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, 2009


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 whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such
files).


 ̈ 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





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
$3,270,946 based on the closing price of $0.09 per share on January 31, 2009, as
reported on the over-the-counter bulletin board.


There
were 45,504,120 shares of issuer’s Common Stock outstanding as of October 14,
2009.











TABLE
OF CONTENTS





PagePART
      IItem
      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
                              14PART
      IIItem
      5.
                              Market
      for Registrant’s Common Equity; Related Stockholder
Mattersand
      Issuer Purchases of Equity Securities
                              14Item
      6.
                              Selected
      Financial Data
                              15Item
      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 andFinancial
      Disclosures
                              42Item
      9A(T).
                              Controls
      and Procedures
                              42Item
      9B.
                              Other
      Information
                              42PART
      IIIItem
      10.
                              Directors,
      Executive Officers and Corporate Governance
                              43Item
      11.
                              Executive
      Compensation
                              45Item
      12.
                              Security
      Ownership of Certain Beneficial Owners and Managementand
      Related Stockholder Matters
                              49Item
      13.
                              Certain
      Relationships and Related Transactions, andDirector
      Independence
                              50Item
      14.
                              Principal
      Accountant Fees and Services
                              51PART
      IVItem
      15.
                              Exhibits
      and Financial Statement Schedules
                              51SIGNATURES




2


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, 2009 (“fiscal 2009”):





·
            Entered
      into a promissory note with San Antonio National Bank and Texas Ventures
      for $425,000 and $850,000, respectively. 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.





·
            Deployed
      a VoIP technology platform to introduce enhanced VoIP services, including
      fully hosted IP/PBX services, IP trunking, call center applications,
      prepaid services, and customized VoIP solutions for specialized
      applications.  In May 2009, the Company obtained its first
      account on the enhanced platform consisting of a VoIP network to 154
      cities for a Fortune 500 company.  The network provided includes
      an interactive voice response auto attendant, call recording, simultaneous
      calling, voicemail to email conversion, and multiple other IP/PBX features
      in a hosted environment.





·
            Commenced
      a rigorous effort to improve call quality and the average call duration
      (“ACD”) of calls processed on our network.  These measures
      included eliminating underperforming vendors and streamlining routes
      offered to our customers.  As of July 31, 2009, the Company had
      eliminated 35 underperforming vendors from its global routing,
      representing 20% of its vendors.  In addition, individual routes
      on which call statistics fell to unacceptable levels, the Company blocked
      VoIP traffic.  These actions resulted in a 55% improvement in
      ACD year over year.


3


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.





·
            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.




4


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.





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.


5





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 orde
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


·
            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.





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.


6


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.





We
recently installed a technology platform developed by NetSapiens, Inc. that
allows us to offer additional VoIP applications including IP/PBX services, IP
trunking, prepaid calling, call center applications, conferencing, messaging and
other innovative IP telephony functionality necessary to offer standard and/or
custom services to the Residentialand Enterprise
markets.  We are currently marketing these new VoIP services to
potential customers through established channel partners that includes data
network providers, value added resellers, telecom operators, and wireless
Internet service providers.   Our strategy is to enable our
channel partners to provide specialized VoIP services to their established base
of customers, thus creating an additional source of revenue for us and our
channel partner.   In May 2009, we secured our first customer on
the NetSapiens technology platform consisting of a VoIP network to 154 cities
for a Fortune 500 company.  The network provided includes an
interactive voice response auto attendant, call recording, simultaneous calling,
voicemail to email conversion, and multiple other IP/PBX features in a hosted
environment.




Due to
the potential cost savings and added features of VoIP, consumers, enterprises,
traditional telecommunication service providers and cable television providers
view VoIP as the future of telecommunications. This is accelerating the
migration from traditional telephone service to VoIP services.  The
recent growth in VoIP services is primarily due to:




·
            Demand
      for a lower cost alternative to traditional telephone
    service;




·
            Improved
      quality and reliability of VoIP calls due to technological advances,
      increased network development and greater bandwidth capacity;
      and




·
            New
      product innovations that can be provided by VoIP services providers, but
      not currently offered by traditional telephone
  companies.




A recent
report published by In-Stat, a market research firm, suggested that revenue in
the United States from VoIP business services such as those we can now provide
with our NetSapiens platform grew from $485 million in 2007 to a forecasted $1.4
billion in 2009.





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.





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.


7




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.





Concession services
requirements





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


10





·
            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, 2009, we had eleven 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:





·
            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;


11





·
            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.





Werely on third parties to provideandmaintainthenetworks 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 tooperationsin 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.





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.


13




Vulnerability of the Internet to
malicious activity.The Internet, and certain components
thereof, is susceptible to malicious damage or destruction by the creation and
distribution of software designed to interrupt of corrupt the transmission of
data, by concerted efforts to cause congestion, and other malicious
activities.  If such activities are successful in interrupting the
transmission of data between our network and the destination of the
transmission, it could have an adverse effect on client confidence in our
ability to maintain a stable and reliable network.  Since we do not
control access to the servers, gateways, and other components of the Internet
that are used to transmit traffic, we are not able to protect such components
from attack.





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 $50,937.  We believe that our leased facilities are
suitable and adequate for their intended use.





ITEM
3.                LEGAL
PROCEEDINGS.





The company is a defendant in CHRISTIAN
& SMITH, LLP and JOHN M. O'QUINN & ASSOCIATES, LLP vs. ATSI
COMMUNICATIONS, INC. filed on December 12, 2008 in the 133rd Judicial District
of Harris County, Texas. The plaintiffs claim that the company is
responsible for the payment of contingent fees in connection with a suit filed
by the plaintiffs as the company’s lawyers against The Shaar Fund.  The
company has denied any liability for the contingent fees because the case filed
against The Shaar Fund was dismissed without recovering any damages.  This
case has been dormant since it was filed and no discovery has been
taken.On April 15,
2009, the Court ordered a six-month abatement of the case.The company intends to vigorously defend
this matter but cannot determine the likelihood of an adverse outcome or the
range of potential loss.





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





None





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.


14





Fiscal 2008
                    
                    Low
                    
                    
                    HighFirst Quarter
                    
                    $
                    0.20
                    
                    
                    $
                    0.30Second
      Quarter
                    
                    $
                    0.17
                    
                    
                    $
                    0.28Third
      Quarter
                    
                    $
                    0.15
                    
                    
                    $
                    0.23Fourth
      Quarter
                    
                    $
                    0.16
                    
                    
                    $
                    0.24Fiscal 2009
                    
                    Low
                    
                    
                    HighFirst Quarter
                    
                    $
                    0.13
                    
                    
                    $
                    0.23Second
      Quarter
                    
                    $
                    0.07
                    
                    
                    $
                    0.15Third
      Quarter
                    
                    $
                    0.04
                    
                    
                    $
                    0.08Fourth
      Quarter
                    
                    $
                    0.04
                    
                    
                    $
                    0.06





Holders





As of July 31, 2009 we had
approximately 8,206 common stockholders.





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, 2009:





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 PlansEquity
      Compensation plans approved by security holders
                  
                  
                  -0-
                  
                  
                  
                  N/A
                  
                  
                  
                  -0-Equity
      Compensation Plans not approved by security holders
                  
                  
                  8,239,000
                  
                  
                  $
                  .04
                  
                  
                  
                  9,261,000Total
                  
                  
                  8,239,000
                  
                  
                  $
                  .04
                  
                  
                  
                  9,261,000





The material features of each equity
compensation plan are described in Note 10 of the Notes to the Financial
Statements.





Sales
of Unregistered Securities





During
the period covered by this report, the Company issued 5,611,962 shares of our
common stock to our employees for services rendered. The shares were issued
without registration pursuant to Section 4(2) of the Securities Act because of
the existing relationship with the individuals to whom the shares were
listed.





ITEM
6.                 SELECTED
FINANCIAL DATA.





Not Applicable


15


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





SPECIAL
NOTE: This Annual Report on Form 10-K 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.”or
words of similar import  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 and actual
results may be materially different than our expectations.





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,
2009 and 2008.  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 2009 or 2009 refers to the year ended July
31, 2009 and fiscal 2008 or 2008 refers to the year ended July 31,
2008.





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:  We incur bandwidth and co-location charges in
connection with Network Services. 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.





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, 2009 and 2008.


16





Year
Ended July 31, 2009 Compared to Year ended July 31, 2008




Years
      ended July 31,2009
                                  
                                  
                                  2008
                                  
                                  
                                  Variances
                                  
                                  
                                  %OPERATING
      REVENUES:VoIP
      services
                                  
                                  $
                                  19,891
                                  
                                  
                                  $
                                  41,961
                                  
                                  
                                  $
                                  (22,070
                                  )
                                  
                                  
                                  -53
                                  %Total
      operating revenues
                                  
                                  
                                  19,891
                                  
                                  
                                  
                                  41,961
                                  
                                  
                                  
                                  (22,070
                                  )
                                  
                                  
                                  -53
                                  %Cost
      of services (exclusive of depreciation and amortization, shown
      below)
                                  
                                  
                                  18,533
                                  
                                  
                                  
                                  38,884
                                  
                                  
                                  
                                  (20,351
                                  )
                                  
                                  
                                  -52
                                  %GROSS
      MARGIN
                                  
                                  
                                  1,358
                                  
                                  
                                  
                                  3,077
                                  
                                  
                                  
                                  (1,719
                                  )
                                  
                                  
                                  -56
                                  %Selling,
      general and administrative expense (exclusive of legal and professional
      fees)
                                  
                                  
                                  2,157
                                  
                                  
                                  
                                  2,400
                                  
                                  
                                  
                                  (243
                                  )
                                  
                                  
                                  -10
                                  %Legal
      and professional fees
                                  
                                  
                                  353
                                  
                                  
                                  
                                  352
                                  
                                  
                                  
                                  1
                                  
                                  
                                  
                                  0
                                  %Bad
      debt expense
                                  
                                  
                                  2
                                  
                                  
                                  
                                  (27
                                  )
                                  
                                  
                                  29
                                  
                                  
                                  
                                  -107
                                  %Depreciation
      and amortization expense
                                  
                                  
                                  152
                                  
                                  
                                  
                                  160
                                  
                                  
                                  
                                  (8
                                  )
                                  
                                  
                                  -5
                                  %OPERATING
      INCOME (LOSS)
                                  
                                  
                                  (1,306
                                  )
                                  
                                  
                                  192
                                  
                                  
                                  
