**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 

| **(Mark One)**                                         |
|--------------------------------------------------------|
| ** **                                             | ** ** | ** ** |
| **ý**                                             | ** ** | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** **                                             | ** ** | ** ** |
| **For the quarterly period ended March 31, 2006** |
| ** **                                             | ** ** | ** ** |
| **o**                                                  | ** ** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934** |

 

**Forthe transition period from                to                **

 

**Commissionfile number 000-50712**

 

**ETS PAYPHONES, INC.**

(Exact name of small businessissuer as specified in its charter)

 

| **Delaware**                                                     | ** ** | **58-2131736**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                             |       |                                  |
| **1490 Westfork Drive, Suite G, Lithia Springs, Georgia**   | ** ** | **30122-1509**                        |
| (Address of  principal executive offices)                        |       | (Zip Code)                            |

 

**(770)819-1600**

(Issuer’s telephone number)

 

Check whether the issuer (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  ý    No  o

 

**APPLICABLEONLY TO ISSUERS INVOLVED IN BANKRUPTCYPROCEEDINGS DURING THE PRECEDING FIVE YEARS**

 

Check whether the registrant filed all documents and reports required tobe filed by Section 12, 13 or 15(d) of the Exchange Act after thedistribution of securities under a plan confirmed by a court. Yes  ý    No  o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes  o    No  ý

 

Transitional Small Business Disclosure Format. Yes  ý    No  o

 

As of March 31, 2006, there were outstanding 4,987,624 shares ofthe Issuer’s common stock $.0001 par value.

 

 

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**ETSPAYPHONES, INC.**

**INDEXTO FORM 10-QSB**

**MARCH 31,2006**

 
| Part I. Financial Information |                                                                                                          |
|------------------------------------|---------------------------------------------------------------------------------------------------------------|
| Item 1.                            | Financial Statements                                                                                          |   |
|                               | Statement of Net Assets in Liquidation March 31,  2006 (Unaudited)                                       |   |
|                               | Statement of Changes in Net Assets in  Liquidation for the three months ended March 31, 2006 (Unaudited) |   |
|                               | Statement of Operations (Going Concern  Basis) for the three months ended March 31, 2005 (Unaudited)     |   |
|                               | Statement of Cash Flows (Going Concern  Basis) for the three months ended March 31, 2005 (Unaudited)     |   |
|                               | Notes to Financial Statements (Unaudited)                                                                     |   |
| Item 2.                            | Plan of Operation                                                                                             |   |
| Item 3.                            | Controls and Procedures                                                                                       |   |
|                               |                                                                                                          |   |
| Part II.  Other Information   |                                                                                                          |
| Item 5.                            | Other Information                                                                                             |   |
| Item 6.                            | Exhibits                                                                                                      |   |
| Signatures                         |                                                                                                          |

 

2

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**PART I.FINANCIAL INFORMATION**

**Item1. Financial Statements**

 

**ETSPAYPHONES, INC.**

**STATEMENTOF NET ASSETS IN LIQUIDATION**

**MARCH 31,2006**

**(Unaudited)**

 
| **ASSETS**                                         |   |      |      |
|----------------------------------------------------|--------|-----------|-----------|
| Cash                                               |   | $         | 2,055,327 |   |
| Cash,  restricted                                  |   | 77,022    |      |
| Accounts  receivable                               |   | 2,043,478 |      |
| Inventories                                        |   | 402,440   |      |
| Prepaid  expenses                                  |   | 109,969   |      |
| Payphones,  property and equipment                 |   | 3,952,305 |      |
| Deposits                                           |   | 163,512   |      |
| Total assets                                       |   | 8,804,053 |      |
|                                               |   |      |      |
| **LIABILITIES**                                    |   |      |      |
| Advance on  sale of business                       |   | 514,286   |      |
| Estimated  costs to be incurred during liquidation |   | 1,929,391 |      |
| Accounts  payable                                  |   | 1,546,783 |      |
| Accrued  expenses                                  |   | 4,328,794 |      |
| Accrued  property, excise and sales taxes          |   | 123,383   |      |
| Total  liabilities                                 |   | 8,442,637 |      |
|                                               |   |      |      |
| **Net  assets in liquidation**                     |   | $         | 361,416   |   |

 

This statement has beenprepared on the liquidation basis of accounting.

The accompanying notes are anintegral part of these financial statements.

