**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 June 30, 2006** |
| ** **                                        | ** ** |
| **o**                                             | **TRANSITION REPORT UNDER SECTION 13 OR  15(d) OF THE EXCHANGE ACT OF 1934** |

**For the transition periodfrom                to                **

**Commission file number 000-50712**

**ETS PAYPHONES, INC.**

(Exact name of small business issuer as specified inits charter)

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

**(770) 819-1600**

(Issuer’s telephone number)

Checkwhether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.Yes  x    No  o

**APPLICABLE ONLY TO ISSUERS INVOLVEDIN BANKRUPTCYPROCEEDINGS DURING THE PRECEDING FIVE YEARS**

Checkwhether the registrant filed all documents and reports required to be filed bySection 12, 13 or 15(d) of the Exchange Act after the distribution ofsecurities under a plan confirmed by a court. Yes  x    No  o

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes  o    No  x

TransitionalSmall Business Disclosure Format. Yes  ý    No  o

As ofJune 30, 2006, there were outstanding 4,987,624 shares of the Issuer’s commonstock $.0001 par value.

 

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**ETS PAYPHONES, INC.**

**INDEX TO FORM 10-QSB**

**JUNE 30, 2006**
| Part I. Financial  Information |                                                                                                              |
|-------------------------------------|-------------------------------------------------------------------------------------------------------------------|
| Item 1.                             | Financial  Statements                                                                                             |   |
|                                | Statement  of Net Assets in Liquidation June 30, 2006 (Unaudited)                                                 |   |
|                                | Statements  of Changes in Net Assets in Liquidation for the three and six months ended  June 30, 2006 (Unaudited) |   |
|                                | Statement  of Operations (Going Concern Basis) for the three and six months ended June  30, 2005 (Unaudited)      |   |
|                                | Statement  of Cash Flows (Going Concern Basis) for the six months ended June 30, 2005  (Unaudited)                |   |
|                                | Notes  to Financial Statements (Unaudited)                                                                        |   |
| Item  2.                            | Plan  of Operation                                                                                                |   |
| Item 3.                             | Controls and Procedures                                                                                           |   |
|                                |                                                                                                              |   |
| Part II.  Other Information    |                                                                                                              |
| Item  1.                            | Legal  Proceedings                                                                                                |   |
| Item  5.                            | Other  Information                                                                                                |   |
| Item 6.                             | Exhibits                                                                                                          |   |
| Signatures                          |                                                                                                              |

2

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**PART I. FINANCIAL INFORMATION**

**Item 1.Financial Statements**

**ETS PAYPHONES, INC.**

**STATEMENT OF NET ASSETS INLIQUIDATION**

**JUNE 30, 2006**

**(Unaudited)**
| **ASSETS**                                         | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|------------|
| Cash                                               |       | $          | 1,472,197  |   |
| Cash, restricted                                   |       | 82,396     |       |
| Accounts  receivable                               |       | 2,259,419  |       |
| Inventories                                        |       | 402,440    |       |
| Prepaid expenses                                   |       | 49,497     |       |
| Payphones,  property and equipment                 |       | 3,952,305  |       |
| Deposits                                           |       | 159,862    |       |
| Total assets                                       |       | 8,378,116  |       |
|                                               |       |       |       |
| **LIABILITIES**                                    | ** ** | ** ** | ** ** |
| Advance on sale  of business                       |       | 514,286    |       |
| Estimated costs  to be incurred during liquidation |       | 1,126,685  |       |
| Accounts payable                                   |       | 2,135,580  |       |
| Accrued expenses                                   |       | 4,433,856  |       |
| Accrued  property, excise and sales taxes          |       | 129,295    |       |
| Total  liabilities                                 |       | 8,339,702  |       |
|                                               |       |       |       |
| **Net assets in liquidation**                      |       | $          | 38,414     |   |

This statement has been prepared on the liquidationbasis of accounting.

The accompanying notes are an integral part ofthese financial statements.

