UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**FORM
      10-K**


(mark
      one)


**x**
            **ANNUAL
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**For
                the fiscal year ended July 31, 2008


or




** ̈**
            **TRANSITION
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**For
                the transition period from _______to
                _________





Commission
      File Number: 001-15687





**ATSI
      COMMUNICATIONS, INC.**


(Exact
      Name of Registrant as Specified in Its Charter)





**Nevada**
              (State
                or Other Jurisdiction of Incorporation or Organization)
            
            **74-2849995**
              (IRS
                Employer Identification No.)**3201
                Cherry Ridge, Building C, Suite 300**
              **San
                Antonio, Texas**
              (Address
                of Principal Executive Offices)
            
            **78230**
              (Zip
                Code)




Registrant’s
      Telephone Number, Including Area Cod: **(210)
      614-7240**





Securities
      registered under Section 12(b) of the Securities Exchange Act: NONE





Securities
      registered under Section 12(g) of the Securities Exchange Act:





**Common
      Stock, Par Value $0.001 Per Share**


(Title
      of
      Class)





Indicate
      by check mark if the registrant is a well-know seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


 ̈ Yes x No





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Securities Exchange Act.  ̈ Yes x No





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. x Yes  ̈ No





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-KSB. x





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting
      company.





Large
                accelerated filer
             ̈
            Accelerated
                filer
             ̈Non-accelerated
                filer
             ̈
            Smaller
                reporting company
            x


(Do
      not
      check if a smaller reporting company)





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


 ̈
      Yes x No





The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates of the issuer was $6,723,569 based on the closing price of $0.17
      per share on October 27, 2008, as reported on the over-the-counter bulletin
      board.





There
      were 39,550,415 shares of issuer’s Common Stock outstanding as of October 27,
      2008.













**TABLE
      OF CONTENTS**




**Page****PART
                I**Item
                1.
            Description
                of Business
            3Item
                1A.
            Risk
                Factors
            11Item
                1B.
            Unresolved
                Staff Comments
            14Item
                2.
            Properties
            14Item
                3.
            Legal
                Proceedings
            14Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            14**PART
                II**Item
                5.
            Market
                for Registrant’s Common Equity; Related Stockholder Matters and Issuer
                Purchases of Equity Securities
            15Item
                6.
            Selected
                Financial Data
            16Item
                7.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            16Item
                7A.
            Quantitive
                and Qualitative Disclosures about Market Risk
            20Item
                8.
            Financial
                Statements and Supplementary Data
            21Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosures
            38Item
                9A(T).
            Controls
                and Procedures
            38Item
                9B.
            Other
                Information
            39**PART
                III**Item
                10.
            Directors,
                Executive Officers and Corporate Governance
            39Item
                11.
            Executive
                Compensation
            41Item
                12.
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            46Item
                13.
            Certain
                Relationships and Related Transactions, and Director
                Independence
            47Item
                14.
            Principal
                Accountant Fees and Services
            47**PART
                IV**Item
                15.
            Exhibits
                and Financial Statement Schedules
            47**SIGNATURES**
            49





**PART
      I**





**ITEM
      I.**  **DESCRIPTION
      OF BUSINESS.**





**Overview**





We
      are an
      international telecommunications carrier that utilizes the Internet to provide
      cost-efficient and economical international telecommunication services. Our
      current operations consist primarily of providing digital voice communications
      over the Internet using Voice-over-Internet-Protocol (“VoIP”). We provide high
      quality voice and enhanced telecommunication services to carriers, telephony
      resellers and other VoIP carriers through various agreements with service
      providers in the United States, Mexico, Asia, the Middle East and Latin America
      utilizing VoIP technology. Typically, these telecommunications companies offer
      their services to the public for domestic and international long distance
      services. In addition, we provide private communications links and VoIP gateway
      services.




**History**





ATSI
      Communications, Inc., a Nevada corporation, was formed in 2004 as the successor
      to the business originally incorporated in 1994 as a Canadian holding company,
      Latcomm International, Inc., with a Texas operating subsidiary, Latin America
      Telecomm, Inc. Both corporations were renamed “American TeleSource
      International, Inc.” in 1994. In May 1998, the Canadian corporation completed a
      share exchange with a newly formed Delaware corporation, also called American
      TeleSource International, Inc., which resulted in the Canadian corporation
      becoming the wholly owned subsidiary of the Delaware Corporation. Our
      stockholders voted to change our name from American TeleSource International,
      Inc. to ATSI Communications, Inc. in 2003 and to reincorporate in the State
      of
      Nevada by merger into our wholly owned subsidiary in 2004. We operate through
      our wholly owned subsidiary, Digerati Networks, Inc. (“Digerati”). Digerati is a
      premier global VoIP carrier providing international communication services
      that
      consist primarily of transporting voice traffic across the world via the
      Internet. Additionally, we own 49% of ATSI Comunicaciones S.A de C.V. (ATSICOM),
      a Mexican corporation that holds a 30-year concession allowing for the sale
      of
      voice and data services, long distance transport, and the operation of a
      telecommunications network in Mexico.




**Recent
      Developments**





During
      the year ended July 31, 2008 (“fiscal 2008”):




·
            We
                entered into a $5 Million accounts receivable financing agreement
                with
                Wells Fargo Bank. The financing arrangement provides us with access
                to
                capital to fund our growth initiatives and allows us to service top
                tier
                customers that required extended payment
                terms.


·
            Our
                Board of Directors approved a $1 million stock repurchase plan allowing
                us
                to buy back our stock in the open market through December 31, 2008
                based
                on price and market conditions.


·
            We
                expanded our IP network capacity with XO Communications. The expansion
                with XO Communications doubled our fixed capacity and gave us the
                ability
                to increase the same fixed capacity by 400% through the on-demand
                capabilities of XO’s Ethernet
                services.


·
            On
                May 1, 2008, ATSI entered into a “Purchase Agreement” with Fiesta
                Communications, Inc. Under the agreement ATSI agreed to sell all
                of the
                outstanding shares of Telefamilia Communications, Inc. to Fiesta
                Communications, Inc. for 975,000 shares of common stock in Fiesta
                Communications and $30,000 in cash.


·
            We
                received an opinion from our auditors that does not contain a “going
                concern” qualification.





**Services
      and Products**





We
      provide two types of services: VoIP Services and Network Services


3




*VoIP
      Services* : ** We
      currently provide VoIP communication services to U.S. and foreign
      telecommunications companies that lack transmission facilities, require
      additional capacity or do not have the regulatory licenses to terminate traffic
      in Mexico, Asia, the Middle East and Latin America. Typically, these
      telecommunications companies offer their services to the public for domestic
      and
      international long distance services. Revenues from this service accounted
      for
      approximately 99% of our total revenue during the year ended July 31, 2008.
      The
      percentage of our total volume of carrier services traffic sent by customers
      can
      fluctuate dramatically, on an annual, quarterly and daily basis. During fiscal
      2008, we entered into various reciprocal agreements with our customers that
      allow them to transport and terminate traffic over our network and allowed
      us to
      transmit and terminate traffic over their networks. These reciprocals agreements
      with our customers are not for a specific period of time and do not require
      either party to transmit or terminate a specific volume of minutes on the others
      network. Under the reciprocal agreements, both parties receive set of rates
      for
      services and each party decides the volume of minutes it will send to be
      processed by the other party. Both parties are free to re-route their traffic
      away from the other party to a lower priced provider.


**


*Network
      Services:* ** We
      provide network links and VoIP gateway services to multi-national and foreign
      carriers and enterprise customers who use a high volume of telecommunications
      services to communicate with their U.S. offices or businesses and need greater
      dependability than is currently available through the foreign telecommunication
      networks. These services include data, voice and fax transmission between
      multiple international offices and branches as well as Internet and collocation
      services in the United States.





**Voice
      over Internet Protocol Networks**





The
      basic
      technology of traditional telecommunications systems was designed for slow
      mechanical switches. Communications over the traditional telephone network
      are
      routed through circuits that must dedicate all circuit resources to each call
      from its inception until the call ends, regardless of whether anyone is actually
      talking on the circuit. This circuit-switching technology incurs a significant
      cost per call and does not efficiently support the integration of voice with
      data services. Data networks, however, were designed for electronic switching.
      They break the data stream into small, individually addressed packages of data
      (“packets”) that are routed independently of each other from the origin to the
      destination. Therefore, they do not require a fixed amount of bandwidth to
      be
      reserved between the origin and destination of each call and they do not waste
      bandwidth when it is not being used for actual transmission of information.
      This
      allows multiple voice or voice and data calls to be pooled, resulting in these
      networks being able to carry more calls with an equal amount of bandwidth.
      Moreover, they do not require the same complex switching methods required by
      traditional voice telephone networks, instead using a multiplicity of routers
      to
      direct each packet to its destination and they automatically route packets
      around blockages, congestion or outages.





Packet
      switching can be used within a data network or across networks, including the
      public Internet. The Internet itself is not a single data network owned by
      any
      single entity, but rather a loose interconnection of networks belonging to
      many
      owners that communicate using the Internet Protocol (“IP”). By converting voice
      signals to digital data and handling the voice signals as data, it can be
      transmitted through the more efficient switching networks designed for data
      transmissions and through the Internet using the IP. The transmission of voice
      signals as digitalized data streams over the Internet is known as Voice over
      Internet Protocol or “VoIP”. A VoIP network has the following advantages over
      traditional networks:





·
            **Integration
                of Voice and Data:**VoIP networks allow for the integration and transmission of voice,
                data,
                and images using the same network equipment.





·
            **Simplification:**An
                integrated infrastructure that supports all forms of communication
                allows
                more standardization, a smaller equipment complement, and less equipment
                management.


4





·
            **Network
                Efficiency:**The integration of voice and data fills up the data communication
                channels
                efficiently, thus providing bandwidth consolidation and reduction
                of the
                costs associated with idle bandwidth. The sharing of equipment and
                operations costs across both data and voice users can also improve
                network
                efficiency since excess bandwidth on one network can be used by the
                other,
                thereby creating economies of scale for voice (especially given the
                rapid
                growth in data traffic). An integrated infrastructure that supports
                all
                forms of communication allows more standardization and reduces the
                total
                equipment complement. This combined infrastructure can support dynamic
                bandwidth optimization and a fault tolerant design. The differences
                between the traffic patterns of voice and data offer further opportunities
                for significant efficiency improvements.





·
            **Co-existence
                with traditional communication mediums:**IP
                telephony can be used in conjunction with existing PSTN switches,
                leased
                and dial-up lines, PBXs and other customer premise equipment (CPE),
                enterprise LANs, and Internet connections. IP telephony applications
                can
                be implemented through dedicated gateways, which in turn can be based
                on
                open standards platforms for reliability and scalability.





·
            **Cost
                reduction:**Under the VoIP network, the connection is directly to the Internet
                backbone and as a result the telephony access charges and settlement
                fees
                are avoided.





The
      growth of voice over the Internet was limited in the past due to poor sound
      quality caused by technical issues such as delays in packet transmission and
      by
      bandwidth limitations related to Internet network capacity and local access
      constraints. However, the continuing addition of data network infrastructure,
      recent improvements in packet switching and compression technology, and new
      software algorithms and improved hardware have substantially reduced delays
      in
      packet transmissions and resulted in better sound quality. Nevertheless, certain
      VoIP routes into countries with limited or poor Internet infrastructure continue
      to lack the consistent quality required for voice transport and termination.





A
      number
      of large long distance carriers have announced Internet telephony service
      offerings. Smaller Internet telephony service providers have also begun to
      offer
      low-cost Internet telephony services from personal computers to telephones
      and
      from telephones to telephones. Traditional carriers have substantial investments
      in traditional telephone network technology, and therefore have been slow to
      embrace Internet technology.





We
      believe that the infrastructure required for a global network is too expensive
      for most companies to acquire and deploy on their own. As a result, many
      companies use a network consisting of a combination of gateways owned by
      different operators. For a network to achieve optimal functionality and quality,
      however, the gateways need to be interoperable, or able to communicate with
      one
      another. Interoperability continues to be a challenge for VoIP providers and
      recently. Technological solutions have emerged that support interoperability
      between different protocols and/or gateways. Cisco Systems, Inc. has emerged
      as
      a dominant supplier of VoIP gateways and other manufacturers often seek to
      make
      their equipment interoperable with Cisco.





Long
      distance telephone calls transported over the Internet are less expensive than
      similar calls carried over the traditional telephone network primarily because
      the cost of using the Internet is not determined by the distance those calls
      need to travel. Also, routing calls over the Internet is more cost-effective
      than routing calls over the traditional telephone network because the technology
      that enables Internet telephony is more efficient than traditional telephone
      network technology. The greater efficiency of the Internet creates cost savings
      that can be passed on to the consumer in the form of lower long distance rates
      or retained by the carrier as higher margins.





By
      using
      the public Internet, VoIP providers like ATSI are able to avoid direct payment
      for transport of communications, instead paying for large “pipes” into the
      public Internet, billed by bandwidth rather than usage, which transmits calls
      to
      a distant gateway. The Internet, which has its origins in programs devised
      by
      the Department of Defense to provide multiple routes and therefore redundancy
      which was largely immune from the failure of a single network element, provides
      great redundancy and can be “self healing” in the event of an outage in a
      particular network element or transmission path. Moreover, adding an additional
      entry or exit point (a Point of Presence or “PoP”) does not require any
      expensive or time consuming reconfiguration or reprogramming of existing network
      elements. The new element is simply installed with a specific IP address and
      it
      can send or receive information to or from any other IP address on the
      Internet.


5





**Strategy
      and Competitive Conditions**




The
      long
      distance telephony market and the Internet telephony market are highly
      competitive. Our competitors include major telecommunications carriers in the
      U.S., foreign telecommunications carriers (which may be owned by foreign
      governments), and numerous small competitors. We expect to face continuing
      competition based on price and service offerings from existing competitors
      and
      new market entrants in the future. The principal competitive factors in our
      market include price, coverage, customer service, technical response times,
      reliability, and network size/capacity. The competitive landscape is rapidly
      altering the number, identity and competitiveness of the marketplace, and we
      are
      unable to determine with certainty the impact of potential consolidation in
      our
      industry.





A
      number
      of large long distance carriers have introduced services that make Internet
      telephony or voice services over the Internet available to other carriers.
      All
      major telecommunications companies either presently do or could route traffic
      to
      destinations worldwide and compete directly with us. Smaller Internet telephony
      service providers have also begun to offer low-cost Internet telephony services
      from personal computers to telephones and from telephones to telephones. In
      addition, Internet service providers and other companies currently in related
      markets have begun to provide voice over the Internet services or adapt their
      products to enable voice over the Internet services. These related companies
      may
      migrate into the Internet telephony market as direct competitors.





Many
      of
      our competitors have substantially greater financial, technical and marketing
      resources, larger customer bases, longer operating histories, greater name
      recognition and more established relationships in the industry than we have.
      As
      a result, certain of these competitors may be able to adopt more aggressive
      pricing policies that could hinder our ability to market our services. We
      believe that our key competitive advantages are our ability to deliver reliable,
      high quality voice service over the Internet in a cost-effective manner. We
      cannot provide assurances, however, that these advantages will enable us to
      succeed against comparable service offerings from our competitors.





Our
      strategy is to take advantage of the increasing demand for international
      communication services and the global shift from the traditional circuit
      switched network to the Internet for transporting voice traffic. We target
      traditional telephone companies migrating towards voice over Internet protocol
      (“VoIP”) and emerging VoIP service providers seeking reliable and competitively
      priced worldwide routes. We are also capitalizing on the continued global trend
      of demonopolization of foreign telecommunications markets. Historically,
      telecommunication services in most foreign countries have been provided by
      state-run companies, operating as a legal or *de
      facto* monopoly. Although these companies historically failed to satisfy the demand
      for
      services in their countries, the regulatory scheme effectively precluded
      competition by foreign carriers. As the demonopolization trend continues in
      the
      telecommunications industry throughout the world, many foreign countries are
      in
      various stages of migration toward a competitive, multi-carrier market. This
      has
      created an opportunity for emerging operators, that typically “leap frog” to the
      most recent VoIP technology, to enter their respective market.




Our
      global strategy also benefits from the continued growth in immigration to the
      United States from foreign countries such as Mexico, Philippines and India.
      In
      addition U.S. based corporations expanding globally to decrease labor costs
      has
      contributed to the increased demand for global communication services.





The
      worldwide demand for telecommunications services has been strengthened
      by:





·
            An
                expanding global market for voice communications growing at approximately
                10% per year


·
            A
                growing demand for VoIP services that was approximately 30% of all
                international voice traffic in
                2007


6


·
            Deregulation
                and demonopolization of government-owned telecommunication companies
                in
                foreign countries


·
            Global
                proliferation of communications devices such as mobile and VoIP
                phones


·
            Growth
                in ethnic communities in the United States; approximately 90 million
                people belong to an ethnic minority group


·
            Increase
                in global trade and travel


·
            Declining
                rates for communication services as a result of increased competition





We
      operate through our wholly owned subsidiary, Digerati Networks, Inc., a premier
      global VoIP carrier providing international communication services that consist
      primarily of transporting voice traffic across the world via the Internet.
      Digerati owns and operates its own VoIP network in San Antonio, Texas for
      processing voice communication traffic between the United States and rapidly
      expanding markets in Asia, Europe, the Middle East, and Latin America. Digerati
      has placed a strong emphasis on Mexico as it is the top producer of voice
      traffic with the U.S. and is considered the most lucrative communications
      corridor in the world in terms of revenue.





Through
      Digerati, we have established numerous partnerships with foreign carriers and
      network operators to provide our international voice services. In our VoIP
      operations, Digerati receives voice traffic from originating carriers who are
      interconnected to its network via the Internet and routes that traffic over
      the
      Internet to local service providers and carriers in the destination countries
      with whom the Company has agreements or partnerships to manage the completion
      of
      the call. Our global VoIP service enables carriers and other communications
      service providers to outsource international voice and fax traffic.





Our
      customers, while cost conscious, are increasingly demanding high reliability
      and
      quality in service delivery. Sustainability and growth in this segment depends
      on specific competitive advantages including foreign partnerships or presence
      of
      an in-country business infrastructure, network reliability, and favorable
      termination agreements for voice traffic. We compete with other telecom
      operators, including dominant providers such as Qwest, IBASIS, and AT&T, for
      transport and termination of international voice services. We believe that
      our
      low cost of operations, international relationships, and cost competitive
      strategy utilizing VoIP technology provides us with a competitive advantage.
      Our
      strengths include our in-depth knowledge of, and relationships within, the
      telecommunications industry in the United States and select foreign markets.





Our
      strategy has been successful to date as evidenced by our growth over the last
      3
      fiscal years. The following table provides the total revenue and minutes for
      the
      fiscal years ended July 31, 2006, 2007 and 2008:





**Period**
            
            **Revenue**
            
            **Minutes**FY-2006
            
            $
            14,695,000
            
            
            266,366,712FY-2007
            
            $
            31,692,000
            
            
            450,557,632FY-2008
            
            $
            41,961,000
            
            
            564,064,005





**Government
      Regulation**





Our
      operations are subject to federal, state and foreign laws and regulations.
      There
      is significant uncertainty regarding the application of the Communications
      Act
      of 1934 and the regulations adopted by the Federal Communications Commission
      to
      Internet telephone and there is a risk that either the FCC or Congress will
      impose common carrier restrictions and other requirements of traditional
      telecommunications providers to providers of VoIP services.