                                  (1,498
                                  )
                                  
                                  
                                  -780
                                  %OTHER
      INCOME (EXPENSE):Gain
      on early extinguishment of debt
                                  
                                  
                                  108
                                  
                                  
                                  
                                  41
                                  
                                  
                                  
                                  67
                                  
                                  
                                  
                                  163
                                  %Loss
      attributed to noncontrolling interest
                                  
                                  
                                  (114
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (114
                                  )
                                  
                                  
                                  -100
                                  %Minority
      Interest
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (16
                                  )
                                  
                                  
                                  16
                                  
                                  
                                  
                                  -100
                                  %Interest
      income (expense)
                                  
                                  
                                  (196
                                  )
                                  
                                  
                                  (105
                                  )
                                  
                                  
                                  (91
                                  )
                                  
                                  
                                  87
                                  %Total
      other income (expense), net
                                  
                                  
                                  (202
                                  )
                                  
                                  
                                  (80
                                  )
                                  
                                  
                                  (122
                                  )
                                  
                                  
                                  153
                                  %NET
      INCOME (LOSS)
                                  
                                  
                                  (1,508
                                  )
                                  
                                  
                                  112
                                  
                                  
                                  
                                  (1,620
                                  )
                                  
                                  
                                  -1446
                                  %LESS:
      PREFERRED DIVIDEND
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (12
                                  )
                                  
                                  
                                  12
                                  
                                  
                                  
                                  -100
                                  %ADD:
      REVERSAL OF PREVIOUSLY RECORDED PREFERRED DIVIDEND
                                  
                                  
                                  -
                                  
                                  
                                  
                                  340
                                  
                                  
                                  
                                  (340
                                  )
                                  
                                  
                                  -100
                                  %NET
      INCOME (LOSS) TO COMMON STOCKHOLDERS
                                  
                                  $
                                  (1,508
                                  )
                                  
                                  $
                                  440
                                  
                                  
                                  $
                                  (1,948
                                  )
                                  
                                  
                                  -443
                                  %





Operating
Revenues.VoIP services revenue decreased by $22,070,000, or
53%, from the fiscal year ended July 31, 2008 to the fiscal year ended July 31,
2009.  VoIP minutes carried by our network on which we generated
revenues decreased by 31% from approximately 564,064,005 minutes of voice
traffic during the year ended July 31, 2008 to approximately 391,925,140 minutes
of voice traffic during the year ended July 31, 2009.  Additionally,
our average revenue per minute (ARPM) decreased by 32% from $0.0742 during the
year ended July 31, 2008 to $0.05068 for the year ended July 31,
2009.  During the second quarter of FY2009, we began a rigorous effort
to increase traffic quality and the average call duration (ACD) of calls
processed by our network. These measures included eliminating and streamlining
many of the routes offered. This contributed to a decrease of approximately 20%
in the number of vendors connected to our network. Despite the decline in
revenue and the total number of minutes processed by our network, our efforts to
streamline the routes we offer and eliminate certain routes resulted in an
increase in average call duration (ACD) from 2.45 minutes per call for the year
ended July 31, 2008 to 4.00 minutes for the year ended July 31, 2009 and
partially offsetting the fewer number of calls that were completed through our
network during the year ended July 31, 2009. The declines in both the total
minutes processed by our network and the average revenue per minute (ARPM) are
the direct result of the lower level of international calling during the current
global economic recession. We believe that the decision made during the second
quarter of Fiscal 2009 to streamline our routes and eliminate under performing
and inefficient routes will positively influence our business in the long term,
as evidenced by the continued increase in the average call duration. We expect
the increase in ACD to have a favorable impact on our total revenues as the
number of completed calls processed through our networks return to normal levels
since each completed call will represent a larger number of minutes
processed.





Cost of Services (exclusive of
depreciation and amortization).  The consolidated cost of
services decreased by $20,351,000, or 52%, from the year ended July 31, 2008 to
the year ended July 31, 2009.  The decrease in cost of services is a
direct result of the decrease in VoIP services revenue.  Cost of
services, as a percentage of revenue increased slightly between periods, from
92.67% of revenue during the year ended July 31, 2008 to 92.89% of revenue
during the year ended July 31, 2009.  The increase in cost of services
as a percentage of revenue is a result of increases received from our vendors
during the period.  As a result of the decrease in VoIP revenues, our
gross margin declined by $1,719,000 or 54% to $1,358,000 for the year ended July
31, 2009 compared to $3,077,000 for the year ended July 31,
2008.


17





Selling, General and Administrative
(SG&A) Expenses (exclusive of legal and professional
fees).SG&A expenses decreased by $243,000, or 10%, from
the year ended July 31, 2008 to the year ended July 31, 2009.  The
decrease is primarily attributable to the decrease in non-cash compensation
expense to employees.  During the year ended July 31, 2008 we
recognized $695,000 in non-cash compensation expense to employees.  In
comparison, we only recognized $389,000 in non-cash compensation expense to
employees during the year ended July 31, 2009.





Legal and Professional
Fees.  Legal and professional fees were comparable between
periods at approximately $353,000. During both fiscal years our legal and
professional fees were composed of fees to our Auditors and attorneys for
matters related to our reporting requirements, legal fees as part of the normal
course of business and litigation.





Bad debt expense.Bad debt
expense increased by $29,000, or 107%, from the year ended July 31, 2008 to the
year ended July 31, 2009.  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. We did not incur similar
adjustment during the year ended July 31, 2009.





Depreciation and
Amortization.  Depreciation and amortization decreased by
$8,000 or 5%, from the year ended July 31, 2008 to the year ended July 31,
2009.  The reduction in depreciation expense is as a result of some of
the equipment and software reaching its depreciable value, thus the decrease
between periods.





Operating Income
(loss).  Our
operating loss increased by $1,498,000, or 780%, from the year ended July 31,
2008 to the year ended July 31, 2009.  The increase in operating loss
between periods is attributed to the decrease in gross margin, which was
slightly offset by the decrease between periods in SG&A expenses and
depreciation expense.





Other Income
(expense).  Other expense during the year ended July 31, 2009
included a gain on early extinguishment of debt of $108,000, which was
attributed to a discount of $108,000 recognized as a result of the settlement of
the promissory note with The Shaar Fund.  However, the gain was offset
by the increase in interest expense of $91,000, or 87%, from $105,000 for the
year ended July 31, 2008 to $196,000 for the year ended July 31,
2009.  The increase is attributed to the additional interest expense
incurred as a result of the new promissory notes with various holders for
$850,000 and a promissory note with San Antonio National Bank for
$425,000.





Net Income
(loss).  Net loss increased by $1,620,000 or 1,446%, from the
year ended July 31, 2008 to the year ended July 31, 2009.  The
increase in net loss between periods is attributed to the decrease between
periods in operating income and the increase between periods in other
expenses.





Preferred Stock
Dividends.  Preferred stock dividends decreased by $12,000, or
100%, between periods, from $12,000 for the year ended July 31, 2008 to $0
during the year ended July 31, 2009.  The decrease in preferred
dividends between periods is mainly attributed to a decrease in dividends
associated with Series A Convertible Preferred Stock and Series D Convertible
Preferred Stock, none of which were outstanding during the year ended July 31,
2009





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 with The Shaar Fund.  Under the settlement
agreement, the Shaar Fund agreed to surrender 742 shares of our 6% Series D
Cumulative Convertible Preferred Stock and forgive accrued dividends of
approximately $340,000 as of October 24, 2007.  We did not recognize
any reversals of previously recorded preferred stock dividends during the year
ended July 31, 2009


18





Net loss Applicable to Common
Stockholders.  Net loss applicable to common stockholders
increased by $1,948,000, or 443%, from the year ended July 31, 2008 to the year
ended July 31, 2009.  The increase in net loss between periods is
attributed to the decrease between periods of $1,719,000 in gross margin and the
increase of $91,000 in interest expense. Additionally, during the year ended
July 31, 2008 we recognized a reversal of previously recorded preferred dividend
of $340,000.  We did not recognize this type of reversal during the
year ended July 31, 2009.  The decrease in the reversal of previously
recorded preferred divided was slightly offset by the decrease of $306,000 in
non-cash compensation expense to employees and a decrease between periods of
$67,000 in gain on early extinguishment of debt as a result of the settlement of
a promissory note.





Liquidity
and Capital Resources





Cash Position:  We
had a cash balance of $637,000 as of July 31, 2009.  Net cash consumed
by operating activities during the year ended July 31, 2009 was
approximately $1,261,000.  Investing activities during the year
ended July 31, 2009 consumed $122,000, consisting of an increase of $7,000
associated with investments in certificates of deposit and $115,000 associated
with the acquisition of various computers and servers.  Financing
activities during the year ended July 31, 2009 provided $682,000 in cash.
 This cash was primarily provided by a $425,000 promissory note payable to
San Antonio National Bank and a financing from various note holders for
$850,000.  The cash received from the various promissory notes was
slightly offset by the cash consumed by debt principal payments of $542,000
associated with various notes payable, acquisition of our common stock of
$48,000 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, 2009 consumed $701,000 in
our available cash.





We are currently utilizing the cash
received from various promissory notes payable for $1,275,000.  We
believe that this financing will allow us to support our growth during the
following fiscal year.  Additionally, we are 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 $32,000 per month.  As of July 31,
2009 we did not have any outstanding receivables under the Wells Fargo Factoring
agreement.





Our
current cash expenses are expected to be approximately $150,000 per month,
including wages, rent, utilities and corporate professional fees.  We
are currently using $105,000 in cash generated from operations and approximately
$40,000 per month of our available cash to cover all monthly cash
expenses.  We anticipate that the July 31, 2009 cash balance of
$637,000, certificate of deposit of $325,000 combined with expected net cash
flow generated from future operations and the factoring agreement with
Wells Fargo Bank, will be sufficient to fund our operations and capital asset
expenditures for the next twelve months.