3

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**ETS PAYPHONES, INC.**

**STATEMENTS OF CHANGES IN NET ASSETSIN LIQUIDATION**

**FOR THE THREE AND SIX MONTHS ENDEDJUNE 30, 2006**

**(Unaudited)**
| ** **                                                     | ** ** | **For the three months  ended June 30, 2006** | ** ** | **For the six months  ended June 30, 2006** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **PRE-LIQUIDATION OPERATIONS**                                 | ** ** | ** **                                                                  | ** ** | ** **                                                                | ** ** |
| **Revenues**                                                   | ** ** | ** **                                                                  | ** ** | ** **                                                                | ** ** |
| Coin calls                                                     |       | $                                                                           | 1,885,941  |                                                                      | $          | 3,784,918 |   |
| Non-coin calls                                                 |       | 1,012,174                                                                   |       | 2,051,257                                                                 |       |
| Other payphone  revenue                                        |       | 75,843                                                                      |       | 419,682                                                                   |       |
| Total revenue                                                  |       | 2,973,958                                                                   |       | 6,255,857                                                                 |       |
|                                                           |       |                                                                        |       |                                                                      |       |
| **Operating  expenses**                                        | ** ** | ** **                                                                  | ** ** | ** **                                                                | ** ** |
| Direct cost of  payphone operations                            |       | 2,705,251                                                                   |       | 5,847,915                                                                 |       |
| Selling, general  and administrative                           |       | 704,618                                                                     |       | 1,528,131                                                                 |       |
| Depreciation                                                   |       | —                                                                      |       | 120,104                                                                   |       |
| Total operating  expenses                                      |       | 3,409,869                                                                   |       | 7,496,150                                                                 |       |
|                                                           |       |                                                                        |       |                                                                      |       |
| **Loss  from operations**                                      |       | (435,911                                                                    | )          | (1,240,293                                                                | )          |
|                                                           |       |                                                                        |       |                                                                      |       |
| **Other  income**                                              |       | 95,109                                                                      |       | 164,552                                                                   |       |
|                                                           |       |                                                                        |       |                                                                      |       |
| **Loss  from pre-liquidation operations**                      |       | (340,802                                                                    | )          | (1,075,741                                                                | )          |
|                                                           |       |                                                                        |       |                                                                      |       |
| **LIQUIDATION ACTIVITIES**                                     | ** ** | ** **                                                                  | ** ** | ** **                                                                | ** ** |
| Administrative  expenses incurred after entering liquidation   |       | —                                                                      |       | (2,468,148                                                                | )          |
| Net unrealized  gain on revaluations of assets and liabilities |       | 17,800                                                                      |       | 1,019,114                                                                 |       |
| **Net  income (loss) in liquidation**                          |       | 17,800                                                                      |       | (1,449,034                                                                | )          |
|                                                           |       |                                                                        |       |                                                                      |       |
| **Net decrease in net assets**                                 |       | (323,002                                                                    | )          | (2,524,775                                                                | )          |
|                                                           |       |                                                                        |       |                                                                      |       |
| Shareholders’  equity at beginning of period              |       | 361,416                                                                     |       | 2,563,189                                                                 |       |
|                                                           |       |                                                                        |       |                                                                      |       |
| Net assets in  liquidation at June 30, 2006                    |       | $                                                                           | 38,414     |                                                                      | $          | 38,414 |   |

This statement has been prepared on the liquidationbasis of accounting.

The accompanying notes are an integral part ofthese financial statements.