7





*U.S
      Federal and State Regulation of Carrier Services*




We
      believe that, under U.S. law, the Internet-related services that we provide
      constitute information services as opposed to regulated telecommunications
      services, and, as such, are not currently regulated as telecommunications common
      carriers by the Federal Communications Commission (FCC) or state agencies
      charged with regulating telecommunications carriers. Nevertheless, aspects
      of
      our operations may be subject to state or federal regulation, including
      regulations governing universal service funding, disclosure of confidential
      communications and excise tax issues. We cannot provide assurances that
      Internet-related services will not be actively regulated in the future. Several
      efforts have been made in the U.S. to enact federal legislation that would
      either regulate or exempt from regulation services provided over the Internet.
      Increased regulation of the Internet may slow its growth, particularly if other
      countries also impose regulations. Such regulation may negatively impact the
      cost of doing business over the Internet and materially adversely affect our
      business, operating results, financial condition and future prospects.





To
      date,
      the FCC has declined to classify VoIP providers as telecommunications carriers
      for regulatory purposes. However, the FCC has ruled that certain traffic carried
      in part utilizing the Internet protocol format was nonetheless regulated
      telecommunications for which certain regulatory obligations applied. The FCC
      has
      considered whether to impose surcharges or other common carrier regulations
      upon
      certain providers of Internet telephony, primarily those which, unlike us,
      provide Internet telephony services directly to end users. The FCC ruled that
      interconnected VoIP service providers must make contributions to the Universal
      Service Fund. Additionally, the FCC has a pending proceeding to further examine
      the question of whether certain forms of VoIP services are information services
      or telecommunications services. The two are treated differently in several
      respects, with certain information services being regulated to a lesser degree.
      The FCC has noted that certain forms of phone-to-phone VoIP services bear many
      of the same characteristics as more traditional voice telecommunications
      services and lack the characteristics that would render them information
      services. The FCC has indicated that the issues as to applicability of access
      charges and other matters will be considered in that context. Adverse rulings
      or
      rulemakings could subject us to licensing requirements and additional fees
      and
      subsidies.





If
      the
      FCC were to determine that certain Internet-related services including Internet
      telephony services are subject to FCC regulations as telecommunications
      services, the FCC could subject providers of such services to traditional common
      carrier regulation, including payment of access charges to local telephone
      companies. A decision to impose such charges could also have retroactive effect.
      It is also possible that the FCC may adopt a regulatory framework other than
      traditional common carrier regulation that would apply to Internet telephony
      providers. Any such determinations could materially adversely affect our
      business, financial condition, operating results and future prospects to the
      extent that any such determinations negatively affect the cost of doing business
      over the Internet or otherwise slow the growth of the Internet.





*Other
      regulations affecting the Internet in the United States.*





Congress
      has enacted legislation that regulates certain aspects of the Internet,
      including online content, user privacy and taxation. In addition, Congress
      and
      other federal entities are considering other legislative and regulatory
      proposals that would further regulate the Internet. Congress has, for example,
      considered legislation on a wide range of issues including Internet spamming,
      database privacy, gambling, pornography and child protection, Internet fraud,
      privacy and digital signatures. Various states have adopted and are considering
      Internet-related legislation. Increased U.S. regulation of the Internet may
      slow
      its growth, particularly if other governments follow suit, which may negatively
      impact the cost of doing business over the Internet and materially adversely
      affect our business, financial condition, results of operations and future
      prospects. Legislation has also been proposed that would clarify the regulatory
      status of VoIP service. The Company has no way of knowing whether legislation
      will pass or what form it might take.





*Domestic
      Service Regulation.*





We
      are
      considered a non-dominant domestic interstate carrier subject to minimal
      regulation by the FCC. We are not required to obtain FCC authority to initiate
      or expand our domestic interstate operations, but we are required to obtain
      FCC
      approval to transfer control or discontinue service and to file various reports
      and pay various fees and assessments. Among other things, interstate common
      carriers must offer service on a nondiscriminatory basis at just and reasonable
      rates. In addition, as a non-dominant carrier, we are subject to the FCC’s
      complaint jurisdiction.


8





All
      interstate telecommunications carriers are required to contribute to the federal
      universal service programs. The FCC currently is considering revising its
      universal service funding mechanism. We cannot predict the outcome of these
      proceedings or their potential effect on us. Although we currently do not
      provide VoIP services to the end users or consumers, VoIP services that we
      may
      provide in the future are not currently subject to direct regulation by the
      FCC
      or state regulatory commissions to the extent that they qualify as “enhanced” or
“information” services. The FCC defines enhanced services as services that (1)
      employ computer processing applications that act on the format, content, code,
      protocol or similar aspects of the subscriber’s transmitted information, (2)
      provide the subscriber additional, different or restructured information, or
      (3)
      involve subscriber interaction with stored information. In 1998, in a
      non-binding report, the FCC observed that “computer-to-computer” VoIP may be
      appropriately considered to be unregulated but that “phone-to-phone” VoIP may
      lack the characteristics that would render them unregulated “information”
services. In February 2004, the FCC ruled that free computer-to-computer VoIP
      service is not “telecommunications service” and that it is an interstate
“information service.” Although this order clarifies some of the relevant VoIP
      issues, the FCC has not yet issued a formal decision as to whether other
      variations of VoIP services should be subject to traditional common carrier
      telecommunications service regulation, such as access charge obligations. In
      March 2004, the FCC released a Notice of Proposed Rulemaking (“NPRM”) regarding
      VoIP service. The NPRM specifically addresses the regulatory classification
      and
      jurisdiction of VoIP; the application of access charges; and how to preserve
      key
      public policy objectives such as universal service, 911/emergency services,
      law
      enforcement surveillance requirements, and the needs of persons with
      disabilities. In November 2004, the FCC ruled that services provided by a
      particular VoIP provider are interstate in nature, and not subject to entry
      regulations of the various state Public Service Commissions. The FCC, however,
      declined to rule on whether the service is a regulated telecommunications
      service or an unregulated information service. In addition, in December 2004,
      the United States Court of Appeals for the 8th Circuit ruled that such VoIP
      provider’s service is not subject to state regulation. Subsequently, in a series
      of orders, the FCC has decided to apply universal service, 911/emergency
      services, law enforcement surveillance requirements, customer privacy
      requirements, and requirements relating to the provision of services to speech
      and hearing-impaired persons to providers of “interconnected” VoIP services
      (i.e., those that are capable of both originating calls from and terminating
      calls to users of the public switched telephone network), but in each case
      the
      FCC has explicitly declined to decide whether such services are
“telecommunications” services subject to more comprehensive regulation. Instead,
      the FCC continues to examine the appropriate regulatory treatment of VoIP on
      a
      piecemeal basis. While initial indications from the FCC suggest that regulation
      of VoIP will be limited in nature, the future regulatory treatment of other
      variations of VoIP by the FCC and state regulatory bodies continues to be
      uncertain. Furthermore, Congressional dissatisfaction with the FCC’s treatment
      of IP telephony could result in legislation requiring the FCC to impose greater
      or lesser regulation. Changes to, and further clarifications of, the treatment
      of VoIP services could result in the imposition of burdensome regulation and
      fees on some of our services and/or increase certain of our operating costs.





*International
      Regulation*





The
      regulatory treatment of Internet telephony outside of the U.S. varies widely
      from country to country. A number of countries that currently prohibit
      competition in the provision of voice telephony also prohibit Internet
      telephony. Other countries permit but regulate Internet telephony. Some
      countries will evaluate proposed Internet telephony service on a case-by-case
      basis and determine whether it should be regulated as a voice service or as
      another telecommunications service. In many countries, Internet telephony has
      not yet been addressed by legislation or regulation. Increased regulation of
      the
      Internet and/or Internet telephony providers or the prohibition of Internet
      telephony in one or more countries could materially adversely affect our
      business, financial condition, operating results and future prospects.





The
      International Settlements Policy governs settlements between U.S. carriers’ and
      foreign carriers’ costs of terminating traffic over each other’s networks. The
      FCC recently enacted certain changes in rules designed to allow U.S. carriers
      to
      propose methods to pay for international call termination that deviate from
      traditional accounting rates and the International Settlement Policy. The FCC
      has also established lower benchmarks for the rates that U.S. carriers can
      pay
      foreign carriers for the termination of international services and these
      benchmarks may continue to decline. These rule changes have lowered the costs
      of
      our competitors to terminate traffic in the United States and are contributing
      to the downward pricing pressure facing us in the carrier market.


9





*Other
      General regulations*





Congress
      has recently enacted legislation that regulates certain aspects of the Internet,
      including online content, user privacy and taxation. In addition, Congress
      and
      other federal entities are considering other legislative and regulatory
      proposals on a wide range of issues including Internet spamming, database
      privacy, gambling, pornography and child protection, Internet fraud, privacy
      and
      digital signatures. Various states have adopted and are considering
      Internet-related legislation. Increased U.S. regulation of the Internet may
      slow
      its growth, particularly if other governments follow suit, which may negatively
      impact the cost of doing business over the Internet and materially adversely
      affect our business, financial condition, results of operations and future
      prospects. The Company has no way of knowing whether legislation will pass
      or
      what form it might take.





The
      Telecommunications Act of 1996 (the “Telecom Act”), which became law in February
      1996, was designed to dismantle the monopoly system and promote competition
      in
      all aspects of telecommunications. The FCC has promulgated and continues to
      promulgate major changes to their telecommunications regulations. One aspect
      of
      the Telecom Act that is of particular importance to us is that it allows Bell
      Operating Companies or BOCs to offer in-region long distance service once they
      have taken certain steps to open their local service monopoly to competition.
      The FCC has now granted such in-region long distance authorization to BOCs
      throughout the nation. Given their extensive resources and established customer
      bases, the entry of the BOCs into the long distance market, specifically the
      international market, has created increased competition for us.





Although
      we do not know of any other specific new or proposed regulations that will
      affect our business directly, the regulatory scheme for competitive
      telecommunications market is still evolving and there could be unanticipated
      changes in the competitive environment for communications in general. For
      example, the FCC is currently considering rules that govern how Internet
      providers compensate local telephone companies. These rules could affect the
      role that the Internet ultimately plays in the telecommunications market.





The
      International Settlements Policy governs settlements between top tier U.S.
      carriers’ and foreign carriers’ costs of terminating traffic over each other’s
      networks. The FCC recently enacted certain changes in these rules designed
      to
      allow U.S. carriers to propose methods to pay for international call termination
      that deviate from traditional accounting rates and the International Settlement
      Policy. The FCC has also established lower benchmarks for the rates that U.S.
      carriers can pay foreign carriers for the termination of international services
      and these benchmarks may continue to decline. These rule changes have lowered
      the costs of our top tier competitors to terminate traffic in the United States
      and are contributing to the downward pricing pressure facing us in the carrier
      market.





**Concession
      License**





The
      Secretaría de Comunicaciones y Transportes and Comisión Federal de
      Telecomunicaciones or Federal Telecommunications Comisión (“COFETEL”) issued
      ATSICOM a 30-year license in June 1998 to install and operate a public network.
      Under this license, ATSICOM is required to:




General
      requirements





·
            Maintain
                approximately $10 million in registered and subscribed capital.


·
            Install
                and operate a network in Mexico according to an operating plan approved
                by
                the Mexican government..


·
            Continuously
                develop and conduct training programs for its staff.


·
            Designate
                an individual responsible for the technical functions to operate
                the
                concession.


10





Concession
      services requirements





·
            Provide
                continuous and efficient services at all times to its customers.


·
            Establish
                a complaint center and correction facilities center and report to
                the
                Mexican government on a monthly basis the complaints received and
                the
                actions taken to resolve the problems.




Tariff
      Requirements





·
            Invoice
                its customer only tariffs rates that have been approved by the Mexican
                government.




Verification
      and Information requirements




·
            Provide
                audited financial statements on a yearly basis that include a detailed
                description of the fixed assets utilized in the network and reporting
                by
                region and location of where the services are being provided.


·
            Provide
                quarterly reports and updates on the expansion of the network in
                Mexico
                and a description of the training programs and research and development
                programs.


·
            Provide
                statistical reports of traffic, switching capacity and other parameters
                in
                the network.





Guarantee
      requirements





·
            Post
                a bond/insurance policy for approximately $500,000 payable to the
                Mexican
                Federal Treasury Department in the event the concession is revoked
                for
                failure to perform any of the
                requirements.





Under
      this concession, we have the right to terminate voice and data communications
      in
      Mexico. The revocation or modification of this concession would not have a
      material adverse effect on our business.





**Customers
      and Suppliers**





We
      rely
      on various suppliers to provide services in connection with our communication
      services. We use various global VoIP companies to complete our voice over
      Internet (VoIP) traffic between US, Mexico,
      Asia, the Middle East and Latin America. We are not dependent upon any single
      supplier.





**Employees**





As
      of
      July 31, 2008, we had twelve employees, all of whom performed operational,
      technical and administrative functions. We believe our future success will
      depend to a large extent on our continued ability to attract and retain highly
      skilled and qualified employees. We consider our employee relations to be good.
      None of these aforementioned employees belong to labor unions.





**ITEM
      1A.**  **RISK
      FACTORS.**





Our
      business is subject to various operational and financial risks that could have
      an adverse effect on our financial condition or our results of operations.
      In
      addition the general economic risks associated with operation of a small company
      in a regulated industry dominated by large well-financed competitors, some
      of
      the risk factors that may apply specifically to us are set forth below.





**Our
      results of operations fluctuate from period to period.** Our
      revenue and results of operations have fluctuated and will continue to fluctuate
      from quarter to quarter in the future due to a number of factors over which
      we
      have no control, including:


11





·
            Many
                of our customers are not obligated to route a minimum amount of traffic
                over our system and the amount of traffic we handle may decline if
                our
                customers elect to route traffic over systems they operate or systems
                operated by other providers;


·
            increased
                competition from other telecommunication service providers or from
                service
                companies in related fields that offer telecommunication services
                may
                adversely affect the amount we can charge for traffic routed over
                our
                system;


·
            we
                may be required to reduce our charges for routing traffic to maintain
                high
                utilization of our equipment;


·
            the
                termination fees, connection fees and other charges from our
                suppliers;


·
            fraudulently
                sent or received traffic for which we are obligated to pay but which
                we
                are unable to bill to any customer;


·
            changes
                in call volume among the countries to which we complete calls;


·
            technical
                difficulties or failures of our network systems or third party delays
                in
                expansion or provisioning system components;
                and


·
            our
                ability to manage our traffic on a constant basis so that routes
                are
                profitable.




**We
      rely on third parties to provide and maintain the networks over which we
      transmit traffic.** Our
      business model depends on the availability of the Internet and traditional
      telephone networks to transmit voice and data. Third parties own and maintain
      the equipment that translates calls from traditional voice networks to the
      Internet and vice versa. If the owners of these systems fail to maintain their
      lines properly, fail to maintain the ability to terminate calls, or otherwise
      disrupt our ability to provide service to our customers, our ability to complete
      calls or provide other services could be interrupted.





**Our
      suppliers could increase the cost of services they provide or deny us access
      to
      systems that they operate.** We
      maintain relationships with communications service providers in many countries
      and with other carriers to carry traffic on their systems. There is no assurance
      that these services will continue to be available to us on acceptable terms,
      if
      at all. If we are unable to replace any provider that ceases to provide services
      to us on acceptable terms, or to identify and develop relationships with new
      service providers, our ability to provide services in certain countries may
      be
      adversely affected.





**We
      are subject to downward pricing pressures and a continuing need to renegotiate
      overseas rates.** As
      a
      result of numerous factors, including increased competition and global
      deregulation of telecommunications services, prices for international long
      distance calls have been decreasing. This downward trend of prices to end-users
      has caused us to lower the prices we charge communication service providers
      for
      call completion on our network. If this downward pricing pressure continues,
      we
      may not be able to offer VoIP services at costs lower than, or competitive
      with,
      the traditional voice network services with which we compete. Moreover, in
      order
      for us to lower our prices, we have to renegotiate rates with our foreign
      service providers who complete calls for us. We may not be able to renegotiate
      these terms favorably enough, or fast enough, to allow us to continue to offer
      services in a particular country on a cost-effective basis. The continued
      downward pressure on prices and our inability to renegotiate favorable terms
      in
      a particular country could have a material adverse effect on our ability to
      operate our network.





**We
      are subject to risks relating to operations in foreign countries.** Because
      we provide many of our services internationally, we are subject to additional
      risks related to providing services into foreign countries. Associated risks
      include:


·
            unexpected
                changes in tariffs, trade barriers and regulatory requirements relating
                to
                Internet access or VoIP;


·
            economic
                weakness, including inflation, or political instability in particular
                foreign economies and markets;


·
            difficulty
                in collecting accounts receivable;


·
            tax,
                consumer protection, telecommunications, and other laws;


·
            foreign
                currency fluctuations, which could result in increased operating
                expenses
                and reduced revenues; and


·
            unreliable
                government power to protect our rights;


12





**International
      governmental regulation and legal uncertainties and other laws could limit
      our
      ability to provide our services, make them more expensive, or subject us to
      legal liability.** Many
      countries currently prohibit or limit competition in the provision of
      traditional voice telephony services. In some of those countries, licensed
      telephony carriers as well as government regulators and law enforcement
      authorities have questioned the legal authority of VoIP services. Our failure
      to
      qualify as a properly licensed service provider, or to comply with other foreign
      laws and regulations, could materially adversely affect our business, financial
      condition, and results of operations. It is also possible that countries may
      apply to our activities laws relating to services provided over the Internet,
      including laws governing:


·
            user
                privacy;


·
            pricing
                controls and termination costs;


·
            characteristics
                and quality of products and services;


·
            qualification
                to do business;


·
            consumer
                protection;


·
            cross-border
                commerce, including laws that would impose tariffs, duties and other
                import restrictions;


·
            copyright,
                trademark and patent infringement; and


·
            claims
                based on the nature and content of Internet materials, including
                defamation, negligence and the failure to meet necessary obligations.





If
      foreign governments or other bodies begin to impose related restrictions on
      VoIP
      or our other services or otherwise enforce other laws against us or our foreign
      suppliers, such actions could have a material adverse effect on our operations.





**If
      we are not able to keep up with rapid technological change in a cost-effective
      way, the relative quality of our services could suffer.** The
      technology upon which our services depend is changing rapidly. Significant
      technological changes could render the hardware and software that we use
      obsolete, and competitors may begin to offer new services that we are unable
      to
      offer. If we are unable to respond successfully to these developments or do
      not
      respond in a cost-effective way, we may not be able to offer competitive
      services and our business results may suffer.





**We
      may not be able to expand and upgrade our network adequately and
      cost-effectively to accommodate any future growth.** Our
      VoIP
      business requires that we handle a large number of international calls
      simultaneously. As we expand our operations, we expect to handle significantly
      more calls. If we do not expand and upgrade our hardware and software quickly
      enough, we will not have sufficient capacity to handle the increased traffic
      and
      growth in our operating performance would suffer as a result. Even with such
      expansion, we may be unable to manage new deployments or utilize them in a
      cost-effective manner. In addition to lost growth opportunities, any such
      failure could adversely affect customer confidence in our network and services.





**Single
      points of failure on our network may make our business vulnerable.** We
      operate one network control center in San Antonio, Texas. We have not yet
      designed a redundant system, provided for excess capacity, or taken other
      precautions against platform and network failures as well as facility failures
      relating to power, air conditioning, destruction, or theft. We are vulnerable
      to
      a network failure that may prohibit us from offering services.