 

3

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**ETSPAYPHONES, INC.**

**STATEMENTOF CHANGES IN NET ASSETS IN LIQUIDATION**

**FORTHE THREE MONTHS ENDED MARCH 31, 2006**

**(Unaudited)**

 
| **PRE-LIQUIDATION  OPERATIONS**                                |   |       |      |
|----------------------------------------------------------------|--------|------------|-----------|
| **Revenues**                                                   |   |       |      |
| Coin calls                                                     |   | $          | 1,898,977 |   |
| Non-coin  calls                                                |   | 1,039,083  |      |
| Other  payphone revenue                                        |   | 343,839    |      |
| Total  revenue                                                 |   | 3,281,899  |      |
|                                                           |   |       |      |
| **Operating  expenses**                                        |   |       |      |
| Direct cost  of payphone operations                            |   | 3,142,664  |      |
| Selling,  general and administrative                           |   | 823,513    |      |
| Depreciation                                                   |   | 120,104    |      |
| Total  operating expenses                                      |   | 4,086,281  |      |
|                                                           |   |       |      |
| **Loss  from operations**                                      |   | (804,382   | )         |
|                                                           |   |       |      |
| **Other  income**                                              |   | 69,443     |      |
|                                                           |   |       |      |
| **Loss  from pre-liquidation operations**                      |   | (734,939   | )         |
|                                                           |   |       |      |
| **LIQUIDATION  ACTIVITIES**                                    |   |       |      |
| Administrative  expenses incurred after entering liquidation   |   | (2,468,148 | )         |
|                                                           |   |       |      |
| Net unrealized  gain on revaluations of assets and liabilities |   | 1,001,314  |      |
| **Net loss  in liquidation**                                   |   | (1,466,834 | )         |
|                                                           |   |       |      |
| **Net  decrease in net assets**                                |   | (2,201,773 | )         |
|                                                           |   |       |      |
| Shareholders’  equity at December 31, 2005           |   | 2,563,189  |      |
|                                                           |   |       |      |
| Net assets  in liquidation at March 31, 2006              |   | $          | 361,416   |   |

 

This statement has beenprepared on the liquidation basis of accounting.

The accompanying notes are anintegral part of these financial statements.

 

4

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**ETSPAYPHONES, INC.**

**STATEMENTOF OPERATIONS (GOING CONCERN BASIS)**

**FORTHE THREE MONTHS ENDED MARCH 31, 2005**

**(Unaudited)**

 
| REVENUE                                               |   |       |       |
|-------------------------------------------------------|--------|------------|------------|
| Coin Calls                                            |   | $          | 2,890,033  |   |
| Non - coin  calls                                     |   | 1,378,410  |       |
| Other  payphone revenue                               |   | 178,196    |       |
|                                                  |   |       |       |
|   Total Revenue                                  |   | 4,446,639  |       |
|                                                  |   |       |       |
| OPERATING  EXPENSES                                   |   |       |       |
|  Telephone Charges                               |   | 1,413,791  |       |
|  Commissions                                     |   | 1,250,694  |       |
|  Service, maintenance and network costs          |   | 1,521,622  |       |
|  Depreciation & amortization            |   | 210,958    |       |
|  Selling, general and administrative             |   | 1,286,379  |       |
| Total  operating expenses                             |   | 5,683,444  |       |
|                                                  |   |       |       |
| Loss from  Operations                                 |   | (1,236,805 | )          |
|                                                  |   |       |       |
| OTHER INCOME  (EXPENSE)                               |   |       |       |
|  Interest expense                                |   | (1,053     | )          |
|  Gain on asset disposition                       |   | 7,020      |       |
|  Other income                                    |   | 205,113    |       |
|                                                  |   |       |       |
| Total other  income                                   |   | 211,080    |       |
|                                                  |   |       |       |
| NET LOSS                                              |   | $          | (1,025,725 | ) |
|                                                  |   |       |       |
| Basic and  diluted net loss per common share          |   | $          | (0.21      | ) |
|                                                  |   |       |       |
| Weighted  average number of common shares outstanding |   | 4,987,624  |       |

 

This statement has beenprepared on the going concern basis of accounting.

The accompanying notes are anintegral part of these financial statements.

 