Our
working capital (deficit) was $574,000 as of July 31, 2009.  This
represents a decline of approximately $1,001,000 from our working capital at
July 31, 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:





·
            ATSI
      is the primary obligor in its
arrangements,


·
            ATSI
      has latitude in establishing
pricing,


19





·
            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, we 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.  We estimate the
fair market value of its stock options using the Black Scholes pricing
model.  We use the following key assumptions in determining the fair
market value of its options:





For the Years Ended July 31,2009
                      
                      
                      2008Expected
      dividends yield
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %Expected
      stock price volatility
                      
                      
                      126%
      - 296
                      %
                      
                      
                      75%
      - 105
                      %Risk-free
      interest rate
                      
                      
                      2.28%
      - 3.48
                      %
                      
                      
                      3.15%
      - 4.65
                      %Expected
      life of options
                      
                      3.75
      - 4.5 years
                      
                      
                      4 -
      6 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 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,
we use 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




PageConsolidated
      Financial Statements of ATSI Communications, Inc. and
      SubsidiariesReport
      of Independent Registered Public Accounting Firm
                          22Consolidated
      Balance Sheets as of July 31, 2009 and 2008
                          23Consolidated
      Statements of Operations for the Years Ended July 31, 2009 and
      2008
                          24Consolidated
      Statement of Changes in Stockholders’ Equity (Deficit) for the Years Ended
      July 31, 2008 and 2009
                          25Consolidated
      Statements of Cash Flows for the Years Ended July 31, 2009 and
      2008
                          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 ofATSI Communications,
Inc. and subsidiaries as of July 31, 2009 and 2008, 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 ATSIas of July 31, 2009 and
2008 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
15, 2009


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
      31,2009
                    
                    
                    2008ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                    
                    $
                    637
                    
                    
                    $
                    1,338Certificates
      of deposit
                    
                    
                    325
                    
                    
                    
                    -Accounts
      receivable, net of allowance for bad debt of $10 and $60,
      respectively
                    
                    
                    337
                    
                    
                    
                    1,082Notes
      receivable, related party
                    
                    
                    -
                    
                    
                    
                    25Prepaid
      & other current assets
                    
                    
                    77
                    
                    
                    
                    124Total
      current assets
                    
                    
                    1,376
                    
                    
                    
                    2,569LONG-TERM
      ASSETS:Certificates
      of deposit
                    
                    
                    -
                    
                    
                    
                    319Intangible
      Assets, net of amortization of $16 and $1, respectively
                    
                    
                    134
                    
                    
                    
                    149PROPERTY
      AND EQUIPMENT
                    
                    
                    794
                    
                    
                    
                    611Less
      - accumulated depreciation
                    
                    
                    (576
                    )
                    
                    
                    (439
                    )Net
      property and equipment
                    
                    
                    218
                    
                    
                    
                    172Total
      assets
                    
                    $
                    1,728
                    
                    
                    $
                    3,209LIABILITIES AND STOCKHOLDERS' EQUITY
      (DEFICIT)CURRENT
      LIABILITIES:Accounts
      payable
                    
                    $
                    585
                    
                    
                    $
                    1,361Wells
      Fargo factoring collateral
                    
                    
                    -
                    
                    
                    
                    18Accrued
      liabilities
                    
                    
                    192
                    
                    
                    
                    116Current
      portion of obligation under capital leases
                    
                    
                    -
                    
                    
                    
                    3Notes
      payable, net of unamortized discount of $33 and $0,
      respectively
                    
                    
                    1,173
                    
                    
                    
                    566Convertible
      debentures, net of unamortized discount of $0 and $5,
      respectively
                    
                    
                    -
                    
                    
                    
                    78Total
      current liabilities
                    
                    
                    1,950
                    
                    
                    
                    2,142LONG-TERM
      LIABILITIES:Notes
      payable
                    
                    
                    291
                    
                    
                    
                    588Derivative
      liability
                    
                    
                    85
                    
                    
                    
                    -Convertible
      debentures, net of unamortized discount of $0 and $3,
      respectively
                    
                    
                    -
                    
                    
                    
                    81Obligation
      under capital leases, less current portion
                    
                    
                    -
                    
                    
                    
                    1Other
                    
                    
                    3
                    
                    
                    
                    3Total
      long-term liabilities
                    
                    
                    379
                    
                    
                    
                    673Total
      liabilities
                    
                    
                    2,329
                    
                    
                    
                    2,815STOCKHOLDERS'
      EQUITY (DEFICIT):Preferred
      Stock, 16,063,000 shares authorized, none issued
      and  outstanding
                    
                    
                    -
                    
                    
                    
                    -Common
      stock, $0.001 par value, 150,000,000 shares authorized, 45,504,120 and
      39,550,415 sharesissued
      and outstanding, respectively
                    
                    
                    46
                    
                    
                    
                    39Additional
      paid in capital
                    
                    
                    73,253
                    
                    
                    
                    72,747Noncontrolling
      interest
                    
                    
                    (114
                    )
                    
                    
                    -Accumulated
      deficit
                    
                    
                    (73,787
                    )
                    
                    
                    (72,393
                    )Other
      comprehensive income
                    
                    
                    1
                    
                    
                    
                    1Total
      stockholders' equity (deficit)
                    
                    
                    (601
                    )
                    
                    
                    394Total
      liabilities and stockholders' equity (deficit)
                    
                    $
                    1,728
                    
                    
                    $
                    3,209





See
accompanying notes to financial statements


23


ATSI
COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(In
thousands, except per share amounts)





Years
      ended July 31,2009
                  
                  
                  2008OPERATING
      REVENUES:VoIP
      services
                  
                  $
                  19,891
                  
                  
                  $
                  41,961Total
      operating revenues
                  
                  
                  19,891
                  
                  
                  
                  41,961OPERATING
      EXPENSES:Cost
      of services (exclusive of depreciation and amortization)
                  
                  
                  18,533
                  
                  
                  
                  38,884Selling,
      general and administrative expense (exclusive of legal and professional
      fees)
                  
                  
                  2,157
                  
                  
                  
                  2,400Legal
      and professional fees
                  
                  
                  353
                  
                  
                  
                  352Bad
      debt expense
                  
                  
                  2
                  
                  
                  
                  (27
                  )Depreciation
      and amortization expense
                  
                  
                  152
                  
                  
                  
                  160Total
      operating expenses
                  
                  
                  21,197
                  
                  
                  
                  41,769OPERATING
      INCOME (LOSS)
                  
                  
                  (1,306
                  )
                  
                  
                  192OTHER
      INCOME (EXPENSE):Gain
      on early extinguishment of debt
                  
                  
                  108
                  
                  
                  
                  41Loss
      attributed to noncontrolling interest
                  
                  
                  (114
                  )
                  
                  
                  -Investment
      loss
                  
                  
                  -
                  
                  
                  
                  (16
                  )Interest
      expense
                  
                  
                  (196
                  )
                  
                  
                  (105
                  )Total
      other expense
                  
                  
                  (202
                  )
                  
                  
                  (80
                  )NET
      INCOME (LOSS)
                  
                  
                  (1,508
                  )
                  
                  
                  112LESS:
      PREFERRED DIVIDEND
                  
                  
                  -
                  
                  
                  
                  (12
                  )ADD:
      REVERSAL OF PREVIOUSLY RECORDED PREFERRED DIVIDEND
                  
                  
                  -
                  
                  
                  
                  340NET
      INCOME (LOSS) TO COMMON  STOCKHOLDERS
                  
                  $
                  (1,508
                  )
                  
                  $
                  440BASIC
      INCOME (LOSS) PER SHARE TO COMMON STOCKHOLDERS
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.01DILUTED
      INCOME (LOSS) PER SHARE TO COMMON STOCKHOLDERS
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.01WEIGHTED
      AVERAGE BASIC COMMON SHARES OUTSTANDING
                  
                  
                  40,043,303
                  
                  
                  
                  39,143,748WEIGHTED
      AVERAGE DILUTED COMMON SHARES OUTSTANDING
                  
                  
                  40,043,303
                  
                  
                  
                  39,197,319See
      accompanying notes to financial statements




24


ATSI
COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)


FOR
THE YEARS ENDED JULY 31, 2008 AND 2009


(in
thousands, except share amounts)





AdditionalPreferred (D)
                  
                  
                  Preferred (E)
                  
                  
                  Common
                  
                  
                  Paid-in
                  
                  
                  Noncontrolling
                  
                  
                  Accumulated
                  
                  
                  Other Comp.Shares
                  
                  
                  Par
                  
                  
                  Shares
                  
                  
                  Par
                  
                  
                  Shares
                  
                  
                  Par
                  
                  
                  Capital
                  
                  
                  interest
                  
                  
                  Deficit
                  
                  
                  Income/Loss
                  
                  
                  TotalsBALANCE,
      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
                  
                  
                  
                  
                  
                  
                  
                  112BALANCE,
      July 31, 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  39,550,415
                  
                  
                  
                  39
                  
                  
                  $
                  72,747
                  
                  
                  $
                  -
                  
                  
                  $
                  (72,393
                  )
                  
                  $
                  1
                  
                  
                  $
                  394Repurchase
      of common shares
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (295,981
                  )
                  
                  
                  -
                  
                  
                  
                  (48
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (48
                  )Stock
      issued for services to employees
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  5,611,963
                  
                  
                  
                  6
                  
                  
                  
                  219
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  225Stock
      option expense
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  164
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  164Shares
      issued for conversion of notes payable
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  637,723
                  
                  
                  
                  1
                  
                  
                  
                  171
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  172Net
      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (114
                  )
                  
                  
                  (1,394
                  )
                  
                  
                  
                  
                  
                  
                  (1,508
                  )BALANCE,
      July 31, 2009
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  45,504,120
                  
                  
                  
                  46
                  
                  
                  $
                  73,253
                  
                  
                  $
                  (114
                  )
                  
                  $
                  (73,787
                  )
                  
                  $
                  1
                  
                  
                  $
                  (601
                  )








25


ATSI
COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(In
thousands, except per share amounts)





Years
      ended July 31,2009
                          
                          
                          2008CASH
      FLOWS FROM OPERATING ACTIVITIES:NET
      INCOME (LOSS)
                          
                          $
                          (1,508
                          )
                          
                          $
                          112Adjustments
      to reconcile net loss to cash used in operating
activities:Investment
      loss
                          
                          
                          -
                          
                          
                          
                          16Loss
      attributed to noncontrolling interest
                          
                          
                          114
                          
                          
                          
                          -Gain
      on early extinguishment of debt
                          
                          
                          (108
                          )
                          
                          
                          (41
                          )Depreciation
      and amortization
                          
                          
                          152
                          
                          
                          
                          160Issuance
      of stock grants and options, employees for services
                          
                          
                          389
                          
                          
                          
                          695Issuance
      of common stock and warrants for services
                          
                          
                          -
                          
                          
                          
                          77Provisions
      for losses on accounts receivables
                          
                          
                          2
                          
                          
                          
                          (27
                          )Amortization
      of debt discount
                          
                          
                          60
                          
                          
                          