**We
      depend on our current personnel and may have difficulty attracting and retaining
      the skilled employees we need to execute our business plan.** Our
      future success will depend, in large part, on the continued service of our
      key
      management and technical personnel. If any of these individuals or others we
      employ are unable or unwilling to continue in their present positions, our
      business, financial condition and results of operations could suffer.


13





**If
      the Internet infrastructure is not adequately maintained, we may be unable
      to
      maintain the quality of our services and provide them in a timely and consistent
      manner.** Our
      future success will depend upon the maintenance of the Internet infrastructure,
      including a reliable network backbone with the necessary speed, data capacity
      and security for providing reliability and timely Internet access and services.
      To the extent that the Internet continues to experience increased numbers of
      users, frequency of use or bandwidth requirements, the Internet may become
      congested and be unable to support the demands placed on it and its performance
      or reliability may decline thereby impairing our ability to complete calls
      and
      provide other services using the Internet at consistently high quality. The
      Internet has experienced a variety of outages and other delays as a result
      of
      failures of portions of its infrastructure or otherwise. Future outages or
      delays could adversely affect our ability to complete calls and provide other
      services. Moreover, critical issues concerning the commercial use of the
      Internet, including security, cost, ease of use and access, intellectual
      property ownership and other legal liability issues, remain unresolved and
      could
      materially and adversely affect both the growth of Internet usage generally
      and
      our business in particular. Finally, important opportunities to increase traffic
      on our network will not be realized if the underlying infrastructure of the
      Internet does not continue to be expanded to more locations worldwide.





**ITEM
      1B.**  **UNRESOLVED
      STAFF COMMENTS.**





Not
      Applicable





**ITEM
      2.**  **PROPERTIES.**





Our
      executive office is located at 3201 Cherry Ridge, Building C, Suite 300, San
      Antonio, Texas, in leased space consisting of 3,618 square feet. The lease
      for
      this facility will expire on November 15, 2011. We pay annual rent of $49,419.
      We believe that our leased facilities are suitable and adequate for their
      intended use.





**ITEM
      3.**  **LEGAL
      PROCEEDINGS.**





In
      August
      2007, ATSI reached a confidential settlement agreement with the holders of
      the
      1,170 shares of Series E Preferred Stock. Under the confidential settlement
      agreement ATSI paid $175,000 to the Series E Preferred Stock shareholders and
      the 1,170 shares of Series E Preferred Stock have been cancelled.





In
      June
      2007, ATSI initiated a declaratory judgment action in the United States District
      Court for the Western District of Texas against The Shaar Fund, Ltd., holder
      of
      series 6% Series D Cumulative Convertible Preferred Stock, to declare that
      any
      right to convert or redeem the shares of the Series D Preferred Stock was barred
      by the applicable statute of limitations (the “Texas Case”). On August 2, 2007,
      The Shaar Fund Ltd. filed a separate suit against ATSI in the United States
      District Court for the Southern District Court of New York seeking damages
      and
      equitable relief for alleged defaults under the Securities Purchase
      Agreement dated February 18, 2000 under which it acquired the Series D Preferred
      Stock (the “New York Case”). The claims of the parties were consolidated in the
      New York Case by agreement. In December 2007, the parties entered into a
      settlement agreement in which they released each other from all claims relating
      to the Series D Preferred Stock. Under the terms of the settlement agreement,
      The Shaar Fund, Ltd. agreed to surrender all outstanding shares of Series D
      Preferred Stock.  Additionally, The Shaar Fund waived its claims
      for alleged accrued and unpaid dividends thereon in the amount of
      approximately $340,000.  The cancellation of the preferred stock was
      effective as of October 24, 2007. ATSI agreed to pay to The Shaar Fund,
      Ltd. the sum of $75,000 in cash in December 2007 and issue to The
      Shaar Fund a promissory note in the original principal amount of $450,000,
      bearing interest at the rate of 7.5% per annum and payable in 16 quarterly
      payments over 48 months. If paid in full within the first 18 months, ATSI will
      be entitled to a discount of 22.5% on the then outstanding principal balance.





**ITEM
      4.**  **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS.**





None


14







**PART
      II**





**ITEM
              5.**
            **MARKET
                FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
                PURCHASES OF EQUITY
                SECURITIES.**





**Market
      for Common Equity**




Our
      common stock is quoted on the OTC Bulletin Board under the symbol “ATSX”. The
      following table sets forth the high and low bid prices for our common stock
      for
      the two most recently completed fiscal years, as reported by Bloomberg, LP.
      Price quotations on the OTC Bulletin Board reflect inter-dealer prices, without
      retail mark-up, markdown or commission, and may not necessarily represent actual
      transactions.





**Fiscal
                2007**
            
            **Low**
            
            **High****First****Quarter**
            
            $
            0.19
            
            $
            0.34**Second
                Quarter**
            
            $
            0.22
            
            $
            0.36**Third
                Quarter**
            
            $
            0.19
            
            $
            0.34**Fourth
                Quarter**
            
            $
            0.23
            
            $
            0.24**Fiscal
                2008**
            
            
            **Low**
            
            
            **High****First****Quarter**
            
            $
            0.20
            
            $
            0.30**Second
                Quarter**
            
            $
            0.17
            
            $
            0.28**Third
                Quarter**
            
            $
            0.15
            
            $
            0.23**Fourth
                Quarter**
            
            $
            0.16
            
            $
            0.24





**Holders**





As
      of
      July 31, 2008 we had approximately 8,206 common stockholders of record.





**Dividends**





We
      have
      not paid cash dividends on our common stock and we do not anticipate paying
      a
      dividend in the future. ****





**Equity
      Compensation Plans**





The
      following table provides information regarding securities that have been or
      are
      authorized to be issued under our equity compensation plans as of July 31,
      2008:





**Number of Securities to be**
              **Issued Upon Exercise of**
              **Outstanding Options,**
              **Warrants and Rights**
            
            **Weighted-Average Exercise**
              **Price of Outstanding**
              **Options, Warrants and**
              **Rights**
            
            **Number of Securities**
              **Remaining Available for**
              **Future Issuance Under**
              **Equity Compensation Plans****Equity
                Compensation plans approved by security holders**
            
            
            -0-
            
            
            N/A
            
            
            -0-**Equity
                Compensation Plans not approved by security
                holders**
            
            
            8,239,000
            
            $
            .17
            
            
            9,261,000**Total**
            
            
            8,239,000
            
            $
            .17
            
            
            9,261,000





The
      material features of each equity compensation plan are described in Note 2
      of
      the Notes to the Financial Statements.


15


**Sales
      of Unregistered Securities**





On
      June
      1, 2008, the Company issued 391,348 shares of its common stock to the holders
      of
      its debentures dated June 1, 2006. The shares were exempt from registration
      under Section 4(2) of the Securities Act of 1933, as amended, and were
      restricted from further transfer without registration.





**ITEM
              6.**
            **SELECTED
                FINANCIAL DATA.**





Not
      Applicable





**ITEM
              7.**
            **MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS.**





*SPECIAL
      NOTE: This Annual Report on Form 10-KSB contains “forward-looking statements”
within the meaning of Section 27A of the Securities Act of 1933, as amended
      and
      Section 21E of the Securities and Exchange Act of 1934, as amended. “Forward
      looking statements” are those statements that describe management’s beliefs and
      expectations about the future. We have identified forward-looking statements
      by
      using words such as “anticipate,” “believe,” “could,” “estimate,” “may,”
“expect,” and “intend.” Although we believe these expectations are reasonable,
      our operations involve a number of risks and uncertainties, including those
      listed in Item 1A of this Annual Report on Form 10-K .*





The
      following is a discussion of the consolidated financial condition and results
      of
      operations of ATSI Communications, Inc., for the fiscal years ended July 31,
      2008 and 2007. It should be read in conjunction with our Consolidated Financial
      Statements, the Notes thereto, and the other financial information included
      elsewhere in this annual report on Form 10-K. For purposes of the following
      discussion, fiscal 2008 or 2008 refers to the year ended July 31, 2008 and
      fiscal 2007 or 2007 refers to the year ended July 31, 2007.





**Sources
      of revenue and direct cost** ****





*Sources
      of revenue:*





VoIP
      Services: ** We
      currently provide VoIP communication services to U.S. and foreign
      telecommunications companies that lack transmission facilities, require
      additional capacity or do not have the regulatory licenses to terminate traffic
      in Mexico, Asia, the Middle East and Latin America. Typically, these
      telecommunications companies offer their services to the public for domestic
      and
      international long distance services





Network
      Services :
      We
      provide private communication links and VoIP gateway services to multi-national
      and foreign carriers and enterprise customers who require a high volume of
      telecommunications services to communicate with their U.S. offices or businesses
      and need greater dependability than is currently available through the foreign
      telecommunication networks. These services include data, voice and fax
      transmission between multiple international offices and branches as well as
      Internet and co-location services in the United States. **





*Direct
      Costs:*





VoIP
      Services: ** We
      incur
      transmission and termination charges from our suppliers and the providers of
      the
      infrastructure and network. The cost is based on rate per minute, volume of
      minutes transported and terminated through the network. Additionally, we incur
      fixed Internet bandwidth charges and per minute billing charges. In some cases
      we incur installation charges from certain carriers. These installation costs
      are passed on to our customers for the connection to our VoIP network.





Network
      Services: Under
      the network services, we incur bandwidth and co-location charges. The bandwidth
      charges are incurred as part of the connection links between the customer’s
      different remote locations and sites to transmit data, voice and Internet
      services. We also incur co-location charges that are passed through to our
      customers.


16


**Results
      of Operations**





The
      following table sets forth certain items included in our results of operations
      in thousands of dollars amounts and variances between periods for the years
      ended July 31, 2008 and 2007.


Years
                  ended July 31,2008
              
              2007
              
              Variances
              
              %TOTAL
                  OPERATING REVENUES
              
              $
              41,961
              
              $
              31,692
              
              $
              10,269
              
              
              32
              %COST
                  OF SERVICES (exclusive of depreciation and amortization, shown
                  below)
              
              
              38,884
              
              
              29,521
              
              
              9,363
              
              
              32
              %GROSS
                  PROFITS
              
              
              3,077
              
              
              2,171
              
              
              906
              
              
              42
              %Selling,
                  general and administrative expense (exclusive of legal and professional
                  fees)
              
              
              2,400
              
              
              1,625
              
              
              775
              
              
              48
              %Legal
                  and professional fees
              
              
              352
              
              
              258
              
              
              94
              
              
              36
              %Bad
                  debt expense
              
              
              (27
              )
              
              98
              
              
              (125
              )
              
              -128
              %Depreciation
                  and amortization expense
              
              
              160
              
              
              99
              
              
              61
              
              
              62
              %OPERATING
                  INCOME (LOSS)
              
              
              192
              
              
              91
              
              
              101
              
              
              111
              %OTHER
                  INCOME (EXPENSE):Debt
                  forgiveness income
              
              
              41
              
              
              -
              
              
              41
              
              
              100
              %Minority
                  Interest
              
              
              (16
              )
              
              -
              
              
              (16
              )
              
              -100
              %Interest
                  income (expense)
              
              
              (105
              )
              
              (348
              )
              
              243
              
              
              70
              %Total
                  other income (expense), net
              
              
              (80
              )
              
              (348
              )
              
              268
              
              
              77
              %NET
                  INCOME (LOSS)
              
              
              112
              
              
              (257
              )
              
              369
              
              
              144
              %LESS:
                  PREFERRED DIVIDEND
              
              
              (12
              )
              
              (56
              )
              
              44
              
              
              79
              %ADD:
                  REVERSAL OF PREVIOUSLY RECORDED PREFERRED DIVIDEND
              
              
              340
              
              
              828
              
              
              (488
              )
              
              -59
              %NET
                  INCOME TO COMMON STOCKHOLDERS
              
              $
              440
              
              $
              515
              
              $
              (75
              )
              
              -15
              %





**Year
      Ended July 31, 2008 Compared to Year ended July 31, 2007**





*Operating
      Revenues* .
      Consolidated operating revenues increased by $10,269,000, or 32%, between
      periods from $31,692,000 for the year ended July 31, 2007 to $41,961,000 for
      the
      year ended July 31, 2008. The increase in VoIP services revenue is attributed
      to
      the increase in carrier minutes. Our carrier services minutes increased
      by 25% from approximately 450,557,632 minutes of voice traffic during the year
      ended July 31, 2007 to approximately 564,064,005 minutes of voice traffic during
      the year ended July 31, 2008. The
      increase in revenue and VoIP minutes is attributable primarily to the upgrade
      to
      our NexPoint® Soft Switch, which allows us to offer high quality and dependable
      VoIP services, serve more customers and efficiently process greater volume
      of
      data records and calls.





C *ost
      of Services (Exclusive of depreciation and amortization).* The
      consolidated cost of services increased by $9,363,000, or 32%, from the year
      ended July 31, 2007 to the year ended July 31, 2008. The increase in cost of
      services is a direct result of the increase in voice traffic, which required
      an
      increase in service fees paid to our vendors for transmission services.
      Consolidated cost of services, as a percentage of revenue, was comparable
      between periods at 93%. Despite the increase in cost of services (exclusive
      of
      depreciation and amortization), gross profits increased from $2,171,000 during
      the year ended July 31, 2007 to $3,077,000 during the year ended July 31, 2008
      as a result of the increase in revenues.





*Selling,
      General and Administrative (SG&A) Expenses (exclusive of legal and
      professional fees).* SG&A
      expenses increased by $775,000, or 48%, from the year ended July 31, 2007 to
      the
      year ended July 31, 2008. The increase is primarily attributable to an increase
      in salaries and wages of approximately $487,000 as a result of the hiring of
      four new employees and bonuses paid to officers. Non-cash compensation expense
      to employees and warrant expense increased by $268,000 from the year ended
      July
      31, 2007 to the year ended July 31, 2008. The increase is attributed to the
      recognition during the year ended July 31, 2008 of approximately $695,000 of
      non-cash compensation expense associated with the stock options issued to
      employees and directors recorded under the adopted of FAS-123R, Modified Stock
      based Compensation. We incurred approximately $473,000 on non-cash compensation
      expense during the year ended July 31, 2007.


17


*Legal
      and Professional Fees* .
      Legal
      and professional fees increased by $94,000, or 36%, from the year ended July
      31,
      2007 to the year ended July 31, 2008. The increase is primarily attributable
      to
      $57,000 in legal fees incurred during the year ended July 31, 2008 in connection
      with the litigation and settlement of a dispute between ATSI and the holders
      of
      the 6% Series D Cumulative Convertible Preferred Stock. We did not incur similar
      expenses during the year ended July 31, 2007.





*Bad
      debt expense.* Bad
      debt
      expense decreased by $125,000, or 128%, from the year ended July 31, 2007 to
      the
      year ended July 31, 2008. During the year ended July 31, 2007 we recognized
      $98,000 in bad debt expense associated with uncollectible accounts. During
      the
      year ended July 31, 2008 we recognized an adjustment in bad debt of $27,000
      as a
      result of changes in the VoIP market and historical uncollectible accounts,
      thus
      decreasing bad debt expense between periods.





*Depreciation
      and amortization* .
      Depreciation and amortization increased by $61,000, or 62%, from the year ended
      July 31, 2007 to the year ended July 31, 2008. The increase is attributed to
      the
      amortization during fiscal 2008 of the new computers and the upgrade to our
      Nextone soft-switch, which was acquired during the Fiscal 2008.





*Operating
      income (loss)* .
      Our
      operating income improved by $101,000, or 111%, from the year ended July 31,
      2007 to the year ended July 31, 2008. The improvement in operating income is
      primarily attributable to an increase in gross profits between periods, which
      was partially offset by increases in salaries and wages, non-cash compensation
      expenses and legal fees.





*Other
      Income (expense)* .
      Other
      income (expense) during fiscal 2008 included debt forgiveness income of $41,000,
      which was attributed to the restructuring of the note payable and settlement
      with Alfonso Torres and the recognition of $16,000 of a minority interest in
      the
      loss of our ownership in Fiesta Communications. Neither of these categories
      of
      other income was recognized in fiscal 2007. Interest expense in fiscal 2008
      decreased by $243,000, or 70%, from $348,000 for the year ended July 31, 2007
      to
      $105,000 for the year ended July 31, 2008. The decrease can be attributed to
      the
      payoff of various promissory notes during fiscal 2008; and the related lower
      average balance of notes payable during the year ended July 31, 2008. Interest
      expense for the year ended July 31, 2007 also included $143,723 attributed
      to
      the beneficial conversion feature associated with the conversion of various
      notes payable and accrued interest and the amortization of approximately $93,000
      in deferred financing fees as part of a private placement common stock
      financing.





*Net
      income (loss)* .
      Net
      income (loss) improved by $369,000 from the year ended July 31, 2008 compared
      to
      the year ended July 31, 2007. The improvement in net income (loss) is attributed
      to the increase between periods in gross profit profits, the reduction in
      interest expense. These improvements were offset by the increase of
      approximately $775,000 in selling, general and administrative expenses.




*Preferred
      stock dividends* .
      Preferred stock dividends decreased by $44,000, or 79%, between periods, from
      $56,000 for the year ended July 31, 2007 to $12,000 during the year ended July
      31, 2008. The decrease in preferred dividends between periods is mainly
      attributed to a decrease in dividends associated with Series A Convertible
      Preferred Stock, Series H Convertible Preferred Stock and Series D Convertible
      Preferred Stock. As of July 31, 2008 all Convertible Preferred Stock has been
      converted or redeemed to common stock.





*Reversal
      of previously recorded preferred stock dividends.* During
      the year ended July 31, 2008, we recognized a reversal of previously recorded
      dividend expense of $340,000. This reversal occurred as result of the settlement
      agreement reached between ATSI and The Shaar Fund. As a result of the
      settlement, The Shaar Fund agreed to surrender 742 shares of ATSI’s 6% Series D
      Cumulative Convertible Preferred Stock and forgive accrued dividends of
      approximately $340,000 as of October 24, 2007. During the year ended July 31,
      2007 we recognized a reversal of previously recorded dividend expense of
      $828,000. This reversal occurred as result of the conversion into common stock
      of 2,750 shares of Series A Convertible Preferred Stock and 11,802,381 shares
      of
      Series H Convertible Preferred Stock.


18


*Net
      income applicable to common stockholders* .
      Net
      income applicable to common stockholders decreased by $75,000, or 15%, from
      the
      year ended July 31, 2007 to the year ended July 31, 2008 even though we
      recognized an increase in net income of $369,000. The decrease in net income
      applicable to common stockholders is attributed to the ** reversal
      of previously recorded preferred stock dividends of $828,000 recognized during
      the year ended July 31, 2007 compared to a reversal of previously recorded
      preferred stock dividend in the amount of $340,000 during the year ended July
      31, 2008.