5

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**ETSPAYPHONES, INC.**

**STATEMENTOF CASH FLOWS (GOING CONCERN BASIS)**

**FORTHE THREE MONTHS ENDED MARCH 31, 2005**

**(Unaudited)**

 
| Operating  Activities                                                       |   |      |       |
|-----------------------------------------------------------------------------|--------|-----------|------------|
| Net Loss                                                                    |   | $         | (1,025,725 | ) |
| Adjustments  to reconcile net loss to net cash used by operating activities |   |      |       |
| Depreciation  expense                                                       |   | 280,146   |       |
| Decrease in  restricted cash balance                                        |   | 406,760   |       |
| Increase in  accounts receivable                                            |   | (327,912  | )          |
| Decrease in  inventories                                                    |   | 53,041    |       |
| Increase in  prepaid expenses                                               |   | (2,264    | )          |
| Decrease in  accounts payable                                               |   | (175,402  | )          |
| Decrease in  tax liabilities                                                |   | (19,531   | )          |
| Increase in  accrued expenses                                               |   | 151,659   |       |
| Decrease in  other non-current assets                                       |   | 6,026     |       |
|                                                                        |   |      |       |
| Total  Adjustments                                                          |   | 372,523   |       |
|                                                                        |   |      |       |
| Net cash  used by operating activities                                      |   | (653,202  | )          |
|                                                                        |   |      |       |
| Investing  Activity                                                         |   |      |       |
| Purchase of  fixed assets                                                   |   | (4,922    | )          |
|                                                                        |   |      |       |
| Net decrease  in cash                                                       |   | (658,124  | )          |
|                                                                        |   |      |       |
| Cash, December 31,  2004                                               |   | 1,544,999 |       |
|                                                                        |   |      |       |
| Cash, March 31,  2005                                                  |   | $         | 886,875    |   |
|                                                                        |   |      |       |
| Supplemental  Disclosure of Cash Flow Information                           |   |      |       |   |
| Cash paid  for interest                                                     |   | $         | 1,053      |   |

 

This statement has beenprepared on the going concern basis of accounting.

The accompanying notes are anintegral part of these financial statements.

 

6

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**ETSPAYPHONES, INC.**

**NOTESTO FINANCIAL STATEMENTS (UNAUDITED)**

**MARCH 31,2006**

 

**NOTE A— BASIS OF PRESENTATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

***Summary Information***

 

The accompanying unaudited financialstatements have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”) for interim financial informationand the general instructions to Form 10-QSB. Certain information andfootnote disclosures, normally included in annual financial statements, havebeen condensed or omitted pursuant to such SEC rules and regulations. Theseinterim financial statements should be read in conjunction with our auditedfinancial statements and notes thereto included in our Annual Report on Form 10-KSBfor the fiscal year ended December 31, 2005.

 

***Basis of Accounting***

 

The financial statements for the three monthsended March 31, 2005 and the fiscal year ended December 31, 2005,were prepared on the going concern basis of accounting, which contemplatesrealization of assets and satisfaction of liabilities in the normal course ofbusiness. As a result of our shareholders’ approval of the sale ofsubstantially all of the Company’s assets and the imminent nature of theliquidation of our Company, the Company adopted the liquidation basis ofaccounting effective February 15, 2006. The financial statements for thethree months ended March 31, 2006 were prepared on the liquidation basisof accounting. The liquidation basis of accounting is considered appropriatewhen, among other things, liquidation of a company is probable and the netrealizable values of assets are reasonably determinable. Under this basis ofaccounting, assets are valued at their estimated net realizable values andliabilities are stated at their estimated settlement amounts. For financialstatement presentation purposes, liquidating activities are limited to thoserelating to the revaluation and disposition of assets and liabilities as wellas costs incurred or expected to be incurred specifically as a result ofliquidation.

 

We are in the process of finalizing thedisposition of our remaining operating assets and anticipate this process willbe completed by the end of 2006. The Company will continue in existence untilits final dissolution, which is currently expected to occur during early 2007. Allnormal operations engaged in during the portion of the wind-down periodpresented prior to completion of the liquidation are included inpre-liquidation activities but do not include estimated future operating lossesexpected to be incurred prior to the final liquidation.

 

Interim results are not necessarilyindicative of results to be expected for the entire year. The preparation offinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses.Actual results could differ from those estimates. In the opinion of management,all adjustments (consisting of normal recurring adjustments) considerednecessary for a fair presentation have been included. With regard to theliquidating activities, the amounts ultimately realizable from the dispositionof the remaining assets, including costs to be incurred in connection with theliquidation, or the amounts that creditors will agree to accept in settlementof the obligations due them, may differ materially from the estimated orother amounts shown in the accompanying financial statements, and the estimatesare subject to material change in the near term.

 

*Estimated Costs to be Incurred DuringLiquidation*

 

Under the liquidation basis of accounting, weaccrue for the remaining costs to be incurred during liquidation, includingcompensation and severance for the remaining employees, board fees, fees ofprofessional service providers, and miscellaneous other costs. Such costs wereestimated at $1.9 million as of March 31, 2006. Our estimates are based onassumptions regarding our ability to settle outstanding obligations tocreditors, resolve outstanding litigation, settle remaining facility leases,and the timing of distributions to shareholders. If there are delays, or we arenot successful, in achieving these objectives, actual costs incurred may increase,reducing net assets available in liquidation.

