UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**FORM
      10-KSB**





(mark
      one)





x
                ANNUAL
                    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                    ACT OF
                    1934 FOR THE FISCAL YEAR ENDED JULY 31,
                    2005





o
                TRANSITION
                    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                    ACT OF
                    1934 FOR THE TRANSITION PERIOD
                  FROM
                    _______TO _________





Commission
      File Number: 1-15687





**ATSI
      COMMUNICATIONS, INC.**


(Name
      of Small Business Issuer as Specified in Its Charter)





**Nevada**
              (State
                or Other Jurisdiction of Incorporation or Organization)
            
            **74-2849995**
              (IRS
                Employer Identification No.)**8600
                Wurzbach, Suite 700W**
              **San
                Antonio, Texas**
              (Address
                of Principal Executive Offices)
            
            **78240**
              (Zip
                Code)





**(210)
      614-7240**


(Issuer’s
      Telephone Number, Including Area Code)





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





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





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


**Series
      H Convertible Preferred Stock, Par Value $0.001 Per Share**


(Title
      of Class)





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
o





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 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-KSB or any amendment to this Form 10-KSB. o





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Exchange Act) Yes o No
x





Registrant’s
      revenues for its recent fiscal year were $6,011,472




As
      of
      October 20, 2005, the aggregate market value of the voting common equity held
      by
      non-affiliates of the Registrant was $3,535,055 based on
      the closing price of
      $0.34 per
      share on October
      20, 2005 as
      reported on the over-the-counter bulletin board.




There
      were 10,397,222 shares of Registrant’s Common Stock outstanding as of October
      20, 2005.













Table
        of Contents





**TABLE
      OF CONTENTS**


**Page****PART
                I**Item
                1. Description of Business
            ****3Overview
            3History
            4Recent
                Developments
            4Services
                and Products
            5Carrier
                Services
            5Network
                Services
            5Communication
                Services
            6Voice
                over Internet Protocol
                Network
            6Strategy
                and Competitive
                Conditions
            7Government
                Regulations/ Concession
                License
            9Suppliers
            13Employees
            13Item
                2. Description of Properties
            13Item
                3. Legal Proceedings
            13Item
                4. Submission of Matters to a Vote of Security
                Holders
            14**PART
                II**Item
                5. Market for Registrant’s Common Equity and Related
                Stockholder Matters
            14Item
                6. Management’s Discussion and Analysis or Plan of
                Operations
            17Item
                7. Financial Statements and Supplementary
                Data
            24Item
                8. Changes in and Disagreements with Accountants on
                Accounting and Financial
                Disclosures
            46Item
                8A. Controls and Procedures
            46**PART
                III**Item
                9. Directors, Executive Officers, Promoters and Control
                Persons, Compliancewith
                Section 16(A) of the Exchange
                Act
            46Item
                10. Executive Compensation
            48Item
                11. Security Ownership of Certain Beneficial Owners
                and Management
            50Item
                12. Certain Relationships and Related
                Transactions
            51Item
                13. Exhibits and Reports on Form
                8-K
            51Item
                14. Principal Accountant Fees and
                Services
            54








-2-
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          of Contents





**PART
      I**





**ITEM
      I.****BUSINESS.**





**Overview**





We
      are an
      international telecommunications carrier that utilizes the Internet to provide
      cost-efficient and economical international telecommunications 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 telephony services. Our services are as
      follows:





*Carrier
      Services:* We
      provide VoIP termination services to United States and Latin American
      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.




*Network
      Services:* We
      provide private communication links and VoIP gateway services to multi-national
      and Latin American 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 their own
      telecommunication network. 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.





*Communication
      Services:* We
      provide retail local phone service and international VoIP long distance service
      to the U.S. Hispanic market throughout Texas, mainly in the Rio Grande Valley.
      Our local phone service includes access to a landline and value-added services
      such a caller ID and call waiting. These services are offered to our customers
      on both a prepaid and postpaid basis. Additionally, we provide prepaid domestic
      and long-distance services; under these services we allow our customers to
      access our prepaid VoIP network platform. The customer will access this platform
      and be able to complete the call by using their local phone number as their
      “PIN” or personal identification number.





On
      August
      1, 2004, we acquired a
      Competitive Local Exchange Carrier (“CLEC”) based in South Texas. This
      acquisition served as a gateway to reach out to the Hispanic communities
      residing along the US and Mexico border. Our strategy is to provide reliable
      and
      affordable local and long distance services to the underserved Hispanic
      community through Texas. Our entry to the retail services under our TeleFamilia
      brand and subsidiary will allow us to leverage our existing international VoIP
      network with additional services that have the potential to deliver higher
      margins than our wholesale international VoIP services. We have deployed various
      postpaid and prepaid retail services and generated approximately $94,500 in
      retail services revenue during the fiscal year ended July 31, 2005.





Additionally,
      during the third quarter of Fiscal year 2005, we expanded our
      NexTone ’ Communications Session Controller (soft-switch) by 50% to enhance our VoIP
      network. This network expansion has allowed us to route our traffic more
      efficiently, improve our call processing, monitor quality of service and enable
      us to share port resources with our customers. The NexTone technology has
      allowed us to be more competitive and to improve our margins in our wholesale
      international telecommunication services. As a result of these enhancements
      to
      our VoIP Network our customer base has grown to approximately 45 customers
      and
      our revenue increased from $1,254,000 during the year ended July 31, 2004 to
      $6,011,000 for the year ended July 31, 2005.




-3-
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We
      have
      had operating losses for almost every quarter since we began operations in
      1994. Our
      operating losses from continuing operations were approximately $2,224,000 and
      $8,485,000, for the years ending July 31, 2005 and 2004, respectively.
      Additionally, we had a working capital deficit of approximately $5,428,000
      at
      July 31, 2005. We
      have
      experienced difficulty in paying our vendors and lenders on time in the past,
      and we expect this trend to continue over the next 12 months as we continue
      to
      rebuild our operations. Moreover, we are currently pursuing various alternatives
      including equity offerings, exchanging some portion or all of our debt for
      equity, and restructuring our debt to extend the maturity. However, in the
      event
      we fail to execute on our current plan or that circumstances currently unknown
      or unforeseen by us arise, we may not succeed in re-capitalizing the Company
      or
      be able to obtain additional funding to allow us to meet our
      obligations.





Due
      to
      the recurring losses, negative cash flows generated from our operations and
      our
      substantial working capital deficit, our auditor’s opinion on our financial
      statements as of July 31, 2005 calls attention to substantial doubts about
      our
      ability to continue as a going concern. This means that there is substantial
      doubt that we will be able to continue in business through the end of our next
      fiscal year, July 31, 2006. In order to remain a going concern, we intend to
      attract new customers to generate additional revenues and/or generate cash
      from
      debt or equity offerings. There is no assurance that we will be able to obtain
      sufficient additional customers or funding to continue as a going concern.





As
      a
      result of the recurring losses negative cash flows from operations and our
      substantial working capital deficit, during the fiscal year ended July 31,
      2005
      management continued to pursue different avenues for funding and we entered
      into
      various short-term convertible promissory notes in the aggregate amount of
      $514,000. These funds have allowed the Company to pay those operating and
      corporate expenses that were not covered by our current cash inflows from
      operations. We will continue to require additional funding until the cash
      inflows from operations are sufficient to cover the monthly operating expenses.
      There is no assurance that we will be successful in securing additionally
      funding over the next twelve months.





**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 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
      our fiscal year ending July 31, 2005:





·
            On
                August 1, 2004, we acquireda
                Competitive Local Exchange Carrier (“CLEC”) based in South Texas. This
                acquisition served as a gateway to reach out to the Hispanic communities
                residing along the US and Mexico border. Our strategy is to provide
                reliable and affordable local and long distance services to the
                underserved Hispanic community through Texas utilizing our VoIP
                infrastructure.





·
            We
                expanded our NexTone’Communications Session Controller (soft-switch) by 50% to enhance
                our
                Voice over Internet Protocol (VoIP) network. This network expansion
                has
                allowed us to route our traffic more efficiently, improve our call
                processing, monitor quality of service and enable us to share port
                resources with our customers. The NexTone technology has allowed
                us to be
                more competitive and to improve margins in our wholesale international
                telecommunication services. As a result of these enhancements to
                our VoIP
                Network our customer base has grown to approximately 45 customers
                and our
                revenue increased from $1,254,000 during the year ended July 31,
                2004 to
                $6,011,000 for the year ended July 31, 2005.






-4-
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          of Contents




**Services
      and Products**





We
      provide three types of services: Carrier Services, Network Services and
      Communication Services.




*Carrier
      Services*





We
      provide VoIP termination services to United States and Latin American
      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. We also provide 800
      toll-free voice origination services from Mexico. ** Typically these telecommunications companies offer their services to the public
      for local and international long distance services. Revenues from this service
      accounted for approximately 81% of our total revenue in the year ended July
      31,
      2004 (“fiscal 2004”) and 96% of our total revenue in the year ended July 31,
      2005 (“fiscal 2005”). The percentage of our total volume of carrier services
      traffic sent by customers can fluctuate dramatically, on a quarterly, and
      sometimes, daily basis. Historically, a handful of customers have accounted
      for
      a majority of the total carrier services volume, although not necessarily the
      same customers from period to period. During fiscal 2005, we entered into
      various reciprocal agreements with our customers that allow them to transport
      and terminate traffic over our network and allowed us to transmit and terminate
      traffic over their networks. These reciprocals agreements with our customers
      were not for a specific period of time or volume of minutes. Under the
      reciprocal agreements, both parties were given a set of rates for services
      and
      each party would decide the volume of minutes it would send to be process.
      Therefore on a month-to-month basis there was not a required volume commitment
      of minutes from each party and the parties were free to re-route their traffic
      away to a lower priced provider.




*Network
      Services*





We
      provide private communication links and VoIP gateway services to multi-national
      and Latin American 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. During
      fiscal 2005 we provided network services to Bell Canada, a Canadian corporation
      on a month-to-month basis and generated approximately $23,000 per month in
      revenue. As of May 2005 we are no longer providing these services to the Bell
      Canada. We currently provide network Services to World Data, a Mexican
      corporation on a month-to-month basis and generate approximately $1,500 per
      month in revenue. There is no assurance that we will continue to generate this
      level of revenue in the future or that we will be able to enter into a long-term
      contract with World Data or any other customer.





We
      compete with MCI and ** AT&T,
      as well as the former telecommunication monopolies in the Latin American
      countries, in providing network services. Factors contributing to our
      competitiveness include reliability, network quality, speed of installation,
      and
      in some cases, geography, network size, and hauling capacity. We are at a
      competitive disadvantage with respect to larger carriers who are able to provide
      networks for corporations that encompass more countries in Latin America, as
      well as Europe, Asia and other parts of the globe. As a result of these
      disadvantages we do not expect a significant increase in revenue from this
      source in the near future.




-5-
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*Communication
      Services*





We
      provide local phone service and international VoIP long distance service to
      the
      U.S. Hispanic market in Texas, through our wholly owned subsidiary, Telefamilia
      Communications, Inc. Our local phone service includes value-added services
      such
      a caller ID and call waiting.





On
      August
      1, 2004, we acquired a
      Competitive Local Exchange Carrier (“CLEC”) based in South Texas. This
      acquisition served as a gateway to reach out to the Hispanic communities
      residing along the US and Mexico border. Revenues
      from this service accounted for approximately 1.5% of our total revenue in
      the
      year ended July 31, 2005. ** We
      have
      deployed various postpaid and prepaid retail services and generated
      approximately $94,500 in retail services revenue during the fiscal year ended
      July 31, 2005




**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 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 in the direction of its destination and they automatically
      route packets around blockages, congestion or outages.





Packet
      switching is a method of transmitting messages that 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 allows for the integration of voice, data traffic and
                images
                into the same network.





·
            **Simplification:**An
                integrated infrastructure that supports all forms of communication
                allows
                more standardization and less equipment management. The result is
                a fault
                tolerant design.





·
            **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.




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The
      growth of voice on 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, new software
      algorithms and improved hardware have substantially reduced delays in packet
      transmissions and the effect of these delays. 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 deploy on their own. This mandates that the network be
      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 appears to have 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 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. There are several large and numerous small competitors, and 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, quality of service, coverage,
      customer service, reliability, and network size/capacity. Our competitors
      include major and emerging telecommunications carriers in the U.S. and foreign
      telecommunications carriers. The financial difficulties of many
      telecommunications providers are rapidly altering the number, identity and
      competitiveness of the marketplace, and we are unable to determine with
      certainty the eventual result of the consolidation occurring in our
      industry.




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During
      the past several years, a number of companies have introduced services that
      make
      Internet telephony or voice services over the Internet available to other
      carriers. All major telecommunications companies either presently or could
      potentially route traffic to destinations worldwide and compete or can compete
      directly with us. Other Internet telephony service providers focus on a retail
      customer base and may in the future compete with us in the carrier services
      business. In addition, 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 potentially migrate
      into
      the Internet telephony market as direct competitors.





Carriers
      buying wholesale termination into Mexico, while cost conscious, are increasingly
      demanding high reliability and quality in service delivery. Sustainability
      and
      growth in this segment depends on specific competitive advantages that companies
      may possess in specific markets. Competitive advantages like proper licenses,
      network redundancy, favorable termination agreements, or the presence of a
      business infrastructure and relationships in the specific terminating market.
      The Company competes with the dominant providers, such as Qwest and MCI, as
      well
      as other, smaller providers for international long distance services to Mexico.
      The Company believes that in contrast to the dominant providers, it has a much
      more focused and cost competitive strategy that targets select higher margin
      telecommunication niches utilizing VoIP technology. Certain carriers provide
      termination services in Mexico at lower prices (e.g., $0.015 to $0.06) because
      they contract with other carriers that “leak” into the local network using
      unlicensed IP points of presence. These carriers, however, have several
      disadvantages including: (i) generally poor quality, (ii) limited
      capacity, and (iii) poor reliability, since Mexican authorities
      periodically shut down their operations. Additionally, there are a few market
      trends that affect our wholesale product’s competitiveness in the market. First,
      unauthorized, non-conventional operators continue to have a major impact by
      offering prices below real costs. Second, the elimination of settlement rates
      in
      Mexico continues to drive down costs. The result of this trend is a significant
      reduction in revenue per minute. The combination of non-conventional termination
      and the new settlement rates have reduced U.S to Mexico termination prices
      from
      an average price of $0.27 per minute in 1998 to a current $0.045 per minute.





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. A large
      number of telecommunications companies, including MCI and Qwest currently
      provide wholesale voice telecommunications service which competes with our
      business. These companies, which tend to be large entities with substantial
      resources, generally have large budgets available for research and development,
      and therefore may further enhance the quality and acceptance of the transmission
      of voice over the Internet.





Our
      strategy is to position ourselves to take advantage of the demonopolization
      of
      the Latin American telecommunications markets, as well as the increasing demand
      for international communications services between these markets and the United
      States. Historically, telecommunications services in Latin America have been
      provided by state-run companies, operating as a legal or *de
      facto* monopoly. Although these companies failed to satisfy the demand for services
      in
      their countries, the regulatory scheme effectively precluded competition by
      foreign carriers. Currently, there is a trend toward demonopolization of the
      telecommunications industry in Latin America, and many of these countries are
      in
      various stages of migration toward a competitive, multi-carrier market. Many
      Latin American countries produce a significant number of immigrants to the
      United States, or are becoming homes to U.S. based corporations seeking lower
      labor costs. At the same time that Latin American markets have been opening
      up,
      the demand for telecommunications services between the United States and Latin
      America (particularly Mexico) has been strengthened by:





·
            the
                rapid growth of the Latino segment of the United States population


·
              Mexico’s
                  status as the top calling partner with the United States


·
            increase
                in trade and travel between Latin America and the United States


·
              the
                  build-out of local networks and corresponding increase in the number
                  of
                  telephones in homes and businesses in Latin countries


·
            proliferation
                of communications devices such as faxes, mobile phones, pagers, and
                personal computers


·
              declining
                  rates for services as a result of increased competition.




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Our
      strengths include our knowledge of, and relationships within, the
      telecommunications industry in the United States and certain countries within
      Latin America, particularly Mexico. Our management and employees have in-depth
      knowledge of the Mexican culture, business environment and telecommunications
      industry. As a result, we have been able to obtain a key long distance
      concession through our 49% ownership in ATSICOM that allows us to both generate
      and carry traffic within Mexico and between Mexico and the United States.





**Government
      Regulation / Concession License**





**Regulation
      of Internet Telephony**





Our
      operations are subject to federal, state and foreign laws and regulations. The
      use
      of the Internet to provide telephone service is a fairly recent market
      development. At present, we are not aware of any domestic, and only aware of
      a
      few foreign, laws or regulations that prohibit voice communications over the
      Internet.





*United
      States.*





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 actively regulated by the Federal
      Communications Commission (FCC) or any state agencies charged with regulating
      telecommunications carriers. Nevertheless, aspects of our operations may be
      subject to state or federal regulation, including regulation 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 *.*





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. While the FCC has
      presently refrained from such regulation, the regulatory classification of
      Internet telephony remains unresolved. Additionally, the FCC has expressed
      an
      intention to further examine the question of whether certain forms of
      phone-to-phone 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 mechanisms for contributing to the Universal Service Fund,
      issues as to applicability of access charges and other matters will be
      considered in that context.





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 requirements to make universal service
      contributions, and pay access charges to local telephone companies. A decision
      to impose such charges could also have retroactive effect, which could
      materially adversely affect us. 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. Congressional dissatisfaction with FCC conclusions could result in
      requirements that the FCC impose greater or lesser regulation, which in turn
      could materially adversely affect our business, financial condition, operating
      results and future prospects.





State
      regulatory authorities may also retain jurisdiction to regulate certain aspects
      of the provision of intrastate Internet telephony services. Several state
      regulatory authorities have initiated proceedings to examine the regulation
      of
      such services. Others could initiate proceedings to do so.




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





Congress
      has recently adopted 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.





R *egulations
      pertaining to our retail operations.*





In
      the
      United States, services provided through our retail operations are subject
      to
      the provisions of the Communications Act of 1934, as amended, the FCC
      regulations, and the applicable laws and regulations of the various states
      and
      state regulatory commissions.




As
      a
      carrier offering services to the public, we must comply with the requirements
      of
      common carriage under the Communications Act of 1934, including the offering
      of
      service on a nondiscriminatory basis at just and reasonable rates, and obtaining
      FCC approval prior to any assignment of authorizations or any transfer of legal
      or actual control of the company.




We
      are
      subject to various specific common carrier telecommunications requirements
      set
      forth in the FCC’s rules, including operating, reporting and fee requirements.
      Both federal and state regulatory agencies have broad authority to impose
      monetary and other penalties on us for violations of regulatory
      requirements.