**Liquidity
      and Capital Resources**




*Cash
      Position:* We had a
      cash balance of $1,338,000 as of July 31, 2008. Net cash provided by operating
      activities during the year ended July 31, 2008 was approximately $965,000.
      Net
      cash provided by operating activities consisted primarily of operating revenues
      of $41,961,000 after deduction of cash expenses incurred in cost of services
      and
      selling, general and administrative expenses. Investing activities during the
      year ended July 31, 2008 consumed $163,000 as a result of advances of $100,000
      to NetSapiens, notes receivables of $25,000 with Fiesta Communications, a
      related party, investments in certificates of deposit of $13,000 and purchases
      of $25,000 of equipment. Financing activities during the year ended July 31,
      2008 consumed $514,000 in cash. This cash was primarily consumed by debt
      principal payments of $251,000 associated with various notes payable,
      acquisition of the Redeemable Preferred stock Series D&E of $250,000,
      acquisition of our common stock of $10,000 and principal payments of $3,000
      associated with a capital lease obligation. Overall, our net operating,
      investing and financing activities during the year ended July 31, 2008 resulted
      in an increase of $288,000 in our available cash.





We
      are
      currently utilizing the factoring agreement with Wells Fargo Bank as necessary
      to provide cash for operations. Under the agreement we are able to factor up
      to
      $5,000,000 of our monthly accounts receivable. On average, we are factoring
      account receivables of $875,000 per month. As of July 31, 2008 we had $18,000
      of
      outstanding receivables under the Wells Fargo Factoring agreement. We believe
      that the improvement in our cash flows from operations as a result of our growth
      will facilitate our ability to obtain debt and/or equity funding from
      institutional investors. Subsequent to our fiscal year end, we entered into
      various promissory notes payable for $850,000; we believe that this financing
      will allow us to support our growth during the following fiscal year.





Our
      current cash expenses are expected to be approximately $150,000 per month,
      including wages, rent, utilities and corporate professional fees. We are
      currently generating sufficient cash from operations to cover all monthly cash
      expenses. We anticipate that the July 31, 2008 balance of $1,338,000 in cash
      combined with expected net cash flow generated from operations, cash received
      from the subsequent financing of $850,000 and the factoring agreement with
      Wells
      Fargo Bank, will be sufficient to fund our operations, capital asset
      expenditures and potential common stock repurchases for the next twelve
      months.





Our
      working capital was $427,000 as of July 31, 2008. This represents an improvement
      of approximately $851,000 from our working capital deficit at July 31, 2007.
      The
      improvement can primarily be attributed to the reversal of previously recorded
      preferred stock dividends of $340,000 as a result of the settlement with The
      Shaar Fund and the net operating income generated from operations during Fiscal
      2008.





**Critical
      Accounting Policies**





*Revenue
      Recognition.* We
      derive
      our revenue from VoIP Services and Network Services. Revenue
      is recognized when persuasive evidence of an arrangement exists, service or
      network capacity has been provided, the price is fixed or determinable,
      collectibility is reasonably assured and there are no significant obligations
      remaining.




We
      record
      and report our revenue on the gross amount billed to our customers in accordance
      with the following “gross indicators” discussed in EITF 99-19:




19




·
            ATSI
                is the primary obligor in its
                arrangements,


·
            ATSI
                has latitude in establishing
                pricing,


·
            ATSI
                changes the product or performs part of the service and is involved
                in the
                determination of the product or service
                specifications,


·
            ATSI
                has discretion in supplier selection;
                and


·
            ATSI
                assumes credit risk for the amount billed to the
                customer





We
      recognize revenue from VoIP Services in the period the service is provided,
      net
      of revenue reserves for potential billing credits. Such disputes can result
      from
      disagreements with customers regarding the duration, destination or rates
      charged for each call. ATSI recognizes network services revenue during the
      period the service is provided.





*Direct
      Cost of Revenue.* We
      incur
      termination charges in connection with providing VoIP services, installation
      charges connection to the VoIP network of our carriers, and Internet,
      co-location and fiber optic charges in connection with providing network
      services. Termination charges, connection charges and other direct costs of
      revenue are recognized in the period incurred.





*Stock-based
      Compensation.* We
      record compensation expense associated with stock options and other forms of
      equity compensation in accordance with Statement of Financial Accounting
      Standards No. 123R, “ *Share-Based
      Payment”,* ** as
      interpreted by SEC Staff Accounting Bulletin No. 107. Prior to February 1,
      2006, ATSI had accounted for stock options according to the provisions of
      Accounting Principles Board Opinion No. 25,  *“Accounting
      for Stock Issued to Employees”* , and
      related interpretations, and therefore no related compensation expense was
      recorded for awards granted with no intrinsic value. ATSI estimates the fair
      market value of its stock options using the Black Scholes pricing model. ATSI
      uses the following key assumptions in determining the fair market value of
      its
      options:





For
                the Years Ended July 31,2008
            
            2007Expected
                dividends yield
            
            
            0.00
            %
            
            0.00
            %Expected
                stock price volatility
            
            
            75%
                - 105
            %
            
            80
            %Risk-free
                interest rate
            
            
            3.15% - 4.65
            %
            
            4.51
            %Expected life of
                options
            
            
            4
                - 6 years
            
            
            7
                years





*Derivative
      financial instruments* .
      We do
      not use derivative instruments to hedge exposures to cash flow, market, or
      foreign currency risks. We evaluate the application of SFAS 133 and EITF 00-19
      for all of its convertible financial instruments and freestanding
      warrants.




For
      derivative financial instruments that meet the definition of liabilities, the
      derivative instrument is initially recorded at its fair value and is then
      re-valued at each reporting date, with changes in the fair value reported as
      charges or credits to income. For option-based derivative financial instruments,
      ATSI uses the Black-Scholes option-pricing model to value the derivative
      instruments. The classification of derivative instruments, including whether
      such instruments should be recorded as liabilities or as equity, is re-assessed
      at the end of each reporting period. Derivative instrument liabilities are
      classified in the balance sheet as current or non-current based on whether
      or
      not net-cash settlement of the derivative instrument could be required within
      12
      months of the balance sheet date.





**ITEM
              7A.**
            **QUANTITIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK.**





Not
      Applicable


20


**ITEM
      8.**  **FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA**





**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**





Page**Consolidated
                Financial Statements of ATSI Communications, Inc. and
                Subsidiaries**Report
                of Independent Registered Public Accounting Firm
            22Consolidated
                Balance Sheets as of July 31, 2008 and 2007
            23Consolidated
                Statements of Operations for the Years Ended July 31, 2008 and 2007
            24Consolidated
                Statement of Changes in Stockholders’ Equity (Deficit) for the Years Ended
                July 31, 2008 and 2007
            25Consolidated
                Statements of Cash Flows for the Years Ended July 31, 2008 and 2007
            26Notes
                to Consolidated Financial Statements
            27


21


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      board of directors and Stockholders


ATSI
      Communications, Inc.


San
      Antonio, Texas





We
      have
      audited the accompanying consolidated balance sheets of **** ATSI
      Communications, Inc. and subsidiaries as of July 31, 2008 and 2007, and the
      related consolidated statements of operations, stockholders’ equity
      (deficit) and cash flows for each of the two years then ended. These
      consolidated financial statements are the responsibility of ATSI’s management.
      Our responsibility is to express an opinion on these consolidated financial
      statements based on our audits.





We
      conducted our audits in accordance with standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. ATSI is not required to have,
      nor
      were we engaged to perform, an audit of its internal control over financial
      reporting. Our audits included consideration of internal control over financial
      reporting as a basis for designing audit procedures that are appropriate in
      the
      circumstances, but not for the purpose of expressing an opinion on the
      effectiveness of ATSI’s internal control over financial reporting. Accordingly,
      we express no such opinion. An audit also 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, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of
      ATSI **** as
      of
      July 31, 2008 and 2007 and the consolidated results of their operations and
      its
      cash flows for each of the two years then ended in conformity with accounting
      principles generally accepted in the United States of America.





MALONE
      & BAILEY, PC


www.malone-bailey.com


Houston,
      Texas





October
      23, 2008


22


**PART
      1. FINANCIAL INFORMATION**





**ITEM
      1. FINANCIAL STATEMENTS**





ATSI
      COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
      BALANCE SHEETS


(In
      thousands, except per share amounts)





July 31,
            
            July 31,2008
            
            2007ASSETSCURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            1,338
            
            $
            1,050Accounts
                receivable, net of allowance for bad debt of $60 and $98,
                respectively
            
            
            1,082
            
            
            866Note
                receivable, related party
            
            
            25
            
            
            -Note
                receivable
            
            
            -
            
            
            50Prepaid
                & other current assets
            
            
            124
            
            
            94Total
                current assets
            
            
            2,569
            
            
            2,060LONG-TERM
                ASSETS:Certificates
                of deposit
            
            
            319
            
            
            306Intangible
                Assets
            
            
            149
            
            
            -PROPERTY
                AND EQUIPMENT
            
            
            611
            
            
            499Less
                - accumulated depreciation
            
            
            (439
            )
            
            (281
            )Net
                property and equipment
            
            
            172
            
            
            218Total
                assets
            
            $
            3,209
            
            $
            2,584LIABILITIES
                AND STOCKHOLDERS' EQUITY (DEFICIT)CURRENT
                LIABILITIES:Accounts
                payable
            
            $
            1,361
            
            $
            1,071Wells
                Fargo factoring collateral
            
            
            18
            
            
            -Accrued
                liabilities
            
            
            116
            
            
            516Current
                portion of obligation under capital leases
            
            
            3
            
            
            3Notes
                payable
            
            
            566
            
            
            818Convertible
                debentures, net of unamortized discount of $5 and $8, respectively
            
            
            78
            
            
            76Total
                current liabilities
            
            
            2,142
            
            
            2,484LONG-TERM
                LIABILITIES:Notes
                payable
            
            
            588
            
            
            177Convertible
                debentures, net of unamortized discount of $3 and $8, respectively
            
            
            81
            
            
            158Obligation
                under capital leases, less current portion
            
            
            1
            
            
            3Other
            
            
            3
            
            
            4Total
                long-term liabilities
            
            
            673
            
            
            342Total
                liabilities
            
            
            2,815
            
            
            2,826STOCKHOLDERS'
                EQUITY (DEFICIT):Series
                D Cumulative Preferred Stock, 3,000 shares authorized, 0 and 742
                shares
                issued and outstanding
            
            
            -
            
            
            1Series
                E Cumulative Preferred Stock, 10,000 shares authorized, 0 and 1,170
                shares
                issued and outstanding
            
            
            -
            
            
            1Common
                      stock, $0.001 par value, 150,000,000 shares authorized, 39,550,415
                      and
                      37,620,513 shares issued and outstanding,
                      respectively
            
            
            39
            
            
            38Additional
                paid in capital
            
            
            72,747
            
            
            72,222Accumulated
                deficit
            
            
            (72,393
            )
            
            (72,505
            )Other
                comprehensive income
            
            
            1
            
            
            1Total
                stockholders' equity (deficit)
            
            
            394
            
            
            (242
            )Total
                liabilities and stockholders' equity (deficit)
            
            $
            3,209
            
            $
            2,584





See
      accompanying summary of accounting policies and notes to financial
      statements.


23





ATSI
      COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF OPERATIONS


(In
      thousands, except per share amounts)





Years
                ended July 31,2008
            
            2007OPERATING
                REVENUES:VoIP
                services
            
            $
            41,961
            
            $
            31,692Total
                operating revenues
            
            
            41,961
            
            
            31,692OPERATING
                EXPENSES:Cost
                of services (exclusive of depreciation and amortization, shown
                below)
            
            
            38,884
            
            
            29,521Selling,
                general and administrative expense (exclusive of legal and professional
                fees)
            
            
            2,400
            
            
            1,625Legal
                and professional fees
            
            
            352
            
            
            258Bad
                debt expense (recovery)
            
            
            (27
            )
            
            98Depreciation
                and amortization expense
            
            
            160
            
            
            99Total
                operating expenses
            
            
            41,769
            
            
            31,601OPERATING
                INCOME
            
            
            192
            
            
            91OTHER
                INCOME (EXPENSE):Debt
                forgiveness income
            
            
            41
            
            
            -Investment
                  loss
            
            
            (16
            )
            
            -Interest
                  expense
            
            
            (105
            )
            
            (348
            )Total
                  other expense
            
            
            (80
            )
            
            (348
            )NET
                INCOME (LOSS)
            
            
            112
            
            
            (257
            )LESS:
                PREFERRED DIVIDEND
            
            
            (12
            )
            
            (56
            )ADD:
                REVERSAL OF PREVIOUSLY RECORDED PREFERRED DIVIDEND
            
            
            340
            
            
            828NET
                INCOME TO COMMON STOCKHOLDERS
            
            $
            440
            
            $
            515BASIC
                INCOME PER SHARE TO COMMON STOCKHOLDERS
            
            $
            0.01
            
            $
            0.02DILUTED
                INCOME PER SHARE TO COMMON STOCKHOLDERS
            
            $
            0.01
            
            $
            0.02WEIGHTED
                AVERAGE COMMON SHARES OUTSTANDING
            
            
            39,143,748
            
            
            27,908,044DILUTED
                COMMON SHARES OUTSTANDING
            
            
            39,197,319
            
            
            28,049,739





See
      accompanying summary of accounting policies and notes to financial
      statements.


24





**ATSI
      COMMUNICATIONS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)**


**(in
      thousands, except share amounts)**


**Additional**
              
              
              
              **Other****Preferred
                  (D)**
              
              **Preferred****(E)**
              
              **Preferred****(H)**
              
              **Common**
              
              
              
              **Paid-in**
              
              **Retained**
              
              **Comp.****Shares**
              
              **Par**
              
              **Shares**
              
              **Par**
              
              **Shares**
              
              **Par**
              
              **Shares**
              
              **Par**
              
              **Capital**
              
              **(Deficit)**
              
              **Income/Loss**
              
              **Totals****BALANCE,
                  JULY 31, 2006**
              
              
              **742**
              
              
              **1**
              
              
              **1,170**
              
              
              **1**
              
              
              **11,802,420**
              
              
              **12**
              
              
              **16,444,403**
              
              
              **16**
              
              **$**
              **68,775**
              
              **$**
              **(72,248**
              **)**
              **$**
              **1**
              
              **$**
              **(3,442**
              **)**Shares
                  issued for Services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,475,062
              
              
              1
              
              
              333
              
              
              
              
              
              
              
              
              334Common
                  shares issued for Preferred Stock Conversion
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (11,802,420
              )
              
              (12
              )
              
              16,261,847
              
              
              16
              
              
              1,137
              
              
              
              
              
              
              
              
              1,141Exercise
                  of warrants
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              150,000
              
              
              2
              
              
              35
              
              
              
              
              
              
              
              
              37Dividends
                  declared
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (56
              )
              
              
              
              
              
              
              
              (56
              )Reversal
                  of previously recorded preferred dividend
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              828
              
              
              
              
              
              
              
              
              828Stock
                  option expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              267
              
              
              
              
              
              
              
              
              267Proceeds
                  from exercise of options
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              100,000
              
              
              1
              
              
              16
              
              
              
              
              
              
              
              
              17Beneficial
                  Conversion Feature, private placement
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              144
              
              
              
              
              
              
              
              
              144Shares
                  issued for conversion of notes payable
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,189,201
              
              
              2
              
              
              743
              
              
              
              
              
              
              
              
              745Net
                  (Loss)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (257
              )
              
              
              
              
              (257
              )**BALANCE,
                  JULY 31, 2007**
              
              
              **742**
              
              
              **1**
              
              
              **1,170**
              
              
              **1**
              
              
              **-**
              
              
              **-**
              
              
              **37,620,513**
              
              
              **38**
              
              **$**
              **72,222**
              
              **$**
              **(72,505**
              **)**
              **$**
              **1**
              
              **$**
              **(242**
              **)**Repurchase
                  of Common Shares
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              **(44,002**
              **)**
              
              **-**
              
              **$**
              **(10**
              **)**
              
              
              
              
              
              
              
              (10
              )Shares
                  issued for Services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,448,686
              
              
              1
              
              
              348
              
              
              
              
              
              
              
              
              349Common
                  shares issued for Preferred Stock Conversion
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,434
              
              
              -
              
              
              1
              
              
              
              
              
              
              
              
              1Dividends
                  declared
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (12
              )
              
              
              
              
              
              
              
              (12
              )Reversal
                  of previously recorded preferred dividend
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              340
              
              
              
              
              
              
              
              
              340Stock
                  option expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              423
              
              
              
              
              
              
              
              
              423Shares
                  issued for conversion of notes payable
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -
              
              
              -
              
              
              521,784
              
              
              -
              
              
              135
              
              
              
              
              
              
              
              
              135Retirement
                  of preferred stock, settlement of lawsuit
              
              
              (742
              )
              
              (1
              )
              
              (1,170
              )
              
              (1
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              (700
              )
              
              
              
              
              
              
              
              (702
              )Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              112
              
              
              
              
              
              112**BALANCE,
                  July 31, 2008**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **39,550,415**
              
              
              **39**
              
              **$**
              **72,746**
              
              **$**
              **(72,393**
              **)**
              **$**
              **1**
              
              **$**
              **394**





See
      accompanying summary of accounting policies and notes to the consolidated
      financial statements.


25





ATSI
      COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
      STATEMENTS OF CASH FLOWS


(In
      thousands, except per share amounts)


Years
                  ended July 31,2008
              
              2007CASH
                  FLOWS FROM OPERATING ACTIVITIES:NET
                  INCOME (LOSS)
              
              $
              112
              
              $
              (257
              )Adjustments
                  to reconcile net loss to cash used in operating
                  activities:Investment
                    loss
              
              
              16
              
              
              -Debt
                  forgiveness income
              
              
              (41
              )
              
              -Depreciation
                  and amortization
              
              
              160
              
              
              99Issuance
                  of stock grants and options, employees for services
              
              
              695
              
              
              473Issuance
                  of common stock and warrants for services
              
              
              77
              
              
              129Provisions
                  for losses on accounts receivables
              
              
              (27
              )
              
              98Amortization
                  of debt discount
              
              
              8
              
              
              152Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              (238
              )
              
              (343
              )Prepaid
                  expenses and other
              
              
              (96
              )
              
              (61
              )Accounts
                  payable
              
              
              322
              
              
              174Accounts
                  payable-related party
              
              
              -
              
              
              15Accrued
                  liabilities
              
              
              (23
              )
              
              83Net
                  cash provided by operating activities
              
              
              965
              
              
              562CASH
                  FLOWS FROM INVESTING ACTIVITIES:Investment
                  in certificates of deposit
              
              
              (13
              )
              
              (306
              )Note
                  receivable, related party
              
              
              (25
              )
              
              -Purchase
                  of VoIP License
              
              
              (100
              )
              
              (50
              )Purchases
                  of property & equipment
              
              
              (25
              )
              
              (145
              )Net
                  cash used in investing activities
              
              
              (163
              )
              
              (501
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Payments
                  on notes payable, related party
              
              
              -
              
              
              (106
              )Payments
                  on notes payable
              
              
              (251
              )
              
              (104
              )Payments
                  on advances from shareholders
              
              
              -
              
              
              (148
              )Retirement
                  of redeemable preferred stock series D&E
              
              
              (250
              )
              
              -Acquisition
                  of common stock
              
              
              (10
              )
              
              -Proceeds
                  from advances from shareholders
              
              
              -
              
              
              713Proceeds
                  from Notes payables
              
              
              -
              
              
              550Proceeds
                  from the exercise of stock options
              
              
              -
              
              
              16Proceeds
                  from the exercise of warrants
              
              
              -
              
              
              35Principal
                  payments on capital lease obligation
              
              
              (3
              )
              
              (3
              )Net
                  cash (used in) / provided by financing activities
              
              
              (514
              )
              
              953INCREASE
                  IN CASH
              
              
              288
              
              
              1,014CASH
                  AND CASH EQUIVALENTS, beginning of period
              
              
              1,050
              
              
              36CASH
                  AND CASH EQUIVALENTS, end of period
              
              $
              1,338
              
              $
              1,050SUPPLEMENTAL
                  DISCLOSURES:Cash
                  paid for interest
              
              $
              62
              
              $
              77Cash
                  paid for income tax
              
              
              -
              
              
              -NON-CASH
                  INVESTING AND FINANCING TRANSACTIONSIssuance
                  of common stock for conversion of debt
              
              $
              136
              
              $
              688Issuance
                  of common stock for accounts payable
              
              
              -
              
              
              58Conversion
                  of preferred stock to common stock
              
              
              1
              
              
              1,141Preferred
                  stock dividends
              
              
              12
              
              
              56Reversal
                  of previously recorded preferred stock dividend
              
              
              (340
              )
              
              (828
              )Discount
                  for beneficial conversion feature on convertible debt
              
              
              -
              
              
              144Gain
                  from the sale of Telefamilia
              
              
              82
              
              
              -Acquisition
                  of VoIP license, conversion of note receivable
              
              
              150
              
              
              -Acquisition
                  of fixed assets, conversion of accounts receivable
              
              
              50
              
              
              -Note
                  payable, settlement of redeemable preferred stock
              
              
              450
              
              
              -





See
      accompanying summary of accounting policies and notes to financial
      statements.