 

***The Company***

 

ETS Payphones, Inc. (“ETS” or the “Company”)is a Delaware corporation that operates, services, and maintains a system ofpayphones. ETS is one of the largest independent payphone operators in theUnited States, and currently manages approximately 12,000 payphones from fourbranch offices handling 32 states, Washington D.C., and Puerto Rico.

 

7

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The Company enters into binding agreements with location owners tooperate payphones at locations such as shopping centers, hospitals, hotels,convenience stores, service stations, grocery stores, restaurants, airports,truck stops and bus terminals. In addition to agreements with private propertyowners, ETS is party to various agreements with municipalities under which theCompany has been granted the right to provide payphone services on municipalproperty. In most instances, the site agreements on location leases entitle theprivate property owner or municipality to a percentage of revenues as “rent.”In other instances, these agreements take the form of franchises pursuantto which ETS is required to pay either a fixed per phone fee or a percentage ofrevenues.

 

***Sale of the Company; Winding Down of Operations***

 

As wehave previously reported, the Company entered into an Asset Sale Agreementdated November 1, 2005 (the “Asset Sale Agreement”), and relatedagreements including a security agreement and a promissory note to sellsubstantially all of its operating assets to Empire Payphones, Inc. (“Empire”),an independent third party. In addition, the Company also entered into aManagement Services Agreement effective November 1, 2005 (“ManagementServices Agreement”), with Empire in which Empire has agreed to providemanagement services and fund the operational losses of ETS pending consummationof the sale transaction. A summary description of the transactions is below.The description below is qualified in its entirety by the more detaileddescription in the Current Report on Form 8-K filed by the Company on November 7,2005, the Definitive Proxy Statement filed on January 4, 2006 and the Form 10-KSBfor the fiscal year ended December 31, 2005, and to the exhibits therein.

 

***Asset Sale Agreement***

 

Pursuantto the Asset Sale Agreement, the Company has agreed to sell substantially allof its assets used in its payphone business to Empire. Under the Asset SaleAgreement, the purchase price aggregates $4.5 million and will be paid ininstallments, some prior to the consummation of the transaction, as follows: (i) $250,000in cash on November 1, 2005, (ii) payment of certain commissionsunder assigned contracts not to exceed $2.4 million in the aggregate and (iii) $1.85million in cash, payable in monthly installments of $132,143 commencing December 1,2005, with any remaining balance being paid at the closing of the transaction.

 

Theclosing of the Asset Sale Agreement is subject to a number of conditions,including compliance with regulatory requirements. The Asset Sale Agreementalso includes termination provisions that may require ETS to repay certainamounts paid by Empire under this agreement and the Management ServicesAgreement discussed below.

 

***Management Services Agreement***

 

Inorder to provide for the funding of operational losses of ETS’ payphonebusiness pending consummation of the Asset Sale Agreement, ETS and Empire enteredinto the Management Services Agreement. Under the Management ServicesAgreement, Empire has agreed to provide to ETS management services and fundoperational losses of the payphone business of ETS, subject to the oversight ofthe Board of Directors of ETS. In consideration for its management services andthe use by ETS of Empire’s affiliates’ resources, Empire shall be entitled toreceive a management fee calculated at the end of the initial term of theManagement Services Agreement and at the end of any renewal term in the amountof the first $400,000 of excess revenue, after repayment of, among otheramounts, all expenses of operation and any advances made by Empire to fundoperational losses plus 50% of any excess revenue above $400,000. ETS shall receivethe remaining 50% of excess revenue above $400,000. For use of Empire’saffiliates’ resources during the term of the Management Agreement, theaffiliates shall receive a monthly resource fee of $92,000.

 

TheManagement Services Agreement has an initial term of two years and will beautomatically extended for successive periods of one year unless Empireprovides notice prior to the end of any term that the agreement will terminateat the end of such term. The Management Services Agreement is also subject toother termination provisions, which includes the consummation of the Asset SaleAgreement detailed above. If the Management Services Agreement is terminatedother than upon the consummation of the Asset Sale Agreement, ETS will berequired to repay certain amounts paid by Empire under the Management ServicesAgreement.

 

As of March 31, 2006, the Company hasnot accrued for any unfunded operational losses by Empire since these shortfalladvances are contingent upon the closing of the sale transaction. Once theclosing occurs the Company will accrue the amount of the shortfall advances dueand increase its net assets in liquidation accordingly. The amount of theunfunded shortfall advances at March 31, 2006 was approximately $752,000.