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.




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 user or consumer, VOIP services we may provide
      to the consumer in the future is 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 or whether any of the
      VOIP
      services should be subject to universal service contribution and 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 8 th Circuit
      ruled that such VOIP provider’s service is an information service and not
      subject to state regulation. The FCC continues to examine the appropriate
      regulatory treatment of VOIP. While initial indications from the FCC suggest
      that any 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.




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State
      Regulation.    Our intrastate long distance operations
      are
      subject to various state laws and regulations, including, in most jurisdictions,
      certification and tariff filing requirements. Telefamilia Communications, Inc.
      (Telefamilia), a wholly owned subsidiary of ours, maintains the necessary
      certificate and tariff approvals, where approvals are necessary, to provide
      intrastate long distance service in Texas. Telefamilia also maintains the
      necessary certificate to provide local services in Texas. Texas requires prior
      approval or notification for certain stock or asset transfers or
      for
      the issuance of securities, debt or for name changes. As a certificated carrier,
      consumers may file complaints against us at the public service commissions.
      Certificates of authority can generally be conditioned, modified, canceled,
      terminated, or revoked by state regulatory authorities for failure to comply
      with state law and/or the rules, regulations and policies of the state
      regulatory authorities. Fines and other penalties also may be imposed for such
      violations. Public service commissions also regulate access charges and other
      pricing for telecommunications services within each state. The RBOCs and other
      LECs have been seeking reduction of state regulatory requirements, including
      greater pricing flexibility, which, if granted, could subject us to increased
      price competition. We may also be required to contribute to universal service
      funds in Texas.





*International.*




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. Finally, 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.





*Other
      General regulations*





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.
      Given their extensive resources and established customer bases, the entry of
      the
      BOCs into the long distance market, specifically the international market,
      will
      create 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 share telephone lines with local telephone companies and 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 our 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.




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*Mexico*





The
      Secretaría de Comunicaciones y Transportes or the SCT and COFETEL (Comisión
      Federal de Telecomunicaciones or Federal Telecommunications Commission) have
      issued ATSICOM a 30-year license granted in June 1998 to install and operate
      a
      public network. Under this license, ATSI Comunicaciones S.A de C.V. is required
      to meet the following:




General
      requirements





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





·
            Install
                and operate a network in Mexico. The Mexican government will need
                to
                approve the operating plan before it is implemented; additionally
                the
                Mexican government will need to approve any future changes to the
                operating plan before it can be implemented.





·
            Continuously
                develop and conduct training programs for its staff.





·
            The
                Concessionaire at all times needs to have an assigned individual
                responsible for the technical functions to operate the concession.





Concession
      services requirements





·
            The
                Concessionaire is required to provide continuous and efficient services
                at
                all times to its customers.





·
            The
                Concessionaire must establish a complaint center and correction facilities
                center. We are required to report to the Mexican Government on a
                monthly
                basis the complaints received and the actions taken to resolve the
                problems.




Tariff
      Requirements





·
            The
                Concessionaire will only be authorized to invoice its customer’s tariffs
                rates that have been approved by the Mexican
                government.




Verification
      and Information requirements




·
            The
                Concessionaire is required to provide audited financial statements
                on a
                yearly basis that includes a detailed description of the fixed assets
                utilized in the network and accounting reporting by region and location
                of
                where the services are being provided.





·
            The
                Concessionaire is required to 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.





·
            The
                Concessionaire is required to provide statistic reports of traffic,
                switching capacity and other parameters in the
                network.





Guarantee
      requirements





The
      Concessionaire is required to have a bond/ insurance policy for approximately
      $500,000, where the Mexican Federal Treasury Department will be the beneficiary
      in the event the Mexican government revokes the concession license.




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**Suppliers**





We
      rely
      on various suppliers to provide services in connection with our communication
      services. We depend on various Global VoIP companies to complete our voice
      over
      Internet (VoIP) traffic between US, Mexico,
      Asia, the Middle East and Latin America. Our critical
      suppliers include, Bestel, Anuera Communciations, Inc. and WireGlobe
      Communications.





**Employees**





As
      of
      July 31, 2005, we had 5 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
      2.****PROPERTIES.**





Our
      executive office is located at 8600 Wurzbach Rd. Suite 700W, San Antonio, Texas,
      consisting of 3,042 square feet. The lease for this facility will expire on
      April 30, 2006. We pay annual rent of $42,560. Management believes that our
      leased facilities are suitable and adequate for their intended use.





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




On
      October 31, 2002, we filed a lawsuit in the United States District Court for
      the
      Southern District Court of New York against several individuals and financial
      institutions, including the holders of our Series D and E Redeemable Preferred
      Stock, for, among other things, stock fraud and manipulation. On February 25,
      2005, Judge Lewis A. Kaplan issued a memorandum opinion and order dismissing
      the
      complaint as to all defendants with prejudice. We plan to appeal that decision
      once a final judgment has been entered. On July 9, 2004, we filed a separate
      but
      related lawsuit in the same court against Sam Levinson and Uri Wolfson. On
      April
      27, 2005, the court entered a final judgment dismissing that action with
      prejudice based on the February 25, 2005 decision in the first action. On May
      25, 2005, we appealed the dismissal of the second action to the United States
      Court of Appeals for the Second Circuit. On September 9, 2005 we appealed the
      dismissal of the first action to the United States Court of Appeals for the
      Second Circuit. Our attorneys are also in the process of investigating whether
      any other institutions participated in the manipulation of the company's stock
      and to advise us whether to pursue other legal proceedings. Currently we cannot
      predict the outcome of this litigation or
      the
      financial impact on our ongoing operations.




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On
      February 3, 2005 Helen G. Schwartz, Trustee for ATSI Communications, Inc. (a
      Texas corporation) and TeleSpan, Inc. filed in the U.S. Bankruptcy Court for
      the
      Western District of Texas an Adversary Proceeding against ATSI Communications,
      Inc., a Nevada corporation alleging that ATSI-Nevada had received preferential
      payments as defined by the U.S. Bankruptcy Code in the amount of $510,836.
      On
      March 31, 2005, ATSI filed its response denying any such payments were received
      by ATSI Nevada, formerly ATSI Delaware. On August 29, 2005 the U.S. Bankruptcy
      Court for the Western District of Texas dismissed this proceeding against ATSI
      Communications, Inc., a Nevada Corporation for lack of merit.





On
      March
      28, 2005, we entered into a Settlement Agreement, which resolved all claims
      in
      the case filed in the 407 th Judicial
      District Court of Bexar County Texas by with James C. Cuevas, Raymond G. Romero,
      Texas Workforce Commission and ATSI-Texas for unpaid wages. The Board of
      Directors met on April 28, 2005 and approved the Settlement Agreement. As part
      of the settlement, we subsequently issued 169,280 shares of our common
      stock.




In
      January 2004, we filed a petition in the 150 th Judicial
      District of Bexar County, Texas against Inter-tel.net, Inc. and Vianet
      Communications, Inc. d/b/a Inter-tel.net seeking declaratory relief that ATSI
      Communications, Inc. is not bound by the Carrier Services Agreement between
      Vianet Communications, Inc. and ATSI-Texas. On February 27, 2004 the Bankruptcy
      Court in the ATSI-Texas Bankruptcy case allowed Vianet Communications, Inc.
      to
      amend its claim against ATSI-Texas that was pending in the Bankruptcy of
      ATSI-Texas and assert its claim for breach of contract against ATSI. The
      Bankruptcy Court then ordered the lawsuit to be remanded back to state court
      for
      hearing. On August 10, 2005 a settlement was reached with Vianet Communications.
      As part of the settlement, we issued 200,000 warrants to purchase ATSI stock,
      the exercise price on the warrants range from $0.12 to $0.23. Additionally,
      we
      issued 200,000 shares of Series H preferred Stock that can be converted into
      1.2
      shares of common stock after it’s been held for (1) one year and into 1.5 shares
      of common stock if held for (2) two years.





On
      June
      17, 2005, ATSI Communications, Inc. filed an arbitration claim against Ntera
      Holdings, Inc. for $100,000 and attorney’s fees. The claim is associated with a
      dispute over supposed debt incurred under a Reciprocal Network Carrier Service
      Agreement between the parties. On July 7, 2005 Ntera Holdings, Inc. filed a
      counterclaim. Under the arbitration claim we are not disputing all of the
      alleged indebtedness but we are alleging the offset of services and that the
      payment should be in the form of exchange of services, as implied in the
      Reciprocal Network Carrier Service Agreement with Ntera Holdings, Inc. Currently
      we can not predict the result of the arbitration or the financial impact on
      our
      ongoing operations.




We
      may
      become a party to future claims and legal proceedings arising in the ordinary
      course of business. Due to the inherent uncertainty of litigation, the range
      of
      possible loss, if any, cannot be estimated with a reasonable degree of precision
      and there can be no assurance that the resolution of any particular claim or
      proceeding would not have an adverse effect on our results of operations in
      the
      period in which it occurred.





**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.**





(a)
            Market
                for Common Equity




Our
      common stock is quoted on the OTC Bulletin Board under the symbol “ATSX”. From
      May 9, 2003 through July 31, 2004 our common stock traded in the pink sheets
      under the symbol “ATSC”. Prior to January 15, 2003, our common stock was quoted
      on the AMEX under the symbol “AI”. Our Series H Preferred Stock is not traded on
      any market. The following table sets forth the high and low bid prices for
      our
      common stock from August 1, 2003 through July 31, 2005 as reported by OTC
      bulletin board. 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. All stock prices for Fiscal 2004 have been
      adjusted to reflect the 1:100 reverse split effective on May 24,
      2004.




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**Fiscal
                2004**
            
            **High**
            
            **Low****First****Quarter**
            
            $
            2.00
            
            $
            2.00**Second
                Quarter**
            
            $
            1.00
            
            $
            1.00**Third
                Quarter**
            
            $
            1.00
            
            $
            1.00**Fourth
                Quarter**
            
            $
            6.00
            
            $
            1.25**Fiscal
                2005**
            
            
            **High**
            
            
            **Low****First****Quarter**
            
            $
            1.20
            
            $
            0.56**Second
                Quarter**
            
            $
            1.25
            
            $
            0.48**Third
                Quarter**
            
            $
            0.92
            
            $
            0.21**Fourth
                Quarter**
            
            $
            0.32
            
            $
            0.16





(b)
              Holders


As
      of
      July 31, 2005, we had approximately 8,169 common shareholders of record. This
      amount does not include shares held in street name.





(c)
            Dividends





We
      have
      never paid any cash dividends on our common stock. Additionally, the terms
      of
      our Series A, Series D and Series E Preferred Stock restrict us from paying
      dividends on our common stock until such time as all outstanding dividends
      have
      been fulfilled related to each series of preferred stock. There are presently
      a
      total of $1,296,237 in unpaid dividends payable on outstanding series of
      preferred stock. Consequently, we do not anticipate paying any cash dividends
      in
      the foreseeable future.




(d)
            Securities
                issued under Equity Compensation
                Plans




The
      following table provides information relating to the grant of stock, options,
      and warrants pursuant to equity based compensation plans as of July 31, 2005.
      A
      description of each equity compensation plan adopted by the Company is included
      in the Notes to the Consolidated Financial Statements contained in this
      report.




**Plan
                Category**
            
            **Number
                of Securities to be Issued upon Exercise of Outstanding Options,
                Warrants
                and Rights**
            
            **Weighted-average
                Exercise Price of Outstanding Options, Warrants and
                Rights**
            
            **Number
                of Securities Remaining Available for Future Issuance Under Equity
                Compensation Plans (excluding securities reflected in column
                (a))**(a)
            
            (b)
            
            (c)**Equity
                Compensation Plans Not**
              **Approved
                by Security Holders**
            
            
            303,140
            
            
            $0.25
            
            
            1,054,149**Total**
            
            
            303,140
            
            
            $0.25
            
            
            1,054,149






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(e)
              Sales
                  of Unregistered Securities





During
      the year ended July 31, 2004, prior to the reincorporation to the state of
      Nevada, ATSI issued 400,965 common shares. Of this total, 101,786 shares were
      issued as a result of the conversions of ATSI’s Series F Preferred Stock and
      accumulated dividends, 297,974 shares were issued as a result of the conversion
      of ATSI’s Series G Preferred Stock and accumulated dividends, and 1,205 shares
      were issued as a result of the conversion of ATSI’s Series A Preferred Stock.
      All shares were exempt from registration pursuant to Section 3(a)(9) of the
      Securities Act of 1933 as an exchange for other securities issued by the Company
      in which no person was paid any consideration.





Also
      during the year ended July 31, 2004, 165 shares were issued for services
      rendered to ATSI. These shares were exempt from registration pursuant to Section
      4(2) of the Securities Act of 1933 since they were issued in a transaction
      not
      involving a public offering.





On
      May 6,
      2004 ATSI’s stockholders approved the reincorporation of ATSI in Nevada through
      the merger of the Company into a wholly owned subsidiary, ATSI Merger
      Corporation. As a result of the merger, ATSI’s stockholders of record as of May
      24, 2004 received one (1) share of New ATSI Common Stock and ten (10) shares
      of
      New ATSI Series H Convertible Preferred Stock for each 100 shares of Old ATSI
      Common Stock surrendered. As a result of the merger ATSI exchanged 143,751,710
      common shares of the Old ATSI for 1,437,517 shares of the New ATSI Common stock
      and 14,385,000 shares of the New ATSI Series H Convertible Preferred Stock.
      These shares were exempt from registration pursuant to Rule 145 and Rule 414
      under the Securities Act of 1933 as an exchange for the purpose of changing
      the
      domiciling the Company.





On
      August
      1, 2004, we issued 40,000 shares of our common stock for the acquisition of
      Hinotel, Local Exchange Carrier (“CLEC”) based in South Texas. These shares were
      issued pursuant to an exemption from registration under Section 4(2) of the
      Securities Act because of the limited size of the group, the direct relationship
      between us and the individuals to whom they were issued, the absence of public
      solicitation or advertising, and restrictions on resale of the
      shares.





On
      October 1, 2004, we issued 687,600 shares of our common stock for the settlement
      of debt of approximately $859,500 with Alfonso Torres Roqueni; this debt was
      associated with the acquisition of the concision license in July 2000. These
      shares were issued pursuant to an exemption from registration under Section
      4(2)
      of the Securities Act because of the limited size of the group, the direct
      relationship between us and the individuals to whom they were issued, the
      absence of public solicitation or advertising, and restrictions on resale of
      the
      shares.





On
      October 26, 2004, we issued 30,000 shares of our common stock for the settlement
      of a note payable of approximately $250,000 with Infraestructura
      Espacial, S.A de C.V. and Tomas Revesz, a former ATSI director. These
      shares were issued pursuant to an exemption from registration under Section
      4(2)
      of the Securities Act because of the limited size of the group, the direct
      relationship between us and the individuals to whom they were issued, the
      absence of public solicitation or advertising, and restrictions on resale of
      the
      shares.





On
      April
      28, 2005, we issued 169,280 shares of our common stock in settlement of all
      claims made by James C. Cuevas, Raymond G. Romero, Texas Workforce Commission
      and ATSI-Texas for unpaid wages. These shares were issued pursuant to an
      exemption from registration under Section 4(2) of the Securities Act because
      of
      the limited size of the group, the direct relationship between us and the
      individuals to whom they were issued, the absence of public solicitation or
      advertising, and restrictions on resale of the shares.




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





*SPECIAL
      NOTE: This Annual Report on Form 10-KSB contains “forward-looking statements”
      within the meaning of Section 27A of the Securities Act of 1933, as amended
      and
      Section 21E of the Securities and Exchange Act of 1934, as amended. “Forward
      looking statements” are those statements that describe management’s beliefs and
      expectations about the future. We have identified forward-looking statements
      by
      using words such as “anticipate,”“believe,”“could,”“estimate,”“may,”“expect,”
      and “intend.” Although we believe these expectations are reasonable, our
      operations involve a number of risks and uncertainties, including those
      described in the Additional Risk Factors section of this Annual Report Form
      10-KSB and other documents filed with the Securities and Exchange Commission.
      Therefore, these types of statements may prove to be incorrect.*





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,
      2005 and 2004. 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-KSB. For purposes of the following
      discussion, fiscal 2005 or 2005 refers to the year ended July 31, 2005 and
      fiscal 2004 or 2004 refers to the year ended July 31, 2004.





**Sources
      of revenue and direct cost**





*Sources
      of revenue:*





Carrier
      Services: **  We
      currently provide transmission and termination 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 local
      and international long distance services.





Network
      Services:  We
      provide private communication links and VoIP gateway services to multi-national
      and Latin American 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.




Communication
      Services *:* We
      provide retail local phone service and international VoIP
      long
      distance service to the U.S. Hispanic market throughout Texas, mainly in the
      Rio
      Grande Valley. Our local phone service includes access to a landline and
      value-added services such a caller ID and call waiting. These services are
      offered to our customers on both a prepaid and postpaid basis. Additionally,
      we
      provide prepaid domestic and long-distance services; under these services we
      allow our customers to access our prepaid VoIP network platform. The customer
      will access this platform and be able to complete the call by using their local
      phone number as their “PIN” or personal identification number.





*Direct
      Cost:*





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





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





Communication
      Services: We incur
      charges for local telephone service and related features from the local exchange
      carrier. Additionally, we incur a cost per minute and platform fees from our
      suppliers for long distance services and platform access based on the number
      of
      accounts and calls accessed by our customers.




-17-
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          of Contents




**Results
      of Operations**





The
      following table sets forth certain items included in our results of operations
      in thousands of dollar amounts and as a percentage of total revenues for the
      years ended July 31, 2005 and 2004.