4

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**ETS PAYPHONES, INC.**

**STATEMENTS OF OPERATIONS (GOINGCONCERN BASIS)**

**FOR THE THREE AND SIX MONTHS ENDEDJUNE 30, 2005**

**(Unaudited)**
| ** **                                            | ** ** | **For the Three Months  Ended June 30, 2005** | ** ** | **For the Six Months  Ended June 30, 2005** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
|                                                  |       |                                                                        |       |                                                                      |       |
| REVENUE                                               |       |                                                                        |       |                                                                      |       |
| Coin Calls                                            |       | $                                                                           | 3,014,053  |                                                                      | $          | 5,904,087 |   |
| Non - coin calls                                      |       | 1,085,574                                                                   |       | 2,463,984                                                                 |       |
| Other payphone revenue                                |       | 196,685                                                                     |       | 374,880                                                                   |       |
| Total Revenue                                         |       | 4,296,312                                                                   |       | 8,742,951                                                                 |       |
|                                                  |       |                                                                        |       |                                                                      |       |
| OPERATING  EXPENSES                                   |       |                                                                        |       |                                                                      |       |
| Telephone Charges                                     |       | 1,420,132                                                                   |       | 2,833,923                                                                 |       |
| Commissions                                           |       | 1,313,546                                                                   |       | 2,564,237                                                                 |       |
| Service, maintenance and network costs                |       | 1,408,587                                                                   |       | 2,930,208                                                                 |       |
| Depreciation & amortization                       |       | 278,264                                                                     |       | 558,408                                                                   |       |
| Selling, general and administrative                   |       | 1,154,898                                                                   |       | 2,372,092                                                                 |       |
| Total operating expenses                              |       | 5,575,427                                                                   |       | 11,258,868                                                                |       |
|                                                  |       |                                                                        |       |                                                                      |       |
| Loss from  Operations                                 |       | (1,279,115                                                                  | )          | (2,515,917                                                                | )          |
|                                                  |       |                                                                        |       |                                                                      |       |
| OTHER INCOME  (EXPENSE)                               |       |                                                                        |       |                                                                      |       |
| Interest income (expense)                             |       | 1,017                                                                       |       | (35                                                                       | )          |
| Reorganization expense                                |       | (10,000                                                                     | )          | (20,710                                                                   | )          |
| Gain on asset disposition                             |       | 380,712                                                                     |       | 387,732                                                                   |       |
| Other income                                          |       | 1,000,198                                                                   |       | 1,216,020                                                                 |       |
| Total other income                                    |       | 1,371,927                                                                   |       | 1,583,007                                                                 |       |
|                                                  |       |                                                                        |       |                                                                      |       |
| NET INCOME(LOSS)                                      |       | $                                                                           | 92,812     |                                                                      | $          | (932,910 | ) |
|                                                  |       |                                                                        |       |                                                                      |       |
| Basic and  diluted net income(loss) per common share  |       | $                                                                           | 0.02       |                                                                      | $          | (0.19 | ) |
|                                                  |       |                                                                        |       |                                                                      |       |
| Weighted average number  of common shares outstanding |       | 4,987,624                                                                   |       | 4,987,624                                                                 |       |

This statement has been prepared on the going concernbasis of accounting.

The accompanying notes are an integral part ofthese financial statements.

5

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**ETS PAYPHONES, INC.**

**STATEMENT OF CASH FLOWS (GOINGCONCERN BASIS)**

**FOR THE SIX MONTHS ENDED JUNE 30,2005**

**(Unaudited)**
| Operating Activities                                                        |   |      |      |
|-----------------------------------------------------------------------------|--------|-----------|-----------|
| Net Loss                                                                    |   | $         | (932,910  | ) |
| Adjustments to  reconcile net loss to net cash used by operating activities |   |      |      |
| Depreciation and  amortization                                              |   | 558,408   |      |
| Decrease in  restricted cash balance                                        |   | 405,164   |      |
| Gain from sale  of payphones                                                |   | (380,711  | )         |
| Changes in  operating assets and liabilities:                               |   |      |      |
| Decrease in  accounts receivable                                            |   | 28,826    |      |
| Decrease in  inventories                                                    |   | 36,064    |      |
| Increase in  prepaid expenses                                               |   | (28,910   | )         |
| Decrease in  accounts payable                                               |   | (480,517  | )         |
| Increase in  accrued expenses and other liabilities                         |   | 510,497   |      |
| Decrease in  other non-current assets                                       |   | 2,843     |      |
| Total  Adjustments                                                          |   | 651,664   |      |
|                                                                        |   |      |      |
| Net cash used by  operating activities                                      |   | (281,246  | )         |
|                                                                        |   |      |      |
| Investing Activity                                                          |   |      |      |
| Purchase of  fixed assets                                                   |   | (12,170   | )         |
|                                                                        |   |      |      |
| Net decrease in cash                                                        |   | (293,416  | )         |
|                                                                        |   |      |      |
| Cash – December 31,  2004                                              |   | 1,544,999 |      |
| Cash – June 30, 2005                                                   |   | $         | 1,251,583 |   |
|                                                                        |   |      |      |
| Supplemental Disclosure  of Cash Flow Information                           |   |      |      |
| Cash paid for  interest                                                     |   | $         | 35        |   |