 

8

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***Stockholder Approval; Winding Down of Operations***

 

Pursuantto the Annual Meeting of Stockholders held February 15, 2006, thestockholders of the Company approved, among other things, the sale ofsubstantially all of our assets to Empire pursuant to the Asset Sale Agreementand the winding down of our operations following the sale of substantially allof our assets to Empire. As a result, the Company has changed its basis ofaccounting to the liquidation basis as of February 15, 2006, on a goforward basis. Following the consummation of the Asset Sale Agreement, it isthe intention of the Board of Directors to dissolve the Company in accordancewith applicable laws and to distribute any proceeds remaining after suchdissolution to its stockholders. Upon consummation of the Asset Sale Agreement,the Company intends to file a certificate of dissolution with the Secretary ofState of Delaware and close the stock transfer books to discontinue recordingtransfers of our common stock at the close of business on the date we file thecertificate of dissolution with the Secretary of State of Delaware.

 

Afterconsummation of the Asset Sale Agreement our activities will be limited tocollecting proceeds from assets not included in the sale, paying off creditors,performing requirements under applicable law and distributing any remainingproceeds to stockholders. As a result of contingent or unmature liabilitiesthat may materialize or mature, dissolution and liquidation may notcreate value to our stockholders or result in any remaining capital fordistribution to our stockholders. In addition, claims, liabilities and expensesduring the winding down of our company will continue to be incurred which willreduce the amount of assets available for distribution. Any distributions madeby us shall be made solely to the stockholders of record at the close ofbusiness on the Final Record Date, except as may be necessary to reflectsubsequent transfers recorded on our books as a result of assignments by will,intestate succession or operation of law.

 

***Bankruptcy Case***

 

On March 29, 2006 a final decree was enteredclosing the bankruptcy cases.

 

***Revenue Recognition***

 

The Company derives its revenues from twoprincipal sources: coin calls and non-coin calls. Coin calls represent callspaid for by callers with coins deposited into the payphone. Coin call revenuesare recorded in the amount of coins deposited in the payphones and in theperiod deposited. We also receive revenues from non-coin calls made from ourpayphones. These non-coin calls include credit card, calling card, prepaidcalling card, collect and third-party billed calls where the caller dials “0”plus the number or simply dials “0” for an operator. Non-coin calls oftenrequire a number of services, including automated or live operators to answerthe call, verifying billing information, validating calling cards and creditcards, routing and transmitting the call to its destination, monitoring thecall’s duration and determining the charge for the call, and billing andcollecting the applicable charge. We have contracted with a limited number ofoperator service providers to handle these calls and perform allassociated functions, while paying us a commission on the revenues generatedthereby.

 

***Net Income (Loss) Per Common Share***

 

Basic income (loss) per share is computedbased on net income (loss) divided by the weighted average number of commonshares outstanding. There were no potential common share equivalentsoutstanding during 2005; therefore the diluted loss per common share is thesame as the basic loss per common share.

 

**NOTEB—OTHER INCOME (EXPENSE)**

 

Other income for the three months ended March 31, 2006 and 2005consists primarily of dial around true-up receipts for operations.

 

9

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***NOTE C - VALUATION OF ASSETSAND LIABILITIES***

 

***Due to theCompany changing to the liquidation basis of accounting, the valuation of assets and liabilities has been adjusted toreflect the amounts expected in liquidation. The valuation of assets at theirnet realizable value and liabilities at their anticipated settlement amountsrequires many estimates and assumptions. In addition, there are substantialrisks and uncertainties associated with carrying out the liquidation of theCompany’s existing operations. The valuations presented in the accompanyingStatement of Changes in Net Assets in Liquidation represent estimates, based onpresent facts and circumstances, of the net realizable values of assets andcosts associated with carrying out the dissolution and liquidation plan. Theactual values and costs are expected to differ from the amounts shown hereinand could be greater or lesser than the amounts recorded. Accordingly, it isnot possible to predict the aggregate amount, if any, that will ultimately bedistributable to shareholders.***

 

10

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**Item 2. Plan ofOperation**

 

ETS Payphones, Inc. owns and operatesapproximately 12,000 public pay telephones in 32 states concentrated primarilyin the Eastern and Southern United States, as well as the District of Columbiaand Puerto Rico. We are an independent owner of payphone equipment placed atlocations with client site owners that include retail establishments,convenience stores, hotels, hospitals and other publicly and privately ownedbusinesses. These locations are owned or managed by over 4,000 clients thatinclude Fortune 100 companies as well as single store accounts andmunicipalities.

 

Our primary business is to install andoperate payphones pursuant to contracts with location owners. We install publicpayphones in properties owned or controlled by others where significant demandexists for public payphone services, such as shopping centers, hospitals,hotels, convenience stores, service stations, grocery stores, restaurants,airports, truck stops and bus terminals. We service and maintain the payphonesand collect the revenue generated.