26






**ATSI
      COMMUNICATIONS, INC.**


**AND
      SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**NOTE
      1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**




***Description
      of Business.*** ATSI
      Communications, Inc. was incorporated in Nevada on May 24, 2004. ATSI is an
      international telecommunications carrier that utilizes the Internet to provide
      economical international communication services to carriers and telephony
      resellers around the world. ATSI’s continuing operations consist of VoIP carrier
      services and network services. ATSI’s primary business consists of providing
      VoIP communication services to U.S. and foreign telecommunications companies
      that lack transmission facilities and require additional capacity or do not
      have
      the regulatory licenses to terminate traffic in Mexico, Asia, the Middle East
      and Latin America.





***Principles
      of Consolidation.*** The
      consolidated financial statements have been prepared on the accrual basis of
      accounting under accounting principles generally accepted in the United States.
      All significant inter-company balances and transactions have been eliminated
      in
      consolidation.





***Reclassifications.*** Certain
      amounts in the consolidated financial statements of the prior year have been
      reclassified to conform to the presentation of the current year for comparative
      purposes.





***Use
      of Estimates.*** In
      preparing financial statements, management makes estimates and assumptions
      that
      affect the reported amounts of assets and liabilities in the balance sheet
      and
      revenue and expenses in the statement of expenses. Actual results could differ
      from those estimates.





***Concentration
      of Credit Risk.*** Financial
      instruments that potentially subject ATSI to concentration of credit risk
      consist primarily of trade receivables. In the normal course of business, ATSI
      provides credit terms to its customers. Accordingly, ATSI performs ongoing
      credit evaluations of its customers and maintains allowances for possible
      losses, which, when realized, have been within the range of management’s
      expectations. ATSI maintains cash in bank deposits accounts, which, at times,
      may exceed federally insured limits. ATSI has not experienced any losses in
      such
      accounts and ATSI does not believe ATSI is exposed to any significant credit
      risk on cash and cash equivalents.





***Revenue
      Recognition.*** ATSI
      derives revenue from two product offerings Carrier Services and Network
      Services. Revenue
      is recognized when persuasive evidence of an arrangement exists, service or
      network capacity has been provided, the price is fixed or determinable,
      collectibility is reasonably assured and there are no significant obligations
      remaining.





ATSI
      records and reports its revenue on the gross amount billed to its customers
      in
      accordance with the following indicators in EITF 99-19:





·
            ATSI
                is the primary obligor in its
                arrangements,


·
            ATSI
                has latitude in establishing
                pricing,


·
            ATSI
                changes the product or performs part of the service and is involved
                in the
                determination of the product or service
                specifications,


·
            ATSI
                has discretion in supplier selection
                and


·
            ATSI
                assumes credit risk for the amount billed to the
                customer.





*VoIP
      Service* :
      ATSI
      provides VoIP communication services to U.S. and foreign telecommunications
      companies, who lack transmission facilities, require additional capacity or
      do
      not have the regulatory licenses to terminate traffic in Mexico, Asia, the
      Middle East and Latin America. Typically
      these telecommunications companies offer their services to the public for
      domestic and international long distance services. Carrier
      service revenue is derived through transporting and terminating minutes of
      telecommunications traffic over ATSI’s owned or leased VoIP network (Voice over
      Internet Protocol). ATSI recognizes revenue in the period the service is
      provided, net of revenue reserves for potential billing credits. Such disputes
      can result from disagreements with customers regarding the duration, destination
      or rates charged for each call.


27


*Network
      Services:* ATSI provides
      private communication links and VoIP gateway services to multi-national and
      foreign carriers and enterprise customers who use a high volume of
      telecommunications services to communicate with their U.S. offices or businesses
      and need greater dependability than is currently available through the foreign
      telecommunication networks. These services include data, voice and fax
      transmission between multiple international offices and branches as well as
      Internet and collocation services in the United States. ATSI
      recognizes network services revenue during the period the service is provided.
      Currently Network services is less than 0.01% of total revenue.





***Direct
      Cost of Revenue:***





**VoIP
      Services** *:* Under
      carrier services, ATSI incurs termination charges. These charges are related
      to
      the fees that ATSI is charged by carriers/vendors for the termination of phone
      calls into their infrastructure and network to
      terminate traffic in Mexico, Asia, the Middle East and Latin America. The
      cost
      is based on a per minute rate and volume. ATSI also incurs installation charges
      from various carriers; this cost is passed on to customers for the connection
      to
      the VoIP network from ATSI’s carriers.





**Network
      Services** :
      Under
      network services, ATSI incurs Internet, co-location, and fiber optic charges.
      The Internet and fiber optic charges are incurred as part of the connection
      links between the customer’s different remote locations and sites to transmit
      data, voice and Internet services. Co-location charges are incurred for space
      utilized to install gateways, servers, and other communications equipment.





***Cash
      and Cash Equivalents.*** For
      purposes of the statement of cash flows, ATSI considers all highly liquid
      investments purchased with an original maturity of three months or less to
      be
      cash equivalents.





***Allowance
      for Doubtful Accounts.*** Bad debt
      expense is recognized based on management’s estimate of likely losses each year
      based on past experience and an estimate of current year uncollectible amounts.
      As of July 31, 2008 and 2007, ATSI’s allowance for doubtful accounts balance was
      approximately $60,000 and $98,000, respectively.





***Investment
      in unconsolidated subsidiaries.***





**ATSI
      Comunicaciones S.A de C.V., (ATSICOM)**





On
      May
      22, 2003 ATSI sold 51% of its interest in ATSI Comunicaciones S.A de C.V.,
      (ATSICOM) As of July 31, 2008, ATSI has a 49% interest in the profits and equity
      of ATSICOM, a Mexican corporation engaged in providing telecommunication
      services. During fiscal 2003, ATSI recorded the investment in the unconsolidated
      subsidiary in conformity with the equity method of accounting. During the year
      ended July 31, 2004, ATSI determined that the estimated future cash flows
      expected from the concession license were less than its carrying value. As
      a
      result ATSI recorded an impairment loss of approximately $702,000 to reduce the
      recorded value of the concession license to zero. A lthough
      there is no assurance of future value appreciation, from time to time ATSI
      will
      conduct a valuation of its investment in the concession license and record
      the
      determined value, if any, in its financial statements. As of July 31, 2008,
      nothing has come to management’s attention that would require ATSI to make any
      adjustment to its financial statement.





**Fiesta
      Communications, Inc.**





On
      May 1,
      2008, ATSI agreed to sell all of the outstanding shares of Telefamilia
      Communications, Inc. to Fiesta Communications, Inc. for 975,000 shares of common
      stock in Fiesta Communications and $30,000 in cash to be paid in July
      2008. As of
      July 31, 2008, ATSI has approximately 15% interest in the profits and equity
      of
      Fiesta Communications, Inc. During fiscal 2008, ATSI recorded the investment
      in
      the unconsolidated subsidiary in conformity with the equity method of accounting
      and as a result recognized a minority interest loss on the investment of
      $16,000.


28


***Property
      and equipment.*** Property
      and equipment is recorded at cost. Additions are capitalized and maintenance
      and
      repairs are charged to expense as incurred. Gains and losses on dispositions
      of
      equipment are reflected in operations. Depreciation is provided using the
      straight-line method over the estimated useful lives of the assets, which are
      one to five years.





***Impairment
      of Long-Lived Assets.*** ATSI
      reviews the carrying value of its long-lived assets annually or whenever events
      or changes in circumstances indicate that the value of an asset may no longer
      be
      appropriate. ATSI assesses recoverability of the carrying value of the asset
      by
      estimating the future net cash flows expected to result from the asset,
      including eventual disposition. If the future net cash flows are less than
      the
      carrying value of the asset, an impairment loss is recorded equal to the
      difference between the asset’s carrying value and fair value.





***Derivative
      financial instruments*** .
      ATSI
      does not use derivative instruments to hedge exposures to cash flow, market,
      or
      foreign currency risks. ATSI analyzes its convertible instruments and
      free-standing instruments such as warrants for derivative liability accounting
      according to Statement of Financial Accounting Standards No. 133 and Emerging
      Issues Task Force 00-19.





For
      derivative financial instruments that are accounted for as liabilities, the
      derivative instrument is initially recorded at its fair value and is then
      re-valued at each reporting date, with changes in the fair value reported as
      charges or credits to income. For option-based derivative financial instruments,
      ATSI uses the Black-Scholes option-pricing model to value the derivative
      instruments.





The
      classification of derivative instruments, including whether such instruments
      should be recorded as liabilities or as equity, is re-assessed at the end of
      each reporting period. Derivative instrument liabilities are classified in
      the
      balance sheet as current or non-current based on whether or not net-cash
      settlement of the derivative instrument could be required within 12 months
      of
      the balance sheet date. There are no derivative instrument liabilities as of
      July 31, 2008 or 2007, respectively.





***Income
      taxes.*** ATSI
      recognizes deferred tax assets and liabilities based on differences between
      the
      financial reporting and tax bases of assets and liabilities using the enacted
      tax rates and laws that are expected to be in effect when the differences are
      expected to be recovered. ATSI provides a valuation allowance for deferred
      tax
      assets for which it does not consider realization of such assets to be more
      likely than not.





***Stock-based
      compensation.***  ATSI
      records compensation expense associated with stock options and other forms
      of
      equity compensation in accordance with Statement of Financial Accounting
      Standards No. 123R, Share-Based Payment, as
      interpreted by SEC Staff Accounting Bulletin No. 107.





***Basic
      and diluted net loss per share.*** The
      basic net loss per common share is computed by dividing the net loss by the
      weighted average number of common shares outstanding. Diluted net loss per
      common share is computed by dividing the net loss adjusted on an “as if
      converted” basis, by the weighted average number of common shares outstanding
      plus potential dilutive securities.





***Recently
      issued accounting pronouncements.*** ATSI
      does not expect the adoption of any other recently issued accounting
      pronouncements to have a significant impact on ATSI’s results of operations,
      financial position or cash flows.





**NOTE
      2 - ACCOUNTS RECEIVABLE**





On
      December 12, 2007, ATSI entered into a $3,000,000 accounts receivable financing
      agreement with Wells Fargo Business Credit (“WFBC”), a division of Wells Fargo
      Bank, N.A. On March 26, 2008, WFBC increased the accounts receivable financing
      to $5,000,000. ATSI may offer to sell with recourse not less than $350,000
      and
      no more than $5,000,000 of its accounts receivable to WFBC each month. WFBC
      pays
      to ATSI 85% of the aggregate amount of each account transferred under the
      Account Transfer Agreement. Once the account is collected by WFBC, it retains
      the amount originally paid for the account plus a daily factoring rate of
      0.0349% for each day outstanding measured from the funding date and until the
      account is paid by ATSI’s customer. If an account is not paid within 90 days,
      ATSI must repurchase the account for the amount that it originally received
      for
      the account and pay the factor rate that has accrued prior to repurchase. The
      factoring agreement is for twelve months and ATSI can terminate this agreement
      upon 30 days written notice, subject to a $15,000 early termination fee. Under
      the receivable financing agreement with WFBC, ATSI is factoring approximately
      $875,000 of its monthly receivables. As of July 31, 2008, ATSI had approximately
      $18,000 of factored account receivables outstanding; ATSI will continue to
      factor its receivables on a monthly basis as services are rendered to its
      customers.


29


**NOTE
      3** **–
      CERTIFICATES OF DEPOSIT**




On
      February 23, 2007 ATSI purchased a $200,000 certificate of deposit, with a
      two
      year maturity and a 4.50% annual yield of return, from Wells Fargo Bank, with.
      The certificate of deposit is pledged as collateral on a $200,000 promissory
      note with Wells Fargo Bank.




On
      March
      9, 2007 ATSI purchased a $100,000 certificate of deposit, with a two year
      maturity and a 4.75% annual yield of return, from Wells Fargo Bank. The
      certificate of deposit is pledged as collateral on a $100,000 promissory note
      with Wells Fargo Bank.





**NOTE
      4 – INTANGIBLE ASSETS**





During
      fiscal 2008 ATSI
      loaned $150,000 to NetSapiens Inc. The
      note
      receivable had a maturity date of June 26, 2008 with interest at 8% per year. The
      note
      was secured by NetSapiens’ proprietary Starter Platform License and SNAPsolution
      modules. On June 26, 2008 ATSI converted the outstanding interest and principal
      balance into a perpetual NetSapiens’ License. The License provides ATSI with the
      ability to offer Hosted
      PBX  **(** Private **** Branch **** eXchange),
      IP Centrex application, prepaid calling, call center, conferencing, messaging and other
      innovative telephony functionality necessary to offer standard and/or custom
      services to the Residential and Enterprise markets.
      The NetSapiens’ License will be amortized equally over a period of 10 years.





**NOTE
      5 -** **PROPERTY
      AND EQUIPMENT**





Following
      is a summary of ATSI’s property and equipment at July 31, 2008 and 2007 (in
      thousands):





Useful
                lives
            
            2008
            
            2007Telecom
                equipment & software
            
            
            1-5
                years
            
            $
            611
            
            $
            499Less:
                accumulated depreciation
            
            
            
            
            
            (439
            )
            
            (281
            )Net-property
                and equipment
            
            
            
            
            $
            172
            
            $
            218





For
      the
      years ended July 31, 2008 and 2007, depreciation and amortization totaled
      approximately $160,000 and $99,000, respectively.


30


**NOTE
      6 – DEBT**





**At
      July 31, 2008 and 2007 outstanding debt consisted of the
      following:**





July
                31,2008
            
            2007(in
                thousands)9%
                Convertible Subordinated Debenture, bering interest at 9.00% per
                annum
                maturing June 1, 2010, convertible into common stock annually at
                the
                higher of A) $0.27 per share or B) the average closing price of ATSI
                common stock for the 10 days immediately preceding the date of conversion,
                subject to a maximum number of 1,540,741 common shares issuable upon
                conversion, outstanding balance, net of unamortized discount of $5
                and $8,
                respectively
            
            $
            159
            
            $
            234Note
                payable to CCA Financial Services payable in monthly installments
                bering
                interest at 13.50% per annum, maturing December 31, 2008, collateralized
                by ATSI's equipment deposit of accounts and accounts
                receivables
            
            
            101
            
            
            207Note
                payable to Alfonso Torres, payable upon maturity bearing interest
                of 6.00%
                per annum, maturing October 1, 2009.
            
            
            460
            
            
            500Note
                payable to The Shaar Fund, payable in quarterly installments bearing
                interest of 7.50% per annum, maturing April 12, 2012.
            
            
            416
            
            
            -Note
                payable to Wells Fargo bank payable in monthly installments bering
                interest at 7.00% per annum, maturing April 1, 2009, collateralized
                by
                ATSI's certificates of deposit
            
            
            39
            
            
            88Note
                payable to Wells Fargo bank payable in monthly installments bering
                interest at 7.25% per annum, maturing July 25, 2010, collateralized
                by
                ATSI's certificates of deposit
            
            
            138
            
            
            200Total
                outstanding long term debt
            
            
            1,313
            
            
            1,229Current
                portion of long-term debt
            
            
            (644
            )
            
            (894
            )Long-term
                debt, net of current portion
            
            $
            669
            
            $
            335





**Payments
      on long-term debt of ATSI as of July 31, 2008 are due as
      follows:**





(in
                thousands)Fiscal
                2009
            
            $
            414Fiscal
                2010
            
            
            899Total
                payments
            
            $
            1,313





ATSI
      analyzed these instruments for derivative accounting consideration under SFAS
      133 and EITF 00-19, and determined that derivative accounting is not applicable
      for the new loans obtained during fiscal 2008 and 2007.





**NOTE
      7 - INCOME TAXES**





At
      July
      31, 2008, ATSI had a consolidated net operating loss carry-forward (“NOL”) of
      approximately $16,120,705 expiring ranging from 2009 through 2026. ATSI had
      no
      deferred tax asset resulting from its NOL. The loss carry forwards are subject
      to certain limitations under the Internal Revenue Code including Section 382
      of
      the Tax Reform Act of 1986.





ATSI
      conducts a periodic examination of its valuation allowance. Factors considered
      in the evaluation include recent and expected future earnings and ATSI’s
      liquidity and equity positions. As of July 31, 2008, ATSI has determined that
      a
      valuation allowance is necessary for the entire amount of deferred tax
      assets.


31


Deferred
      tax assets are comprised of the following as of July 31, 2008 and
      2007:





2008
            
            2007Deferred
                tax assets
            
            $
            5,642,000
            
            $
            5,675,000Valuation
                allowance
            
            
            (5,642,000
            )
            
            (5,675,000
            )Total
                deferred tax asset, net
            
            $
            -
            
            $
            -





In
      June 2006, the Financial Accounting Standards Board (FASB) issued FASB
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an
      interpretation of FASB Statement No. 109” (FIN 48). This Interpretation
      provides guidance on recognition, classification and disclosure concerning
      uncertain tax liabilities. The evaluation of a tax position requires recognition
      of a tax benefit if it is more likely than not it will be sustained upon
      examination. We adopted this Interpretation effective January 1, 2007. The
      adoption did not have a material impact on our consolidated financial
      statements.





**NOTE
      8 - COMMITMENTS AND CONTINGENCIES**





Leases:





ATSI
      leases its office space with monthly payments of $4,085; the lease expires
      in
      November 2011. The annual rent expense under the operating lease was $45,442
      and $49,419 for
      2007
      and 2008, respectively. The future minimum lease payments under the operating
      lease are as follows:





FY2009
            
            
            48,199FY2010
            
            
            49,100FY2011
            
            
            49,250





**NOTE
      9 – EQUITY**





***Common
      Stock***





During
      the year ended July 31, 2008 ATSI issued:





-
            149,288
                common shares valued at $30,820 to its placement agent and consultants
                for
                their services rendered.





-
            1,299,398
                common shares to its employees and directors for services rendered.
                ATSI
                recorded the fair value of $272,873 as the compensation expense in
                its
                statement of operations.





-
            3,434
                common shares to a Series H Preferred Stock stockholder for an conversion
                of the Series H Preferred Stock.