                          8Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          609
                          
                          
                          
                          (238
                          )Prepaid
      expenses and other
                          
                          
                          (21
                          )
                          
                          
                          (96
                          )Accounts
      payable
                          
                          
                          (1,041
                          )
                          
                          
                          322Wells
      Fargo Factoring Collateral
                          
                          
                          (18
                          )
                          
                          
                          -Accrued
      liabilities
                          
                          
                          109
                          
                          
                          
                          (23
                          )Net
      cash (used in) / provided by operating activities
                          
                          
                          (1,261
                          )
                          
                          
                          965CASH
      FLOWS FROM INVESTING ACTIVITIES:Investment
      in certificates of deposit
                          
                          
                          (7
                          )
                          
                          
                          (13
                          )Note
      receivable, related party
                          
                          
                          -
                          
                          
                          
                          (25
                          )Purchase
      of VoIP License
                          
                          
                          -
                          
                          
                          
                          (100
                          )Purchases
      of property & equipment
                          
                          
                          (115
                          )
                          
                          
                          (25
                          )Net
      cash used in investing activities
                          
                          
                          (122
                          )
                          
                          
                          (163
                          )CASH
      FLOWS FROM FINANCING ACTIVITIES:Payments
      on notes payable
                          
                          
                          (542
                          )
                          
                          
                          (251
                          )Retirement
      of redeemable preferred stock series D&E
                          
                          
                          -
                          
                          
                          
                          (250
                          )Acquisition
      of common stock
                          
                          
                          (48
                          )
                          
                          
                          (10
                          )Proceeds
      from Notes payables
                          
                          
                          1,275
                          
                          
                          
                          -Principal
      payments on capital lease obligation
                          
                          
                          (3
                          )
                          
                          
                          (3
                          )Net
      cash provided by / (used in) financing activities
                          
                          
                          682
                          
                          
                          
                          (514
                          )DECREASE
      IN CASH
                          
                          
                          (701
                          )
                          
                          
                          288CASH
      AND CASH EQUIVALENTS, beginning of period
                          
                          
                          1,338
                          
                          
                          
                          1,050CASH
      AND CASH EQUIVALENTS, end of period
                          
                          $
                          637
                          
                          
                          $
                          1,338SUPPLEMENTAL
      DISCLOSURES:Cash
      paid for interest
                          
                          $
                          117
                          
                          
                          $
                          (62
                          )Cash
      paid for income tax
                          
                          
                          -
                          
                          
                          
                          -NON-CASH  INVESTING
      AND FINANCING TRANSACTIONSIssuance
      of common stock for conversion of debt
                          
                          $
                          172
                          
                          
                          $
                          136Conversion
      of preferred stock to common stock
                          
                          
                          -
                          
                          
                          
                          1Preferred
      stock dividends
                          
                          
                          -
                          
                          
                          
                          12Reversal
      of previously recorded preferred stock dividend
                          
                          
                          -
                          
                          
                          
                          (340
                          )Put
      option classified as derivative liability
                          
                          
                          85
                          
                          
                          
                          -Gain
      from the sale of Telefamilia
                          
                          
                          -
                          
                          
                          
                          82Acquisition
      of VoIP license, conversion of note receivable
                          
                          
                          -
                          
                          
                          
                          150Acquisition
      of fixed assets, conversion of  prepaid and accounts receivable,
      respectively
                          
                          
                          64
                          
                          
                          
                          50Note
      payable, settlement of redeemable preferred stock
                          
                          
                          -
                          
                          
                          
                          450





See
accompanying 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. ATSI recently installed a
VoIP technology platform that allows the Company to offer other VoIP
applications including IP/PBX services, IP trunking, prepaid calling, call
center applications, conferencing, messaging and other innovative IP telephony
functionality.





Principles of
Consolidation.The consolidated financial statements include the accounts
of the Company, and its subsidiaries, which are either majority owned or
controlled by the Company. In accordance with Financial Accounting Standards
Board Interpretation No. 46 (Revised) (“FIN46R”), Consolidation of Variable
Interest Entities, the Company identifies entities for which control is achieved
through means other than through voting rights (a "variable interest entity" or
"VIE") and determines when and which business enterprise, if any, should
consolidate the VIE. In addition, the Company discloses information pertaining
to such entities wherein the Company is the primary beneficiary or other
entities wherein the Company has a significant variable interest. All
significant intercompany transactions and balances have been
eliminated.





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.


27





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.





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.





Certificates
of Deposit.





On July 23, 2009 ATSI purchased a
$215,000 certificate of deposit, with a one month maturity and a variable
interest rate of return, from Wells Fargo Bank. The certificate of deposit
automatically renews on a monthly basis.





On July 9, 2009 ATSI purchased a
$110,000 certificate of deposit, with a monthly maturity and a variable interest
rate of return, from Wells Fargo Bank.  The certificate of deposit is
pledged as collateral on a $100,000 promissory note with Wells Fargo
Bank. The certificate of deposit automatically renews on a monthly
basis.





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, 2009 and 2008, ATSI’s
allowance for doubtful accounts balance was approximately $10,000 and $60,000,
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. Although 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, 2009, nothing has come to management’s
attention that would require ATSI to make any adjustment to its financial
statement.


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, 2009 or 2008, 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.
For the year ended July 31, 2009, potential dilutive securities had an
anti-dilutive effect and were not included in the calculation of diluted net
loss per common share.





Recently issued
accounting pronouncements.Effective August 1, 2008, the Company adopted
SFAS No. 157, Fair Value Measurements ("SFAS 157"), which provides guidance on
how to measure assets and liabilities that use fair value. SFAS 157 applies
whenever another U.S. GAAP standard requires (or permits) measurement of assets
or liabilities at fair value, but does not expand the use of fair value to any
new circumstances. The Company also adopted FASB Staff Position ("FSP") No. FAS
157-2, Effective Date of FASB Statement No. 157, which allows the Company to
partially defer the adoption of SFAS 157. This FSP defers the effective date of
SFAS 157 for nonfinancial assets and nonfinancial liabilities, except those that
are recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually), to fiscal years beginning after November
15, 2008, and interim periods within those fiscal years. Nonfinancial assets and
nonfinancial liabilities include all assets and liabilities other than those
meeting the definition of a financial asset or financial liability as defined in
paragraph 6 of Statement No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities. The adoption of SFAS No. 157 and FSP No. 157-2 had no
impact on our financial statements.


29


In
December 2007, the FASB issued SFAS No. 141R, "Business Combinations" which
establishes principles and requirements for how the acquirer of a business
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed and any noncontrolling interest in the
acquiree. The statement also provides guidance for recognizing and measuring the
goodwill acquired in the business combination and for disclosure to enable
evaluation of the nature and financial effects of the business combination. SFAS
141R is effective for ATSI as to business combinations the Company makes
beginning in fiscal 2010. The Company adopted this standard as of August 1, 2009
and does not expect it to have an impact on the Company’s financial
statements.





In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51. SFAS 160
introduces significant changes in the accounting and reporting for business
acquisitions and noncontrolling interest in a subsidiary. SFAS 160 also changes
the accounting and reporting for the deconsolidation of a subsidiary. Companies
are required to adopt the new standard for fiscal years beginning after January
1, 2009. The Company adopted this standard effectively August 1, 2009 and does
not expect it to have an impact on the Company’s financial
statements.





In April
2008, the FASB issued Staff Position FSP FAS 142-3, "Determination of the Useful
Life of Intangible Assets" ("FSP FAS 142-3"). The FSP amends the factors
considered in developing renewal or extension assumptions for determining the
useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and
Other Intangible Assets." The FSP's intent is to improve the consistency between
the useful life of a recognized intangible asset under SFAS No. 142 and the
period of expected cash flows used to measure the fair value of the asset under
other accounting principles generally accepted in the U.S. Companies must adopt
the FSP for fiscal years and interim periods beginning after December 15, 2008.
Early adoption is prohibited. Companies must apply the guidance for determining
the useful life of a recognized intangible asset prospectively to intangible
assets acquired after the effective date. Companies must also apply certain
disclosure requirements prospectively to all intangible assets recognized as of,
and subsequent to, the effective date. The Company adopted this standard
effectively August 1, 2009 and does not expect it to have an impact on the
Company’s financial statements.





In May
2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments
That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement),
which specifies that issuers of convertible debt instruments that may be settled
in cash upon conversion should separately account for the liability and equity
components in a manner reflecting their nonconvertible debt borrowing rate when
interest costs are recognized in subsequent periods.  FSP APB 14-1 is
effective for interim periods and fiscal years beginning after December 15,
2008.  The Company adopted this standard effectively August 1, 2009
and does not expect it to have an impact on the Company’s financial
statements.





In June
2008, the FASB ratified EITF Issue 07-5, “Determining Whether an Instrument (or
Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). Paragraph
11(a) of Statement of Financial Accounting Standard No 133, “Accounting for
Derivatives and Hedging Activities” (“SFAS 133”) specifies that a contract that
would otherwise meet the definition of a derivative, but is both
(a) indexed to its own stock and (b) classified in stockholders’
equity in the statement of financial position would not be considered a
derivative financial instrument. EITF 07-5 provides a new two-step model to be
applied in determining whether a financial instrument or an embedded feature is
indexed to an issuer’s own stock, including evaluating the instrument’s
contingent exercise and settlement provisions, and thus able to qualify for the
SFAS 133 paragraph 11(a) scope exception. It also clarifies the impact of
foreign-currency-denominated strike prices and market-based employee stock
option valuation instruments on the evaluation. EITF 07-5 will be effective for
the first annual reporting period beginning after December 15, 2008, and
early adoption is prohibited.


30


In November 2008, the FASB issued
EITF Issue 08-8,Accounting for an
Instrument (or an Embedded Feature) with a Settlement Amount That Is Based on
the Stock of an Entity’s Consolidated Subsidiary(“EITF No. 08-8”). This
Issue was effective for fiscal years beginning on or after December 15,
2008, and interim periods within those fiscal years, with early adoption
prohibited. EITF No. 08-8 supersedes EITF No. 00-6 and amends EITF
00-19 such that provided that the subsidiary is a substantive entity,
instruments indexed to the stock of a subsidiary could be considered indexed to
the entity’s own stock within the consolidated financial statements. The Company
adopted this standard effectivelyAugust1, 2009 and does not expect it to have
an impact on the Company’s financial statements.