This statement has been prepared on the going concernbasis of accounting.

The accompanying notes are an integral part ofthese financial statements.

6

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**ETS PAYPHONES, INC.**

**NOTES TO FINANCIAL STATEMENTS(UNAUDITED)**

**JUNE 30, 2006**

**NOTE A— BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

***Summary Information***

The accompanying unaudited financial statements havebeen prepared pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”) for interim financial information and the generalinstructions to Form 10-QSB. Certain information and footnote disclosures,normally included in annual financial statements, have been condensed oromitted pursuant to such SEC rules and regulations. These interimfinancial statements should be read in conjunction with our audited financialstatements 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 six months ended June30, 2005 and the fiscal year ended December 31, 2005, were prepared on thegoing concern basis of accounting, which contemplates realization of assets andsatisfaction of liabilities in the normal course of business. As a result ofour shareholders’ approval of the sale of substantially all of the Company’sassets and the imminent nature of the liquidation of our Company, the Companyadopted the liquidation basis of accounting effective February 15, 2006.The financial statements for the three and six months ended June 30, 2006 wereprepared on the liquidation basis of accounting. The liquidation basis ofaccounting is considered appropriate when, among other things, liquidation of acompany is probable and the net realizable values of assets are reasonablydeterminable. Under this basis of accounting, assets are valued at theirestimated net realizable values and liabilities are stated at their estimatedsettlement amounts. For financial statement presentation purposes, liquidatingactivities are limited to those relating to the revaluation and disposition ofassets and liabilities as well as costs incurred or expected to be incurredspecifically as a result of liquidation.

We are in the process of finalizing the disposition ofour remaining operating assets and anticipate this process will be completed bythe end of 2006. The Company will continue in existence until its finaldissolution, which is currently expected to occur during early 2007. All normaloperations engaged in during the portion of the wind-down period presentedprior to completion of the liquidation are included in pre-liquidationactivities but do not include estimated future operating losses expected to beincurred prior to the final liquidation.

Interim results are not necessarily indicative ofresults to be expected for the entire year. The preparation of financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses. Actualresults could differ from those estimates. In the opinion of management, alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included. With regard to the liquidatingactivities, the amounts ultimately realizable from the disposition of theremaining 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 During Liquidation***

Under the liquidation basis of accounting, we accruefor 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 $1.1 million as of June 30, 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 aDelaware 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 10,000 payphones from fourbranch offices handling 32 states, Washington D.C., and Puerto Rico.

7

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TheCompany enters into binding agreements with location owners to operatepayphones at locations such as shopping centers, hospitals, hotels, conveniencestores, service stations, grocery stores, restaurants, airports, truck stopsand bus terminals. In addition to agreements with private property owners, ETSis party to various agreements with municipalities under which the Company hasbeen granted the right to provide payphone services on municipal property. Inmost instances, the site agreements on location leases entitle the privateproperty owner or municipality to a percentage of revenues as “rent.” In otherinstances, these agreements take the form of franchises pursuant to whichETS is required to pay either a fixed per phone fee or a percentage ofrevenues.