Years
                ended July 31,2005
            
            2004$
            
            %
            
            $
            
            %Operating
                revenuesServicesCarrier
                services
            
            $
            5,782
            
            
            96
            %
            $
            1,020
            
            
            81
            %Network
                services
            
            
            229
            
            
            4
            %
            
            234
            
            
            19
            %Total
                operating revenues
            
            
            6,011
            
            
            100
            %
            
            1,254
            
            
            100
            %Cost
                of services (exclusive of depreciation and amortization, shown
                below
            
            
            5,664
            
            
            94
            %
            
            1,071
            
            
            85
            %Gross
                Margin
            
            
            347
            
            
            6
            %
            
            183
            
            
            15
            %Selling,
                  general and administrativeExpense
            
            
            517
            
            
            9
            %
            
            584
            
            
            47
            %Legal
                and professional fees
            
            
            417
            
            
            7
            %
            
            303
            
            
            24
            %Non-cash
                issuance of common stock and warrants for services
            
            
            1,047
            
            
            17
            %
            
            7,055
            
            
            563
            %Non-cash
                stock-based compensation, employees
            
            
            474
            
            
            8
            %
            
            –
            
            
            0
            %Impairment
                expense
            
            
            –
            
            
            0
            %
            
            702
            
            
            300
            %Bad
                debt expense
            
            
            4
            
            
            0
            %
            
            4
            
            
            0
            %Depreciation
                and amortization
            
            
            112
            
            
            2
            %
            
            20
            
            
            2
            %Operating
                loss
            
            
            (2,224
            )
            
            -37
            %
            
            (8,485
            )
            
            -677
            %Debt
                forgiveness income
            
            
            460
            
            
            8
            %
            
            257
            
            
            0
            %Gain
                on disposal of investment
            
            
            12,104
            
            
            201
            %
            
            –
            
            
            0
            %Other
                income (expense)
            
            
            (44
            )
            
            -1
            %
            
            (241
            )
            
            -19
            %Net
                income (loss)
            
            
            10,296
            
            
            171
            %
            
            (8,469
            )
            
            -675
            %Less:
                preferred stock dividends
            
            
            (709
            )
            
            -12
            %
            
            (306
            )
            
            -24
            %Net
                  income (loss) to applicable tocommon shareholders
            
            $
            9,587
            
            
            159
            %
            
            ($8,775
            )
            
            -700
            %






-18-
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          of Contents





**Year
      Ended July 31, 2005 Compared to Year ended July 31, 2004**





*Operating
      revenues.* Consolidated operating revenues increased by 379% between periods from $1.3
      million for the year ended July 31, 2004 to $6.0 million for the year ended
      July
      31, 2005.




Carrier
      services revenues increased by approximately $4.7 million, or 466% from the
      year
      ended July 31, 2004 to the year ended July 31, 2005. Our VoIP carrier traffic
      increased from approximately 25.8
      million minutes during the year ended July 31, 2004 to
      approximately 149 million minutes during the year ended July 31, 2005. The
      increase in revenue and carrier traffic can mainly be attributed to the growth
      in VoIP carrier services since the implementation of the NexTone VoIP
      soft-switch during the last quarter of fiscal 2004.




Network
      services revenues decreased approximately 2% or $5,000 from the year ended
      July
      31, 2004 to the year ended July 31, 2005. The decrease in network services
      revenue is primarily due to termination of the network service agreement with
      our major customer for this service. A s
      a
      result we expect a reduction of network service revenue by $22,000 per month.





Communication
      services revenues increased by 1% or $94,500 from the year ended July 31, 2004
      to the year ended July 31, 2005. The increase in local and long distance retail
      services is primarily due to the acquisition in August
      1,
      2004, of a Competitive Local
      Exchange Carrier (“CLEC”) based in South Texas. This acquisition has served as a
      gateway to reach out to the Hispanic communities residing along the US and
      Mexico border and allowed our local and long distance retail services to grow
      from $0 during fiscal 2004 to $94,500 for the year ended July 31, 2005.





*Cost
      of Services (Exclusive of depreciation and amortization).* The
      consolidated cost of services increased by approximately $4.6 million, or 429%
      from the year ended July 31, 2004 to the year ended July 31, 2005. The increase
      in cost of services is a direct result of the increase in carrier services
      revenue and network services revenue. As mentioned above, our carrier traffic
      increased from approximately 25.8 million minutes during the year ended July
      31,
      2004 to approximately 149 million minutes in the year ended July 31, 2005,
      thus
      increasing our cost of services between periods.





*Selling,
      General and Administrative (SG&A) Expenses* .
      SG&A expenses decreased by approximately $67,000, or 11% from the year ended
      July 31, 2004 to the year ended July 31, 2005. The decrease is attributable
      to
      an adjustment of $108,648 in salaries and wages and a reversal of an
      over-accrual for services previously recognized.




*Legal
      and professional Fees* .
      Legal
      and professional fees increased by approximately $114,000, or 38% from the
      year
      ended July 31, 2004 to the year ended July 31, 2005. The increase is
      attributable to the recognition of approximately $225,000 in professional fees
      associated with a marketing campaign that commenced during the first quarter
      of
      fiscal 2005.




*Non-cash
      issuance of common stock and warrants for services* .
      Non-cash issuance of common stock and warrants for services decreased by
      approximately $6 million from the year ended July 31, 2004 to the year ended
      July 31, 2005. This decrease is primarily due to recognition of approximately
      $7
      million in non-cash compensation expense, this expense was recognized during
      the
      forth quarter of fiscal 2004 and was associated with the consulting agreements
      entered into with certain individual affiliates of Recap Marketing &
      Consulting, LLP.




-19-
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          of Contents





*Non-cash
      stock-based compensation, employees* .
      Non-cash compensation expense to employees increased by $474,000 from the year
      ended July 31, 2004 to the year ended July 31, 2005. This increase is attributed
      to the recognition of approximately $474,000 in non-cash compensation expense
      associated with the grant of stock options and stock grants to our employees
      and
      board of directors.





*Impairment
      Expense.* Impairment
      expense decreased by 100% or $702,000 from the year ended July 31, 2004 to
      the
      year ended July 31, 2005. During the year ended July 31, 2004, in accordance
      with U.S. GAAP we determined
      that the estimated cash flows expected from the concession license was less
      than
      the recorded value. As a result we recorded
      an impairment loss of approximately $702,000 to reduce the recorded value of
      the
      concession license. During the year ended July 31, 2005 we did not recognized
      any impairment expense.





*Bad
      debt expense.* Bad
      debt
      expense remained consistent at $4,000 over the year ended July 31, 2004 and
      the
      year ended July 31, 2005. During the year ended July 31, 2005 we recognized
      $4,000 in bad debt expense associated with the write-off of a carriers services
      customer that ceased operations.





*Depreciation
      and Amortization* .
      Depreciation and amortization increased by $92,000 from the year ended July
      31,
      2004 to the year ended July 31, 2005. The increase is attributed to the
      recognition of depreciation expense and amortization on the NexTone VoIP
      soft-switch that was acquired during the last quarter of fiscal
      2004.





*Operating
      income (loss)* .
      The
      Company’s operating income (loss) decreased by approximately $6.3 million or 74%
      from the year ended July 31, 2004 to the year ended July 31, 2005. This decrease
      is primarily due to recognition of approximately $7 million in non-cash
      compensation expense, this expense was recognized during the forth quarter
      of
      fiscal 2004 and was associated with the consulting agreements entered into
      with
      certain individual affiliates of Recap Marketing & Consulting, LLP.
      Additionally, d uring
      the
      year ended July 31, 2004, in accordance with U.S. GAAP we determined
      that the estimated cash flows expected from the concession license was less
      than
      the recorded value. As a result we recorded
      an impairment loss of approximately $702,000 to reduce the recorded value of
      the
      concession license. During the year ended July 31, 2005 we did not recognized
      any impairment expense.





*Debt
      forgiveness income.* Our
      debt
      forgiveness income increased by approximately $203,000 from the year ended
      July
      31, 2004 to the year ended July 31, 2005. During the year ended July 31, 2005,
      we negotiated and exchanged various liabilities for equity. These settlements
      were related to the settlement of the $859,500 liability with Alfonso Torres
      Roqueni, the former owner of the concession license acquired in July 2000,
      and
      the settlement of a $250,000 note payable with Infraestructura Espacial, S.A
      de
      C.V. and Tomas Revesz, a former ATSI director. The debt forgiveness income
      was
      based on the difference between the market price of ATSI equity at the time
      of
      issuance and the market price calculated at the time of the settlement of the
      debt.




*Gain
      on disposal of investment.* During
      the year ended July 31, 2005, ATSI recognized a gain on disposal of investment
      of approximately $12,104,000. The gain on disposal of investment was associated
      with the disposal of ATSI’s subsidiaries, American TeleSource International,
      Inc. (ATSI Texas) and TeleSpan, Inc. (TeleSpan). These entities filed for
      protection under Chapter 11 of the U.S. Bankruptcy Code on February 4, 2003
      and
      February 18, 2003 respectively. The court ordered joint administration of both
      cases on April 9, 2003 and on May 14, 2003 the court converted the cases to
      Chapter 7. The two bankrupt subsidiaries have ceased operations.





*Other
      income (expense)* .
      Other
      income (expense) decreased by approximately $197,000 or 82% from the year ended
      July 31, 2004 to the year ended July 31, 2005. The decrease in other income
      (expense) is attributed to the decrease in loss in investment in ATSICOM of
      approximately $85,000 recognized during the year ended July 31, 2004 associated
      with our portion of the losses on our investment in ATSICOM. During the year
      ended July 31, 2005 the Company did not incurred any loss in
      ATSICOM.




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*Preferred
      Stock Dividends* .
      Preferred Stock Dividends expense increased by approximately $403,000 between
      periods, from $306,000 for the year ended July 31, 2004 to $709,000 during
      the
      year ended July 31, 2005. The increase in preferred stock dividend expense
      can
      be attributed to the recognition of $557,000 of dividend expense associated
      with
      the Redeemable Preferred Series H Stock, as per the certificate of designation
      the Redeemable Preferred Series H stockholders earns a 20% premium after is
      been
      held under the shareholders name for 1 year from the reincorporation in May
      2004.




*Net
      income (loss) to Common Stockholders* .
      The net
      (loss) for the year ended July 31, 2005 decreased to $9,587,000 net income
      or
      $1.34 per share from $8,775,000 net (loss) or $7.31 (loss) per share for the
      year ended July 31, 2004. The decrease in net (loss) to common stockholders
      is
      mainly attributed to the recognition of a gain on disposal of investment of
      $12,104,000. The gain on disposal of investment was associated with the disposal
      of ATSI’s subsidiaries, American TeleSource International, Inc. (ATSI Texas) and
      TeleSpan, Inc. (TeleSpan). These entities filed for protection under Chapter
      11
      of the U.S. Bankruptcy Code on February 4, 2003 and February 18, 2003
      respectively. The court ordered joint administration of both cases on April
      9,
      2003 and on May 14, 2003 the court converted the cases to Chapter 7. The two
      bankrupt subsidiaries have ceased operations. The gain on disposal of investment
      was offset slightly by the recognition of $1,047,000 in non-cash warrant expense
      and $474,000 in non-cash stock based compensation expense associated with the
      stock options and stock grants awarded to the company employees and board of
      directors. Also, there was an increase in depreciation and amortization of
      approximately $203,000 from the year ended July 31, 2004 to the year ended
      July
      31, 2005.





**Liquidity
      and Capital Resources**




The
      Company’s financials statements for the year ended July 31, 2005 have been
      prepared on a going concern basis, which contemplates the realization of assets
      and the settlement of liabilities and commitments in the normal course of
      business. For the year ended July 31, 2005, the Company reported a net income
      of
      $9,587,000 and has a stockholders deficit as of July 31, 2005 of approximately
      $5.8 million. In addition, the Company has a working capital deficiency of
      $5.4
      million as of July 31, 2005.





*Cash
      used in operating activities:*





During
      the year ended July 31, 2005, operations consumed approximately $561,000 in
      cash, although, the Company recognized a net income of $10.3 million for 2005.
      The net income for fiscal 2005 is attributed to the recognition of $12,104,000
      associated with a gain on disposal of investment and the recognition of $460,000
      of debt forgiveness income associated with the settlement of various debts.
      Additionally, the company recognized $474,000
      in non-cash compensation expense associated with the stock grants and stock
      options awarded to the employees and board of directors. And we recognized
      $1,047,000 in non-cash warrant expense associated with the consulting services
      agreement entered into during fiscal 2005. We also recognized an increase in
      accounts payable and accrued liabilities of approximately $73,000 and $160,000,
      respectively; these increases are related to the recognition of various invoices
      associated with the carrier services cost of goods. Also, we recognized an
      increase in accounts receivables of $145,000 associated with the billing to
      our
      customers during the last week of fiscal 2005. We also recognized an increase
      in
      prepaid expenses for $18,000 related to the prepayments/retainers to our
      attorneys for legal services.





*Cash
      provided used in investing activities:*





During
      the year ended July 31, 2005, the Company made various payments for $8,000
      related to the acquisition of some telecommunications equipment acquired during
      fiscal 2005. Additionally, during the quarter ended October 31, 2004 ,
      ATSI
      entered into an Asset Purchase Agreement with Hinotel, Inc., a Hispanic owned
      Competitive Local Exchange Carrier (“CLEC”) based in South Texas. The assets
      purchase under the agreement included Hinotel’s customer base, a customer
      management and billing system, and supplier contracts. The transaction also
      included the assignment and transfer of the CLEC license in the State of Texas.
      The purchase price of the assets was $31,500, paid in 40,000 shares of ATSI
      common stock and $7,500 in cash.




-21-
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*Cash
      provided by financing activities:*





During
      the year ended July 31, 2005 we made principal payments on our capital lease
      obligation for approximately $2,000 and we received $918,000 from the exercise
      of warrants and $514,000 from proceeds from various notes payables. In addition,
      as result of the exercise of warrants we also recognized payments of $918,000
      on
      our notes payable.





Overall,
      our net operating, investing and financing activities during the year ended
      July
      31, 2005 provided a decrease of approximately $65,000 in cash balances. We
      intend to cover our monthly operating expenses with our remaining available
      cash. Additionally, we will continue to pursue additional equity offerings
      to
      cover our deficiencies in cash reserves. However, there is no assurance that
      we
      will be able to secure the equity offerings required to supplement our
      deficiencies in cash reserves.





Our
      working capital deficit at July 31, 2005 was approximately $5.4 million. This
      represents a decrease of approximately $13,519,000 from our working capital
      deficit at July 31, 2004. The decrease can primarily be attributed to the
      recognition of a gain on disposal of investment of $12,104,000. The gain on
      disposal of investment was associated with the disposal of ATSI’s subsidiaries,
      American TeleSource International, Inc. (ATSI Texas) and TeleSpan, Inc.
      (TeleSpan). These entities filed for protection under Chapter 11 of the U.S.
      Bankruptcy Code on February 4, 2003 and February 18, 2003 respectively, these
      bankrupt subsidiaries ceased all operations. Additionally, the decrease in
      working capital deficit is also attributed to the settlement of various
      liabilities through the issuance of common stock. These
      settlements were associated with the settlement of $859,500 liability with
      Alfonso Torres Roqueni, the former owner of the concession license acquired
      in
      July 2000 and the settlement of a $250,000 note payable with Infraestructura
      Espacial, S.A de C.V. and Tomas Revesz, a former ATSI director.





*Our
      current liabilities include:*





·
            $103,454
                owed to Attorneys for legal services rendered during fiscal 2004.





·
            $1,186,000
                associated with the Series D Cumulative preferred stock. Of this
                balance,
                $942,000 is associated with the full redemption of this security
                and
                $244,000 is related to the accrued dividends as of July 31, 2005.





·
            $1,351,000
                associated with the Series E Cumulative preferred stock. Of this
                balance,
                $1,058,000 is associated with the full redemption of this security
                and
                $293,000 is related to the accrued dividends as of July 31, 2005.
                During
                the fiscal year ended July 31, 2003, the Company was de-listed from
                AMEX
                and according to the terms of the Series E Cumulative preferred stock
                Certificate of Designation, if the Company fails to maintain a listing
                on
                NASDAQ, NYSE or AMEX the Series E preferred stockholder could request
                a
                mandatory redemption of the total outstanding preferred stock. As
                of the
                date of this filing we have not received such redemption
                notice.On
                October 31, 2002, we filed a lawsuit in the United States District
                Court
                for the Southern District Court of New York against several individuals
                and financial institutions, including Rose Glen Capital and Shaar
                Fund,
                the holders of our Series D and E Redeemable Preferred Stock, for,
                among
                other things, stock fraud and manipulation. On February 25, 2005,
                Judge
                Lewis A. Kaplan issued a memorandum opinion and order dismissing
                the
                complaint as to defendants that included the holders of our Series
                D and E
                Redeemable Preferred Stock. We plan to appeal that decision once
                a final
                judgment has been entered. These liabilities combined for a total
                of
                approximately $2,537,000. Accounting rules dictate that these liabilities
                must remain on our books under Current Liabilities until the lawsuit
                is
                resolved in the judicial system or otherwise. At this time we cannot
                predict the outcome or the time frame for this to
                occur.





We
      also
      have approximately $1,152,000 of current liabilities (net of assets) associated
      to the discontinued operations of the retail services unit. This balance is
      composed primarily of approximately $453,000 owed to the Mexican taxing
      authorities related to a note assumed through the acquisition of Computel and
      approximately $699,000 related to income taxes owed as of July 31,
      2005.




-22-
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          of Contents





**Ongoing
      operations**




We
      believe that, based on our limited access to capital resources and our current
      cash balances, financial resources may not be available to support our ongoing
      operations for the next twelve months or until we are able to generate income
      from operations. These matters raise substantial doubt about our ability to
      continue as a going concern. Our ability to continue as a going concern is
      dependent upon the ongoing support of our stockholders and customers, our
      ability to obtain capital resources to support operations and our ability to
      successfully market our services.





As
      outlined in Note 4 to the financial statements, we have incurred amounts of
      debt
      to finance our working capital requirements. During the year ended July 31,
      2005, we borrowed a total of $984,000 from Recap Marketing & Consulting, LLP
      to fund our operating expenses and other corporate expenses. This debt was
      applied to the payment of warrants issued to certain individual affiliates
      of
      Recap Marketing & Consulting, LLP.





We
      will
      continue to pursue cost cutting or expense deferral strategies in order to
      conserve working capital. These strategies will limit the implementation of
      our
      business plan and increase our future liabilities. We are dependent on our
      operations and the proceeds from future debt or equity investments to fund
      our
      operations and fully implement our business plan. If we are unable to raise
      sufficient capital, we will be required to delay or forego some portion of
      our
      business plan, which will have a material adverse effect on our anticipated
      results from operations and financial condition. Alternatively, we may seek
      interim financing in the form of private placement of debt or equity securities.
      Such interim financing may not be available in the amounts or at the time when
      is required, and will likely not be on the terms favorable to the
      Company.




-23-
 Table
          of Contents





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





**INDEX
      TO CONSOLIDATED FINANCIAL
      STATEMENTS**





Page**Consolidated
                Financial Statements of ATSI Communications, Inc. and
                Subsidiaries**Report
                of Malone and Bailey, PC.
            25Consolidated
                Balance Sheet as of July 31, 2004
            26Consolidated
                Statements of Operations for the Years
                Ended July 31, 2005 and 2004
            27Consolidated
                Statements of Comprehensive Income (loss)
                for the Years Ended July 31, 2005 and 2004
            28Consolidated
                Statements of Stockholders’ Deficit for the
                Years Ended July 31, 2005 and 2004
            29Consolidated
                Statements of Cash Flows for the Years
                Ended July 31, 2005 and 2004
            30Notes
                to Consolidated Financial
                Statements
            31






-24-
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          of Contents





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders


ATSI
      Communications, Inc.