In May 2009, the FASB issued SFAS No.
165, “Subsequent Events” (“SFAS 165”), which provides guidance to establish
general standards of accounting for and disclosures of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. SFAS 165 also requires entities to disclose the date
through which subsequent events were evaluated as well as the rationale for why
that date was selected. This disclosure should alert all users of financial
statements that an entity has not evaluated subsequent events after that date in
the set of financial statements being presented. SFAS 165 is effective for
interim and annual periods ending after June 15, 2009. Since FAS 165 at most
requires additional disclosures, the adoption did not have a material impact onATSI’s consolidated financial position,
results of operations or cash flows.





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 $32,000 of its
monthly receivables.  As of July 31, 2009, ATSI did not have any
outstanding receivables under the Wells Fargo Factoring agreement. ATSI will
continue to factor its receivables on a monthly basis as services are rendered
to its customers.





NOTE 3– INTANGIBLE ASSETS





During fiscal 2008ATSI 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 lifetime and perpetual NetSapiens’ License. The License
provides ATSI with the ability to offer Hosted PBX(PrivateBrancheXchange),IP Centrexapplication, prepaid calling, call
center, conferencing, messaging and other innovative telephony functionality
necessary to offer standard and/or custom services to theResidentialandEnterprisemarkets. The NetSapiens’Licenseis beingamortized equally over a period of 10
years.





NOTE 4 -PROPERTY AND
EQUIPMENT





Following is a summary of ATSI’s
property and equipment at July 31, 2009 and 2008 (in
thousands):





Useful lives
                    
                    2009
                    
                    
                    2008Telecom equipment &
      software
                    1-5 years
                    
                    $
                    794
                    
                    
                    $
                    611Less: accumulated
      depreciation
                    
                    
                    
                    (576
                    )
                    
                    
                    (439
                    )Net–property and
      equipment
                    
                    
                    $
                    218
                    
                    
                    $
                    172


31


For the years ended July 31, 2009 and
2008, depreciation and amortization totaled approximately $152,000 and $160,000,
respectively.





NOTE
5 – DEBT





At July 31, 2009 and 2008 outstanding debt
      consisted of the following: (In thousands, except per share
      amounts)July
      31,
                                                                                                          
                                                                                                          
                                                                                                          July
      31,2009
                                                                                                          
                                                                                                          
                                                                                                          20089%
      Convertible Subordinated Debenture, bearing interest at 9.00% per annum
      maturingJune
      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 daysimmediately
      preceding the date of conversion, subject to a maximum number of
      1,540,741common
      shares issuable upon conversion, outstanding balance, net of unamortized
      discountof
      $0 and $5, respectively. On October 20, 2008 we reached a settlement
      agreement withthe
      Debenture holders, as result we converted the outstanding principal
      balance and accruedinterest
      of $166 into 637,723 shares of common stock.
                                                                                                          
                                                                                                          $
                                                                                                          -
                                                                                                          
                                                                                                          
                                                                                                          $
                                                                                                          159Note
      payable to CCA Financial Services payable in monthlyinstallments
      bearing interest at 13.50% per annum, maturing December 31,
      2008,collateralized
      by ATSI's equipment, deposit of accounts and accounts
      receivables.On
      October 23, 2008, we paid in full the total outstanding principal balance
      and accruedinterest
      of $54.
                                                                                                          
                                                                                                          
                                                                                                          -
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          101Note
      payable to Alfonso Torres, payable upon maturity, bearing interest of
      6.00% per annum,maturing
      January 31, 2011, unsecured.
                                                                                                          
                                                                                                          
                                                                                                          460
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          460Note
      payable to The Shaar Fund, payable in quarterly installments bearing
      interest of7.50%
      per annum, maturing April 12, 2012.  On October 30, 2008, we
      reached a settlementagreement,
      in which we agreed to pay $290 to fully satisfy the note. Additionally,
      thenote
      holder agreed to provide us with a discount of $108,
      unsecured.
                                                                                                          
                                                                                                          
                                                                                                          -
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          416Note
      payable to Wells Fargo bank payable in monthly installments, bearing
      interest at 7.00%per
      annum, maturing April 1, 2009, collateralized by ATSI's certificates of
      deposit.
                                                                                                          
                                                                                                          
                                                                                                          -
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          39Note
      payable to Wells Fargo bank payable in monthly installments, bearing
      interest at  7.25%per
      annum, maturing July 25, 2010, collateralized by ATSI's certificates of
      deposit.
                                                                                                          
                                                                                                          
                                                                                                          72
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          138Note
      payable to ATVF, Scott Crist, Roderick Ciaccio & Vencore Solutions,
      payable in monthlyinstallments,
      bearing interest at 10.00% per annum, maturing September 10, 2010,
      collateralizedby
      ATSI's accounts receivables (other than accounts factored with Wells
      Fargo), $100,000certificate
      of deposit with Wells Fargo and ATSI's ownership in ATSICOM. Additionally,
      weissued
      425,000 warrants to the note holders, at an exercise price per warrant of
      $0.19.The
      warrants have the following “Put” and “Call” rights:Put
      right.
      From and after thesecond
      anniversary of the notes payable, the holder shall have the right to
      request from ATSI,upon
      five (5) Business days prior notice, to acquire from the holders the
      warrants at a price$0.39
      per warrant.Call
      right.  At
      any time any warrants are outstanding, if the last sale price of
      ATSI’scommon
      stock is greater than $.80 per share for ten (10) consecutive trading
      days, ATSI shallbe
      entitled to require the purchaser to exercise the warrants and pay the
      exercise price thereforeupon
      five (5) business days written notice. Net of unamortized discount of $33
      and $0, respectively.
                                                                                                          
                                                                                                          
                                                                                                          604
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          -Note
      payable to San Antonio National Bank payable in monthly installments,
      bearing interestat
      8.00% per annum, maturing October 25, 2011, collateralized by ATSI's
      assets.
                                                                                                          
                                                                                                          
                                                                                                          328
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          -Total
      outstanding debt long-term debt
                                                                                                          
                                                                                                          
                                                                                                          1,464
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          1,313Current
      portion of long-term debt
                                                                                                          
                                                                                                          
                                                                                                          (1,173
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (644
                                                                                                          )Long-term
      debt, net of current portion
                                                                                                          
                                                                                                          $
                                                                                                          291
                                                                                                          
                                                                                                          
                                                                                                          $
                                                                                                          669


32





Payments on long-term debt of ATSI are due as
      follows:(in
      thousands)Fiscal
      2010
                    
                    $
                    1,173Fiscal
      2011
                    
                    
                    291Total
      payments
                    
                    $
                    1,464





ATSI analyzed these instruments for
derivative accounting consideration under SFAS 133 and EITF 00-19, and
determined that the warrants issued to ATVF, Scott Crist, Roderick Ciaccioa
& Vencore Solutions 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.  Additionally, ATSI analyzed the rest of the instruments
for derivative accounting and determined that liability treatment was not
applicable.





NOTE6– GAIN ON EARLY EXTINGUISHMENT OF
DEBT





In December 2007, ATSI entered into a
promissory note payable with The Shaar Fund, Ltd.  The promissory note
was entered into as a result of the settlement agreement reached in which all
parties agreed to release each other from all claims relating to the Series D
Preferred Stock. As part of the settlement 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 is entitled to a discount of 22.5% on the then outstanding principal
balance.  On October 30, 2008, ATSI entered into a note discharged
agreement and agreed to pay to The Shaar Fund, Ltd. $290,000 to satisfy the
principal and accrued interest outstanding of $390,625 and $7,534,
respectively.  As a result of the discharge agreement, ATSI recognized
a gain on early extinguishment of debt of $108,160.





NOTE 7 - INCOME
TAXES





At July
31, 2009, ATSI had a consolidated net operating loss carry-forward (“NOL”) of
approximately $17,665,000 expiring ranging from 2020 through 2029. 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, 2009, ATSI has determined that a valuation allowance is necessary for the
entire amount of deferred tax assets.





Deferred tax assets are comprised of the
following as of July 31, 2009 and 2008:





2009
                      
                      
                      2008Deferred
      tax assets
                      
                      $
                      6,183,000
                      
                      
                      $
                      5,642,000Valuation
      allowance
                      
                      
                      (6,183,000
                      )
                      
                      
                      (5,642,000
                      )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.


33


NOTE
8 - COMMITMENTS AND CONTINGENCIES





Leases:





ATSI leases its office space with
monthly payments of $4,245; the lease expires in November 2011. The annual rent
expense under the operating lease was$49,419 and$50,937 for 2008 and 2009, respectively. The
future minimum lease payments under the operating lease are as
follows:




FY2010
              49,020FY2011
              49,020FY2012
              12,255


NOTE 9 – EQUITY





Common
Stock





During the year ended July 31, 2009 ATSI
issued:





-
            637,723
      common shares to the holders of the Convertible Debentures in lieu of the
      conversion of notes payable in the principal amount of $166,400 and
      accrued interest of $5,785 at a conversion price of $0.27, in accordance
      with the original terms of the notes which allowed for voluntary
      conversion by the company at a conversion price atthe higher of (a) $0.27
      per share or (b) the average closing price of ATSI’s common stock for the
      10 days immediately preceding the date of
  conversion.





-
            5,611,963common shares to its employees
      and directors for services rendered.  ATSI recorded the fair
      value of $225,000 as thecompensation expense in its
      statement of operations





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 thecompensation 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.





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.


34


Series D
Preferred Stock





Series D
Preferred Stock was 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.  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.On October 30, 2008, ATSI
entered into a note discharged agreement and subsequently paid The Shaar Fund,
Ltd. $290,000 to satisfy the principal and accrued interest outstanding of
$390,625 and $7,534, respectively.  As a result of the discharge
agreement ATSI recognized a gain on early extinguishment of debt of
$108,160.





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.





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





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’sBoard ofDirectors 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’sBoard ofDirectors approved an amendment to the
plan.  Under the amendment, ATSI’sBoard ofDirectors increased themaximum aggregate number of shares of
Common Stock that may be issued under the Plan from 7.5 million shares to 17.5
million shares.


35


During
the year ended July 31, 2008, 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.





- 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.





- 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.





- 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.





During
the year ended July 31, 2009, ATSI granted:





- an
option to an employee to purchase 75,000 common shares at an exercise price of
$0.16 per share, the closing price of ATSI’s common stock on the grant date,
September 23, 2008.  The options vest equally at each anniversary of
the grant date over a three year period.  All options expire if not
exercised on or before the seventh anniversary of the grant
date.  Under the fair value option method, ATSI will recognize over
the relevant service periods $9,990 of non-cash compensation expense related to
un-vested options.