 

***Sale of the Company; Winding Down ofOperations***

 

As wehave previously reported, the Company entered into an Asset Sale Agreementdated November 1, 2005 (the “Asset Sale Agreement”), and relatedagreements including a security agreement and a promissory note to sellsubstantially all of its operating assets to Empire Payphones, Inc. (“Empire”),an independent third party. In addition, the Company also entered into aManagement Services Agreement effective November 1, 2005 (“ManagementServices Agreement”), with Empire in which Empire has agreed to providemanagement services and fund the operational losses of the Company pendingconsummation of the sale transaction. A summary description of the transactionsis below. The description below is qualified in its entirety by the moredetailed description in the Current Report on Form 8-K filed on November 7,2005, the Definitive Proxy Statement filed on January 4, 2006 and the Form 10-KSBfor the fiscal year ended December 31, 2005.

 

***Asset Sale Agreement***

 

Pursuantto the Asset Sale Agreement, the Company has agreed to sell substantially allof its assets used in its payphone business to Empire. Under the Asset SaleAgreement, the purchase price aggregates $4.5 million and will be paid ininstallments, some prior to the consummation of the transaction, as follows: (i) $250,000in cash on November 1, 2005, (ii) payment of certain commissionsunder assigned contracts not to exceed $2.4 million in the aggregate and (iii) $1.85million in cash, payable in monthly installments of $132,143 commencing December 1,2005, with any remaining balance being paid at the closing of the transaction.

 

Theclosing of the Asset Sale Agreement is subject to a number of conditions,including compliance with regulatory requirements. The Asset Sale Agreementalso includes termination provisions that may require us to repay certainamounts paid by Empire under this agreement and the Management ServicesAgreement discussed below.

 

***Management ServicesAgreement***

 

Inorder to provide for the funding of operational losses of our payphone businesspending consummation of the Asset Sale Agreement, the Company and Empireentered into the Management Services Agreement. Under the Management ServicesAgreement, Empire has agreed to provide to the Company management services andfund operational losses of our payphone business, subject to the oversight ofour Board of Directors. In consideration for its management services and theuse by us of Empire’s affiliates’ resources, Empire shall be entitled toreceive a management fee calculated at the end of the initial term of theManagement Services Agreement and at the end of any renewal term in the amountof the first $400,000 of excess revenue, after repayment of, among otheramounts, all expenses of operation and any advances made by Empire to fundoperational losses plus 50% of any excess revenue above $400,000. We shallreceive the remaining 50% of excess revenue above $400,000. For use of Empire’saffiliates’ resources during the term of the Management Agreement, theaffiliates shall receive a monthly resource fee of $92,000.

 

TheManagement Services Agreement has an initial term of two years and will beautomatically extended for successive periods of one year unless Empireprovides notice prior to the end of any term that the agreement will terminateat the end of such term. The Management Services Agreement is also subject toother termination provisions, which includes the consummation of the Asset SaleAgreement detailed above. If the Management Services Agreement is terminatedother than upon the consummation of the Asset Sale Agreement, we will berequired to repay certain amounts paid by Empire under the Management ServicesAgreement.

 

11

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***Stockholder Approval;******Winding Down ofOperations***

 

Asdiscussed in Item 4 of Part II in Form 10-KSB for the fiscal yearended December 31, 2005, filed March 31, 2006, pursuant to the AnnualMeeting of Stockholders held February 15, 2006, the stockholders of theCompany approved, among other things, the sale of substantially all of ourassets to Empire pursuant to the Asset Sale Agreement and the winding down ofour operations following the sale of substantially all of our assets to Empire.Following the consummation of the Asset Sale Agreement, it is the intention ofthe Board of Directors to dissolve the Company in accordance with applicablelaws and to distribute any proceeds remaining after such dissolution to itsstockholders. Upon consummation of the Asset Sale Agreement, the Companyintends to file a certificate of dissolution with the Secretary of State ofDelaware and close the stock transfer books to discontinue recording transfersof our common stock at the close of business on the date we file thecertificate of dissolution with the Delaware Secretary of State (the “FinalRecord Date”).

 

Afterconsummation of the Asset Sale Agreement our activities will be limited tocollecting proceeds from assets not included in the sale, paying off creditors,performing requirements under applicable law and distributing any remainingproceeds to stockholders. As a result of contingent or unmature liabilitiesthat may materialize or mature, dissolution and liquidation may notcreate value to our stockholders or result in any remaining capital fordistribution to our stockholders. In addition, claims, liabilities and expensesduring the winding down of our company will continue to be incurred which willreduce the amount of assets available for distribution. Any distributions madeby us shall be made solely to the stockholders of record at the close ofbusiness on the Final Record Date, except as may be necessary to reflectsubsequent transfers recorded on our books as a result of assignments by will,intestate succession or operation of law.