-
            130,436
                common shares to Alfonso Torres in lieu of $30,000 in accrued interest
                associated with the Alfonso Torres note payable.





-
            391,348
                common shares to the holders of the Convertible Debentures in lieu
                of a
                principal payment of $83,200 and $22,464 in accrued interest.


During
        the year ended July 31, 2007 ATSI issued:
 
 -
              495,062
                  shares of common stock valued at $128,920 for its placement agent
                  fees and
                  legal and consulting services rendered by various
                  individuals.
 
 -
              980,000
                  shares of common stock to its employees and directors for services
                  rendered. ATSI recorded compensation expense of $205,800 in its
                  statement
                  of operations for the aggregate market value of the stock at the
                  date of
                  issuance.
 
 -
              16,149,938
                  shares of common stock in connection with the conversion and redemption
                  of
                  11,802,420 shares of Series H Preferred Stock and accrued premium
                  common
                  shares.
 
 -
              111,909
                  shares of common stock in connection with the conversion of 2,750
                  shares
                  of Series A Preferred Stock and accrued dividend.
 
 -
              150,000
                  shares of common stock upon exercise of outstanding warrants for
                  aggregate
                  proceeds of $34,500.  -
              100,000
                  shares of common stock upon exercise of outstanding stock options
                  by an
                  employee for $16,000.
 -
              66,226
                  shares of common stock to Richard Benkendorf as a payment of $15,226
                  under
                  a settlement agreement.
 
 -
              137,412
                  shares of common stock to John Fleming as a payment of $42,600
                  under a
                  settlement agreement.
 
 -
              2,566,482
                  shares of common stock in connection with the conversion of various
                  notes
                  payable in the principal amount of $564,600 and accrued interest
                  of
                  $10,292.  -
              419,081
                  shares of common stock valued at $113,152 in connection with the
                  annual
                  payment on the “New Debentures” dated June 1,
                  2006.


***Preferred
      Stock***





The
      terms
      of ATSI’s preferred stock restrict ATSI from declaring and paying dividends on
      ATSI’s common stock until such time as all outstanding dividends have been
      fulfilled related to the preferred stock. The outstanding preferred stock have
      liquidation preference prior to common stock and ratably with each
      other.


32


**Series
      D Preferred Stock**





Series
      D
      Preferred Stock were issued in February 2000. The Series D Preferred Stock
      accrues cumulative dividends at the rate of 6% per annum payable quarterly.
      The
      Series D Preferred Stock and any accumulated, unpaid dividends may be converted
      into Common Stock for up to two years at the lesser of a) the market price
      on
      the day prior to closing or b) 83% of the five lowest closing bid prices on
      the
      ten days preceding conversion. The terms of ATSI’s Series D Preferred Stock
      allow for mandatory redemption by the holder upon certain conditions. The Series
      D Preferred Stock allows the holder to elect redemption upon the change of
      control of ATSI at 120% of the sum of $1,300 per share and accrued and unpaid
      dividends. Additionally, the holder may elect redemption at $1,270 per share
      plus accrued and unpaid dividends if ATSI refuses to honor conversion notice
      or
      if a third party challenges conversion. The Series D Preferred Stock holders
      are
      not entitled to vote.




On
      December 10, 2007, ATSI and The Shaar Fund entered into a settlement agreement
      relating to certain litigation. ATSI paid $75,000 on December 12, 2007 and
      agreed to pay another $450,000 with interest at 7.5% per annum in quarterly
      payments of $16,667 on each of January 31, 2008 and April 30, 2008, and in
      quarterly payments of $26,042 commencing on July 31, 2008 and continuing until
      April 30, 2012. I f
      paid in
      full within the first 18 months, ATSI will be entitled to a discount of 22.5%
      on
      the then outstanding principal balance. The
      Shaar
      Fund surrendered for cancellation 742 shares of ATSI’s 6% Series D Cumulative
      Convertible Preferred Stock and forgave approximately $340,000 in dividends
      accrued thereon as of October 24, 2007.





**Series
      E Preferred Stock**





Series
      E
      Preferred Stock were issued in October 2000 with a stated value of $1,000 per
      share.. The Series E Preferred Stock contain certain conversion and redemption
      features which provide that (1) they may be converted into Common Stock for
      up
      to three years at the lesser of a) the market price - defined as the average
      of
      the closing bid price for the five lowest of the ten trading days prior to
      conversion or b) the fixed conversion price - defined as 120% of the lesser
      of
      the average closing bid price for the ten days prior to closing or the October
      12, 2000 closing bid price and (2) allow for mandatory redemption by the holder
      upon certain conditions. The Series E Preferred Stock allows the holder to
      elect
      redemption at $1,250 per share plus 6% per annum if: 1) ATSI refuses conversion
      notice, 2) an effective registration statement was not obtained by prior to
      March 11, 2001, 3) bankruptcy proceedings are initiated against ATSI, 4) The
      Secretaría de Comunicaciones y Transportes of the SCT limits or terminates the
      scope of the concession or, 5) if ATSI fails to maintain a listing on NASDAQ,
      NYSE or AMEX. ATSI believes that the holders of the Series E Preferred Stock
      can
      no longer enforce the conversion or redemption features of the Preferred Stock
      instruments due to, among other things, the expiration of the applicable statute
      of limitations. Subsequent to July 31, 2007 the parties reached a confidential
      settlement agreement. Under the confidential settlement agreement the 1,170
      shares of Series E Preferred Stock have been cancelled. The
      Series E Convertible Preferred Stock holders are not entitled to
      vote.





In
      August
      2007, ATSI paid $175,000 to the Series E Preferred Stock stockholders and the 1,170
      shares of Series E Preferred Stock h ave
      been
      cancelled.





**NOTE
      10 – STOCK-BASED COMPENSATION TO EMPLOYEES**





In
      September 2005, ATSI adopted its 2005 stock compensation plan. This plan
      authorizes the grant of up to 7.5 million warrants, stock options, restricted
      common shares, non-restricted common shares and other awards to employees,
      directors, and certain other persons. The plan is intended to permit ATSI to
      retain and attract qualified individuals who will contribute to the overall
      success of ATSI. ATSI’s board of directors determines the terms of any grants
      under the plan. Exercise prices of all warrants, stock options and other awards
      vary based on the market price of the shares of common stock as of the date
      of
      grant. The warrants, stock options, restricted common stock, non-restricted
      common stock and other awards vest based on the terms of the individual
      grant.





In
      August
      2007, ATSI’s board of directors approved an amendment to the plan. Under the
      amendment, ATSI’s board of directors increased the maximum aggregate number of
      shares of Common Stock that may be issued under the Plan from 7.5 million shares
      to 17.5 million shares.


33


The
      grants under the plan during the year ended July 31, 2008 were as follows:





-
      ATSI
      granted options to purchase 1,835,000 common shares to certain employees and
      Board Members with an exercise price of $0.21 per share, the closing price
      of
      ATSI’s common stock on the grant date, August 15, 2007. One third of the options
      vested immediately on the grant date and the remaining two-thirds will vest
      as
      follows: one-third on the first anniversary of the grant date and one-third
      on
      the second anniversary of the grant date. All options expire if not exercised
      on
      or before the tenth anniversary of the grant date. Under the fair value option
      method, ATSI recognized $89,000 of compensation expense associated with the
      vested options on the date of grant. ATSI will recognize the remaining $177,000
      of non-cash compensation expense related to un-vested options over the relevant
      service periods.





-
      ATSI
      granted options to purchase 750,000 common shares to an employee with an
      exercise price of $0.23 per share, the closing price of ATSI’s common stock on
      the grant date, September 1, 2007. Upon successfully achieving performance
      objectives set by ATSI’s board of directors, the options will vest one-third on
      the first anniversary of the date of grant, one-third on the second anniversary
      of the date of grant, and one-third on the third anniversary of the date of
      grant. All options expire if not exercised on or before the tenth anniversary
      of
      the grant date. Under the fair value option method, ATSI will recognize $119,000
      of non-cash compensation expense over the relevant service period.





-
      ATSI
      granted options to purchase 30,000 common shares to an employee with an exercise
      price of $0.27 per share, the closing price of ATSI’s common stock on the grant
      date, November 1, 2007. The options will vest one-third on the first anniversary
      of the date of grant, one-third on the second anniversary of the date of grant,
      and one-third on the third anniversary of the date of grant. All options expire
      if not exercised on or before the tenth anniversary of the grant date. Under
      the
      fair value option method, ATSI will recognize $5,500 of non-cash compensation
      expense over the relevant service period.





-
      ATSI
      granted options to purchase 100,000 common shares to an employee with an
      exercise price of $0.18 per share, the closing price of ATSI’s common stock on
      the grant date, January 28, 2008. The options will vest one-third on the first
      anniversary of the date of grant, one-third on the second anniversary of the
      date of grant, and one-third on the third anniversary of the date of grant.
      All
      options expire if not exercised on or before the tenth anniversary of the grant
      date. Under the fair value option method, ATSI will recognize $14,753 of
      non-cash compensation expense over the relevant service period.





-
      ATSI
      issued 1,299,398 shares of unrestricted common stock to its employees and
      directors for services rendered with a value of $272,873.


The
        grants under the plan during the year ended July 31, 2008 as follows:
 
 -
        1,345,000 options to purchase common stock to its employees and members of
        the
        Board of Directors with an exercise price of $0.21 per share, the closing
        price
        of ATSI’s common stock on the grant date, September 25, 2006. One third of the
        options vested immediately at the issuance date and the remaining two-thirds
        will vest equally over a period of two years. Under the fair value option
        method, ATSI recognized $71,000 of compensation expense associated with the
        vested options at the date of grant. ATSI will recognize the remaining $142,000
        of non-cash compensation expense related to un-vested options over the service
        period.
 
 - 980,000
            shares of unrestricted common stock to its employees and directors for
            services
            rendered




ATSI
      recognized $695,000 and $473,000 in stock based compensation expense to
      employees during fiscal 2008 and 2007, respectively.




The
      fair
      value of each option and warrant granted is estimated on the date of grant
      using
      the Black-Scholes option pricing model with the following
      assumptions:


For
                  the Years Ended July 31,2008
              
              2007Expected
                  dividends yield
              
              
              0.00
              %
              
              0.00
              %Expected
                  stock price volatility
              
              
              75%
                  - 105
              %
              
              80
              %Risk-free
                  interest rate
              
              
              3.15%
                  - 4.65
              %
              
              4.51
              %Expected
                  life of options
              
              
              4
                  -
                  6 years
              
              
              7
                  years


ATSI
      estimates its expected life of its options using the “simplified method” allowed
      for under SAB 108 which is the average between the contract term and the vesting
      period of the options.


34


A
      summary
      of the options as of July 31 ,
      2008
      and 2007 and the
      changes during the years ended July 31,
      2008
      and 2007 are presented
      below:


Weighted-averageWeighted-average
              
              remaining contractual**2005 Stock Compensation Plan**
              
              Options
              
              exercise price
              
              term (years)Outstanding
                  at July 31, 2006
              
              
              4,354,000
              
              $
              0.16
              
              
              6Granted
              
              
              1,345,000
              
              
              0.21
              
              
              6Forfeited
              
              
              (100,000
              )
              
              0.16
              
              
              6Outstanding
                  at July 31, 2007
              
              
              5,599,000
              
              $
              0.17
              
              
              6Granted
              
              
              2,715,000
              
              
              0.22
              
              
              6Forfeited
              
              
              (75,000
              )
              
              0.21
              
              
              6Outstanding
                  at July 31, 2008
              
              
              8,239,000
              
              
              0.19
              
              
              6Exercisable
                  at July 31, 2008
              
              
              4,905,666
              
              $
              0.17
              
              
              6


**NOTE
      11 –WARRANTS ISSUED FOR SERVICES**





During
      the year ended July 31, 2008 ATSI granted 375,000 warrants for consulting
      services. The exercise price of the warrants was set at $.18 per warrant. ATSI
      recognized a non-cash warrant expense of $45,753 during the year ended July
      31,
      2008.





The
      fair
      value of each warrant granted is estimated on the date of grant using the
      Black-Scholes option-pricing model with the following assumptions for fiscal
      2008:


For
                  the year Ended
                July
                  31,2008Expected
                  dividend yield
              
              
              0.00
              %Expected
                  stock price volatility
              
              
              105
              %Risk-free
                  interest rate
              
              
              3.62
              %Contractual
                    life of warrants
              
              
              7
                  years


A
      summary
      of the warrants as of July 31 ,
      2008
      and 2007 and the
      changes during the years ended July 31,
      2008
      and 2007 are presented
      below:




Weighted-averageWeighted-average
            
            remaining contractualWarrants
            
            exercise price
            
            term (years)Outstanding
                at July 31, 2006
            
            
            150,000
            
            $
            0.23
            
            
            3Granted
            
            
            -
            
            
            -
            
            
            -Exercised
            
            
            (150,000
            )
            
            0.23
            
            
            3Forfeited
            
            
            -
            
            
            -
            
            
            -Outstanding
                at July 31, 2007
            
            
            -
            
            $
            -
            
            
            -Granted
            
            
            375,000
            
            
            0.18
            
            
            4Exercised
            
            
            -
            
            
            -
            
            
            -Forfeited
            
            
            -
            
            
            -
            
            
            -Outstanding
                at July 31, 2008
            
            
            375,000
            
            $
            0.18
            
            
            4Exercisable
                at July 31, 2008
            
            
            375,000
            
            $
            0.18
            
            
            4


35


**NOTE
      12 – SHARE REPURCHASE PROGRAM**





On
      April
      16, 2008, ATSI’s Board of Directors approved a share buyback plan allowing ATSI
      to purchase up to $1 million of its common stock. The shares will be bought
      through the open market through December 31, 2008 based on price and market
      conditions. As of July 31, 2008, ATSI has repurchased 44,002 of its common
      stock
      at an average purchase price of $0.22.





**NOTE
      13 –** **NON-STANDARDIZED
      PROFIT SHARING PLAN**





We
      currently provide a Non-Standardized Profit Sharing Plan. The board of directors
      approved the plan on September 15, 2006. Under the plan our employees qualified
      to participate in the plan after one year of employment. Contribution under
      the
      plan is based on 25% of the annual base salary of each eligible employee up
      to
      $46,000 per year. Contributions under the plan are fully vested upon funding.
      During fiscal 2008 and 2007, the Company contributed under the plan $194,000
      and
      $99,000, respectively.




**NOTE
      14 – EARNINGS (LOSS) PER SHARE**





In
      accordance with SFAS No. 128, “Earnings Per Share,” basic earnings per share
      have been computed based upon the weighted average common shares outstanding.
      Diluted earnings per share give effect to outstanding convertible preferred
      shares, warrants and stock options, unless their effect is anti-dilutive.
      Earnings (loss) per common share have been computed as follows:




Year
                ended July 31,2008
            
            2007(In thousands, except share information)Net income (loss) to
                be used to compute income(loss)
                per share:Net
                income (loss)
            
            $
            112
            
            $
            (257
            )Less
                preferred dividends
            
            
            328
            
            
            772Net
                income attributable to commonShareholders
            
            
            440
            
            
            515Weighted
                average number of shares:Weighted
                average common shares outstanding - basic
            
            
            39,143,748
            
            
            27,908,044Effect
                of warrants and options
            
            
            53,571
            
            
            141,695Weighted
                  average common shares outstandingassuming
                  dilution
            
            
            39,197,319
            
            
            28,049,739Basic
                income per common share
            
            $
            0.01
            
            $
            0.02Diluted
                income per common share
            
            $
            0.01
            
            $
            0.02





**NOTE
      15 – SALE OF TELEFAMILIA**





On
      May 1,
      2008, ATSI sold all of the outstanding shares of Telefamilia Communications,
      Inc. to Fiesta Communications, Inc. for 975,000 shares of common stock in Fiesta
      Communications and $30,000 in cash to be paid through a promissory note in
      July
      2008. The shares of Fiesta were determined to have very minimal value due to
      the
      Company is still in the development stage and the shares has no fair market
      value. Additionally, Fiesta Communications issued a three-year promissory note
      in the amount of $52,984 for the services rendered by ATSI under the joint
      management agreement dated January 1, 2006. The three-year promissory note
      will
      be paid quarterly starting July 31, 2008 and has a maturity date of May 1,
      2010
      and an annual interest rate of 8%. The note is secured by all assets of the
      new
      combined entity of Fiesta.


36


The
      following table presents the allocation of the selling price of Telefamilia
      for
      the assets sold and liabilities transferred, based on their fair
      values:





Promissory
                notes from Fiesta/Telefamilia
            
            $
            82,984Note
                payable from Fiesta
            
            
            15,000Total
                purchase price
            
            
            97,984Assets
                sold
            
            
            (67,165
            )Liabilities
                transferred
            
            
            50,728Gain
                on sale of Telefamilia
            
            $
            81,547





As
      of
      August 1, 2008, ATSI and Fiesta agreed to extend the maturity date on the
      $30,000 promissory note to October 31, 2008; all other terms remained the same. Also
      on
      August 1, 2008, Fiesta entered into a note payable with ATSI for $25,000,
      with a maturity date of October 31, 2008 and an interest rate of
      8%.





With
      the
      975,000 shares obtained from Fiesta, ATSI owns approximately 15% of Fiesta.
      Since ATSI’s CEO and President, Arthur L Smith, is also a 16% stockholder of
      Fiesta, ATSI and its CEO and President have significant influence of Fiesta
      and
      the investment in Fiesta is accounted for by ATSI under Equity Method. ATSI
      has
      evaluated its relationship with Fiesta and determined that Fiesta is a variable
      interest entity under FIN 46(R) and also concluded that ATSI has no control
      of
      Fiesta and is not the primary beneficiary as defined by FIN 46(R). Based on
      these findings, ATSI is not required to consolidate Fiesta.





For
      the
      year ended July 31, 2008, ATSI recognized $16,000 loss from its equity
      investment in Fiesta and as of July 31, 2008, the balance of the investment
      in
      Fiesta was netted with the notes receivable from Fiesta to be
      $25,000.





**NOTE
      16 – SUBSEQUENT EVENTS**





On
      September 26, 2008, ATSI borrowed $850,000 under several notes payable. These
      notes bear annual interest of 10%, and provide for twenty-four monthly payments
      of principal and interest. These notes are secured by 1) Accounts receivables
      other than accounts sold under the receivable
      financing agreement with Wells
      Fargo Business Credit (“WFBC”), a division of Wells Fargo Bank, N.A.; 2)
      $100,000 certificate of deposit, and 3) ATSI’s ownership interest in ATSICOM.
      Additionally, ATSI entered into a twenty-four month consulting / advisory
      agreement with Texas Ventures, under the agreement ATSI will pay an annual
      fee
      of 1.5%, based on the total outstanding principal balance due to the holders
      of
      the $850,000 promissory notes. ATSI has the option of paying off the total
      outstanding principal balance at any time without any penalties.





In
      addition, ATSI issued 425,000 warrants to the note holders. The exercise price
      of the warrants was set at $0.19 per warrant.





The
      warrants have the following “Put” and “Call” rights:





Put
      right .
      From
      and after the second anniversary of the notes payable, the holder shall have
      the
      right to “Put” to ATSI, upon five (5) Business days prior notice at a put price
      of $.39 per warrant.





Call
      right .
      At any
      time any warrants are outstanding, if the last sale price of ATSI’s common stock
      is greater than $.80 per share for ten (10) consecutive trading days, ATSI
      shall
      be entitled to require the purchaser to exercise the warrants and pay the
      exercise price therefore upon five (5) business days written
      notice.