San
      Antonio, Texas





We
      have
      audited the consolidated balance sheet of **** ATSI
      Communications, Inc. and subsidiaries (“ATSI”) as of July 31, 2005 and the
      related consolidated statements of operations, comprehensive loss, stockholders’
      deficit and cash flows for the years ended July 31, 2005 and 2004. 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. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of
      ATSI **** as
      of
      July 31, 2005 and the consolidated results of their operations and their cash
      flows for the years ended July 31, 2005 and 2004 in conformity with accounting
      principles generally accepted in the United States of America.





The
      accompanying consolidated financial statements have been prepared assuming
      that
      ATSI will continue as a going concern. As discussed in Note 2 to the
      consolidated financial statements, ATSI has a working capital deficit, has
      suffered recurring losses and has a stockholders’ deficit. These conditions
      raise substantial doubt about ATSI’s ability to continue as a going concern.
      Management's plans in regard to these matters are also described in Note 2.
      The
      consolidated financial statements do not include any adjustments that might
      result from the outcome of this uncertainty.








MALONE
      & BAILEY, PC


www.malone-bailey.com


Houston,
      Texas





September
      9, 2005







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ATSI
                  COMMUNICATIONS, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  BALANCE SHEET(in
                  thousands, except share
                  information)
  July
                  31,2005ASSETSCURRENT
                ASSETS:Cash
                  and cash equivalents
              
              $
              29Accounts
                  receivable
              
              
              170Prepaid
                  & other current assets
              
              
              44Total
                  current assets
              
              
              243PROPERTY
                  AND EQUIPMENT
              
              
              228Less
                  - Accumulated depreciation
              
              
              (90
              )Net
                  property and equipment
              
              
              138Total
                  assets
              
              $
              381LIABILITIES
                  AND STOCKHOLDERS' DEFICITCURRENT
                  LIABILITIES:Accounts
                  payable
              
              
              604Accrued
                  liabilities
              
              
              986Current
                  portion of obligation under capital leases
              
              
              3Notes
                  payable
              
              
              104Note
                  payable - related party
              
              
              16Convertible
                  debentures
              
              
              275Series
                  D Cumulative Preferred Stock, 3,000 shares authorized, 742 shares
                  issued
                  and outstanding
              
              
              1,182Series
                  E Cumulative Preferred Stock, 10,000 shares authorized, 1,170 shares
                  issued and outstanding
              
              
              1,345Liabilities
                  from discontinued operations, net of assets
              
              
              1,152Total
                  current liabilities
              
              
              5,667LONG-TERM
                  LIABILITIES:Notes
                  payable
              
              
              500Obligation
                  under capital leases, less current portion
              
              
              9Other
              
              
              8Total
                  long-term liabilities
              
              
              517Total
                  liabilities
              
              
              6,184STOCKHOLDERS'
                  DEFICIT:Preferred
                  stock, $0.001 par value, 10,000,000 shares authorizedSeries
                    A Cumulative Convertible Preferred Stock, 50,000 shares authorized,
                    3,750
                    issuedand outstanding
              
              
              –Series
                    H Convertible Preferred Stock, 16,000,000 shares authorized,
                    13,912,372
                    issuedand outstanding
              
              
              14Common
                  stock, $0.001, 150,000,000 shares authorized, 10,397,222 issued
                  and
                  outstanding
              
              
              10Additional
                  paid in capital
              
              
              71,916Accumulated
                  deficit
              
              
              (78,249
              )Other
                  comprehensive income
              
              
              502Total
                  stockholders' deficit
              
              
              (5,803
              )Total
                  liabilities and stockholders' deficit
              
              $
              381See
                  accompanying summary of accounting policies and notes to financial
                  statements.






-26-
 Table
          of Contents




ATSI
                  COMMUNICATIONS, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF
                  OPERATIONS(In
                  thousands, except per share
                  amounts)
  Years
                    ended July 31,2005
                
                2004OPERATING
                    REVENUES:ServicesCarrier
                    services
                
                $
                5,782
                
                $
                1,020Network
                    services
                
                
                229
                
                
                234Total
                    operating revenues
                
                
                6,011
                
                
                1,254OPERATING
                    EXPENSES:Cost
                    of services (exclusive of depreciation and amortization, shown
                    below)
                
                
                5,664
                
                
                1,071Selling,
                    general and administrative
                
                
                517
                
                
                584Legal
                    and professional fees
                
                
                417
                
                
                303Non-cash
                    issuance of common stock and warrants for services
                
                
                1,047
                
                
                7,055Non-cash
                    stock-based compensation, employees
                
                
                474
                
                
                –Impairment
                    expense
                
                
                –
                
                
                702Bad
                    debt expense
                
                
                4
                
                
                4Depreciation
                    and amortization
                
                
                112
                
                
                20Total
                    operating expenses
                
                
                8,235
                
                
                9,739OPERATING
                    LOSS
                
                
                (2,224
                )
                
                (8,485
                )OTHER
                    INCOME (EXPENSE):Other
                    income (expense)
                
                
                27
                
                
                7Debt
                    forgiveness income
                
                
                460
                
                
                257Gain
                    on disposal of investment
                
                
                12,104
                
                
                0Gain/(loss)
                    from sale of assets
                
                
                –
                
                
                25Loss
                    on an unconsolidated affiliate
                
                
                –
                
                
                (107
                )Interest
                    expense
                
                
                (71
                )
                
                (166
                )Total
                    other income
                
                
                12,520
                
                
                16NET
                    INCOME (LOSS)
                
                
                10,296
                
                
                (8,469
                )LESS:
                    PREFERRED DIVIDENDS
                
                
                (709
                )
                
                (306
                )NET
                      INCOME (LOSS) TO COMMON STOCKHOLDERS
                
                $
                9,587
                
                
                ($8,775
                )BASIC
                    INCOME (LOSS) PER SHARE
                
                $
                1.34
                
                
                ($7.31
                )DILUTED
                    INCOME (LOSS) PER SHARE
                
                $
                0.41
                
                
                ($7.31
                )WEIGHTED
                      AVERAGE COMMON SHARES OUTSTANDING
                
                
                7,128,847
                
                
                1,199,892
 See
                    accompanying summary of accounting policies and notes to financial
                    statements






-27-
 Table
          of Contents




ATSI
                  COMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF COMPREHENSIVE INCOME
                  (LOSS)(In
                  thousands)
  Years
                  ended July 31,2005
              
              2004Net
                  income (loss) to common stockholders
              
              $
              9,587
              
              
              ($8,775
              )Foreign
                  currency translation adjustment
              
              
              –
              
              
              –Comprehensive
                  income (loss) to common stockholders
              
              $
              9,587
              
              
              ($8,775
              )See
                  accompanying summary of accounting policies and notes to financial
                  statements.








-28-
 Table
          of Contents




ATSI
                  COMMUNICATIONS, INC.AND
                  SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF STOCKHOLDERS'
                  (DEFICIT)(
                  in thousands)
  Notes
              
              Cumulative
              
              TotalPreferred
                  Stock (A)
              
              Preferred
                  Stock (H)
              
              Common
                  Stock
              
              Additional
              
              Accumulated
              
              receivable
                  from
              
              Translation
              
              Stockholders'Shares
              
              Amount
              
              Shares
              
              Amount
              
              Shares
              
              Amount
              
              Paid
                  In Capital
              
              Deficit
              
              officers
              
              Adjustment
              
              (DEFICIT)**BALANCE,
                  JULY 31, 2003**
              
              
              4
              
              
              0
              
              
              –
              
              
              –
              
              
              1,036,393
              
              $
              1
              
              $
              61,125
              
              
              ($80,076
              )
              $
              0
              
              $
              502
              
              
              (18,445
              )Shares
                  issued for services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              929
              
              
              1
              
              
              861
              
              
              
              
              
              
              
              
              
              
              
              862Shares
                  issued for cash
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              567
              
              
              1
              
              
              5
              
              
              
              
              
              
              
              
              
              
              
              6Conversion
                  of redeemable preferred stock
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              401
              
              
              0
              
              
              313
              
              
              
              
              
              
              
              
              
              
              
              313Reincorporation
                  to Nevada
              
              
              
              
              
              
              
              
              14,386
              
              
              14
              
              
              (14
              )
              
              (0
              )
              
              128
              
              
              
              
              
              
              
              
              
              
              
              142Dividends
                  declared
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (306
              )
              
              
              
              
              
              
              
              
              
              
              (306
              )Warrant
                  expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              7,053
              
              
              
              
              
              
              
              
              
              
              
              7,053Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (8,469
              )
              
              
              
              
              
              
              
              (8,469
              )**BALANCE,
                  JULY 31, 2004**
              
              
              4
              
              
              0
              
              
              14,386
              
              
              14
              
              
              1,038,275
              
              $
              3
              
              $
              69,179
              
              
              ($88,545
              )
              $
              0
              
              $
              502
              
              
              (18,843
              )Shares
                  issued for services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,417
              
              
              1
              
              
              606
              
              
              
              
              
              
              
              
              
              
              
              607Shares
                  issued to Purchase Assets
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              121
              
              
              0
              
              
              69
              
              
              
              
              
              
              
              
              
              
              
              69Shares
                  issued for P/S Conversion
              
              
              
              
              
              
              
              
              (473
              )
              
              (0
              )
              
              473
              
              
              0
              
              
              0
              
              
              
              
              
              
              
              
              
              
              
              0Shares
                  issued for Debt Conversion
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,188
              
              
              1
              
              
              943
              
              
              
              
              
              
              
              
              
              
              
              944Exercise
                  of Warrants
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,280
              
              
              4
              
              
              914
              
              
              
              
              
              
              
              
              
              
              
              918Warrant
                  expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              872
              
              
              
              
              
              
              
              
              
              
              
              872Dividends
                  declared
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (709
              )
              
              
              
              
              
              
              
              
              
              
              (709
              )Option
                  Expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              42
              
              
              
              
              
              
              
              
              
              
              
              42Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              10,296
              
              
              
              
              
              
              
              
              10,296**BALANCE,
                  JULY 31, 2005**
              
              
              4
              
              
              0
              
              
              13,912
              
              
              14
              
              
              1,045,754
              
              $
              10
              
              $
              71,916
              
              
              ($78,249
              )
              $
              0
              
              $
              502
              
              
              (5,803
              )See
                  accompanying summary of accounting policies and notes to financial
                  statements.








-29-
 Table
          of Contents




ATSI
                  COMMUNICATIONS, INC. AND SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF CASH FLOWS(In
                  thousands)
  Years
                  ended July 31,2005
              
              2004CASH
                  FLOWS FROM OPERATING ACTIVITIES:NET
                  INCOME (LOSS)
              
              $
              10,296
              
              $
              (8,469
              )Adjustments
                  to net income (loss):Gain
                  on disposal of investment
              
              
              (12,104
              )Debt
                  forgiveness income
              
              
              (460
              )
              
              (257
              )Adjustments
                  to reconcile net loss to cash used in operating
                  activities:Impairment
                  Loss
              
              
              –
              
              
              702Depreciation
                  and amortization
              
              
              112
              
              
              19Loss
                  on an unconsolidated affiliate
              
              
              –
              
              
              107Non-cash
                  issuance of stock grants and options, employees
              
              
              474
              
              
              –Non-cash
                  issuance of common stock and warrants for services
              
              
              1,047
              
              
              7,055Non-cash
                  issuance of common stock for interest
              
              
              61
              
              
              –Provision
                  for losses on accounts receivable
              
              
              4
              
              
              4Changes
                  in operating assets and liabilities:Increase
                  inAccounts
                  receivable
              
              
              (145
              )
              
              (21
              )Prepaid
                  expenses and other
              
              
              (18
              )
              
              (31
              )Increase
                  / (Decrease) inAccounts
                  payable
              
              
              73
              
              
              272Accrued
                  liabilities
              
              
              160
              
              
              162Net
                  cash used in operating activities
              
              
              (561
              )
              
              (457
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Purchases
                  of property & equipment
              
              
              (8
              )
              
              (130
              )Cash
                  proceeds from sale of ATSICOM
              
              
              –
              
              
              187Investment
                  in joint venture in ATSICOM
              
              
              –
              
              
              (47
              )Acquisition
                  of business
              
              
              (8
              )
              
              –Net
                  cash (used in) provided by investing activities
              
              
              (16
              )
              
              10CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from notes payable
              
              
              918
              
              
              410Payments
                  on notes payable
              
              
              (918
              )
              
              (9
              )Proceeds
                  from the exercise of warrants
              
              
              514
              
              
              –Principal
                  payments on capital lease obligation
              
              
              (2
              )
              
              –Net
                  cash provided by financing activities
              
              
              512
              
              
              401DECREASE
                  IN CASH
              
              
              (65
              )
              
              (46
              )CASH
                  AND CASH EQUIVALENTS, beginning of period
              
              
              94
              
              
              140CASH
                  AND CASH EQUIVALENTS, end of period
              
              $
              29
              
              $
              94NON-CASH
                  TRANSACTIONSIssuance
                  of common stock for conversion of debt
              
              $
              829
              
              
              –Issuance
                  of common stock for purchase of intangible assets
              
              
              24
              
              
              –See
                  accompanying summary of accounting policies and notes to financial
                  statements.






-30-
 Table
          of Contents





**ATSI
      COMMUNICATIONS, INC.**


**AND
      SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





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





***Description
      of Business:*** **** ATSI
      Communications, Inc. (“ATSI”) was incorporated in Nevada on May 24, 2004. ATSI
      is an international telecommunications carrier that utilizes the Internet to
      provide economical international telecommunications services to carriers and
      telephony resellers around the world. ATSI’s continuing operations consist of
      VoIP wholesale business and network services. ATSI provides transmission and
      termination 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.





***Reclassifications.*** Certain
      prior year amounts have been reclassified to conform with the current year
      presentation.





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





***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.





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





***Revenue
      Recognition.*** ** ATSI
      derives revenue from both 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.





*Carrier
      Service* : ATSI
      provides transmission and termination 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 local
      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
      Latin American 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.




*Communication
      Services:* ATSI
      provides retail local phone service and international VoIP long distance service
      to the U.S. Hispanic market throughout Texas, mainly in the Rio Grande Valley.
      Our local phone service includes access to a landline and value-added services
      such a caller ID and call waiting. These services are offered to our customers
      in both prepaid and postpaid basis. Additionally, ATSI provides prepaid domestic
      and long-distance services; under these services ATSI allows our customers
      to
      access our prepaid VoIP network platform. The customer will access this platform
      and be able to complete the call by using their local phone number as their
      “PIN” or personal identification number. The revenues derived from prepaid local
      telephone and long-distance are billed monthly in advance and are recognized
      the
      following month when services are provided. Additionally, revenues derived
      from
      postpaid local telephone and long-distance services are recognized monthly
      as
      services are provided.




-31-
 Table
          of Contents





***Allowance
      for Doubtful Accounts.*** Bad debt
      expense is recognized based on management’s estimate of likely losses per year,
      based on past experience and an estimate of current year uncollectible amounts.
      There was no allowance for doubtful accounts as of July 31, 2005.





***Note
      receivable*** **.** ATSI
      has
      an unrecorded note receivable from Telemarketing de Mexico S.A de C.V. for
      the
      sale of 51% of ATSI Comunicaciones S.A de C.V. Under the terms of the “Share
      Purchase Agreement” dated May 24, 2003, ATSI was scheduled to receive from
      T elemarketing
      $20,750 per month for 24 months beginning in May 2004, contingent on ATSI
      generating 20,750,000 minutes of monthly traffic through ATSICOM’s network. In
      the event the ATSI was not able to reach the above-mentioned volume of monthly
      minutes, the monthly payments were to be adjusted based on the percentage of
      the
      shortfall in minutes, until Telemarketing paid the total remaining purchase
      price of $498,000. Currently, ATSI has as a collateral on this note 10% of
      ATSICOM’s stock, which was part of the “Share Purchase Agreement” with
      Telemarketing.





During
      fiscal 2004 ATSI experienced difficulties with DialMex’s network, due primarily
      to deficiencies in DialMex’s network capacity, call interruptions and limited
      traffic routing selections. Additionally ATSI Comunicaciones S.A de C.V. has
      not
      been able to complete the required interconnections with other Mexican carriers,
      to process domestic and international VoIP traffic. As result, ATSI has not
      been
      able to generate the monthly minutes required under the Telemarketing agreement.
      Consequently, ATSI has not received any payments from Telemarketing since May
      2004. Currently ATSI is in negotiations with Telemarketing and its principal
      owners regarding payment of the remaining balance owed to us of approximately
      $498,000.





***Direct
      Cost of Revenue:***





*Carrier
      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 satellite and fiber optic charges. The satellite
      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.





*Communication
      Services* :
      ATSI
      incurs charges for local telephone service and related features from the
      dominant local exchange carrier. Additionally, ATSI incurs a cost per minute
      and
      platform fees from two suppliers for long distance services and platform access.





***Property
      and equipment*** is
      valued 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 historical cost-carrying 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.





During
      the year ended July 31, 2004, in accordance with U.S. GAAP, ATSI determined
      that the estimated cash flows expected from the concession license would be
      less
      than the recorded value. As a result, ATSI recorded
      an impairment loss of approximately $702,000 to reduce the recorded value of
      the
      concession license.




-32-
 Table
          of Contents





***Investment
      in unconsolidated subsidiary.*** On
      May
      22, 2003 ATSI sold 51% of its interest in ATSI Comunicaciones S.A de C.V.,
      (ATSI
      COM) As of July 31, 2003, ATSI has a 49% interest in the profits and equity
      of
      ATSICOM, a Mexican Corporation, engaged in providing telecommunications
      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 has taken a conservative approach and determined
      that
      the estimated future cash flows expected from the concession license will be
      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. A lthough
      there is no assurance of future value appreciation, ATSI will conduct a
      valuation of its investment in the concession license annually and record the
      determined value, if any, in its financial statements.




***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.





***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, 2004, potential
      dilutive securities had an anti-dilutive effect and were not included in the
      calculation of diluted net loss per common share.





***Stock
      based compensation.*** ATSI
      adopted the disclosure requirements of Financial Accounting Standard No. 123,
      Accounting for Stock-Based Compensation (FAS No. 123) and FAS No. 148 with
      respect to pro forma disclosure of compensation expense for options issued.
      For
      purposes of the pro forma disclosures, the fair value of each option grant
      is
      estimated on the grant date using the Black-Scholes option-pricing
      model.