- an
option to an employee to purchase 200,000 common shares at an exercise price of
$0.13 per share, the closing price of ATSI’s common stock on the grant date,
October 13, 2008.  The options vest equally at each anniversary of the
grant date over a three year period.  All options expire if not
exercised on or before the seventh anniversary of the grant
date.  Under the fair value option method, ATSI will recognize over
the relevant service periods $22,156 of non-cash compensation expense related to
un-vested options.





- an
option to an employee to purchase 60,000 common shares at an exercise price of
$0.13 per share, the closing price of ATSI’s common stock on the grant date,
November 4, 2008.  The options vest equally at each anniversary of the
grant date over a three year period.  All options expire if not
exercised on or before the seventh anniversary of the grant
date.  Under the fair value option method, ATSI will recognize over
the relevant service periods $6,681 of non-cash compensation expense related to
un-vested options.


36





- options
to two (2) employees to purchase an aggregate of 520,000 common shares at an
exercise price of $0.08 per share, the closing price of ATSI’s common stock on
the grant date, January 30, 2009, 250,000 vests September 1, 2009, 10,000 vests
November 1, 2009, 250,000 vests September 1, 2010 and 10,000 vests November 1,
2010.  All options expire if not exercised on or before the seventh
anniversary of the grant date.  Under the fair value option method,
ATSI will recognize over the relevant service periods $35,564 of non-cash
compensation expense related to un-vested options.





- On
January 30, 2009, ATSI’s Board of Directors approved the amendment of previously
awarded stock options and as a result ATSI cancelled 8,239,000 stock options and
reissued 7,619,000 stock options to various employees.  The new
exercise price of these options is set at $0.08 per share, the closing price as
of the date of the amendment of the terms.  The options vested upon
issuance and will expire if not exercised on or before the seventh anniversary
of the grant date.  Under SFAS No.123R, a modification of the terms of
an award that makes it more valuable shall be treated as an exchange of the
original award for a new award.  In substance, the entity repurchases
the original instrument by issuing a new instrument of greater value, incurring
additional compensation cost for that incremental value.  The
incremental value shall be measured by the difference between (a) the fair value
of the modified option determined in accordance with the provisions of this
section and (b) the value of the old option immediately before its terms are
modified, determined based on the shorter of (1) its remaining expected life or
(2) the expected life of the modified option. Upon issuance, ATSI recognized
$46,038 of non-cash incremental compensation expense. These options were
subsequently canceled during fiscal 2009.





- On July
16, 2009, ATSI’s Board of Directors approved the amendment of previously awarded
stock options and as a result ATSI cancelled 7,619,000 stock options and
reissued 7,619,000 stock options to various employees.  The new
exercise price of these options is set at $0.04 per share, the closing price as
of the date of the amendment of the terms.  The options vested upon
issuance and will expire if not exercised on or before the seventh anniversary
of the grant date.  Under SFAS No.123R, a modification of the terms of
an award that makes it more valuable shall be treated as an exchange of the
original award for a new award.  In substance, the entity repurchases
the original instrument by issuing a new instrument of greater value, incurring
additional compensation cost for that incremental value.  The
incremental value shall be measured by the difference between (a) the fair value
of the modified option determined in accordance with the provisions of this
section and (b) the value of the old option immediately before its terms are
modified, determined based on the shorter of (1) its remaining expected life or
(2) the expected life of the modified option. Upon issuance, ATSI recognized
$9,747 of non-cash incremental compensation expense.





- On July
16, 2009, ATSI’s Board of Directors approved the amendment of previously awarded
stock options and as a result ATSI reissued 520,000 stock options to two
employees at an exercise price of $0.04 per share, the closing price as of the
date of the amendment of the terms, 250,000 vest September 1, 2009, 10,000 vest
November 1, 2009, 250,000 vest September 1, 2010 and 10,000 vest November 1,
2010.  All options expire if not exercised on or before the seventh
anniversary of the grant date.  Under the fair value option method,
ATSI will recognize over the relevant service periods $19,439 of non-cash
compensation expense related to un-vested options.





During
the year ended July 31, 2009, ATSI forfeited:





-
            ATSI
      forfeited 720,000 options to purchase common shares to various employees
      that were terminated during fiscal 2009. None of the options had
      vested.





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





FortheYearsEndedJuly31,2009
                            
                            
                            2008Expecteddividendsyield
                            
                            
                            0.00
                            %
                            
                            
                            0.00
                            %Expectedstockpricevolatility
                            
                            
                            126%-296
                            %
                            
                            
                            75%-105
                            %Risk-freeinterestrate
                            
                            
                            2.28%-3.48
                            %
                            
                            
                            3.15%- 4.65
                            %Expectedlifeofoptions
                            
                            3.75-4.5years
                            
                            
                            4-6years


37





ATSI
recognized $388,000 and $695,000 in stock based compensation expense to
employees during years ended July 31, 2009 and 2008,
respectively.  Unamortized compensation cost totaled $27,960 and
$147,174 at July 31, 2009 and July 31, 2008, respectively.





ATSI
estimates the expected life of its options using the “simplified method” allowed
for under SAB 107 which is the average between the contract term and the
weighted average vesting period of the options.





The
aggregate intrinsic value for the options outstanding as of July 31, 2009 and
2008 is $68,340 and $164,780, respectively.





A summary of the options as of July 31,
2009 and 2008andthe
changes during the years ended July 31, 2009 and 2008 arepresented
below:




Weighted-averageWeighted-average
                                    
                                    
                                    remaining
      contractual2005 Stock Compensation
      Plan
                                    
                                    Options
                                    
                                    
                                    exercise
    price
                                    
                                    
                                    term
(years)Outstanding 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
                                    
                                    
                                    
                                    6Granted
                                    
                                    
                                    16,613,000
                                    
                                    
                                    
                                    0.06
                                    
                                    
                                    
                                    7Forfeited
                                    
                                    
                                    (16,578,000
                                    )
                                    
                                    
                                    0.14
                                    
                                    
                                    
                                    4Outstanding at July 31,
      2009
                                    
                                    
                                    8,274,000
                                    
                                    
                                    
                                    0.04
                                    
                                    
                                    
                                    7Exercisable at July 31,
      2009
                                    
                                    
                                    7,619,000
                                    
                                    
                                    $
                                    0.04
                                    
                                    
                                    
                                    7





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.





During
the year ended July 31, 2009, ATSI issued warrants to purchase 425,000 common
shares to ATVF, Scott Crist,
Roderick Ciaccio & Vencore solutions.





These warrants havethe following “Put” and “Call”
rights:





Put
right.From and after the secondanniversary of the warrants, the holderhasthe right torequire ATSIto redeem the warrantsupon five (5) Business days prior
noticeat priceof $0.39 per share of common
stock.





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





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


38





Expected
      dividend yield
                    
                    
                    0.00
                    %Expected
      stock price volatility
                    
                    
                    131.4
                    %Risk-free
      interest rate
                    
                    
                    3.37
                    %Contractual
      life of warrants
                    
                    7
      years





ATSI analyzed these warrants 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.





A summary of the warrants as of July
31, 2009 and 2008 andthe
changes during the years ended July 31, 2009 and 2008 arepresented
below:




Weighted-averageWeighted-average
                        
                        
                        remaining
      contractualWarrants
                        
                        
                        exercise
      price
                        
                        
                        term
      (years)Outstanding
      at July 31, 2007
                        
                        
                        -
                        
                        
                        $
                        -
                        
                        
                        
                        -Granted
                        
                        
                        375,000
                        
                        
                        
                        0.18
                        
                        
                        
                        4Exercised
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Forfeited
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      at July 31, 2008
                        
                        
                        375,000
                        
                        
                        $
                        0.18
                        
                        
                        
                        4Granted
                        
                        
                        425,000
                        
                        
                        
                        0.19
                        
                        
                        
                        7Exercised
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Forfeited
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      at July 31, 2009
                        
                        
                        800,000
                        
                        
                        $
                        0.19
                        
                        
                        
                        7Exercisable
      at July 31, 2009
                        
                        
                        800,000
                        
                        
                        $
                        0.19
                        
                        
                        
                        5.5





There
were no aggregate intrinsic values on the warrants outstanding as of July 31,
2009 and 2008.





NOTE
12 – SHARE REPURCHASE PROGRAM





On March 24, 2008, ATSI’s Board of
Directors approved a share buyback plan allowing ATSI to purchase up to $1
million of its common stock.  During fiscal 2009 and 2008, ATSI
repurchased 295,981 shares and 44,002 shares an average purchase price of $0.17
and $0.22, respectively.





NOTE 13 –NON-STANDARDIZEDPROFIT SHARING PLAN





We currently provide a Non-Standardized Profit Sharing
Plan.  Theboard of
directorsapproved 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 planisbased 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 2009 and 2008, we
contributed under the plan$174,000and $194,000,
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:


39





Year
      ended July 31,2009
                            
                            
                            2008(In
      thousands, except share information)Net
      income (loss) to be used to compute income(loss)
      per share:Net
      income (loss)
                            
                            $
                            (1,508
                            )
                            
                            $
                            112Less
      preferred dividends
                            
                            
                            -
                            
                            
                            
                            328Net
      income attributable to commonShareholders
                            
                            
                            (1,508
                            )
                            
                            
                            440Weighted
      average number of shares:Weighted
      average common shares outstanding - basic
                            
                            
                            40,043,303
                            
                            
                            
                            39,143,748Effect
      of warrants and options
                            
                            
                            -
                            
                            
                            
                            53,571Weighted
      average common shares outstandingassuming
      dilution
                            
                            
                            40,043,303
                            
                            
                            
                            39,197,319Basic
      income per common share
                            
                            $
                            (0.04
                            )
                            
                            $
                            0.01Diluted
      income per common share
                            
                            $
                            (0.04
                            )
                            
                            $
                            0.01





NOTE
15 – FINANCIAL CONSOLIDATION OF FIESTA COMMUNICATIONS





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.  With the 975,000
shares obtained from Fiesta, ATSI owns approximately 19.5% of Fiesta. 
Additionally, on May 1, 2008, Fiesta entered into convertible promissory note
with ATSI for $52,984, with a maturity date of May 1, 2011 and an interest rate
of 9%.  Under the convertible promissory note, Fiesta agreed to pay twelve
(12) equal quarterly payments of $5,088 starting on August 1, 2008 and
continuing each quarterly period thereafter until all accrued and unpaid
interest has been paid.