37


The
      fair
      value of the warrant granted to the Note holders was estimated to be
      $70,760 on the date of grant using the Black-Scholes option-pricing model with
      the following assumptions:





Expected
                dividend yield
            
            
            0.00
            %Expected
                stock price volatility
            
            
            126
            %Risk-free
                interest rate
            
            
            3.37
            %Contractual
                  life of warrants
            
            
            7
                years


ATSI
        analyzed these instruments for derivative accounting consideration under
        SFAS
        133 and EITF 00-19, and determined that the warrants did not meet the definition
        of equity under SFAS 133 and EITF 00-19, due to the put right. ATSI estimated
        the fair market value of the put to be the difference between the potential
        cash
        settlement price per share and the exercise price, or approximately $85,000
        which is the maximum amount of potential cash settlement by ATSI. Because
        the
        maximum cash settlement was greater than the fair value of the warrants,
        ATSI
        recorded the maximum cash settlement of $85,000 as a
        liability.


**ITEM 9.**
            **CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE.**





None





**ITEM
      9A(T).**  **CONTROLS
      AND PROCEDURES.**





**Disclosure
      Controls and Procedures**





We
      maintain “disclosure controls and procedures,” as such term is defined in Rule
      13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that
      are designed to ensure that information required to be disclosed in our Exchange
      Act reports is recorded, processed, summarized and reported within the time
      periods specified in the Securities and Exchange Commission rules and forms,
      and
      that such information is accumulated and communicated to our management,
      including our Chief Executive Officer and Chief Financial Officer, as
      appropriate, to allow timely decisions regarding required disclosure. We
      conducted an evaluation (the “Evaluation”), under the supervision and with the
      participation of our Chief Executive Officer and Chief Financial Officer of
      the
      effectiveness of the design and operation of our disclosure controls and
      procedures as of the end of the period covered by this report pursuant to Rule
      13a-15 of the Exchange Act. The evaluation of our disclosure controls and
      procedures included a review of the disclosure controls’ and procedures’
objectives, design, implementation and the effect of the controls and procedures
      on the information generated for use in this report. In the course of our
      evaluation, we sought to identify data errors, control problems or acts of
      fraud
      and to confirm the appropriate corrective actions, if any, including process
      improvements, were being undertaken. Our Chief Executive Officer and our Chief
      Financial Officer concluded that, as of the end of the period covered by this
      report, our disclosure controls and procedures were effective and were operating
      at the reasonable assurance level.





**Internal
      Control Over Financial Reporting**


Our
        management is responsible for establishing and maintaining adequate internal
        control over financial reporting (as defined in Exchange Act Rules 13a-15(f)
        and
        15d-15(f) as amended). Because of its inherent limitations, internal control
        over financial reporting may not prevent or detect misstatements. Also,
        projections of any evaluation of effectiveness to future periods are subject
        to
        the risk that controls may become inadequate because of changes in conditions,
        or that the degree of compliance with policies or procedures may
        deteriorate.
 
 Our
        management assessed the effectiveness of our internal control over financial
        reporting as of July 31, 2008. In making this assessment, we used the criteria
        set forth by the committee of Sponsoring Organizations of the Treadway
        Commission (“COSO”) in Internal Control - Integrated Framework. Based on our
        assessment using those criteria, our management concluded that our internal
        control over financial reporting was effective as of July 31,
        2008.
  38


We
      have
      made no changes in our internal controls over financial reporting during the
      period covered by this report that has materially affected, or is reasonably
      likely to materially affect, our internal control over financial
      reporting.





**ITEM
      9B.**  **OTHER
      INFORMATION.**





**None**





**PART
      III**





**ITEM
          10.** **DIRECTORS,
          EXECUTIVE OFFICERS, PROMOTERS AND CORPORATE
          GOVERNANCE.**





**Business
      Experience**





The
      following table contains the name, age of our directors and executive
      officers.





**Name**
            
            **Age**
            
            **Position
                Held**Arthur
                L. Smith
            
            43
            
            President,
                Chief Executive Officer and DirectorRuben
                R. Caraveo
            
            40
            
            Sr.
                Vice President, Operations and TechnologyAntonio
                Estrada Jr.
            
            34
            
            Sr.
                Vice President, Treasurer & Corporate ControllerJohn
                R. Fleming
            
            54
            
            Director,
                Interim Executive Chairman of the BoardMurray
                R. Nye
            
            54
            
            Director





*Arthur
      L. Smith* has
      served as our Chief Executive Officer and Director since May 2003. Mr. Smith
      also served as the President of ATSI de Mexico S.A de C.V. from August 2002
      to
      April 2003, as our Chief Executive Officer and a Director from June 1996 to
      July
      2002 and as our President since our formation in June 1996 to July 1998. Mr.
      Smith also served as President, Chief Operating Officer and a director of
      ATSI-Canada since its formation in May 1994. From December 1993 until May 1994,
      Mr. Smith served in the same positions with Latcomm International Inc., which
      amalgamated with Willingdon Resources Ltd. to form ATSI-Canada in May 1994.
      From
      June 1989 to December 1993, Mr. Smith was employed as director of international
      sales by GeoComm Partners, a satellite-based telecommunications company located
      in San Antonio, providing telecommunications services to Latin America. Mr.
      Smith has over 19 years’ experience in the telecommunications industry.





*Ruben
      R. Caraveo* has
      served as our Sr. Vice President of Operations and Technology since August
      2006,
      and is also the President for our wholly-owned subsidiary Digerati Networks,
      Inc.  Mr. Caraveo also served as Vice President of Sales and Operations
      from May 2003 to July 2006.  Prior to joining ATSI, Mr. Caraveo served as
      Vice President of Operations and Engineering at Vycera Communications where
      he
      was responsible for overseeing all daily operations, including Network
      Operations, Engineering, Marketing, and the Network Trouble Reporting and
      Resolution departments. His prior experience also includes positions with
      Worldtel Interactive, Frontier, and WorldCom. Mr. Caraveo has more than 19
      years’ telecommunications industry experience, specializing in the areas of
      Carrier Sales, Network Operations, Engineering, Data and Systems Analysis,
      Product Marketing, and Systems Development. Mr. Caraveo attended California
      State University, Northridge, School of Engineering.





*Antonio
      Estrada Jr.* has ** served
      as
      our Sr. Vice President of Finance since August 2007. From May 2003 to July
      2007,
      Mr. Estrada served as the Corporate Controller. From January 2002 through
      January 2003, Mr. Estrada served as our Director of International Accounting
      and
      Treasurer. From January 2001 to January 2002, Mr. Estrada served in various
      roles within ATSI, including International Accounting Manager and General
      Accountant. Prior to joining ATSI in 1999 he served as a Senior Accountant
      for
      the Epilepsy Association of San Antonio and South Texas. Mr. Estrada has more
      than 10 years’ experience in the telecommunications industry, financial
      reporting, treasury management, internal audit, SOX compliance, and accounting.
      Mr. Estrada graduated from the University of Texas at San Antonio, with a
      Bachelors of Business Administration, with a concentration in Accounting.


39


*John
      R. Fleming* has
      served as our Non-executive Chairman of the Board since August 2002 and as
      one of our Directors since January 2001. Mr. Fleming is the principal and
      founder of Vision Corporation, an early-stage investment company that focuses
      on
      communications technologies, service and hardware.  Mr. Fleming also
      owns Secure Media Solutions, Inc., which specializes
      in digital medium transfer technologies for both the film and
      television industries.  Prior to forming Vision Corporation, Mr.
      Fleming served as President, International of IXC Communications, Inc. from
      April 1998 to December 1999. Immediately prior to that he served as IXC’s
      President of Emerging Markets from December 1997, as Executive Vice President
      of
      IXC from March 1996 through November 1997 and as Senior Vice President of IXC
      from October 1994 through March 1996. He served as Vice President of Sales
      and
      Marketing of IXC from its formation in July 1992 until October 1994. Prior
      to
      that, Mr. Fleming served as Director of Business Development and Director of
      Carrier Sales of CTI from 1986 to March 1990 and as Vice President of Marketing
      and Sales of CTI from March 1990 to July 1992. Mr. Fleming was a Branch Manager
      for Satellite Business Systems from 1983 to 1986.




*Murray
      R. Nye* has
      served as one of our Directors since its formation in June 1996. Mr. Nye also
      served as of the Chief Executive Officer and a director of ATSI-Canada from
      its
      formation in May 1994. From December 1993 until May 1994, Mr. Nye served in
      the
      same positions with Latcomm International Inc., which company amalgamated with
      Willingdon Resources Ltd. to form ATSI-Canada in May 1994. From 1992 to 1995,
      Mr. Nye served as President of Kirriemuir Oil & Gas Ltd. From 1989 until
      1992, Mr. Nye was self-employed as a consultant and Mr. Nye is again currently
      self-employed as a consultant. Mr. Nye serves as a director of D.M.I.
      Technologies, Inc., an Alberta Stock Exchange-traded company.





There
      are
      no family relationships between or among our directors and executive
      officers.




**Section
      16(a) Beneficial Ownership Reporting Compliance**





Section
      16(a) of the Securities Exchange Act of 1934, as amended, requires our directors
      and executive officers and persons who own more than 10% of a registered class
      of our equity securities to file various reports with the Securities and
      Exchange Commission concerning their holdings of, and transactions in,
      securities we issued. Each such person is required to provide us with copies
      of
      the reports filed. Based on a review of the copies of such forms furnished
      to us
      and other information, we believe that, during the fiscal year ended July 31,
      2008, none of our officers, directors or owners of 10% of any class of our
      securities failed to report transactions in our securities or reported
      transactions in our securities late.





**Name and Position**
            
            **Number of**
              **Transactions**
              **Not**
              **Reported**
            
            **Number of**
              **Reports**
              **Filed Late**
            
            **Number of**
              **Transactions**
              **Reported**
              **Late**Ruben
                R. Caraveo, Sr. Vice President of Operations and
                Technology
            
            
            0
            
            
            12
            
            
            15





**Code
      of Ethics**





ATSI
      Communications, Inc. adopted an
      Executive Code of Ethics that applies to the Chief Executive Officer, Chief
      Financial Officer, Controller and other members of our management team. The
      Executive Code of Ethics may be viewed on our Website, www.atsi.net .
      Upon
      request, a copy of the Executive Code of Ethics will be provided without charge
      upon written request to ATSI Communications, Inc., 3201 Cherry Ridge, Building
      C, Suite 300, San Antonio, Texas 78230.





**Nominating
      Committee and Nomination of Directors**





We
      do not
      have a formal nominating committee because the size of our board of directors
      is
      too small to establish separate standing committees. Our directors perform
      the
      function of a nominating committee.


40




The
      directors consider director candidates recommended by other members of the
      board
      of directors, by executive officers and by one or more substantial, long-term
      stockholders. In addition, the board of directors may seek candidates through
      a
      third person recruiter. Generally, stockholders who individually or as a group
      have held 5% of our shares for over one year will be considered substantial,
      long-term stockholders. In considering candidates, the directors take into
      consideration the needs of the board of directors and the qualifications of
      the
      candidate. The board of directors has not established a set of criteria or
      minimum qualifications for candidacy and each candidate is considered based
      on
      the demonstrated competence and knowledge of the individual. To have a candidate
      considered by the directors, a stockholder must submit the recommendation in
      writing and must include the following information:





·
            The
                name of the stockholder and evidence of ownership of our shares,
                including
                the number of shares owned and the length of time of ownership;
                and





·
            The
                name of the candidate, the candidate’s resume or a listing of her or his
                qualifications to be one of our directors and the person’s consent to be
                named as a director if nominated by the
                directors.





The
      stockholder’s recommendation and information described above must be sent to us
      at 3201 Cherry Ridge, Building C, Suite 300, San Antonio, TX 78230 and, if
      the
      nominee is to be elected at a meeting of the stockholders, must be received
      by
      the Chief Executive Officer at least 180 days prior to the anniversary date
      of
      our most recent annual meeting of stockholders.





**Audit
      Committee and Audit Committee Financial Expert**





We
      do not
      have an audit or other board committee performing equivalent functions. Our
      board of directors performs all functions of the audit committee. We do not
      have
      an audit committee financial expert because none of our current directors have
      the necessary training or experience to qualify as a financial
      expert.





**ITEM
      11.**  **EXECUTIVE
      COMPENSATION.**





**Compensation
      Discussion and Analysis**





** Our
      compensation programs are designed to meet the following objectives:





·
            Offer
                compensation opportunities that attract highly qualified executives,
                reward outstanding initiative and achievement, and retain the leadership
                and skills necessary to build long-term stockholder value;





·
            Emphasize
                pay-for-performance by maintaining a portion of executives’ total
                compensation at risk, tied to both our annual and long-term financial
                performance and the creation of stockholder value; and





·
            Further
                our short and long-term strategic goals and values by aligning executive
                officer compensation with business objectives and individual performance.





Our
      board
      of directors believes that an executive’s compensation should be tied to the
      performance of the individual and the performance of the complete executive
      team
      against both financial and non-financial goals, some of which are subjective
      and
      within the discretion of the board of directors.





** Our
      executive compensation program is intended to be simple and clear, and consists
      of the following elements (depending on individual performance):





·
            Base
                salary;


·
            Annual
                performance-based cash bonus;


·
            Long-term
                incentives in the form of stock options;
                and


·
            Benefits
                that are offered to executives on the same basis as our non-executive
                employees.




41


**Role
      of Management in Determining Compensation Decisions**





At
      the
      request of our board of directors, our management makes recommendations to
      our
      board of directors relating to executive compensation program design, specific
      compensation amounts, bonus targets, incentive plan structure and other
      executive compensation related matters for each of our executive officers,
      including our Chief Executive Officer. Our board of directors maintains
      decision-making authority with respect to these executive compensation matters.





Our
      board
      of directors reviews the recommendations of our management with respect to
      total
      executive compensation and each element of compensation when making pay
      decisions. In allocating compensation among compensation elements, we emphasize
      incentive, not fixed compensation to ensure that executives only receive
      superior pay for superior results. We equally value short- and long-term
      compensation because both short- and long-term results are critical to our
      success. In addition, our compensation program includes various benefits
      provided to all employees, including life insurance, health insurance and other
      customary benefits. The objectives and details of why each element of
      compensation is paid are described below.





*Base
      Salary.* Our
      objective for paying base salaries to executives is to reward them for
      performing the core responsibilities of their positions and to provide a level
      of security with respect to a portion of their compensation. We consider a
      number of factors when setting base salaries for executives, including:





·
            Existing
                salary levels;


·
            Competitive
                pay practices;


·
            Individual
                and corporate performance; and


·
            Internal
                equity among our executives, taking into consideration their relative
                contributions to our success.





*Annual
      Incentive Awards.* Our
      objective for offering annual cash bonus awards to our named executive officers
      is to motivate them to achieve our annual financial goals, while taking into
      account their individual goals and responsibilities. Our board of directors
      implemented our 2008 executive officer bonus plan, effective as of the first
      quarter of fiscal 2008 pursuant to which our named executive officers became
      eligible to receive cash bonus awards calculated and paid on a quarterly basis.
      The amounts payable under our 2008 executive officer bonus plan were to be
      calculated based on our revenue, margin, cash balance and net income for 2008
      against the 2008 financial plan approved by our board of directors.





Under
      our
      2008 executive officer bonus plan, we assigned a specific bonus target to each
      executive for performance in 2008. Our board of directors designed these bonus
      targets to allow for additional compensation in the event we meet our targets
      set fort under the financial plan approved by our board of directors. Cash
      bonus
      targets were determined based on individual responsibility levels and
      performance expectations and would be payable in a proportionate amount
      representing the percentage of our targeted corporate net income goal pursuant
      to our 2008 financial plan. After discussion and deliberation, our board of
      directors ultimately approved our management’s recommendations as detailed
      below:





**Name**
            
            **Title**
            
            **Bonus**Arthur
                L. Smith
            
            
            President,
                Chief Executive Officer and Director
            
            $
            75,000Ruben
                R. Caraveo
            
            
            Sr.
                Vice President, Operations and Technology
            
            $
            67,500Antonio
                Estrada Jr.
            
            
            Sr.
                Vice President & Corporate Controller
            
            $
            55,000





Payouts
      under our 2008 executive officer bonus plan are dependent on our achievement
      towards our revenue; margin, cash balance and net income goal such that 100%
      of
      the bonus target amounts would be paid upon achievement of 100% of the net
      income goal. Above and below target performance methodologies were also
      established. Cash bonuses for 2008 exceeded the amount set forth above because
      we exceeded all targets established by the board of directors. Similar to the
      2008 executive officer bonus plan, our 2009 executive compensation plan and
      performance targets under the 2009 financial plan are dependent on our
      achievement of revenue; margin, cash balance and net income goals.


42


We
      consider the specific performance goals established in the 2008 and 2009
      financial plan to be our confidential information, the disclosure of which
      would
      cause us to experience financial harm. We believe that tying annual bonus
      payments for each of our named executive officers to the achievement of
      challenging revenue, margin, cash balance and net income goals best aligns
      the
      interest of our executives with the interests of our stockholders and promotes
      a
      unity of purpose among our key business leaders. Regardless of our actual
      financial performance under our 2008 financial plan, our board of directors
      retained the discretion to adjust bonuses payable under our 2008 executive
      officer bonus plan up or down as it deemed appropriate.





*Long-term
      Incentive Awards.* We
      award long-term incentive compensation to focus our executives on our long-term
      growth and stockholder return, as well as to encourage our executives to remain
      with us for the long-term. Long-term incentive awards are primarily in the
      form
      of grants of stock options and/or stock award pursuant to our 2005 Stock
      Compensation Plan (the “Plan”). We selected this form because of the favorable
      accounting and tax treatment and the expectation of key employees in our
      industry that they would receive stock options and/or stock grants. We do not
      have pre-established target award amounts for long-term incentive grants. In
      determining long-term incentive awards for the named executive officers, our
      board of directors relies on recommendations from our Chief Executive Officer,
      who considers the individual performance of the executives, the relation of
      the
      award to base salary and annual incentive compensation, and associated
      accounting expense The terms of and amount of awards are made by our board
      of
      directors in accordance with the Plan.





**SUMMARY
      COMPENSATION TABLE**





**Name and Principal**
              **Position**
            
            **Year**
            
            **Salary**
              **($)**
            
            **Bonus(1)**
              **($)**
            
            **Stock**
              **Awards**
              **($)**
            
            **Option**
              **Awards**
              **($)**
            
            **All Other**
              **Compensation**
              **($)**
            
            **Total**
              **($)**Arthur
                L. Smith
              CEO
                & President
            
            
            2008
              2007
            
            $
              $
            150,000
              150,000
            
            $
              $
            90,392
              42,187
            
            $
              $
            7,012
              47,250
            (2)
              (2)
            $
              $
            94,500
              63,000
            (2)
              (2)
            $
              $
            50,738
              22,154
            (3)
              (3)
            $
              $
            392,642
              324,591Ruben
                R. Caraveo
              Senior
                Vice President of Operations and Technology
            
            
            2008
              2007
            
            $
              $
            135,000
              130,000
            
            $
              $
            127,371
              48,750
            
            $
              $
            -0-
              36,750
            (2)
            $
              $
            78,750
              52,500
            (2)
              (2)
            $
              $
            47,327
              19,904
            (3)
              (3)
            $
              $
            388,448
              287,904Antonio
                Estrada Jr.
              Senior
                Vice President of Finance & Corporate Controller
            
            
            2008
              2007
            
            $
              $
            110,000
              90,000
            
            $
              $
            101,126
              28,686
            
            $
              $
            15,226
              36,750
            (2)
              (2)
            $
              $
            78,750
              52,500
            (2)
              (2)
            $
              $
            32,102
              15,216
            (3)
              (3)
            $
              $
            337,204
              223,152





(1)
            Bonus
                amounts are based on the bonus payments for the 2008 fiscal year


(2)
            A
                description of the assumptions made in valuation of options granted
                can be
                found in Note 9 to the Financial Statements, which is deemed to be
                a part
                of this Item.