 

***Liquidation Basis of Accounting***

 

Thecondensed financial statements for the three months ending March 31, 2006were prepared on the liquidation basis of accounting. Under the liquidationbasis of accounting, assets are stated at their estimated net realizable valuesand liabilities are stated at their estimated settlement amounts. Estimateswill be periodically reviewed and adjusted. Since the Company is inliquidation, the need to present future quarterly Statements of Operations andStatements of Cash Flows is eliminated.

 

***The valuation of assets attheir net realizable value and liabilities at their anticipated settlementamounts necessarily requires many estimates and assumptions. In addition, thereare substantial risks and uncertainties associated with carrying out theliquidation of the Company’s existing operations. The valuations presented inthe accompanying Statement of Changes in Net Assets in Liquidation representestimates, based on present facts and circumstances, of the net realizablevalues of assets and costs associated with carrying out the dissolution andliquidation plan based on the assumptions set forth below. The actual valuesand costs are expected to differ from the amounts shown herein and could begreater or lesser than the amounts recorded. Accordingly, it is not possible topredict the aggregate amount, if any, that will ultimately be distributable toshareholders.***

 

***Factors to Consider***

 

Thefollowing characteristics of our operations or industry may have amaterial impact upon our future financial performance.

 

# ***1. Dissolution;Winding Down and Liquidation***

 

Pursuantto the Annual Meeting of Stockholders held February 15, 2006, thestockholders of the Company approved, among other things, the sale ofsubstantially all of our assets to Empire pursuant to the Asset Sale Agreementand the winding down of our operations following the sale of substantially allof our assets to Empire. After consummation of the Asset Sale Agreement ouractivities will be limited to collecting proceeds from assets not included inthe sale, paying off creditors, performing requirements under applicable lawand distributing any remaining proceeds to stockholders of record. As a resultof contingent or unmature liabilities that may materialize or mature,dissolution and liquidation may not create value to our stockholders orresult in any remaining capital for distribution to our stockholders. Inaddition, claims, liabilities and expenses during the winding down of ourcompany will continue to be incurred which will reduce the amount of assetsavailable for distribution. We will close our stock transfer books anddiscontinue recording transfers of our common stock at the close of business onthe date we file the certificate of dissolution with the Delaware Secretary ofState which is anticipated to be filed promptly following the consummation ofthe Asset Sale Agreement. Any distributions made by us shall be made solely tothe stockholders of record at the close of business on the Final Record Date,except as may be necessary to reflect subsequent transfers recorded on ourbooks as a result of assignments by will, intestate succession or operation oflaw. We cannot assure the stockholders of the amount, if any, or timing of anydistribution to our stockholders as a result of the dissolution.

 

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# ***2.**Possiblediscontinuance of operations***

 

If weare unable to consummate the sale transaction to Empire pursuant to the AssetSale Agreement we may not be able to remain a viable company and may haveto discontinue operations. Our expenses have historically exceeded our revenuesand we have sustained losses since our bankruptcy reorganization in December 2002.Based on continued erosion of revenue and despite management’s reduction ofoperating expenses, there is substantial doubt about the Company’s ability tocontinue as a going concern.

 

# ***3.**Regulatory Issues***

 

Theenactment of the Telecommunications Act significantly altered the regulatorylandscape in which payphone companies operate. Although we believe that theTelecommunications Act, as implemented by the FCC, addressed certain historicalinequities in the payphone marketplace, uncertainties relating to the impactand timing of the implementation of the new regulatory framework still exist.The uncertainty with the greatest potential financial impact relates to revenuefrom access code calls and toll-free dialed calls, also referred to asdial-around compensation. Dial-around compensation accounts for a materialpercentage of our revenues. Additionally, the March 2004 Court of Appealsdecision to vacate the FCC Unbundled Network Element rules will have anunknown effect on local line access pricing, but is expected to increase pricesto payphone service providers.

 

# ***4.**Limited FinancialResources***

 

Ourfuture performance and liquidity will depend on a number of factors, includingindustry performance, general business and economic conditions, the absence ofcontingencies, and other matters, many of which are beyond our control. We havelimited financial resources, and it may be the case that we will not havethe funds to make capital improvements arising in the ordinary course ofbusiness.

 

# ***5.**Dependence UponThird-Party Providers***

 

Weassemble payphones from components provided by outside suppliers. In addition,we rely on outside suppliers for local line access, billing and collectionservices, and long-distance and operator services. We believe that multiplesuppliers are available to meet all of our product and service needs atcompetitive prices and rates and expect the availability of such products andservices to continue in the future. However, we cannot assure the continuingavailability of alternative sources.

