Company recognized net income and positive cash flow from operations of approximately $236,000 and $532,000, respectively, enabling the Company to fund its operations from current period operating cash flow and resulting in cash on hand of approximately $1,749,000 as of September 30, 2012. The Company expects to continue to fund its operations during fiscal 2013 with cash flow from operations. The Company will continue to focus on sales and expense management during fiscal 2013 and expects future cash flow from operations to remain strong.
The Company plans to pursue strategic acquisitions in the near and medium term in addition to upgrading its systems to provide higher speeds and increased reliability for its customers. We expect that our capital expenditures and any future acquisitions will be funded from available cash, public or private sales of debt or equity securities, or borrowing from commercial banks and/or third parties; however there is no assurance that such financing will be able to be obtained when needed at desirable rates which could affect our success in achieving any or all of our initiatives. Any unexpected decreases in revenue or subscriber count may adversely affect our liquidity and plans for future growth.
Cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities. For the three months ended September 30, 2012, cash provided by operations was $532,000 compared to $346,000 for the three months ended September 30, 2011. For the three months ended September 30, 2012, net income plus non-cash items contributed cash of $445,000 compared to $307,000 contributed during the prior year period. Changes in operating assets and liabilities provided cash of $86,000 and of $40,000 for the three months ended September 30, 2012 and 2011, respectively.
Cash used in investing activities totaled $155,000 and $88,000 for the three months ended September 30, 2012 and 2011, respectively, due primarily to the improvements in existing wireless broadband Internet infrastructure and acquisition of subscribers, partially offset by release of restricted cash of $6,000.
Cash used in financing activities totaled $61,000 and $136,000 for the three months ended September 30, 2012 and 2011, respectively, and consisted of principal payments on long term debt, including notes related to acquisitions.
Cash on hand increased by $315,000 during the quarter ended September 30, 2012. As of September 30, 2012, cash on hand was $1,749,000 compared to $1,433,000 as of June 30, 2012. We believe our continuing efforts to improve the quality and efficiency of our operations, along with our focus on increasing revenues, may lead to a more rapid rate of growth and improving cash flow from operations.
Off Balance Sheet Arrangements
“Safe Harbor” Statement and Risk Factors
The following "Safe Harbor" Statement is made pursuant to the Private Securities Litigation Reform Act of 1995.
Certain of the statements contained in the body of this Quarterly Report are forward-looking statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include, without limitation, that (1) we will not be able to increase our rural customer base at the expected rate, (2) we will not improve EBITDA, profitability or product margins,(3) Internet revenue in high-speed broadband will continue to increase at a slower pace than the decrease in revenue from other Internet services resulting in greater operating losses in future periods, (4) financing will not be available to us if and as needed, (5) we will not be competitive with existing or new competitors, (6) we will not keep up with industry pricing or technological developments impacting the Internet, (7) we will be adversely affected by dependence on network infrastructure, telecommunications providers and other vendors or by regulatory changes, (8) service interruptions or impediments could harm our business, (9) acts of God and other events outside our control, such as hurricanes and other dangerous weather conditions, fires and lightning, could damage or destroy our facilities and network infrastructure, (10) we may be accused of infringing upon the intellectual property rights of third parties, which will be costly to defend and could limit our ability to use certain technologies in the future, (11) government regulations could force us to change our business practices, (12) we may be unable to hire and retain qualified personnel, including our key officers, (13) future acquisitions of wireless broadband Internet customers and infrastructure may not be available on attractive terms and, if available, we may not successfully integrate those acquisitions into our operations, (14) provisions in our certificate of incorporation, bylaws and shareholder rights plan could limit our share price and delay a change of management and (15) our stock price has historically been thinly traded and volatile and may continue to be thinly traded and volatile. This list is intended to identify certain of the principal factors that could cause actual results to differ materially from those described in the forward-looking statements included elsewhere herein but is not a comprehensive list of all of such factors.
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our Chief Executive Officer, who also performs the functions of the principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of September 30, 2012 was conducted under the supervision and with the participation of our management, including our Chief Executive Officer, who also serves as our principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer, also performing function of the principal financial officer, concluded that our disclosure controls and procedures, as of September 30, 2012, were effective.
(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INDEX TO EXHIBITS