***Sale of theCompany; Winding Down of Operations***

As we have previously reported, the Company enteredinto an Asset Sale Agreement dated November 1, 2005 (the “Asset SaleAgreement”), and related agreements including a security agreement and apromissory note to sell substantially all of its operating assets to EmpirePayphones, Inc. (“Empire”), an independent third party. In addition, theCompany also entered into a Management Services Agreement effectiveNovember 1, 2005 (“Management Services Agreement”), with Empire in whichEmpire has agreed to provide management services and fund the operational lossesof ETS pending consummation of the sale transaction. A summary description ofthe transactions is below. The description below is qualified in its entiretyby the more detailed description in the Current Report on Form 8-K filedby the Company on November 7, 2005, the Definitive Proxy Statement filedon January 4, 2006 and the Form 10-KSB for the fiscal year endedDecember 31, 2005, filed on March 31, 2006, and to the exhibits therein.

***Asset Sale Agreement***

Pursuant to the Asset Sale Agreement, the Company hasagreed to sell substantially all of its assets used in its payphone business toEmpire. Under the Asset Sale Agreement, the purchase price aggregates $4.5million and will be paid in installments, some prior to the consummation of thetransaction, as follows: (i) $250,000 in cash on November 1, 2005,(ii) payment of certain commissions under assigned contracts not to exceed$2.4 million in the aggregate and (iii) $1.85 million in cash, payable inmonthly installments of $132,143 commencing December 1, 2005, with anyremaining balance being paid at the closing of the transaction.

The closing of the Asset Sale Agreement is subject toa number of conditions, including compliance with regulatory requirements. TheAsset Sale Agreement also includes termination provisions that may requireETS to repay certain amounts paid by Empire under this agreement and theManagement Services Agreement discussed below.

***Management ServicesAgreement***

In order to provide for the funding of operationallosses of ETS’ payphone business pending consummation of the Asset SaleAgreement, ETS and Empire entered into the Management Services Agreement. Underthe Management Services Agreement, Empire has agreed to provide to ETSmanagement services and fund operational losses of the payphone business ofETS, subject to the oversight of the Board of Directors of ETS. Inconsideration for its management services and the use by ETS of Empire’saffiliates’ resources, Empire shall be entitled to receive a management feecalculated at the end of the initial term of the Management Services Agreementand at the end of any renewal term in the amount of the first $400,000 ofexcess revenue, after repayment of, among other amounts, all expenses ofoperation and any advances made by Empire to fund operational losses plus 50%of any excess revenue above $400,000. ETS shall receive the remaining 50% ofexcess revenue above $400,000. For use of Empire’s affiliates’ resources duringthe term of the Management Agreement, the affiliates shall receive a monthlyresource fee of $92,000.

The Management Services Agreement has an initial termof two years and will be automatically extended for successive periods of oneyear unless Empire provides notice prior to the end of any term that theagreement will terminate at the end of such term. The Management ServicesAgreement is also subject to other termination provisions, which includes theconsummation of the Asset Sale Agreement detailed above. If the ManagementServices Agreement is terminated other than upon the consummation of the AssetSale Agreement, ETS will be required to repay certain amounts paid by Empireunder the Management Services Agreement.

As of June 30, 2006, the Company has not accrued forany unfunded operational losses by Empire since these shortfall advances arecontingent upon the closing of the sale transaction. Once the closing occursthe Company will accrue the amount of the shortfall advances due and increaseits net assets in liquidation accordingly. The amount of the unfunded shortfalladvances at June 30, 2006 was approximately $1.2 million.

8

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***StockholderApproval; Winding Down of Operations***

Pursuant to the Annual Meeting of Stockholders heldFebruary 15, 2006, the stockholders of the Company approved, among otherthings, the sale of substantially all of our assets to Empire pursuant to theAsset Sale Agreement and the winding down of our operations following the saleof substantially all of our assets to Empire. As a result, the Company haschanged its basis of accounting to the liquidation basis as ofFebruary 15, 2006, on a go forward basis. Following the consummation ofthe Asset Sale Agreement, it is the intention of the Board of Directors todissolve the Company in accordance with applicable laws and to distribute anyproceeds remaining after such dissolution to its stockholders. Uponconsummation of the Asset Sale Agreement, the Company intends to file acertificate of dissolution with the Secretary of State of Delaware and closethe stock transfer books to discontinue recording transfers of our common stockat the close of business on the date we file the certificate of dissolutionwith the Secretary of State of Delaware.