ATSI
      applies APB No. 25 in accounting for its stock option plans and, accordingly,
      no
      compensation cost has been recognized in ATSI financial statements for stock
      options under any of the stock plans which on the date of grant the exercise
      price per share was equal to or exceeded the fair value per share. However,
      compensation cost has been recognized for warrants and options granted to
      non-employees for services provided. The following table illustrates the effect
      on net loss and net loss per share if ATSI had applied the fair value provisions
      of FASB Statement No. 123, Accounting for Stock-Based Compensation, to
      stock-based employee compensation.





Twelve
                months ended July 31,2005
            
            2004Net
                  income (loss) to commonshareholders, as reported
            
            $
            9,587,000
            
            
            ($8,775,000
            )Add:  stock
              based compensation determinedunder intrinsic value based
              method
            
            
            42,080
            
            
            –Less: 
                stock based compensation determinedunder fair value based
                method
            
            
            (1,000,493
            )
            
            –Pro
                forma net income (loss)
            
            $
            8,628,587
            
            
            ($8,775,000
            )Basic
                net income (loss) per common share:As
                reported
            
            $
            1.34
            
            
            ($7.31
            )Pro
                forma
            
            $
            1.22
            
            
            ($7.31
            )Diluted
                net income (loss) per common share:As
                reported
            
            $
            0.41
            
            
            ($7.31
            )Pro
                forma
            
            $
            0.38
            
            
            ($7.31
            )





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





For
                the Years Ended July 31,2005
            
            2004Expected
                dividends yield
            
            
            0.00
            %
            
            0.00
            %Expected
                stock price volatility
            
            
            297
            %
            
            248
            %Risk-free
                interest rate
            
            
            3.5
            %
            
            2
            %Expected
                life of options
            
            
            3
                years
            
            
            1-3
                years


ATSI
      granted 2,104,001 options to purchase common stock to employees during fiscal
      2005. Sixty percent of these options vested immediately and the remaining
      balance vest over three years. ATSI recorded compensation expense of $42,000
      under the intrinsic value method during the year ended July 31, 2005. The
      weighted average fair value of options granted during 2005 is $0.46. There
      were no options granted to employees during fiscal 2004.





***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.





***Recently
      issued accounting pronouncements.*** In
      December 2004, the FASB issued SFAS No.123R, “Accounting for Stock-Based
      Compensation”. SFAS No.123R establishes standards for the accounting for
      transactions in which an entity exchanges its equity instruments for goods
      or
      services. This Statement focuses primarily on accounting for transactions in
      which an entity obtains employee services in share-based payment transactions.
      SFAS No.123R requires that the fair value of such equity instruments be
      recognized as expense in the historical financial statements as services are
      performed. Prior to SFAS No.123R, only certain pro forma disclosures of fair
      value were required. SFAS No.123R shall be effective for small business issuers
      as of the beginning of the first interim or annual reporting period that begins
      after December 15, 2005. The adoption of this new accounting pronouncement
      is
      not expected to have a material impact on the financial statements of ATSI
      during fiscal year 2006.





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 flow.





**NOTE
      2 - GOING CONCERN**





As
      shown
      in the accompanying financial statements, ATSI incurred recurring net losses
      from operations of $2,224,000 and $8,485,000 in fiscal 2005 and 2004,
      respectively, has an accumulated deficit of $78 million and a working capital
      deficit of $5.4 million as of July 31, 2005. These conditions create substantial
      doubt as to ATSI’s ability to continue as a going concern. Management will
      continue to pursue financings that may include raising additional capital
      through sale of common stock, preferred stock, or warrants. The financial
      statements do not include any adjustments that might be necessary if ATSI is
      unable to continue as a going concern.





**NOTE
      3 - PROPERTY AND EQUIPMENT**





Following
      is a summary of ATSI’s property and equipment at July 31, 2005 (in
      thousands):




Depreciable
                lives
            
            July
                31, 2005Telecom
                equipment & Software
            
            
            1-5
                years
            
            $
            228Less:
                accumulated depreciation
            
            
            
            
            
            (90
            )Net-property
                and equipment
            
            
            
            
            $
            138





For
      the
      years ended July 31, 2005 and 2004, depreciation and amortization totaled
      approximately $112,000 and $20,000, respectively.




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**NOTE
      4 - NOTES PAYABLE**





During
      the year ended July 31, 2005, ATSI borrowed a total of $514,000 from Recap
      Marketing & Consulting, LLP (“Recap”) and entered into a series of unsecured
      convertible promissory notes bearing interest at the rate of 12% per annum,
      with
      the following maturity dates:





**Origination
                Date**
            
            **Amount**
            
            **Maturity
                Date**August
                23, 2004
            
            $
            25,000
            
            
            August
                23, 2005August
                30, 2004
            
            
            25,000
            
            
            August
                30, 2005September
                15, 2004
            
            
            25,000
            
            
            September
                15, 2005September
                20, 2004
            
            
            150,000
            
            
            September
                20, 2005October
                8, 2004
            
            
            25,000
            
            
            October
                8, 2005October
                12, 2004
            
            
            25,000
            
            
            October
                12, 2005October
                15, 2004
            
            
            10,000
            
            
            October
                15, 2005October
                25, 2004
            
            
            15,000
            
            
            October
                25, 2005November
                5, 2004
            
            
            25,000
            
            
            November
                5, 2005November
                15, 2004
            
            
            15,000
            
            
            November
                15, 2005December
                1, 2004
            
            
            10,000
            
            
            December
                1, 2005December
                21, 2004
            
            
            10,000
            
            
            December
                21, 2005January
                4, 2005
            
            
            10,000
            
            
            January
                4, 2006February
                2, 2005
            
            
            10,000
            
            
            February
                2, 2006February
                3, 2005
            
            
            4,000
            
            
            February
                3, 2006February
                17, 2005
            
            
            10,000
            
            
            February
                17, 2006March
                22, 2005
            
            
            10,000
            
            
            March
                22, 2006April
                6, 2005
            
            
            10,000
            
            
            April
                6, 2006May
                10, 2005
            
            
            75,000
            
            
            May
                10, 2006July
                14, 2005
            
            
            25,000
            
            
            July
                14, 2006**TOTAL
                DURING FY2005:**
            
            $
            514,000





Additionally,
      on November 1, 2004, ATSI entered into a note payable with Franklin Cardwell
      and
      Jones, PC, for $103,454 associated with legal and professional services
      previously rendered. The promissory note payable has a maturity date of December
      1, 2005 and has an annual interest rate of 6%. Beginning November 1, 2005,
      the
      holder of the note may convert all or any part of the outstanding balance and
      accrued and unpaid interest to shares of ATSI’s common stock equal to the amount
      converted divided by the product of (a) 0. 90 times (b) the five-day average
      of
      the last sales of the common stock prior to the conversion day.




**NOTE
      5 - CONVERTIBLE SUBORDINATED DEBENTURES**





During
      fiscal 2002 ATSI received $275,000 of advances without specific terms of
      repayment or interest. In January 2003 ATSI issued 275 9% Convertible
      Subordinated Debentures with a face value of $1,000 each, due December 2005
      and
      warrants to purchase 137,500 shares of common stock in exchange for the $275,000
      previously advanced. Each debenture accrues interest at the rate of 9% per
      annum
      payable quarterly. The debentures convert into common stock at a conversion
      price of $13.50 and the warrants are priced at $11.20. At July 31, 2005, ATSI
      was in default of the terms of the debentures for non-payment of quarterly
      interest. As of July 31, 2005, ATSI had approximately $80,070 in accrued
      interest related to these debentures.




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**NOTE
      6 - GAIN ON DISPOSAL OF INVESTMENT**





During
      the year ended July 31, 2005, ATSI recognized a gain on disposal of investment
      of approximately $12,104,000. The gain on disposal of investment was associated
      with the disposal of ATSI’s subsidiaries, American TeleSource International,
      Inc. (ATSI Texas) and TeleSpan, Inc. (TeleSpan). These entities filed for
      protection under Chapter 11 of the U.S. Bankruptcy Code on February 4, 2003
      and
      February 18, 2003, respectively. The court ordered joint administration of
      both
      cases on April 9, 2003 and on May 14, 2003 the court converted the cases to
      Chapter 7. The two bankrupt subsidiaries were ATSI’s primary operating companies
      and they have ceased operations. These bankruptcies did not include ATSI
      Communications, Inc., the reporting entity. On July 2, 2003, the U.S. Bankruptcy
      Court handling the Chapter 7 cases for ATSI Texas and TeleSpan approved the
      sale
      of two of their subsidiaries, ATSI de Mexico S.A de C.V. (ATSI Mexico) and
      Servicios de Infraestructura S.A de C.V. (SINFRA), to Latingroup Ventures,
      L.L.C. (LGV), a non-related party. Under the purchase agreement LGV acquired
      all
      the communication center assets and assumed all related liabilities.
      Additionally, under the agreement, LGV acquired the *“Comercializadora”* License
      owned by ATSI Mexico and the Teleport and Satellite Network License and the
      20-year Packet Switching Network license owned by SINFRA. The Chapter 7
      Bankruptcy Trustee received $17,500, which represented all the proceeds from
      the
      sale of these entities. The Chapter 7 Bankruptcy Trustee has managed the
      designation of these funds for the benefit of the creditors of ATSI Texas and
      TeleSpan. Upon liquidation of all the assets owned by ATSI Texas and TeleSpan,
      the Chapter 7 Trustee will manage all claims with the related creditors. ATSI
      did not receive any creditor objections to these court proceedings.





The
      following represents the pre-petition liabilities of the bankrupt subsidiaries,
      net of assets (in thousands):





Accounts
                payable
            
            $
            7,496Accrued
                liabilities
            
            
            2,015Notes
                payable
            
            
            386Capital
                leases
            
            
            2,207TOTAL
                CURRENT LIABILITIES:
            
            $
            12,104





**NOTE
      7 - SETTLEMENT AND RESTRUCTURING OF DEBT**





On
      October 1, 2004, ATSI entered into a Settlement Agreement and Mutual release
      with Alfonso Torres Roqueni, the former owner of the concession license
      purchased by ATSICOM in July 2000. Under the settlement agreement amounts owed
      of $1,360,000 were restructured and settled in exchange for the issuance by
      ATSI
      of 687,600 common shares for the payment of $860,000 of the related obligation.
      The common shares were considered issued at $1.25 per share. Additionally,
      on
      the measurement date of April 1, 2005, the average closing price of ATSI common
      stock for the ten (10) trading days immediately preceding the measurement date
      was below $1.15, as a result ATSI issued an additional 59,791 common shares.
      As
      well as part of the settlement, ATSI issued a promissory note for the remaining
      balance of $500,000. The note accrues interest at the rate of 6% per annum
      and has a maturity date of October 1, 2007, with no monthly payments. ATSI
      recognized a gain of $235,000 on the settlement of this debt. As
      of
      July 31, 2005, ATSI had approximately $25,000 in accrued interest related to
      this note.





On
      October 26, 2004, ATSI entered into a Settlement Agreement and Mutual release
      with Infraestructura Espacial, S.A de C.V. and Tomas Revesz, a former ATSI
      director. Under the settlement agreement, ATSI issued 30,000 shares of its
      common stock for the settlement of all principal and interest owed under a
      note
      payable in the amount of $250,000. This note was originally entered into on
      March 22, 2001 and subsequently restructured on September 12, 2002. ATSI
      recognized a gain of $225,000 on the settlement of this debt.




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On
      March
      28, 2005, ATSI entered into a Settlement Agreement (at mediation) with James
      C.
      Cuevas, Raymond G. Romero, Texas Workforce Commission and ATSI-Texas. The
      Settlement Agreement was subject to board approval. The Board of Directors
      met
      on April 28, 2005 and approved the Settlement Agreement, subsequently; ATSI
      issued 169,280 shares of its common stock for the settlement of all unpaid
      wages
      in the amount of $90,000. This claim was originally filed in December 2003
      by
      ATSI as a cause of action in the 407th Judicial District of Bexar County, Texas
      against James C. Cuevas, Raymond G. Romero, Texas Workforce Commission and
      ATSI-Texas whereby ATSI was seeking judicial review on the decision issued
      by
      the Texas Workforce Commission were it awarded a claim for unpaid wages against
      ATSI.





**NOTE
      8 - ACQUISITION OF A LOCAL EXCHANGE CARRIER COMPANY**





On
      August
      1, 2004, ATSI entered into an Asset Purchase Agreement with Hinotel, Inc.,
      a
      Hispanic owned Competitive Local Exchange Carrier (“CLEC”) based in South Texas.
      The assets purchased under the agreement included Hinotel’s customer base, a
      customer management and billing system, and supplier contracts. Additionally,
      the transaction included the assignment and transfer of the CLEC license in
      the
      State of Texas. The purchase price of the assets was $32,000 paid in 40,000
      shares of ATSI common stock and $8,000 in cash.





**NOTE
      9 COMMITMENTS AND CONTINGENCIES**




**Leases:**





ATSI
      leases its office space with monthly payments of $3,547; the lease expires
      in
      March 2006. The rent expense under the operating lease was $38,760 and $41,420
      for 2004 and 2005, respectively. The future minimum lease payment under the
      operating lease is $42,564 for FY2006.




**Litigation:**





On
      October 31, 2002, ATSI filed a lawsuit in the United States District Court
      for
      the Southern District Court of New York against several individuals and
      financial institutions, including the holders of our Series D and E Redeemable
      Preferred Stock, for, among other things, stock fraud and manipulation. On
      February 25, 2005, Judge Lewis A. Kaplan issued a memorandum opinion and order
      dismissing the complaint as to all defendants with prejudice. ATSI plans to
      appeal that decision once a final judgment has been entered. On July 9, 2004,
      ATSI filed a separate but related lawsuit in the same court against Sam Levinson
      and Uri Wolfson. On April 27, 2005, the court entered a final judgment
      dismissing that action with prejudice based on the February 25, 2005 decision
      in
      the first action. On May 25, 2005, ATSI appealed the dismissal of the second
      action to the United States Court of Appeals for the Second Circuit. On
      September 9, 2005, ATSI appealed the dismissal of the first action to the United
      States Court of Appeals for the Second Circuit. Our attorneys are also in the
      process of investigating whether any other institutions participated in the
      manipulation of the company's stock and to advise us whether to pursue other
      legal proceedings. Currently ATSI cannot predict the outcome of this litigation
      or the financial impact on our ongoing operations.





On
      February 3, 2005 Helen G. Schwartz, Trustee for ATSI Communications, Inc. (a
      Texas corporation) and TeleSpan, Inc. filed in the U.S. Bankruptcy Court for
      the
      Western District of Texas an Adversary Proceeding against ATSI Communications,
      Inc., a Nevada corporation alleging that ATSI-Nevada had received preferential
      payments as defined by the U.S. Bankruptcy Code in the amount of $510,836.
      On
      March 31, 2005, ATSI filed its response denying any such payments were received
      by ATSI Nevada, formerly ATSI Delaware. On August 29, 2005 the U.S. Bankruptcy
      Court for the Western District of Texas dismissed this proceeding against ATSI
      Communications, Inc., a Nevada Corporation for lack of merit.





On
      March
      28, 2005, ATSI entered into a Settlement Agreement, which resolved all claims
      in
      the case filed in the 407 th Judicial
      District Court of Bexar County Texas by with James C. Cuevas, Raymond G. Romero,
      Texas Workforce Commission and ATSI-Texas for unpaid wages. The Board of
      Directors met on April 28, 2005 and approved the Settlement Agreement. As part
      of the settlement, ATSI subsequently issued 169,280 shares of our common
      stock.




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In
      January 2004, ATSI filed a petition in the 150 th Judicial
      District of Bexar County, Texas against Inter-tel.net, Inc. and Vianet
      Communications, Inc. d/b/a Inter-tel.net seeking declaratory relief that ATSI
      Communications, Inc. is not bound by the Carrier Services Agreement between
      Vianet Communications, Inc. and ATSI-Texas. On February 27, 2004 the Bankruptcy
      Court in the ATSI-Texas Bankruptcy case allowed Vianet Communications, Inc.
      to
      amend its claim against ATSI-Texas that was pending in the Bankruptcy of
      ATSI-Texas and assert its claim for breach of contract against ATSI. The
      Bankruptcy Court then ordered the lawsuit to be remanded back to state court
      for
      hearing. On August 10, 2005 a settlement was reached with Vianet Communications.
      As part of the settlement, ATSI issued 200,000 warrants to purchase ATSI stock,
      the exercise price on the warrants range from $0.12 to $0.23. Additionally,
      ATSI
      issued 200,000 shares of Series H preferred Stock that can be converted into
      1.2
      shares of common stock after it’s been held for (1) one year and into 1.5 shares
      of common stock if held for (2) two years.





On
      June
      17, 2005, ATSI filed an arbitration claim against Ntera Holdings, Inc. for
      $100,000 and attorneys fees. The claim is associated with a dispute over
      supposed debt incurred under a Reciprocal Network Carrier Service Agreement
      between the parties. On July 7, 2005 Ntera Holdings, Inc. filed a counterclaim.
      Under the arbitration claim, ATSI is not disputing all of the alleged
      indebtedness but ATSI is alleging the offset of services and that the payment
      should be in the form of exchange of services, as implied in the Reciprocal
      Network Carrier Service Agreement with Ntera Holdings, Inc. Currently ATSI
      can
      not predict the result of the arbitration or the financial impact on our ongoing
      operations.




We
      may
      become a party to future claims and legal proceedings arising in the ordinary
      course of business. Due to the inherent uncertainty of litigation, the range
      of
      possible loss, if any, cannot be estimated with a reasonable degree of precision
      and there can be no assurance that the resolution of any particular claim or
      proceeding would not have an adverse effect on our results of operations in
      the
      period in which it occurred.





**NOTE
      10 - EQUITY**





***Common
      stock***




During
      the year ended July 31, 2005, ATSI issued 4,280,290 shares of common stock
      related to the exercise of warrants. (See note 11). Additionally, during the
      year ended July 31, 2005, ATSI issued 472,630 common shares associated with
      the
      redemption of 472,630 shares of Series H Convertible Preferred Stock.




During
      fiscal 2005, ATSI issued 516,780 shares of common stock valued at $175,202
      for
      legal and consulting services rendered during the year by various
      individuals.





On
      August
      1, 2004, ATSI issued 40,000 shares of common stock valued at $24,000 for the
      acquisition of Hinotel, Inc., a Hispanic owned Competitive Local Exchange
      Carrier (“CLEC”) based in South Texas. (See note 8)





On
      October 1, 2004, ATSI issued 747,391 shares of common stock associated with
      the
      Settlement Agreement and Mutual release entered with Alfonso Torres Roqueni,
      the
      former owner of the concession license purchased by ATSICOM in July 2000. The
      Settlement was for the amounts owed of approximately $860,000.





On
      October 26, 2004, ATSI issued 30,000 shares of common stock associated with
      the
      Settlement Agreement and Mutual release with Infraestructura Espacial, S.A
      de
      C.V. and Tomas Revesz, a former ATSI director. The settlement included all
      principal and interest owed under a note payable in the amount of $250,000.