For the year ended July 31, 2009, ATSI
analyzed its investment in Fiesta and concluded that Fiesta to be a Variable
Interest Entity as defined under FIN46R. ATSI also evaluated all of its
outstanding arrangements with Fiesta and determined ATSI not as a primary
beneficiary of Fiesta. ATSI accounted for its investment in Fiesta under equity
method. ATSI recognized a loss of $16,000 from its investment in Fiesta during
fiscal 2008.




On October 31, 2008, ATSI and Fiesta
agreed to extend the maturity date on the $30,000 promissory note to April 30,
2009 and all other terms remained the same.  On October 31, 2008, Fiesta
entered into a note payable with ATSI for $95,000, with a maturity date of April
30, 2009 and an interest rate of 10%. Additionally, on October 31, 2008, Fiesta
paid in full to ATSI a promissory note with a principal balance of $35,000 and
$1,467 in accrued interest.During theyear ended July 31, 2009, ATSI also
advanced additional $80,000 to Fiesta; the promissory note has a maturity
date of January 31, 2010 and an interest rate of 8%. This note is secured by
Fiesta’s assets, including contracts and intangible assets.




As July 31, 2009, ATSI reconsidered its
investment in Fiesta under the guidance of FIN46R and concluded that because the
additional funding provided to Fiesta during fiscal 2009, ATSI became the
primary beneficiary of Fiesta. ATSI will absorb a majority of losses of Fiesta.
As of July 31, 2009, ATSIfinanciallyconsolidated Fiesta. All significant
intercompany transactions and balances have been
eliminated.


40


NOTE 16 – MAJOR CUSTOMERS AND MAJOR
VENDORS




ATSI generated 20 percent of its
revenues from three customers during the year ended July 31, 2009 and 26 percent
of its revenues from three customers during the year ended July 31,
2008.




ATSI incurred 28 percent of its cost of
revenues to three vendors during the year ended July 31, 2009 and 43 percent of
its cost of revenues to three vendors during the year ended July 31,
2008.




41




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





None





ITEM
9A(T).      CONTROLS AND
PROCEDURES.




Evaluation of Disclosure Controls and
Procedures





In accordance with Exchange Act
Rules 13a-15 and 15a-15, we carried out an evaluation, under the
supervision and with the participation of management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures
were effective as ofJuly31, 2009.





Management’s Report on Internal Control
over Financial Reporting




Our management is responsible for
establishing and maintaining adequate internal control over financial reporting,
as such term is defined in Exchange Act Rule 13a-15(f). Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of our internal control over financial reporting
based on the framework inInternal
Control—Integrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).




Based on our evaluation under the
framework inInternal
Control—Integrated Frameworkissued by COSO, our management
concluded that our internal control over financial reporting was effective as of July 31,
2009in providing
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles.




This annual report does not include an
attestation report of the Company’s registered public accounting firm regarding
internal control over financial reporting. Management’s report was not subject
to attestation by the Company’s registered public accounting firm pursuant to
temporary rules of the Securities Exchange Commission that permit the company to
provide only management’s report in this annual report.





ITEM
9B.           OTHER
INFORMATION.





None


42





PART
III





ITEM10.
            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
      HeldArthur L.
    Smith
                      
                      44
                      
                      President, Chief Executive Officer
      and DirectorRuben R.
      Caraveo
                      
                      41
                      
                      Sr. Vice President, Operations and
      TechnologyAntonio Estrada
      Jr.
                      
                      34
                      
                      Sr. Vice President, Treasurer
      & Corporate ControllerJohn R.
    Fleming
                      
                      55
                      
                      Director, Interim Executive
      Chairman of the BoardMurray R.
    Nye
                      
                      55
                      
                      Director




Arthur L.
Smithhas 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. Mr. Smith also served
as Chairman of the Board of ATSI’s subsidiary,Globalscape, Inc.
(NYSE:GSB), until its spin-off and subsequent sale in June 2002. 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 20 years’ experience in the telecommunications
industry.





Ruben R.
Caraveohas 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. 
Prior to joining ATSI, Mr. Caraveo served as Vice President of Vycera
Communications where he was responsible for overseeing wholesale carrier sales,
and daily operations, including Engineering, Marketing, and the Network
Operations Center. His prior experience also includes management positions with
Worldtel Interactive, Frontier, and WorldCom.  Mr. Caraveo has more than 20
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.hasserved as our Sr.Vice Presidentof 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, 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 11 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.





John R.
Fleminghas served as
our Non-executive Chairman of the Board sinceAugust 2002and as one of our Directors sinceJanuary 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
sets on the board of Mediaxstream Communications which is a high definition
delivery system that services major studios and sports venues throughout the
country.  Prior to forming Vision Corporation, Mr. Fleming served as
President, International of IXC Communications, Inc. fromApril 1998toDecember 1999. Immediately prior to that he served as
IXC’s President of Emerging Markets fromDecember 1997, as Executive Vice President of IXC
fromMarch 1996throughNovember 1997and as Senior Vice President of IXC
fromOctober
1994throughMarch 1996. He served as Vice President of Sales
and Marketing of IXC from its formation inJuly 1992untilOctober 1994. Prior to that, Mr. Fleming served as
Director of Business Development and Director of Carrier Sales of CTI from 1986
toMarch 1990and as Vice President of Marketing and
Sales of CTI fromMarch
1990toJuly 1992. Mr. Fleming was a Branch Manager for
Satellite Business Systems from 1983 to 1986 (a unit of
IBM).


43


Murray R.
Nyehas 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,
2009, 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.





Code of Ethics





Weadoptedan 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. 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.





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.


44


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 donot have an audit or other board
committee performing equivalent functions. Our board of
directors performs all
functions of the audit
committee.We do nothave an audit committee financial expert
because none ofourcurrent 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 tothe 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.





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.


45


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 2009 executive officer bonus plan, effective as of the first
quarter of fiscal 2009 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 2009 executive officer bonus plan were to be
calculated based on our revenue, margin, cash balance and net income for 2009
against the 2009 financial plan approved by our board of
directors.





Under our 2009 executive officer bonus
plan, we assigned a specific bonus target to each executive for performance in
2009. 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 2009
financial plan. After discussion and deliberation, our board of directors
ultimately approved our management’s recommendations as detailed
below:




Name
                              
                              Title
                              
                              BonusArthur L.
    Smith
                              
                              President, Chief Executive Officer
      and Director
                              
                              $
                              82,500Ruben R.
      Caraveo
                              
                              Sr. Vice President, Operations and
      Technology
                              
                              $
                              74,250Antonio Estrada
      Jr.
                              
                              Sr. Vice President & Corporate
      Controller
                              
                              $
                              60,500


Payouts
under our 2009 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





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 and 2009 financial plan, our board of
directors retained the discretion to adjust bonuses payable under our 2008 and
2009 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.


46


SUMMARY
COMPENSATION TABLE





Name and Principal
                                  Position
                                
                                Year
                                
                                Salary
                                  ($)
                                
                                
                                Bonus (1)
                                  ($)
                                
                                
                                Stock
                                  Awards (2)
                                  ($)
                                
                                
                                Option
                                  Awards
                                  Awards (2)
                                  ($)
                                
                                
                                All Other
                                  Compensation (3)
                                  ($)
                                
                                
                                Total
                                  ($)Arthur
      L. Smith
                                
                                2009
                                
                                $
                                165,000
                                
                                
                                $
                                76,767
                                
                                
                                $
                                -0-
                                
                                
                                $
                                2,168
                                
                                
                                $
                                35,429
                                
                                
                                $
                                279,364CEO
      & President
                                
                                2008
                                
                                $
                                150,000
                                
                                
                                $
                                90,392
                                
                                
                                $
                                7,012
                                
                                
                                $
                                94,500
                                
                                
                                $
                                50,738
                                
                                
                                $
                                392,642Ruben
      R. Caraveo
                                
                                2009
                                
                                $
                                148,500
                                
                                
                                $
                                66,185
                                
                                
                                $
                                -0-
                                
                                
                                $
                                1,887
                                
                                
                                $
                                39,165
                                
                                
                                $
                                255,737Senior
      Vice President of
                                
                                2008
                                
                                $
                                135,000
                                
                                
                                $
                                127,371
                                
                                
                                $
                                -0-
                                
                                
                                $
                                78,750
                                
                                
                                $
                                47,327
                                
                                
                                $
                                388,448Operations
      and TechnologyAntonio
      Estrada Jr.
                                
                                2008
                                
                                $
                                121,000
                                
                                
                                $
                                74,590
                                
                                
                                $
                                -0-
                                
                                
                                $
                                1,851
                                
                                
                                $
                                46,000
                                
                                
                                $
                                243,441Senior
      Vice President of
                                
                                2008
                                
                                $
                                110,000
                                
                                
                                $
                                101,126
                                
                                
                                $
                                15,226
                                
                                
                                $
                                78,750
                                
                                
                                $
                                32,102
                                
                                
                                $
                                337,204Finance
      & Corporate Controller





(1)
            Bonus
      amounts are based on the bonus payments for the 4th
      quarter of 2008, a one-time bonus for achieving profitability and positive
      working capital during fiscal 2008 and one-time bonus for services
      provided in previous fiscal years without
  compensation.


(2)
            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.


(3)
            All
      other compensation consists of contributions to 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
options, but has repriced options under the Plan.  The following
tables set forth information about the number of grants made during fiscal 2009
and 2008 and the number of outstanding stock options held by each of our named
executive officers as of July 31, 2009.





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
                              FairValue
                              of Stockand
                              Option
                              AwardsArthur
      L. Smith
                            
                            8/14/2007
                            
                            
                            275,000
                            
                            
                            
                            450,000
                            
                            
                            $
                            0.21
                            
                            
                            $
                            369,5007/16/2009
                            
                            
                            885,737
                            (1)
                            
                            
                            1,695,000
                            (2)
                            
                            $
                            0.04
                            
                            
                            $
                            103,230Ruben
      R. Caraveo
                            
                            8/14/2007
                            
                            
                            225,369
                            
                            
                            
                            375,000
                            
                            
                            $
                            0.21
                            
                            
                            $
                            304,1197/16/2009
                            
                            
                            979,130
                            (1)
                            
                            
                            1,475,000
                            (2)
                            
                            $
                            0.04
                            
                            
                            $
                            98,165Antonio
      Estrada, Jr.
                            