(3)
            All
                other compensation consists of contributions by the Company into
                the
                Non-Standardized Profit Sharing
                Plan.





**Equity-based
      Compensation Plans**





Our
      board
      of directors adopted the 2005 Stock Compensation Plan (the “Plan”). Under the
      Plan the board of directors may grant up to 17,500,000 shares of our common
      stock to our officers, directors, employees and consultants. Grants may be
      in
      the form of incentive stock options, non-statutory stock options, restricted
      stock awards, and/or unrestricted stock awards. The number and terms of each
      award is determined by the board of directors, subject to the limitation that
      the exercise price of any option may not be less than the fair market value
      of
      the common stock on the date of grant. The board of directors has not
      retroactively granted or repriced options under the Plan. The following tables
      set forth information about the number of grants made during fiscal 2008 and
      2007 and the number of outstanding stock options held by each of our named
      executive officers as of July 31, 2008.


43


**GRANTS
      OF PLAN-BASED AWARDS**


**Name**
              
              **Grant Date**
              
              **Number of**
                **Shares of**
                **Stock or**
                **Units**
                **(#)**
              
              **Number of**
                **Securities**
                **Underlying**
                **Options**
                **(#)**
              
              **Exercise or**
                **Base Price**
                **of Option**
                **Awards**
                **($/Sh)**
              
              **Grant Date**
                **Fair Value**
                **of Stock and**
                **Option Awards**Arthur
                  L. Smith
              
              
              9/25/2006
              
              
              225,000
              
              
              300,000
              
              $
              0.21
              
              $
              288,0008/14/2007
              
              
              275,000
              
              
              450,000
              
              $
              0.21
              
              $
              369,500Ruben
                  R. Caraveo
              
              
              9/25/2006
              
              
              175,000
              
              
              250,000
              
              $
              0.21
              
              $
              227,5008/14/2007
              
              
              225,369
              
              
              375,000
              
              $
              0.21
              
              $
              304,119Antonio
                  Estrada, Jr.
              
              
              9/25/2006
              
              
              175,000
              
              
              250,000
              
              $
              0.21
              
              $
              227,5008/14/2007
              
              
              225,369
              
              
              375,000
              
              $
              0.21
              
              $
              304,119





**OUTSTANDING
      EQUITY AWARDS AT FISCAL YEAR-END**





**Option Awards**
            
            **Stock Awards****Name**
            
            **Number
                of**
              **Securities**
              **Underlying
                Unexercised**
              **Options**
              **(#)**
              **Exercisable**
            
            **Number
                of**
              **Securities**
              **Underlying
                Unexercised**
              **Options**
              **(#)**
              **Unexercisable**
            
            **Option**
              **Exercise**
              **Price**
              **($)**
            
            **Option**
              **Expiration**
              **Date**
            
            **Number
                of**
              **Shares
                or**
              **Units
                of**
              **Stock That**
              **Have Not**
              **Vested**
              **(#)**
            
            **Market**
              **Value of**
              **Shares or**
              **Units of**
              **Stock That**
              **Have Not**
              **Vested**
              **($)**Arthur
                L. Smith
            
            
            420,000
            
            
            -
            
            $
            0.16
            
            
            9/29/2015
            
            
            -
            
            
            -350,000
            
            
            175,000
            
            $
            0.16
            
            
            10/3/2015
            
            
            -
            
            
            -200,000
            
            
            100,000
            
            $
            0.21
            
            
            9/25/2016
            
            
            -
            
            
            -150,000
            
            
            300,000
            
            $
            0.21
            
            
            8/15/2017
            
            
            -
            
            
            -Ruben
                R. Caraveo
            
            
            375,000
            
            
            -
            
            $
            0.16
            
            
            9/29/2015
            
            
            -
            
            
            -316,666
            
            
            158,334
            
            $
            0.16
            
            
            10/3/2015
            
            
            -
            
            
            -166,666
            
            
            83,334
            
            $
            0.21
            
            
            9/25/2016
            
            
            -
            
            
            -125,000
            
            
            250,000
            
            $
            0.21
            
            
            8/15/2017
            
            
            -
            
            
            -Antonio
                Estrada Jr.
            
            
            347,000
            
            
            -
            
            $
            0.16
            
            
            9/29/2015
            
            
            -
            
            
            -316,666
            
            
            158,334
            
            $
            0.16
            
            
            10/3/2015
            
            
            -
            
            
            -166,666
            
            
            83,334
            
            $
            0.21
            
            
            9/25/2016
            
            
            -
            
            
            -125,000
            
            
            250,000
            
            $
            0.21
            
            
            8/15/2017
            
            
            -
            
            
            -





**Non-Standardized
      Profit Sharing Plan**





We
      currently provide a Non-Standardized Profit Sharing Plan. The board of directors
      approved the plan on September 15, 2006. Under the plan our employees qualified
      to participate in the plan after one year of employment. Contribution under
      the
      plan by the Company is based on 25% of the annual base salary of each eligible
      employee up to $46,000 per year. Contributions under the plan are fully vested
      upon funding. The following table contains certain information relating to
      the
      benefits accrued under the Non-Standardized Profit Sharing Plan for the named
      executive officers.


44


**NONQUALIFIED
      DEFERRED COMPENSATION**





**Name**
            
            **Executive
                Contribution in**
              **Last FY**
              **($)**
            
            **Registrant**
              **Contribution in**
              **Last FY**
              **($)(1)**
            
            **Aggregate**
              **Earnings in Last**
              **FY**
              **($)**
            
            **Aggregate**
              **Withdrawals /**
              **Distributions**
              **($)**
            
            **Aggregate**
              **Balance at Last**
              **FYE**
              **($)(2)**Arthur
                L. Smith
            
            
            
            
            $
            50,738
            
            
            
            
            
            
            
            $
            22,154Ruben
                R. Caraveo
            
            
            
            
            $
            47,327
            
            
            
            
            
            
            
            $
            19,904Antonio
                Estrada, Jr.
            
            
            
            
            $
            32,102
            
            
            
            
            
            
            
            $
            15,216





(1)
            All
                amounts reported in this column are included as Other Compensation
                for
                fiscal 2008 in the Summary Compensation
                Table.


(2)
            All
                amounts reported in this column are included as Other Compensation
                for
                fiscal 2007 in the Summary Compensation
                Table.





**Compensation
      of Directors**





The
      following table sets forth information relating to compensation of directors
      who
      are not also named executive officers during the year ended July 31,
      2008.





**Name**
            
            **Fees**
              **Earned
                or**
              **Paid
                in**
              **Cash**
              **($)**
            
            **Stock**
              **Awards**
              **($)**
            
            **Option**
              **Awards**
              **($)**
            
            **Nonqualified**
              **Deferred**
              **Compensation**
              **Earnings**
              **($)**
            
            **All
                Other**
              **Compensation**
              **($)**
            
            **Total**
              **($)**John
                R. Fleming
            
            
            
            
            $
            36,750
            (1)
            $
            52,500
            (1)
            
            
            
            
            
            
            $
            89,250Murray
                R. Nye
            
            
            
            
            $
            36,750
            (2)
            $
            52,500(2
            (2)
            
            
            
            
            
            
            $
            89,250





(1)
            As
                of July 31, 2008, Mr. Fleming had options to purchase an aggregate
                of
                1,075,000 shares of common stock and 175,000 shares of common stock
                issued
                pursuant to Stock awards. A description of the assumptions made in
                valuation of options granted can be found in Note 10 to the Financial
                Statements, which is deemed to be a part of this Item.


(2)
            As
                of July 31, 2008, Mr. Nye had options to purchase an aggregate of
                1,075,000 shares of common stock and 175,000 shares of common stock
                issued
                pursuant to Stock awards. A description of the assumptions made in
                valuation of options granted can be found in Note 2 to the Financial
                Statements, which is deemed to be a part of this Item.





Each
      Director that is not an officer of the Company receives $2,000 for each meeting
      of the Board attended in person and $500 for each meeting attended by telephone.
      In addition to the foregoing, each Director is reimbursed the reasonable
      out-of-pocket expenses in connection with their travel to an attendance at
      meetings of the board of directors.





**Compensation
      Committee Interlocks and Insider Participation**





Mr.
      Arthur L. Smith is presently our Chief Executive Officer and serves on our
      board
      of directors. In addition, we entered into a transaction with Fiesta
      Communications, Inc., in which Mr. Smith owns 16% of the outstanding equity
      interests, in which we transferred all of the issued and outstanding shares
      of
      Telefamilia Communications, Inc. to Fiesta Communications, Inc. for a $30,000
      secured promissory note and 975,000 shares of common stock of Fiesta. The
      transaction is discussed in more detail under Item 13 below. Except for Mr.
      Smith, none of our directors are or have been an officer or employee of the
      Company or had any relationship with that required disclosure in this report.


45


**ITEM
              12.**
            **SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS.**





Information
      regarding securities authorized to be issued under equity compensation plans
      is
      set forth under Item 5 of this Annual Report on Form 10-K.





The
      following table lists the beneficial ownership of shares of our Common Stock
      (i)
      each person know to the Company to own more than 5% of the outstanding voting
      securities issued by the Company, (ii) each director and nominee, (iii) the
      named executive officers, and (iv) all directors and officers as a group.
      Information with respect to officers, directors and their families as of July
      31, 2008 and is based on the books and records of the Company and information
      obtained from each individual. Information with respect to other stockholders
      is
      based upon the Schedule 13D or Schedule 13G filed by such stockholders with
      the
      Securities and Exchange Commission. Unless otherwise stated, the business
      address of each individual or group is the same as the address of the Company’s
      principal executive office and all securities are beneficially owned solely
      by
      the person indicated *.*




**NAME
                OF**
            
            **COMMON**
            
            **%
                OF**
            
            **TOTAL
                VOTING****INDIVIDUAL
                OR GROUP**
            
            **STOCK**
            
            **CLASS
                (1)**
            
            **INTEREST****INDIVIDUAL
                OFFICERS, DIRECTORS AND NOMINEES**Arthur
                L. Smith
            
            
            2,690,152
            (2)
            
            5.9
            %
            
            2,690,152
            (2)President,
                Chief Executive OfficerDirectorRuben
                R. Caraveo
            
            
            1,880,148
            (3)
            
            4.1
            %
            
            1,880,148
            (3)Sr.
                Vice President of Operations and TechnologyAntonio
                Estrada Jr.
            
            
            1,894,827
            (4)
            
            4.1
            %
            
            1,894,827
            (4)Sr.
                VP of Finance & Corporate ControllerJohn
                R. Fleming
            
            
            1,641,757
            (5)
            
            3.6
            %
            
            1,641,757
            (5)DirectorMurray
                R. Nye
            
            
            1,641,757
            (6)
            
            3.6
            %
            
            1,641,757
            (6)Director**ALL
                OFFICERS AND****DIRECTORS
                AS A GROUP**
            
            
            9,748,641
            (7)
            
            21.3
            %
            
            9,748,641
            (7)





(1)
            Based
                upon 45,750,739 shares of common stock outstanding as of July 31,
                2008.
                Any shares represented by options exercisable within 60 days after
                July
                31, 2008 are treated as being outstanding for the purpose of computing
                the
                percentage of the class for such person but not
                otherwise.


(2)
            Includes
                1,120,000 shares subject to options exercisable at July 31,
                2008.


(3)
            Includes
                983,333 shares subject to options exercisable at July 31,
                2008.


(4)
            Includes
                955,333 shares subject to options exercisable at July 31,
                2008.


(5)
            Includes
                725,000 shares subject to options exercisable at July 31,
                2008.


(6)
            Includes
                725,000 shares subject to options exercisable at July 31, 2008.


(7)
            Includes
                4,508,666 shares subject to options exercisable at July 31,
                2008.


46


**ITEM
      13.**  **CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE.**





On
      May 1,
      2008, ATSI sold all of the outstanding shares of Telefamilia Communications,
      Inc. to Fiesta Communications, Inc. for 975,000 shares of common stock in Fiesta
      Communications and $30,000 in cash to be paid in July 2008. As of August 1,
      2008, ATSI and Fiesta agreed to extend the maturity date on the $30,000
      promissory note to October 31, 2008; all other terms remained the same.
      Additionally, Fiesta Communications issued a three-year promissory note in
      the
      amount of $52,984 for the services rendered by ATSI under the joint management
      agreement dated January 1, 2006. The three-year promissory note will be paid
      quarterly starting July 31, 2008 and has a maturity date of May 1, 2010 and
      an
      annual interest rate of 8%. The note is secured by all assets of the new
      combined entity of Fiesta. **** Also,
      on
      August 1, 2008 Fiesta entered into a note payable with ATSI for $25,000,
      with a maturity date of October 31, 2008 and an interest rate of 8%.  ATSI’s
      CEO and President, Arthur L Smith, is a 16% stockholder of Fiesta.





Except
      as
      set forth above, we have not engaged in any transactions in which a member
      of
      the board of directors had an interest. Our board of directors has determined
      that the directors other than Mr. Smith are independent as that term is defined
      in New York Stock Exchange Rule 303A.02.





**ITEM
      14.**  **PRINCIPAL
      ACCOUNTANT FEES AND SERVICES.**





The
      following table sets forth the aggregate fees paid to Malone & Bailey, PC
      for audit services rendered in connection with the audits and reviews of ATSI’s
      consolidated financial statements and reports for the years ended July 31,
      2008
      and 2007.





Year Ended July 31,Description
                of Fees
            
            2008
            
            2007Audit
                Fees
            
            $
            68,000
            
            $
            57,640Tax
                fees
            
            
            -0-
            
            
            -0-





The
      board
      of directors has instructed Malone and Bailey, PC that any fees for non-audit
      services must be approved before being incurred. All such fees incurred in
      fiscal 2008 were approved by the board of directors before they were
      incurred.





**PART
      IV**





**ITEM
      15.**  **EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES.**





The
      following documents are exhibits to this report.





2.1
            Plan
                and Agreement of Merger of ATSI Communications, Inc. with and into
                ATSI
                Merger Corporation, dated as of March 24, 2004.*(Exhibit
                2.1 to Form 8-K of ATSI filed on May 24,
                2004)*




3.1
            Articles
                of Incorporation of ATSI Merger Corporation.*(Exhibit
                3.1 to Form 8-K of ATSI filed on May 24,
                2004)*





3.2
            Bylaws
                of ATSI Merger Corporation.*(Exhibit
                3.2 to Form 8-K of ATSI filed on May 24,
                2004)*





3.3
            Articles
                of Merger of ATSI Communications, Inc. with and into ATSI Merger
                Corporation.*(Exhibit
                3.3 to Form 8-K of ATSI filed on May 24,
                2004)*


47


4.1
            Secured
                Promissory Note and Security Agreement dated November 4, 2005 between
                ATSI
                Communications,Inc.
                and CSI Business Finance, Inc.*(Exhibit
                4.2 to form 10-QSB for the period Ended October 31, 2005 filed**December
                15, 2005)*





4.3
            Convertible
                Debenture Agreement*(Exhibit
                4.18 to Annual Report on Form 10-KSB for the year ended July 31,
                2006
                filed October 30, 2006)*




4.4
            Promissory
                note payable to Alfonso Torres dated October 1, 2007 in the principal
                amount of $459,170.*(Exhibit
                10.4 to Form 10-QSB for the period ended October 31, 2006 filed December
                1
                4, 2007)*





4.5
            Promissory
                note payable to The Shaar Fund dated December 10, 2007 in the principal
                amount of $460,000.***(Exhibit
                10.2 to Form 10-QSB for the period ended October 31, 2006 filed December
                1
                4, 2007)*





4.6
            Promissory
                Notes payable to several holders dated September 26, 2008 in the
                principal
                amount of$850,000.***





10.1
            Interconnection
                Agreement TELMEX and ATSICOM (English summary) (*Exhibit
                10.26 to Annual Report on Form 10-K for year ended July 31, 2003
                filed
                November 12, 2003)*





10.2
            Interconnection
                Agreement TELMEX and ATSICOM (English Translation)*(Exhibit
                10.27 to Amended Annual Report on Form 10-K/A for the year ended
                July 31,
                2003 filed March 2, 2004)*





10.3
            Settlement
                Agreement dated December 10, 2007 between ATSI Communications, Inc.
                and
                The Shaar Fund, Inc.*(Exhibit 10.3 to Form 10-QSB for the period ended October 31, 2006
                filed
                December 1 4, 2007)*





10.4
            Confidential
                Settlement Agreement dated August 27, 2007 between ATSI Communications,
                Inc. and RGC International Investors, LDC.*(Exhibit 10.7 to Annual Report on Form 10-KSB for the period ended
                July
                31, 2007 filed October 17,
                2007)*





31.1
            Certification
                of our President and Chief Executive Officer, under Section 302 of
                the
                Sarbanes-Oxley Act of 2002.***





31.2
            Certification
                of our Corporate Controller and Principal Financial Officer, under
                Section
                302 of the Sarbanes-Oxley Act of 2002.
                *





32.1
            Certification
                of our President and Chief Executive Officer, under Section 906 of
                the
                Sarbanes-Oxley Act of 2002.***





32.2
            Certification
                of our Corporate Controller and Principal Financial Officer, under
                Section
                906 of the Sarbanes-Oxley Act of 2002.***




48


**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) 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.





**ATSI COMMUNICATIONS, INC.**Date:
                October 29, 2008
            By:
            /s/
                Arthur L. SmithArthur
                L. SmithPresident
                andChief
                Executive Officer





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacity and on the dates indicated.





**Signature**
            
            **Title**
            
            **Date**/s/
                Arthur L. Smith
            
            Principal
                Executive Officer and Director
            
            October
                29, 2008Arthur
              L. Smith/s/
                Antonio Estrada Jr.
            
            Principal
                Accounting Officer
            
            October
                29, 2008Antonio
                Estrada Jr.
            
            Principal
                  Finance Officer/s/
                John R. Fleming
            
            Director
            
            October
                29, 2008John
                R. Fleming/s/
                Murray R. Nye
            
            Director
            
            October
                29, 2008Murray
                R. Nye




49


**EXHIBIT
      INDEX**





4.6
            Promissory
                Notes payable to several holders dated September 26, 2008 in the
                principal
                amount of$850,000.***





31.3
            Certification
                of our President and Chief Executive Officer, under Section 302 of
                the
                Sarbanes-Oxley Act of 2002.***





31.4
            Certification
                of our Corporate Controller and Principal Financial Officer, under
                Section
                302 of the Sarbanes-Oxley Act of 2002.
                *





33.1
            Certification
                of our President and Chief Executive Officer, under Section 906 of
                the
                Sarbanes-Oxley Act of 2002.***





32.3
            Certification
                of our Corporate Controller and Principal Financial Officer, under
                Section
                906 of the Sarbanes-Oxley Act of 2002.***


50