On
      October 31, 2004, ATSI issued 131,000 shares of common stock valued at $95,050
      for the settlement of debt associated with legal services previously rendered.





On
      March
      11, 2005, ATSI issued 80,625 shares of common stock valued at $45,150 for the
      maintenance of equipment and consulting services rendered during the
      year.




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On
      March
      28, 2005, ATSI issued 169,280 shares of common stock associated with the
      Settlement Agreement (at mediation) with James C. Cuevas, Raymond G. Romero
      and
      Texas Workforce Commission. The Settlement was for all unpaid wages in the
      amount of $90,000.





No
      dividends were paid on ATSI’s common stock during fiscal 2005 and
      2004.




***Preferred
      Stock***




The
      terms
      of ATSI’s Series A, Series D, Series E and Series H 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 Series A, Series D, Series E and Series H preferred stock have
      liquidation preference prior to common stock and ratably with each
      other.




**Series
      A Preferred Stock**





During
      Fiscal 2005 there were no conversions of the Series A Preferred stock and 3,750
      shares of Series A Preferred Stock remain outstanding. As of July 31, 2005,
      ATSI
      has accrued approximately $212,500 for dividends associated with the Series
      A
      Preferred Stock.





The
      Series A Preferred Stock and any accumulated, unpaid dividends may be converted
      into Common Stock for up to one year at the average closing price of the Common
      Stock for twenty (20) trading days preceding the Date of Closing (the “Initial
      Conversion Price”). On each Anniversary Date up to and including the fifth
      Anniversary Date, the Conversion price on any unconverted Preferred Stock,
      will
      be reset to be equal to 75% of the average closing price of the stock for the
      then twenty (20) preceding days provided that the Conversion price can not
      be
      reset any lower than 75% of the Initial Conversion Price. As these conversion
      features are considered a “beneficial conversion feature” to the holder, ATSI
      allocated approximately $3.6 million of the approximate $5.0 million in proceeds
      to additional paid-in capital as a discount to be amortized over various periods
      ranging from ninety days to a twelve-month period. During fiscal year 2001
      the
      remaining beneficial conversion feature was fully amortized. The Series A
      Preferred Stock is callable and redeemable by ATSI at 100% of its face value,
      plus any accumulated, unpaid dividends at ATSI’s option any time after the
      Common Stock of ATSI has traded at 200% or more of the conversion price in
      effect for at least twenty (20) consecutive trading days, so long as ATSI does
      not call the Preferred Stock prior to the first anniversary date of the Date
      of
      Closing.





**Series
      D Preferred Stock**





The
      Series D Preferred Stock accrues cumulative dividends at the rate of 6% per
      annum payable quarterly. As of July 31, 2005, 742 shares of Series D Preferred
      Stock remain outstanding, for which ATSI accrued approximately $240,000 for
      dividends. Additionally, on January 24, 2003 ATSI received a demand redemption
      letter from the Series D Preferred holders. ATSI has not issued these shares;
      it
      is the position of ATSI that the investor’s shares are not owed. Further ATSI
      has filed a lawsuit against one or more parties to whom the investors share
      are
      allegedly owed. ATSI is seeking damages from the parties involved for stock
      manipulation and fraud.




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. As
      mentioned earlier on January 24, 2003, ATSI received a redemption letter. As
      a
      result ATSI adjusted Series D Preferred Stock to the full redemption amount
      of
      approximately $942,000 by recording an additional amount of dividend expense
      of
      approximately $284,000.




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**Series
      E Preferred Stock**





As
      of
      July 31, 2005, 1,170 shares of Series E Preferred Stock remain outstanding
      and
      accrued dividends of approximately $287,000.





The
      Series E Preferred Stock 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. Of the approximate $1.5 million of proceeds assigned
      to the first issuance of Series E Preferred Stock approximately $802,000 was
      allocated to additional paid-in capital as a discount to be amortized over
      the
      lesser of the period most beneficial to the holder or upon exercise of the
      conversion feature. In accordance with the agreement, the conversion price
      was
      reset on February 11, 2001 to the then defined “market price”. The reset of the
      conversion price resulted in additional “beneficial conversion feature” of
      approximately $188,000, which was allocated to additional paid-in capital as
      a
      discount and recognized during fiscal 2001. No beneficial conversion expense
      was
      required to be recognized related to the second and third issuance of Series
      E
      Preferred Stock.





The
      terms
      of ATSI’s Series E Preferred Stock 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.





**Series
      H Preferred Stock**





During
      fiscal 2005 472,628 shares of Series H Convertible Preferred Stock were redeemed
      for 472,628 shares of common stock. As of July 31, 2005 13,912,372 shares of
      Series H Convertible Preferred Stock remained outstanding and accrued dividends
      of $556,000.





On
      May 6,
      2004 ATSI’s stockholders approved the reincorporation of ATSI into a wholly
      owned subsidiary, ATSI Merger Corporation in Nevada. As a result of the merger,
      ATSI’s Stockholders of record as of May 24, 2004 received one (1) share of New
      ATSI Common Stock and ten (10) shares of New ATSI Series H Convertible Preferred
      Stock for each 100 shares of Old ATSI Common Stock surrendered. During fiscal
      2004, 14,385,000 shares of the New ATSI Series H Convertible Preferred Stock
      were issued.





Pursuant
      to ATSI’s Certificate of Incorporation, ATSI’s board of directors may issue, in
      series, 16,000,000 of the New ATSI Series H Convertible Preferred shares, with
      a
      par value of $0.001.





**NOTE
      11 - WARRANTS AND STOCK OPTIONS**





On
      October 13, 2003, ATSI entered into consulting agreements for twelve months
      with
      certain individual affiliates of Recap Marketing and Consulting LLC. (Recap)
      that provided for the issuance of compensation warrants to purchase a total
      of
      3,900,000 shares of ATSI’s common stock at prices as indicated in the following
      table. These warrants expire on November 30, 2005. At issuance ATSI recognized
      $7,053,000 of non-cash compensation expense associated with the issuance of
      these warrants.





COMMON
                SHARES
            
            EXERCISE
                PRICE2,000,000
            
            $
            0.01/share800,000
            
            $
            0.25/share850,000
            
            $
            0.50/share250,000
            
            $
            0.75/share






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During
      the year ended July 31, 2005, individual affiliates of Recap elected to exercise
      4,280,290 warrants and Recap forgave notes in the amount of $918,000 as the
      conversion price. The exercise price of the warrants ranged from $0.01 per
      share
      to $0.50 per share.




On
      November 1, 2004, ATSI extended the consulting agreements for an additional
      six
      months with certain individual affiliates of Recap that provided for the
      issuance of compensation warrants to purchase a total of 1,000,000 shares of
      ATSI’s common stock at price of $0.50 per share. These warrants expire on
      October 31, 2005. At signing of the extension to the consulting agreements
      ATSI
      recognized $591,000 of non-cash compensation expense associated with the
      issuance of these warrants.




On
      March
      1, 2005, ATSI amended the extension to the consulting agreement with certain
      individuals’ affiliates of Recap and extended the agreement for an additional 12
      months. The amendment to the agreements allows for the repricing of 1,250,000
      compensation warrants at a new exercise price’s ranging from $0.30 per share to
      $0.40 per share. At signing of the amendment to the extension of the consulting
      agreement, ATSI recognized $220,000 of
      non-cash compensation expense associated with the issuance of these
      warrants.




On
      June
      1, 2005, ATSI entered into mutual release and termination agreement with certain
      individuals’ affiliates of Recap. The mutual release and termination agreement
      allows for the repricing of 783,500 compensation warrants at a new exercise
      price’s ranging from $0.17 per share to $0.25 per share. At signing of the
      mutual release and termination agreement, ATSI recognized $61,375 of
      non-cash compensation expense associated with the issuance of these
      warrants.




**Modification
      of Non-Employee Awards Accounted for Under FAS 123**




ATSI
      granted 1,250,000 warrants to outsiders in March 2005 and the amendment to
      the
      agreement allowed for the repricing of the warrants, as a result of the
      modification of these warrants ATSI recognized $220,000 of
      non-cash compensation expense. Additionally,
      on June 1, 2005, ATSI entered into a mutual release and termination agreement
      with certain individuals’ affiliates of Recap. The mutual release and
      termination agreement allows for the repricing of 783,500 compensation warrants.
      At signing of the mutual release and termination agreement, ATSI recognized
      $61,375 of
      non-cash compensation expense associated with the issuance of these
      warrants. The
      repricing of these warrants in March 2005 and June 2005 triggered a modification
      of the original awarded warrants. 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.





Following
      is a summary of warrant activity for the years ended July 31, 2005 and 2004
      (Excluding warrants issued under the 2004 Stock Compensation plan):





**Year
                Ending July 31,****2005**
            
            **2004**Warrants
                outstanding, beginning
            
            
            19,874
            
            
            45,088Warrants
                issued
            
            
            –
            
            
            –Warrants
                expired
            
            
            (19,874
            )
            
            (25,214
            )Warrants
                exercised
            
            
            –
            
            
            –Warrants
                outstanding, ending
            
            
            –
            
            
            19,874





During
      fiscal 2005 no options were granted or exercised under the 2003, 2002, 1998
      and
      1997 Stock Option Plans adopted during those years. Additionally, all options
      previously granted under these plans were forfeited during fiscal
      2005.






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In
      May
      2004, ATSI’s board of directors adopted the 2004 Stock Compensation Plan. The
      2004 Stock Compensation Plan authorizes the grant of up to 7.5 million of
      warrants, stock options, restricted common stock, non-restricted common stock
      and other awards, or a combination, to employees, directors, consultants and
      certain other persons. The 2004 Stock Compensation Plan is intended to permit
      ATSI to retain and attract qualified individuals who will contribute to ATSI’s
      overall success of ATSI. The exercise price of all of the warrants, stock
      options, restricted common stock, non-restricted common stock and other awards
      will 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 pursuant based in the individual security
      granted.





In
      January 2005, the Board of directors granted the issuance of 2,104,000 stock
      options to ATSI’s employees and Board of Directors. The exercise price of the
      stock options granted was set at $0.46 per option. In addition, 60% of the
      options vested immediately and the remaining options will vest over the next
      three years. Additionally, the Board of Directors granted 900,000 stock grants
      to ATSI’s employees and Board of Directors. Furthermore, during the year ended
      July 31, 2005, the Board of Directors granted the issuance and repricing of
      3,033,500 warrants to consultants for services rendered, the warrants exercise
      price range from $0.17 to $0.50. As of July 31, 2005 4,280,286 warrants have
      been exercised at an average exercised price of $0.21 and 303,140 warrants
      remained outstanding at an average exercise price of $0.25





Additionally,
      during fiscal 2005 the Board of Directors granted the issuance of 516,780 common
      shares for legal services and consulting services performed during the year.
      The
      average exercise price of the common stock issued was set at $0.34.





During
      fiscal 2004, the Board of directors granted the issuance of 3,900,000 warrants
      to consultants for services rendered, the warrants exercise price range from
      $0.01 to $0.75. During fiscal 2004 566,574 warrants were exercised at an average
      exercised price of $0.01.





A
      summary
      of the status of ATSI’s 1997, 1998, 2000 and 2004 Stock Option Plans for the
      fiscal 2005, and 2004 changes during the periods are presented
      below:




Years
                  Ended July 31,**1997
                  Stock Option Plan**
              
              2005
              
              2004Options
              
              Weighted
                  Average
                Exercise
                  Price
              
              Options
              
              Weighted
                  Average
                Exercise
                  PriceOutstanding,Beginning
                  of year
              
              
              –
              
              $
              –
              
              
              20
              
              $
              58Granted
              
              
              –
              
              
              –
              
              
              –
              
              
              –Exercised
              
              
              –
              
              
              –
              
              
              –
              
              
              –Forfeited
              
              
              –
              
              
              –
              
              
              (20
              )
              
              58Outstanding,
                  end of year
              
              
              –
              
              $
              –
              
              
              –
              
              $
              58Options
                  exercisable at end of year
              
              
              
              
              
              
              
              
              (20
              )
              $
              58Weighted
                  average fair value of options granted during the year
              
              
              
              
              $
              N/A
              
              
              
              
              
              N/A
  **1998
                  Stock Option Plan**
              
              2005
              
              2004Options
              
              Weighted
                  Average
                Exercise
                  Price
              
              Options
              
              Weighted
                  Average
                Exercise
                  PriceOutstanding,Beginning
                  of year
              
              
              3,559
              
              $
              56
              
              
              3,559
              
              $
              56Granted
              
              
              –
              
              
              –
              
              
              –
              
              
              –Exercised
              
              
              –
              
              
              –
              
              
              –
              
              
              –Forfeited
              
              
              (3,559
              )
              
              56
              
              
              –
              
              
              –Outstanding,
                  end of year
              
              
              –
              
              $
              –
              
              
              3,559
              
              $
              56Options
                  exercisable at end of year
              
              
              
              
              
              
              
              
              3,559
              
              $
              56Weighted
                  average fair value of options granted during the year
              
              
              
              
              $
              N/A
              
              
              
              
              
              N/A
  -42-
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  **2000
                  Stock Option Plan**
              
              2005
              
              2004Options
              
              Weighted
                  Average
                Exercise
                  Price
              
              Options
              
              Weighted
                  Average
                Exercise
                  PriceOutstanding,Beginning
                  of year
              
              
              28,767
              
              $
              48
              
              
              38,100
              
              $
              45Granted
              
              
              –
              
              
              –
              
              
              –
              
              
              –Exercised
              
              
              –
              
              
              –
              
              
              –
              
              
              –Forfeited
              
              
              (28,767
              )
              
              48
              
              
              (9,333
              )
              
              48Outstanding,
                  end of year
              
              
              –
              
              $
              –
              
              
              28,767
              
              $
              48Options
                  exercisable at end of year
              
              
              
              
              
              
              
              
              22,466
              
              $
              47Weighted
                  average fair value of options granted during the year
              
              
              
              
              $
              N/A
              
              
              
              
              
              N/A
 
 **2004
                  Stock Option Plan**
              
              2005
              
              2004Options
              
              Weighted
                  Average
                Exercise
                  Price
              
              Options
              
              Weighted
                  Average
                Exercise
                  PriceOutstanding,Beginning
                  of year
              
              
              –
              
              $
              –
              
              
              –
              
              $
              –Granted
              
              
              3,004,000
              
              
              0.46
              
              
              57,786
              
              
              0.95Exercised
              
              
              (900,000
              )
              
              0.46
              
              
              (57,786
              )
              
              0.95Forfeited
              
              
              –
              
              
              –
              
              
              –
              
              
              –Outstanding,
                  end of year
              
              
              2,104,000
              
              $
              –
              
              
              –
              
              $
              –Options
                  exercisable at end of year
              
              
              1,328,000
              
              $
              0.46
              
              
              –
              
              $
              –Weighted
                  average fair value of options granted during the year
              
              
              
              
              $
              0.46
              
              
              
              
              $
              0.95
 
 **2004
                  Stock Compensation Plan (WARRANTS)**
              
              2005
              
              2004Warrants
              
              Weighted
                  Average
                Exercise
                  Price
              
              Warrants
              
              Weighted
                  Average
                Exercise
                  PriceOutstanding,Beginning
                  of year
              
              
              3,333,426
              
              $
              0.25
              
              
              –
              
              $
              –Granted
              
              
              2,183,500
              
              
              0.32
              
              
              3,900,000
              
              
              0.21Exercised
              
              
              (4,280,286
              )
              
              0.21
              
              
              (566,574
              )
              
              0.21Forfeited
              
              
              (933,500
              )
              
              0.56
              
              
              –
              
              
              –Outstanding,
                  end of year
              
              
              303,140
              
              $
              0.25
              
              
              3,333,426
              
              $
              0.25Warrants
                  exercisable at end of year
              
              
              303,140
              
              $
              0.25
              
              
              –
              
              $
              –Weighted
                  average fair value of warrants granted during the year
              
              
              
              
              $
              0.32
              
              
              
              
              $
              0.21


During
      the year ending July 31, 2005 all options granted but not exercised under the
      1997, 1998 and 2000 Stock Option Plan were forfeited. The weighted average
      remaining contractual life of the stock options outstanding at July 31, 2005
      is
      approximately 9 years and for warrants granted under the 2004 Stock Option
      Plan
      is 1 year.




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The
      following table summarizes information about stock options and warrants
      outstanding for all plans at July 31, 2005:





Options
                and Warrants Outstanding
            
            Options
                and Warrants ExercisableRange
                of Exercise Price
            
            Number
                Outstanding
            
            Weighted
                Average Exercise Price
            
            Weighted
                Average Remaining Contractual Life (Years)
            
            Number
                Exercisable
            
            Weighted
                Average Exercise PriceOptions$0.46
            
            
            2,140,000
            
            $
            0.46
            
            
            9.50
            
            
            1,328,000
            
            $
            0.46Warrants$0.25
            
            
            303,140
            
            $
            0.25
            
            
            0.80
            
            
            303,140
            
            $
            0.25


**NOTE
      12 - INCOME TAXES**





Deferred
      tax assets are comprised of the following as of July 31, 2005:


Net
                operating loss carry-forward
            
            $
            11,491,000Valuation
                allowance
            
            
            (11,491,000
            )Total
                deferred tax asset
            
            $
            –





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, 2005, ATSI has determined that
      a
      valuation allowance is necessary for the entire amount of deferred tax assets.





At
      July
      31, 2005, ATSI had net operating loss carry-forwards related to U.S. operations
      of approximately $35 million with expiration dates ranging from 2009
      through 2024.





**NOTE
      13 - EARNINGS (LOSS) PER SHARE**





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





Year
                ended July 31,2005
            
            2004Net
                income (loss) to be used to compute income (loss) per
                share:Net
                income (loss)
            
            $
            10,296,000
            
            $
            (8,469,000
            )Less
                preferred dividends
            
            
            (709,000
            )
            
            (306,000
            )Net
                  income (loss) attributable to commonShareholders -
                  Basic
            
            $
            9,534,000
            
            $
            (8,775,000
            )Add
                back preferred dividends
            
            
            709,000
            
            
            –Net
                income (loss) attributable to common shareholders -Diluted
            
            $
            10,296,000
            
            $
            (8,775,000
            )Weighted
                average number of shares:Weighted
                average common shares outstanding
            
            
            7,128,847
            
            
            1,199,892Effect
                of conversion of preferred shares
            
            
            xxx
            
            
            –Effect
                of warrants and options
            
            
            xxx
            
            
            –Weighted
                average common shares outstanding assuming dilution
            
            
            xxx
            
            
            1,199,892Basic
                income (loss) per common share
            
            $
            1.34
            
            $
            (7.31
            )Diluted
                income (loss) per common share
            
            $
            0.45
            
            $
            (7.31
            )




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**NOTE
      14 - RISKS AND UNCERTAINTIES AND CONCENTRATIONS**





ATSI
      is
      subject to regulations by the United States and Mexican Government. And
      according to ATSI’s concession requirements, ATSI is required to maintain
      approximately $10 million in capital. As of July 31, 2005, ATSICOM has not
      met
      this requirement. Currently, Telemarketing, ATSI’s equity partner in ATSICOM is
      in negotiations with the Mexican government on meeting this
      requirement.