                            8/14/2007
                            
                            
                            225,369
                            
                            
                            
                            375,000
                            
                            
                            $
                            0.21
                            
                            
                            $
                            304,1197/16/2009
                            
                            
                            1,150,000
                            (1)
                            
                            
                            1,447,000
                            (2)
                            
                            $
                            0.04
                            
                            
                            $
                            103,880





(1)
            Contributions
      to the Non-Standardized Profit Sharing Plan during fiscal
    2009


(2)
            This
      represents the repricing of previously issued stock options.  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.




47




OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END




Option
      Awards
                                              
                                              Stock
      AwardsName
                                              
                                              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
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              9/29/2015
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -525,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              10/3/2015
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -300,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              9/25/2016
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -300,000
                                              
                                              
                                              
                                              150,000
                                              
                                              
                                              $
                                              0.04
                                              
                                              8/15/2017
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Ruben
      R. Caraveo
                                              
                                              
                                              375,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              9/29/2015
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -475,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              10/3/2015
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -250,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              9/25/2016
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -250,000
                                              
                                              
                                              
                                              125,000
                                              
                                              
                                              $
                                              0.04
                                              
                                              8/15/2017
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Antonio
      Estrada Jr.
                                              
                                              
                                              347,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              9/29/2015
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -475,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              10/3/2015
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -250,000
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.04
                                              
                                              9/25/2016
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -250,000
                                              
                                              
                                              
                                              125,000
                                              
                                              
                                              $
                                              0.04
                                              
                                              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 us 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.





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
                                
                                
                                
                                $
                                35,429
                                
                                
                                
                                
                                
                                $
                                50,738Ruben
      R. Caraveo
                                
                                
                                
                                $
                                39,165
                                
                                
                                
                                
                                
                                $
                                47,327Antonio
      Estrada, Jr.
                                
                                
                                
                                $
                                46,000
                                
                                
                                
                                
                                
                                $
                                32,102





(1)
            All
      amounts reported in this column are included as Other Compensation for
      fiscal 2009 in the Summary Compensation
Table.


(2)
            All
      amounts reported in this column are included as Other Compensation for
      fiscal 2008 in the Summary Compensation
Table.




48




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,
2009.





Name
                                  
                                  Fees
                                    Earned or
                                    Paid
      in
                                    Cash
                                    ($)
                                  
                                  Stock
                                    Awards
                                    ($)
                                  
                                  
                                  Option
                                    Awards
                                    ($)
                                  
                                  Nonqualified
                                    Deferred
                                    Compensation
                                    Earnings
                                    ($)
                                  
                                  All
      Other
                                    Compensation
                                    ($)
                                  
                                  Total
                                    ($)John
      R. Fleming
                                  
                                  
                                  
                                  $
                                  25,000
                                  (1)
                                  
                                  $
                                  43,000
                                  (1)
                                  
                                  
                                  
                                  
                                  $
                                  68,000Murray
      R. Nye
                                  
                                  
                                  
                                  $
                                  25,000
                                  (2)
                                  
                                  $
                                  43,000
                                  (2)
                                  
                                  
                                  
                                  
                                  $
                                  68,000





(1)
            As
      of July 31, 2009, Mr. Fleming had options to purchase an aggregate of
      1,075,000 shares of common stock and 625,000 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, 2009, Mr. Nye had options to purchase an aggregate of
      1,075,000 shares of common stock and 625,000 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.





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 or
had any relationship with that required disclosure in this report.





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, 2009 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.




49




NAME
      OF
                                        
                                        COMMON
                                        
                                        
                                        %
      OF
                                        
                                        
                                        TOTAL
      VOTINGINDIVIDUAL
      OR GROUP
                                        
                                        STOCK
                                        
                                        
                                        CLASS
      (1)
                                        
                                        
                                        INTERESTINDIVIDUAL
      OFFICERS,DIRECTORS
      AND NOMINEESArthur
      L. Smith
                                        
                                        
                                        3,725,889
                                        (2)
                                        
                                        
                                        7.1
                                        %
                                        
                                        
                                        3,725,889
                                        (2)President,
      Chief Executive OfficerDirectorRuben
      R. Caraveo
                                        
                                        
                                        2,984,279
                                        (3)
                                        
                                        
                                        5.7
                                        %
                                        
                                        
                                        2,984,279
                                        (3)Sr.
      Vice President, Sales and OperationsAntonio
      Estrada
                                        
                                        
                                        3,169,828
                                        (4)
                                        
                                        
                                        6.1
                                        %
                                        
                                        
                                        3,169,828
                                        (4)Sr.
      VP of Finance & Corporate ControllerJohn
      R. Fleming
                                        
                                        
                                        2,350,090
                                        (5)
                                        
                                        
                                        4.5
                                        %
                                        
                                        
                                        2,350,090
                                        (5)DirectorMurray
      R. Nye
                                        
                                        
                                        2,350,090
                                        (6)
                                        
                                        
                                        4.5
                                        %
                                        
                                        
                                        2,350,090
                                        (6)DirectorALL
      OFFICERS ANDDIRECTORS
      AS A GROUP
                                        
                                        
                                        14,580,176
                                        (7)
                                        
                                        
                                        27.9
                                        %
                                        
                                        
                                        14,580,176
                                        (7)





(1)
            Based
      upon 52,271,120 shares of common stock outstanding as of July 31, 2009.
      Any shares represented by options exercisable within 60 days after July
      31, 2009 are treated as being outstanding for the purpose of computing the
      percentage of the class for such person but not
  otherwise.


(2)
            Includes
      1,695,000 shares subject to options exercisable at July 31,
      2009.


(3)
            Includes
      1,475,000 shares subject to options exercisable at July 31,
      2009.


(4)
            Includes
      1,447,000 shares subject to options exercisable at July 31,
      2009.


(5)
            Includes
      1,075,000 shares subject to options exercisable at July 31,
      2009.


(6)
            Includes
      1,075,000 shares subject to options exercisable at July 31,
      2009.


(7)
            Includes
      6,767,000 shares subject to options exercisable at July 31,
      2009.





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 through a promissory note in July 2008.  With the 975,000
shares obtained from Fiesta, ATSI owns approximately 19.5% of Fiesta. 
Additionally, on May 1, 2008, Fiesta entered into convertible promissory note
with ATSI for $52,984, with a maturity date of May 1, 2011 and an interest rate
of 9%.  Under the convertible promissory note, Fiesta agreed to pay twelve
(12) equal quarterly payments of $5,088 starting on August 1, 2008 and
continuing each quarterly period thereafter until all accrued and unpaid
interest has been paid.




50




For the year ended July 31, 2009, ATSI
analyzed its investment in Fiesta and concluded that Fiesta to be a Variable
Interest Entity as defined under FIN46R. ATSI also evaluated all of its
outstanding arrangements with Fiesta and determined ATSI not as a primary
beneficiary of Fiesta. ATSI accounted for its investment in Fiesta under equity
method. ATSI recognized a loss of $16,000 from its investment in Fiesta during
fiscal 2008.




On October 31, 2008, ATSI and Fiesta
agreed to extend the maturity date on the $30,000 promissory note to April 30,
2009 and all other terms remained the same.  On October 31, 2008, Fiesta
entered into a note payable with ATSI for $95,000, with a maturity date of April
30, 2009 and an interest rate of 10%. Additionally, on October 31, 2008, Fiesta
paid in full to ATSI a promissory note with a principal balance of $35,000 and
$1,467 in accrued interest. During the year ended July 31, 2009, ATSI also
advanced additional $80,000 to Fiesta; the promissory note has a maturity date
of January 31, 2010 and an interest rate of 8%. This note is secured by Fiesta’s
assets, including contracts and intangible assets.




As July 31, 2009, ATSI reconsidered its
investment in Fiesta under the guidance of FIN46R and concluded that because the
additional funding provided to Fiesta during fiscal 2009, ATSI became the
primary beneficiary of Fiesta. ATSI will absorb a majority of losses of Fiesta.
As of July 31, 2009, ATSI financially consolidated Fiesta. All significant
intercompany transactions and balances have been eliminated.





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, 2009
and 2008.





Year
      Ended July 31,Description
      of Fees
                    
                    2009
                    
                    
                    2008Audit
      Fees
                    
                    $
                    74,000
                    
                    
                    $
                    68,000Tax
      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.  We did not incur any
non-audit fees to Malone and Bailey, PC during fiscal 2009.





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)




51




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)





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)





4.2
            Convertible
      Debenture Agreement(Exhibit 4.18 to Annual Report
      on Form 10-KSB for the year ended July 31, 2006 filed October 30,
      2006)





4.3
            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)





4.4
            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)





4.5
            Promissory
      Notes payable to several holders dated September 26, 2008 in the principal
      amount of $850,000.(Exhibit4.6to Form 10-KSB for the period endedJuly31, 2009filed October 29,
      2008)





4.6
            Promissory
      note payable to San Antonio National Bank dated October 23, 2008 in the
      principal amount of $425,000.(Exhibit10.1to Form 10-KSB for the period endedOctober31,
      2008filedDecember 15, 2008)





4.7
            Promissory
      note receivable between ATSI Communications, Inc. and Fiesta
      Communications, Inc. dated October 31, 2008 for $95,000.(Exhibit10.2to Form 10-KSB for the period endedOctober31,
      2008filed December 15, 2008)





4.8
            Note
      Discharge Agreement dated October 30, 2008 between ATSI Communications,
      Inc. and The Shaar Fund, Inc.(Exhibit10.3to Form 10-KSB for the period endedOctober31,
      2008filedDecember 15, 2008)





4.9
            Settlement
      Agreement dated October 20, 2008 between ATSI Communications, Inc. and the
      9% Convertible Debenture holders.(Exhibit10.4to Form 10-KSB for the period endedOctober31,
      2008filedDecember 15, 2008)





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 10.3to 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)





21.1
            Subsidiary
      List *





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.
*




52




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.*





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 15,
      2009
                
                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
      15, 2009Arthur
      L. Smith/s/ Antonio Estrada Jr.
                            
                            Principal
      Accounting Officer
                            
                            October
      15, 2009Antonio
      Estrada Jr.
                            
                            Principal
      Finance Officer/s/ John R. Fleming
                            
                            Director
                            
                            October
      15, 2009John
      R. Fleming/s/ Murray R. Nye
                            
                            Director
                            
                            October
      15, 2009Murray
      R. Nye


53


EXHIBIT
INDEX





Number
                        
                        Description21.1
                        
                        Subsidiary
      List *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.*


54