 

# ***6.**Competition***

 

Wecompete with other telecommunications providers, including providers ofwireless services, other payphone providers and long-distance carriers. Many ofthese competitors have substantially greater financial, marketing, and otherresources than the Company.

 

# ***7.**Technological Change andNew Services***

 

Continuoustechnological change, frequent service and product innovations, and evolvingindustry standards characterize the telecommunications industry. We believethat our future success will depend in part on our ability to anticipatetechnological changes and respond in a timely and effective manner to meet newindustry standards. Any failure to keep pace with technological change(including the technical support component required to operate payphones) andnew customer service demands could have a material adverse effect on ourbusiness.

 

# ***8.**Impact of Seasonality***

 

Ourrevenue from payphone operations is affected by seasonal variations. Becausemany of our payphones are located outdoors, weather patterns have differingeffects on our revenue depending on the region of the country where thepayphones are located and the enclosure housing of the phone. For example, ourpayphones throughout the Midwestern and Eastern United States produce theirhighest call volumes during the second and third quarters, when the climatetends to be more favorable. Seasonal variations in revenues could have amaterial adverse effect on our business. Changes in the geographic distributionof our payphones may in the future result in different seasonal variationsin our results.

 

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# ***9.**No established market forthe Common Stock***

 

Our Common Stock is not listed on any stockexchange. Our Common Stock was issued to approximately 12,500 individuals andentities that entered into agreements with Old ETS to purchase payphones.Ownership interests are tracked by the transfer agent, American Stock Transferand Trust Company (“AST&T”), and transfers of ownership may bedocumented through AST&T. The Common Stock is not traded on any recognizedstock exchange, stock market or bulletin board system and there are no marketmakers for the Common Stock. There can be no assurance that an active or liquidtrading market for our shares of Common Stock will develop or be maintained.The number of shares of Common Stock distributed to each Payphone Investor wasdetermined by formula confirmed by the bankruptcy court and that formula may notbe indicative of the market price for the Common Stock following registration.

 

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**Item 3.Controls and Procedures**

 

Our Chief Executive Officer and ChiefFinancial Officer (collectively, the “Certifying Officers”) are responsible forestablishing and maintaining disclosure controls and procedures for theCompany. Based upon such officers’ evaluation of these controls and proceduresas of a date within 45 days of the filing of this Quarterly Report, and subjectto the limitations noted hereinafter, the Certifying Officers have concludedthat our disclosure controls and procedures are effective to ensure thatinformation required to be disclosed by us in this Quarterly Report isaccumulated and communicated to management, including our principal officers asappropriate, to allow timely decisions regarding required disclosure.

 

The Certifying Officers have also indicatedthat there were no significant changes in our internal controls or otherfactors that could significantly affect such controls subsequent to the date oftheir evaluation, and there were no corrective actions with regard tosignificant deficiencies and material weaknesses.

 

Our management, including each of theCertifying Officers, does not expect that our disclosure controls or ourinternal controls will prevent all error and fraud. A control system, no matterhow well conceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met. In addition, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs. Because ofthe inherent limitations on all control systems, no evaluation of controls canprovide absolute assurance that all controls issues and instances of fraud, ifany, within a company have been detected. These inherent limitations includethe realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake. Additionally, controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people or by management override of the control. The design of anysystem of controls also is based in part upon certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Over time, control may become inadequate because of changes inconditions, or the degree of compliance with the policies or procedures may deteriorate.Because of these inherent limitations in a cost-effective control system,misstatements due to error or fraud may occur and not be detected.

 

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**PART II.OTHER INFORMATION**

 

**Item 5. OtherInformation**

 

***None***

 

**Item 6. Exhibits**

 
| **EXHIBIT  NUMBER** | ** ** | **DESCRIPTION**                                                                      |
|---------------------|------------|--------------------------------------------------------------------------------------|
|                |       |                                                                                 |
| 31.1                |       | Certification of CEO pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
| 31.2                |       | Certification of CFO pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
| 32.1                |       | Certification of CEO pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
| 32.2                |       | Certification of CFO pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                    | ETS PAYPHONES, INC. |
|-------------------------|--------------------------|
|                    |                     |   |
| Date: May 15, 2006 | By:                      | /s/ GUY A. LONGOBARDO |   |
|                    |                     | Guy A. Longobardo |   |
| * *                | * *                 | *President and Chief Executive Officer* | * * |
|                    |                     |   |   |
|                    | By:                      | /s/ MICHAEL H. MCCLELLAN |   |
|                    |                     | Michael H. McClellan |   |
| * *                | * *                 | *Executive Vice President,* | * * |
| * *                | * *                 | *Chief Financial Officer and Treasurer* | * * |

 

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