ATSI’s
      business is dependent upon key pieces of equipment, switching and transmission
      facilities capacity from ATSI’s carriers. Should ATSI experience service
      interruptions from ATSI’s underlying carriers, equipment failures there would
      likely be a temporary interruption of ATSI’s services, which could adversely or
      materially affect ATSI’s operations. ATSI believes that suitable arrangements
      could be obtained with other carriers to provide transmission capacity. Although
      there can be no assurance that such arrangement could be obtained or obtained
      when needed.





**NOTE
      15 - RELATED PARTY TRANSACTIONS**





In
      December 2002, ATSI entered into a note payable with a related party, a director
      of ATSI, Mr. John R. Fleming, in the amount of $25,000. The note called for
      12
      monthly payments of $2,163.17 including interest, commencing on February 1,
      2003. The note has an interest rate of 7% annually and a maturity date of
      January 1, 2004. During fiscal 2004 ATSI made payments towards this note in
      the
      amount of $9,000. As of July 31, 2005 the principal balance is $16,000 and
      the
      accrued interest is $3,700. Additionally, at July 31, 2005, ATSI had a payable
      of approximately $42,519 for board fees and related expenses.





**NOTE
      16 - SUBSEQUENT EVENTS** ****





On
      August
      29, 2005 the U.S. Bankruptcy Court for the Western District of Texas dismissed
      all claims from Helen G. Schwartz against ATSI Communications, Inc., a Nevada
      Corporation for lack of merit. As mentioned in note 9, on February 3, 2005
      Helen
      G. Schwartz, Trustee for ATSI Communications, Inc. (a Texas corporation) and
      TeleSpan, Inc. filed in the U.S. Bankruptcy Court for the Western District
      of
      Texas an Adversary Proceeding against ATSI Communications, Inc., a Nevada
      corporation alleging that ATSI-Nevada had received preferential payments as
      defined by the U.S. Bankruptcy Code in the amount of $510,836. On March 31,
      2005, ATSI filed its response denying any such payments were received by ATSI
      Nevada, formerly ATSI Delaware.





On
      August
      10, 2005 a settlement was reached between ATSI Communications, Inc. with Vianet
      Communications. As mentioned in note 9, in January 2004, ATSI filed a petition
      in the 150 th Judicial
      District of Bexar County, Texas against Inter-tel.net, Inc. and Vianet
      Communications, Inc. d/b/a Inter-tel.net seeking declaratory relief that ATSI
      Communications, Inc. is not bound by the Carrier Services Agreement between
      Vianet Communications, Inc. and ATSI-Texas. On February 27, 2004 the Bankruptcy
      Court in the ATSI-Texas Bankruptcy case allowed Vianet Communications, Inc.
      to
      amend its claim against ATSI-Texas that was pending in the Bankruptcy of
      ATSI-Texas and assert its claim for breach of contract against ATSI. The
      Bankruptcy Court then ordered the lawsuit to be remanded back to state court
      for
      hearing. As part of the settlement, ATSI issued 200,000 warrants to purchase
      ATSI stock, the exercise price on the warrants range from $0.12 to $0.23.
      Additionally, ATSI issued 200,000 shares of Series H preferred Stock that can
      be
      converted into 1.2 shares of common stock after it’s been held for (1) one year
      and into 1.5 shares of common stock if held for (2) two years. As part of the
      settlement during fiscal 2005, ATSI recognized approximately $53,000 in
      settlement expense associated with the value of the warrants and Series H
      preferred stock issued.




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





NONE.





**ITEM
      8A.****CONTROLS
      AND PROCEDURES.**





**Evaluation
      of Disclosure Controls and Procedures**





The
      Company has adopted and implemented disclosure controls and procedures designed
      to provide reasonable assurance that all reportable information will be
      recorded, processed, summarized and reported within the time period specified
      in
      the SEC’s rules and forms. Under the supervision and with the participation of
      the Company's management, including the Company's President and Chief Executive
      Officer and the Company’s Controller and Principal Financial Officer, the
      Company has evaluated the effectiveness of the design and operation of its
      disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e)
      as of
      the end of the period covered by this report. Based on that evaluation, the
      President and Chief Executive Officer and the Controller and Principal Financial
      Officer have concluded that these disclosure controls and procedures are
      effective as of the end of the period covered by this report.





**Changes
      in Internal Control Over Financial Reporting**





There
      were no changes in the Company's internal control over financial reporting
      during the fourth fiscal quarter covered by this report that have had a material
      affect or are reasonably likely to have a material affect on internal control
      over financial reporting. The registered public accounting firm that audited
      the
      financial statements included in this report has issued an attestation report
      on
      management’s assessment of the Company’s internal control over financial
      reporting.





**PART
      III**





**ITEM
      9.****DIRECTORS,
      EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION
      16(A)
      OF THE EXCHANGE ACT.**





**Business
      Experience**





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





**Name**
            
            **Age**
            
            **Position
                Held**Arthur
                L. Smith
            
            40
            
            President,
                Chief Executive Officer and DirectorRuben
                Caraveo
            
            37
            
            Vice
                President, Sales and OperationsAntonio
                Estrada
            
            31
            
            Corporate
                ControllerJohn
                R. Fleming
            
            51
            
            Interim
                Executive Chairman of the BoardMurray
                R. Nye
            
            52
            
            Director


*Arthur
      L. Smith* has
      served as our Chief Executive Officer and Director since May 2003. Mr. Smith
      also served as the President of ATSI de Mexico S.A de C.V. from August 2002
      to
      April 2003, as our Chief Executive Officer and a Director from June 1996 to
      July
      2002 and as our President since our formation in June 1996 to July 1998. Mr.
      Smith also served as President, Chief Operating Officer and a director of
      ATSI-Canada since its formation in May 1994. From December 1993 until May 1994,
      Mr. Smith served in the same positions with Latcomm International Inc., which
      amalgamated with Willingdon Resources Ltd. to form ATSI-Canada in May 1994.
      Mr.
      Smith has also served as President and Chief Executive Officer of American
      TeleSource International, Inc., a Texas corporation (“ATSI-Texas”), one of our
      principal operating subsidiaries, since December 1993. 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 15 years’ experience in the telecommunications industry.




-46-
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          of Contents





*Ruben
      R. Caraveo* has
      served as our Vice President of Sales and Operations since May 2003. Mr. Caraveo
      is responsible for Carrier Sales and the delivery of Carrier Services for both
      the U.S. and Mexico. Mr. Caraveo served as our Vice President of Operations
      from
      May 2001 to January 2003. Prior to joining ATSI, Mr. Caraveo served as Vice
      President of Operations and Engineering at Vycera Communications where he was
      responsible for overseeing all daily operations, including network engineering,
      marketing, and the network trouble reporting and resolution departments. His
      prior experience also includes positions with Worldtel Interactive, Frontier,
      and WorldCom. Mr. Caraveo is armed with more than 15 years’ telecommunications
      industry experience, specializing in the areas of Network Engineering, Data
      and
      Systems Analysis, Product Marketing, and Systems Development. Mr. Caraveo
      attended California State University, Northridge, School of
      Engineering.





*Antonio
      Estrada* has ** served
      as
      our Corporate Controller since May 2003. From January 2002 through January
      2003,
      Mr. Estrada served as our Director of International Accounting and Treasurer.
      From January 2001 to January 2002, Mr. Estrada served in various roles within
      ATSI, including International Accounting Manager and general Accountant. Prior
      to joining ATSI in 1999 he served as a Senior Accountant for the Epilepsy
      Association of San Antonio and South Texas. Mr. Estrada graduated from the
      University of Texas at San Antonio, with a Bachelors of Business Administration,
      with a concentration in Accounting.





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





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




**Audit
      Committee and Audit Committee Financial Expert**





The
      Company does not presently have an audit or compensation committee or other
      board committee performing equivalent functions. All functions of the audit
      committee and compensation committee are performed by the Company’s Board of
      Directors. The Company does not have an audit committee financial expert because
      none of its current directors have the necessary training or experience to
      qualify as a financial expert.





**Recent
      developments with ATSI Board of Directors**




On
      October 20, 2005 the Board of Directors accepted the voluntary resignation
      of
      Michael G. Santry as a member of the board. Mr. Santry resigned to pursue other
      business interests. There were no disagreements with Mr. Santry. The vacancy
      caused by Mr. Santry’s resignation will either be filled by a candidate
      receiving a vote of a majority of the Board or the seat could remain vacant
      until the next election of directors at the corporation's next annual
      stockholder meeting.




-47-
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**Section
      16(a) Beneficial Ownership Reporting Compliance**





Section
      16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s
      directors and executive officers and persons who own more than 10% of a
      registered class of the Company’s equity securities to file various reports with
      the Securities and Exchange Commission concerning their holdings of, and
      transactions in, securities of the Company. Copies of these filings must be
      furnished to the Company. Based on a review of the copies of such forms
      furnished to the Company and other information, the Company believes that,
      during the fiscal year ended July 31, 2005, the following individuals failed
      to
      report transactions in the Company’s equity securities or reported transactions
      late:





**Name
                and Position**
            
            **Number
                of Transactions Not Reported**
            
            **Number
                of Reports Filed Late**
            
            **Number
                of Transactions Reported Late**Arthur
                L. Smith, President and Director
            
            
            0
            
            
            6
            
            
            5Ruben
                R. Caraveo, Vice President
            
            
            0
            
            
            7
            
            
            6Antonio
                Estrada, Controller
            
            
            0
            
            
            5
            
            
            4John
                R. Fleming
            
            
            0
            
            
            0
            
            
            0Murray
                R. Nye
            
            
            0
            
            
            0
            
            
            0


**Code
      of Ethics**





ATSI
      Communications, Inc. adopted an
      Executive Code of Ethics that applies to the Chief Executive Officer, Chief
      Financial Officer, Controller and other members of our management team. The
      Board of Directors approved the code of Ethics on December 7, 2004. The
      Executive Code of Ethics may be viewed on our Website, www.atsi.net .
      Upon
      request, a copy of the Executive Code of Ethics will be provided without charge
      upon written request to ATSI Communications, Inc., 8600
      Wurzbach Road, Suite 700W., San Antonio, TX 78240





**ITEM
      10.****EXECUTIVE
      COMPENSATION.**





**Summary
      Compensation Table**





The
      following table sets forth information concerning the compensation earned during
      the Company’s last three fiscal years by the Company’s Chief Executive Officer
      and each of the Company’s four most highly compensated executive officers whose
      total cash compensation exceeded $100,000 for services rendered in all
      capacities for the fiscal year ended July 31, 2005 (collectively, the “Named
      Executive Officers”).




**Annual
                  Compensation**
              
              **Long-Term
                  Compensation****Awards**
              
              **Payouts****Name
                  And Principal Position**
              
              **Fiscal**
                **Year**
              
              **Salary
                  ($)**
              
              **Stock**
                **Grant
                  ($)**
              
              **Other
                  Annual Compensation****($)(1)**
              
              **Restricted
                  Stock**
                **Awards
                  ($)**
              
              **Securities**
                **Underlying**
                **Options/**
                **SARs
                  (#)**
              
              **LTIP**
                **Payout**
                **($)**
              
              **All
                  Other Compens-****ation
                  ($)**Arthur
                  L. Smith (2)
              
              
              2005
              
              $
              128,000
              
              $
              31,500
              
              
              –
              
              
              –
              
              $
              193,200
                  (5
              )
              
              –
              
              
              –CEO
                  & President
              
              
              2004
              
              $
              128,000
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –Ruben
                  Caraveo (3)
              
              
              2005
              
              $
              115,000
              
              $
              26,250
              
              
              –
              
              
              –
              
              $
              172,500
                  (5
              )
              
              –
              
              
              –Vice
                  President, Operations
              
              
              2004
              
              $
              115,000
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –Antonio
                  Estrada (4)
              
              
              2005
              
              $
              80,000
              
              $
              26,250
              
              
              –
              
              
              –
              
              $
              159,620
                  (5
              )
              
              –
              
              
              –Corporate
                  Controller
              
              
              2004
              
              $
              65,000
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –





(1)
              Certain
                  of the Company’s executive officers receive personal benefits in addition
                  to salary. The Company has concluded that the aggregate amount
                  of such
                  personal benefits does not exceed the lesser of $5,000 or 10% of
                  annual
                  salary and bonus for any Named Executive Officer.


(2)
              Mr.
                  Smith has served as CEO & President and Director of ATSI Nevada
                  (Formerly a Delaware Corp.) since May
                  2003


(3)
              Mr.
                  Caraveo has served as Vice President of Sales and Operations of
                  ATSI
                  Nevada since May 2003.


(4)
              Mr.
                  Estrada has served as Corporate Controller of ATSI Nevada since
                  May 2003.


(5)
              Stock
                  options granted during Fiscal 2005 have an exercise price of $0.46






-48-
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**Aggregate
      options exercisable and unexercisable during Fiscal 2005**





The
      following table reflects the Company’s officer’s shares covered by both
      exercisable and unexercisable stock options as of July 31, 2005.




**Shares**
              **Acquired**
              **On**
              **Exercise**
            
            **Value**
              **Realized**
            
            **Number
                of Securities Underlying Unexercised Options at
                FYE(#)**
            
            **Value
                of Unexercised In-the-Money Options at FYE ($)****Name**
            
            **(#)**
            
            **($)**
            
            **Exercisable**
            
            **Unexercisable**
            
            **Exercisable**
            
            **Unexercisable**Arthur
                L. Smith
            
            
            –
            
            
            –
            
            
            272,000
            
            
            148,000
            
            
            –
            
            
            –Ruben
                Caraveo
            
            
            –
            
            
            –
            
            
            241,000
            
            
            134,000
            
            
            –
            
            
            –Antonio
                Estrada
            
            
            –
            
            
            –
            
            
            213,000
            
            
            134,000
            
            
            –
            
            
            –


**COMPENSATION
      OF DIRECTORS**




ATSI
      Directors are reimbursed their reasonable out-of-pocket expenses in connection
      with their travel to and attendance at meetings of the Board of Directors.
      In
      addition, each Director that is not an officer of the Company receives 1,500
      shares of Common Stock for each meeting of the Board attended in person and
      $250
      for each meeting attended by telephone. In January 2005, ATSI issued a total
      of
      400,000 shares of our common stock as part of the stock grant, valued at
      $84,000, to outside directors.




**Aggregate
      options exercisable and unexercisable during Fiscal 2005**





The
      following table reflects the Company’s director’s shares covered by both
      exercisable and unexercisable stock options as of July 31, 2005.





**Shares**
              **Acquired**
              **On**
              **Exercise**
            
            **Value**
              **Realized**
            
            **Number
                of Securities Underlying Unexercised Options at
                FYE(#)**
            
            **Value
                of Unexercised In-the-Money Options at FYE ($)****Name**
            
            **(#)**
            
            **($)**
            
            **Exercisable**
            
            **Unexercisable**
            
            **Exercisable**
            
            **Unexercisable**John
                Fleming
            
            
            –
            
            
            –
            
            
            175,000
            
            
            100,000
            
            
            –
            
            
            –Murray
                Nye
            
            
            –
            
            
            –
            
            
            175,000
            
            
            100,000
            
            
            –
            
            
            –







-49-
 Table
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**ITEM
      11.****SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**





The
      following table lists the beneficial ownership of shares of our Common Stock
      and
      Series A Preferred Stock by (i) all persons and groups known by the Company
      to
      own beneficially more than 5% of the outstanding shares of our Common Stock
      or
      Series A Preferred Stock, (ii) each director and nominee, (iii) the Named
      Executive Officers, and (vi) all directors and officers as a group. Information
      with respect to officers, directors and their families is as of July 31, 2005
      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 solely the person indicated beneficially owns
      all
      shares *.*




**SERIES
                    A****COMMON**
              
              **%
                  OF**
              
              **PREFERRED**
              
              **%
                  OF**
              
              **TOTAL
                  VOTING**
              
              **%
                  OF**NAME
                      OF INDIVIDUAL OR GROUP
              
              **STOCK**
              
              **CLASS
                  (1)**
              
              **STOCK**
              
              **CLASS
                  (2)**
              
              **INTEREST**
              
              **CLASS
                  (3)**5%
                  STOCKHOLDERSPeter
                  Blindt
              
              
              0
              
              
              *
              
              
              500
              
              
              13.3
              %
              
              743
              
              
              *30
                  E. Huron #5407Chicago,
                  IL 60611Edward
                  Corcoran
              
              
              0
              
              
              *
              
              
              500
              
              
              13.3
              %
              
              743
              
              
              *6006
                  W. 159th StreetBldg.
                  C 1-WOak
                  Forest, IL 60452Gerald
                  Corcoran
              
              
              0
              
              
              *
              
              
              500
              
              
              13.3
              %
              
              743
              
              
              *11611
                  90th AvenueSt.
                  John, IN 46373Joseph
                  Migilio
              
              
              0
              
              
              *
              
              
              500
              
              
              23.0
              %
              
              743
              
              
              *13014
                  Sandburg Ct.Palos
                  Park, IL 60464Jeffrey
                  Tessiatore
              
              
              0
              
              
              *
              
              
              500
              
              
              13.3
              %
              
              743
              
              
              *131
                  Settlers Dr.Naperville,
                  IL 60565Albert
                  Vivo
              
              
              0
              
              
              *
              
              
              500
              
              
              13.3
              %
              
              743
              
              
              *9830
                  Circle ParkwayPalos
                  Park, IL 60464Gary
                  Wright
              
              
              0
              
              
              *
              
              
              750
              
              
              20.0
              %
              
              1,115
              
              
              *3404
                  Royal Fox Dr.St.
                  Charles, IL 60174INDIVIDUAL
                      OFFICERS, DIRECTORS AND NOMINEESArthur
                  L. Smith
              
              
              630,853
                  (4
              )
              
              5.4
              %
              
              0
              
              
              *
              
              
              630,853
                  (4
              )
              
              5.4
              %President,
                  Chief Executive Officer, DirectorAntonio
                  Estrada
              
              
              328,000
                  (5
              )
              
              2.83
              %
              
              
              
              
              *
              
              
              328,000
                  (5
              )
              
              2.8
              %Corporate
                  ControllerRuben
                  R. Caraveo
              
              
              303,500
                  (6
              )
              
              2.62
              %
              
              0
              
              
              *
              
              
              303,500
                  (6
              )
              
              2.6
              %Vice
                  President, Salesand
                  OperationsJohn
                  R. Fleming
              
              
              325,000
                  (7
              )
              
              2.80
              %
              
              0
              
              
              *
              
              
              325,000
                  (7
              )
              
              2.8
              %DirectorMurray
                  R. Nye
              
              
              325,000
                  (8
              )
              
              2.80
              %
              
              0
              
              
              *
              
              
              325,000
                  (8
              )
              
              2.8
              %DirectorALL
                      OFFICERS AND DIRECTORS AS A GROUP
              
              
              1,912,353
                  (9
              )
              
              18.4
              %
              
              0
              
              
              *
              
              
              1,912,353
                  (9
              )
              
              18.4
              %


*
              Less
                  than 1%


(1)
                Based
                    on 11,593,222 shares of Common Stock outstanding as of July 31,
                    2005. Any
                    shares represented by options exercisable within 60 days
 After
                  July 31, 2005 are treated as being outstanding for the purpose
                  of
                  computing the percentage of class for such person but not for any
                  other
                  purpose
 (2)
              Based
                  on 3,750 shares of Series A Preferred Stock outstanding as of July
                  31,
                  2005.
 (3)
                Based
                    on 11,593,222 shares of Common Stock outstanding as of July 31,
                    2005. Any
                    shares represented by options exercisable within 60 days
 After
                  July 31, 2005 are treated as being outstanding for the purpose
                  of
                  computing the percentage of class for such person but not for any
                  other
                  purpose
 (4)
              Includes
                  272,000 shares subject to options exercisable at July 31,
                  2005.
 (5)
              Includes
                  213,000 shares subject to options exercisable at July 31,
                  2005.
 (6)
              Includes
                  241,000 shares subject to options exercisable at July 31,
                  2005.
 (7)
              Includes
                  175,000 shares subject to options exercisable at July 31,
                  2005.
 (8)
              Includes
                  175,000 shares subject to options exercisable at July 31,
                  2005.
 (9)
              Includes
                  1,076,000 shares subject to options exercisable at July 31,
                  2005.






-50-
 Table
          of Contents




**ITEM
      12.****CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS.**




In
      December 2002, ATSI entered into a note payable with a related party, a director
      of ATSI, Mr. John R. Fleming, in the amount of $25,000. The note called for
      12
      monthly payments of $2,163.17 including interest, commencing on February 1,
      2003. The note has an interest rate of 7% annually and a maturity date of
      January 1, 2004. During fiscal 2004 ATSI made payments towards this note in
      the
      amount of $9,000. As of July 31, 2005 the principal balance is $16,000 and
      the
      accrued interest is $3,700. Additionally, at July 31, 2005, ATSI had a payable
      of approximately $42,519 for board fees and related expenses.





**ITEM
      13.****EXHIBITS
      AND REPORTS ON FORM 8-K**





(a)
            Exhibits.
                The following documents are exhibits to this
                report.




2.1
                Plan
                    and Agreement of Merger of ATSI Communications, Inc. with and
                    into ATSI
                    Merger Corporation, dated as of March 24, 2004. (Exhibit 2.1
                    to Form 8-K
                    of ATSI filed on May 24, 2004)3.1
                Articles
                    of Incorporation of ATSI Merger Corporation. (Exhibit 3.1 to
                    Form 8-K of
                    ATSI filed on May 24, 2004)3.2
                Bylaws
                    of ATSI Merger Corporation. (Exhibit 3.2 to Form 8-K of ATSI
                    filed on May
                    24, 2004)3.3
                Articles
                    of Merger of ATSI Communications, Inc. with and into ATSI Merger
                    Corporation. (Exhibit 3.3 to Form 8-K of ATSI filed on May 24,
                    2004)4.1
                Securities
                    Purchase Agreement between The Shaar Fund Ltd. and ATSI dated
                    July 2, 1999
                    (Exhibit 10.33 to Registration statement on Form S-3 (No. 333-84115)
                    filed
                    August 18, 1999)4.2
                Common
                    Stock Purchase Warrant issued to The Shaar Fund Ltd. by ATSI
                    dated July 2,
                    1999 (Exhibit 10.35 to Registration statement on Form S-3 (No.
                    333-84115)
                    filed August 18, 1999)4.3
                Registration
                    Rights Agreement between The Shaar Fund Ltd. and ATSI dated July
                    2, 1999
                    (Exhibit 10.36 to Registration statement on Form S-3 (No. 333-84115)
                    filed
                    August 18, 1999)4.4
                Securities
                    Purchase Agreement between The Shaar Fund Ltd. and ATSI dated
                    September
                    24, 1999 (Exhibit 10.39 to Registration statement on Form S-3
                    (No.
                    333-84115) filed October 26, 1999)4.5
                Common
                    Stock Purchase Warrant issued to The Shaar Fund Ltd. by ATSI
                    dated
                    September 24, 1999 (Exhibit 10.41 to Registration statement on
                    Form S-3
                    (No. 333-84115) filed October 26, 1999)4.6
                Registration
                    Rights Agreement between The Shaar Fund Ltd. and ATSI dated September
                    24,
                    1999 (Exhibit 10.42 to Registration statement on Form S-3 (No.
                    333-84115)
                    filed October 26, 1999)4.7
                Form
                    of letter dated December 30, 1999 from H. Douglas Saathoff, Chief
                    Financial Officer of American TeleSource International, Inc.
                    to holders of
                    Convertible Notes (Exhibit 4.1 to Registration statement on Form
                    S-3 (No.
                    333-35846) filed April 28, 20004.8
                Form
                    of letter dated January 24, 2000 from H. Douglas Saathoff, Chief
                    Financial
                    Officer of American TeleSource International, Inc. to holders
                    of
                    Convertible Notes (Exhibit 4.2 to Registration statement on Form
                    S-3 (No.
                    333-35846) filed April 28, 2000)4.9
                Registration
                    Rights Agreement between American TeleSource International, Inc.
                    and Kings
                    Peak, LLC dated February 4, 2000 (Exhibit 4.4 to Registration
                    statement on
                    Form S-3 (No. 333-35846) filed April 28, 2000)4.10
                Form
                    of Convertible Note for $2.2 million principal issued March 17,
                    1997
                    (Exhibit 4.5 to Registration statement on Form S-3 (No. 333-35846)
                    filed
                    April 28, 2000)4.11
                Form
                    of Modification of Convertible Note (Exhibit 4.6 to Registration
                    statement
                    on Form S-3 (No. 333-35846) filed April 28, 2000)4.12
                Promissory
                    Note issued to Four Holdings, Ltd. dated October 17, 1997 (Exhibit
                    4.7 to
                    Registration statement on Form S-3 (No. 333-35846) filed April
                    28,
                    2000)4.13
                Securities
                    Purchase Agreement between The Shaar Fund Ltd. and ATSI dated
                    February 22,
                    2000 (Exhibit 4.5 to Registration statement on Form S-3 (No.
                    333-89683)
                    filed April 13, 2000)4.14
                Common
                    Stock Purchase Warrant issued to The Shaar Fund Ltd. by ATSI
                    dated
                    February 22, 2000 (Exhibit 4.7 to Registration statement on Form
                    S-3 (No.
                    333-89683) filed April 13, 2000)4.15
                Common
                    Stock Purchase Warrant issued to Corporate Capital Management
                    LLC by ATSI
                    dated February 22, 2000 (Exhibit 4.8 to Registration statement
                    on Form S-3
                    (No. 333-89683) filed April 13, 2000)4.16
                Registration
                    Rights Agreement between The Shaar Fund Ltd. and ATSI dated February
                    22,
                    2000 (Exhibit 4.9 to Registration statement on Form S-3 (No.
                    333-89683)
                    filed April 13, 2000)
   -51-
 Table
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  4.17
                  Securities
                      Purchase Agreement between ATSI and RGC International Investors,
                      LDC dated
                      October 11, 2000 (Exhibit 10.1 to Form 8-K filed October 18,
                      2000)4.18
                  Registration
                      Rights Agreement between ATSI and RGC International Investors,
                      LDC dated
                      October 11, 2000 (Exhibit 10.5 to Form 8-K filed October 18,
                      2000)4.19
                  Stock
                      Purchase Warrant between ATSI and RGC International Investors,
                      LDC dated
                      October 11, 2000 (Exhibit 10.6 to Form 8-K filed October 18,
                      2000)4.20
                  Securities
                      Purchase Agreement between ATSI and “Buyers” dated March 21, 2001(Exhibit
                      4.31 to Annual Report on Form 10-K for the year ended July
                      31, 2001 filed
                      October 30, 2001)4.21
                  Stock
                      Purchase Warrant between ATSI and “Buyers” dated March 23, 2001 (Exhibit
                      4.32 to Annual Report on Form 10-K for the year ended July
                      31, 2001 filed
                      October 30, 2001)4.22
                  Securities
                      Purchase Agreement between ATSI and “Buyers” dated March 21, 2001(Exhibit
                      4.34 to Annual Report on Form 10-K for the year ended July
                      31, 2001 filed
                      October 30, 20014.23
                  Stock
                      Purchase Warrant between ATSI and “Buyers” dated March 21, 2001 (Exhibit
                      4.35 to Annual Report on Form 10-K for the year ended July
                      31, 2001 filed
                      October 30, 2001)4.24
                  Convertible
                      Debenture Agreement (Exhibit 4.37 to Annual Report on Form
                      10-K for the
                      year ended July 31, 2003 filed November 12, 2003)4.25
                  Convertible
                      Promissory Notes issued to Recap Marketing & Consulting, LLP. (Exhibit
                      4.1 to Form 10-QSB for the period Ended October 31, 2004 filed
                      December
                      15, 2004)4.26
                  Convertible
                      Promissory Notes issued to Recap Marketing & Consulting, LLP. (Exhibit
                      4.1 to form 10-QSB for the period Ended January 31, 2005 filed
                      March 15,
                      2005)4.27
                  Convertible
                      Promissory Note issued to Franklin Cardwell and Jones, PC.
                      dated November
                      1, 2004 (Exhibit 4.2 to form 10-QSB for the period Ended January
                      31, 2005
                      filed March 15, 2005)4.28
                  Convertible
                      Promissory Notes issued to Recap Marketing & Consulting, LLP. (Exhibit
                      4.1 to form 10-QSB for the period Ended April 30, 2005 filed
                      June 14,
                      2005)4.29
                  Convertible
                      Promissory Notes issued to Recap Marketing & Consulting, LLP. (Exhibit
                      4.1 to form 10-QSB for the period Ended July 31, 2005 filed
                      October 24,
                      2005)*10.1
                  American
                      TeleSource International, Inc. 1998 Stock Option Plan (Exhibit
                      4.7 to
                      Registration statement on Form S-8 filed January 11,
                      2000)10.2
                  2000
                      Option Plan (Exhibit 4.36 to annual Report on Form 10-K for
                      the year ended
                      July 31, 2003 filed November 12. 2000.)10.3
                  Agreement
                      with SATMEX (Agreement #095-1) (Exhibit 10.31 to Annual Report
                      on Form
                      10-K for year ended July 31, 1998 (No. 000-23007))10.4
                  Agreement
                      with SATMEX (Agreement #094-1) (Exhibit 10.32 to Annual Report
                      on Form
                      10-K for year ended July 31, 1998 (No. 000-23007))10.5
                  Amendment
                      to Agreement #094-1 with SATMEX (Exhibit 10.3 to Amended Annual
                      Report on
                      Form 10-K for year ended July 31, 1999 filed August 25, 2000)10.6
                  Amendment
                      to Agreement #095-1 with SATMEX (Exhibit10.4 to Amended Annual
                      Report on
                      Form 10-K for year ended July 31, 1999 filed August 25, 2000)
   -52-
 Table
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  10.7
                    Bestel
                        Fiber Lease (Exhibit 10.5 to Amended Annual Report on Form
                        10-K for year
                        ended July 31, 1999 filed April 14, 2000)10.8
                    Addendum
                        to Fiber Lease with Bestel, S.A. de C.V. (Exhibit 10.6 to
                        Amended Annual
                        Report on Form 10-K for year ended July 31, 1999 filed August
                        25, 2000)10.9
                    Commercial
                        Lease with BDRC, Inc (Exhibit 10.24 to Annual Report on Form
                        10-K for year
                        ended July 31, 2003 filed November 12, 2003)10.10
                    Stock
                        Purchase Agreement with Telemarketing (Sale of ATSICOM) (Exhibit
                        10.1 to
                        Form 8-K filed June 16, 2003)10.11
                    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)10.12
                    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)10.13
                    Carrier
                        Service Agreement DialMex and ATSI (Exhibit 10.27 to Annual
                        Report on Form
                        10-K for year ended July 31, 2003 filed November 12, 2003)10.14
                    Confidential
                        Settlement Agreement and Mutual Release, Note Payable and
                        Lock out
                        agreement between ATSI and Alfonso Torres Roqueni, dated
                        October 1, 2004.
                        (Exhibit 10.1 to Form 10-QSB for the quarter ended October
                        31, 2004 filed
                        December 15, 2004)10.15
                    Extension
                        to consulting agreements with Hunter M. A. Carr and Donald
                        W. Sapaugh
                        dated November 1, 2004. (Exhibit 10.1 to Form 10-QSB for
                        the quarter ended
                        January 31, 2005 filed March 15, 2005)10.16
                    Extension
                        of consulting agreements (Amendment No: 1) with Hunter M.
                        A. Carr and
                        Donald W. Sapaugh dated March 1, 2005. (Exhibit 10.1 to Form
                        10-QSB for
                        the quarter ended April 30, 2005 filed June 14, 2005)10.17
                    Settlement
                        Agreement (at mediation) with James C. Cuevas, Raymond G.
                        Romero, Texas
                        Workforce Commission and ATSI-Texas dated March 28, 2005.
                        (Exhibit 10.2 to
                        Form 10-QSB for the quarter ended April 30, 2005 filed June
                        14, 2005)10.18
                    Order
                        granting Joint Motion to dismiss all claims against ATSI
                        Communications,
                        Inc. (A Nevada Corp., formerly a Delaware Corp.) by Helen
                        G. Schwartz,
                        Chapter 7 Trustee for TeleSpan, Inc. dated August 29, 2005.
                        (Exhibit 10.18
                        to annual report Form 10-KSB for the year ended July 31,
                        2005 filed
                        October 18, 2005)*10.19
                    Agreement
                        of compromise, settlement and release between ATSI Communications,
                        Inc.
                        and Vianet, Inc. dated August 10, 2005. (Exhibit 10.19 to
                        annual report
                        Form 10-KSB for the year ended July 31, 2005 filed October
                        18, 2005)
                        *10.20
                    Mutual
                        release and Termination Agreement between Hunter M. A. Carr
                        and Donald W.
                        Sapaugh and ATSI Communciations, Inc. dated June 1, 2005.
                        (Exhibit 10.20
                        to annual report Form 10-KSB for the year ended July 31,
                        2005 filed
                        October 18, 2005)*21
                    Subsidiaries
                        of ATSI (Exhibit 21 to Annual Report on Form 10-K for year
                        ended July 31,
                        2004 filed November 9, 2004)
  -53-
 Table
                  of Contents
  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. *99.1
                    FCC
                        Radio Station Authorization - C Band (Exhibit 10.10 to Registration
                        statement on Form S-4 (No. 333-05557) filed June 7,
                        1996)99.2
                    FCC
                        Radio Station Authorization - Ku Band (Exhibit 10.11 to Registration
                        statement on Form 10 (No. 333-05557) filed June 7,
                        1996)99.3
                    Section
                        214 Certification from FCC (Exhibit 10.12 to Registration
                        statement on
                        Form 10 (No. 333-05557) filed June 7, 1996)99.4
                    Comercializadora
                        License (Payphone License) issued to ATSI-Mexico (Exhibit
                        10.24 to
                        Registration statement on Form 10 (No. 000-23007) filed August
                        22,
                        1997)99.5
                    Network
                        Resale License issued to ATSI-Mexico (Exhibit 10.25 to Registration
                        statement on Form 10 (No. 000-23007) filed August 22,
                        1997)99.6
                    Shared
                        Teleport License issued to Sinfra (Exhibit 99.7 to Amended
                        Annual Report
                        on Form 10-K for year ended July 31, 1999 filed April 14,
                        2000)99.7
                    Packet
                        Switching Network License issued to SINFRA (Exhibit 10.26
                        to Registration
                        statement on Form 10 (No. 000-23007) filed August 22,
                        1997)99.8
                    Value-Added
                        Service License issued to SINFRA (Exhibit 99.9 to Amended
                        Annual Report on
                        Form 10-K for year ended July 31, 1999 filed April 13, 2000)99.9
                    Public
                        Utility Commission of Texas ("PUC") approval of transfer
                        of the Service
                        Provider Certificate of Authority ("SPCOA") from Hinotel,
                        Inc. to ATSI's
                        subsidiary, Telefamilia Communications, Inc. Dated October
                        25, 2004.
                        (Exhibit 99.1 on Form 10-QSB for the quarter ended October
                        31, 2004 filed
                        December 15,
                        2004)




(b)
                Reports
                    on Form 8-K
 
 No
                  reports on Form 8-K were filed during the last quarter of the period
                  covered by this report





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





The
      Company paid the following fees to its principal independent accountants for
      services during the fiscal years ended July 31, 2005 and July 31,
      2004.




Year
                Ended July 31,Description
                of Fees
            
            2005
            
            2004Audit
                Fees
            
            $
            29,000
            
            $
            14,000Audit
                Related Fees
            
            
            -0-
            
            
            -0-Tax
                Fees
            
            
            -0-
            
            
            -0-All
                Other Fees
            
            
            -0-
            
            
            -0-





The
      Audit
      Committee has instructed Malone and Bailey PC that any fees for non-audit
      services must be approved before being incurred.






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 Table
          of Contents




**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized.




**ATSI
              COMMUNICATIONS, INC.**By:
            /s/ Arthur
              L. SmithArthur
                L. Smith
              President and Chief Executive
                Officer





In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.





**Signature**
            
            **Title**
            
            **Date**/s/
                Arthur L. Smith
            
            Principal
                Executive Officer and Director
            
            October
                24, 2005Arthur
                L. Smith/s/
                Antonio Estrada
            
            Principal
                Accounting Officer
            
            October
                24, 2005Antonio
                Estrada
            
            Principal
                Finance Officer/s/
                John R. Fleming
            
            Director
            
            October
                24, 2005John
                R. Fleming/s/
                Murray R. Nye
            
            Director
            
            October
                24,2005Murray
                R. Nye








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