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. As a result ofcontingent 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. Any distributions made by us shall be made solelyto the stockholders of record at the close of business on the Final RecordDate, except as may be necessary to reflect subsequent transfers recordedon our books as a result of assignments by will, intestate succession oroperation of law.

***Revenue Recognition***

The Company derives its revenues from two principalsources: coin calls and non-coin calls. Coin calls represent calls paid for bycallers with coins deposited into the payphone. Coin call revenues are recordedin the amount of coins deposited in the payphones and in the period deposited.We also receive revenues from non-coin calls made from our payphones. Thesenon-coin calls include credit card, calling card, prepaid calling card, collectand third-party billed calls where the caller dials “0” plus the number orsimply dials “0” for an operator. Non-coin calls often require a number ofservices, including automated or live operators to answer the call, verifyingbilling information, validating calling cards and credit cards, routing andtransmitting the call to its destination, monitoring the call’s duration anddetermining the charge for the call, and billing and collecting the applicablecharge. We have contracted with a limited number of operator service providersto handle these calls and perform all associated functions, while payingus a commission on the revenues generated thereby.

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

Basic income (loss) per share is computed based on netincome (loss) divided by the weighted average number of common sharesoutstanding. There were no potential common share equivalents outstandingduring 2005; therefore the diluted loss per common share is the same as thebasic loss per common share.

**NOTEB—OTHER INCOME (EXPENSE)**

Other income for the six months ended June 30, 2006and 2005 consists of the following:

| 2006                                                              | ** ** | **Q2** | ** ** | **Q1**  | ** ** | **YTD** | ** ** |
|-------------------------------------------------------------------|------------|--------|------------|---------|------------|---------|------------|
|                                                              |       |   |       |    |       |    |       |
| Dial around true-up  receipts for prior years’ operations    |       | $      | 3,761      |    | $          | 90,027  |       | $ | 93,788 |   |
| Local exchange carrier  credits from prior years’ operations |       | 29,704 |       | 12,372  |       | 42,076  |       |
| Loss recovery                                                     |       | 21,000 |       | 1,196   |       | 22,196  |       |
| Reorganization expense                                            |       | — |       | (43,985 | )          | (43,985 | )          |
| Interest income                                                   |       | 17,881 |       | 9,571   |       | 27,452  |       |
| Other miscellaneous  income items                                 |       | 22,763 |       | 262     |       | 23,025  |       |
|                                                              |       |   |       |    |       |    |       |
| Total                                                             |       | $      | 95,109     |    | $          | 69,443  |       | $ | 164,552 |   |

 

| 2005                                                           | ** ** | **Q2**  | ** ** | **Q1** | ** ** | **YTD** | ** ** |
|----------------------------------------------------------------|------------|---------|------------|--------|------------|---------|------------|
|                                                           |       |    |       |   |       |    |       |
| Dial around true-up  receipts for prior years’ operations |       | $       | 237,275    |   | $          | 182,074 |       | $ | 419,349 |   |
| MCI bankruptcy  settlement                                     |       | 276,626 |       |   |       | 276,626 |       |
| EUCL and other legal  settlements                              |       | 463,099 |       |   |       | 463,099 |       |
| Other miscellaneous  income items                              |       | 23,198  |       | 33,748 |       | 56,946  |       |
|                                                           |       |    |       |   |       |    |       |
| Total                                                          |       | $       | 1,000,198  |   | $          | 215,822 |       | $ | 1,216,020 |   |

 

9

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***NOTE C - VALUATION OF ASSETS ANDLIABILITIES***

***Dueto the Company changing to the liquidation basis of accounting, the valuationof assets and liabilities has been adjusted to reflect the amounts expected inliquidation. The valuation of assets at their net realizable value andliabilities at their anticipated settlement amounts requires many estimates andassumptions. In addition, there are substantial risks and uncertaintiesassociated with carrying out the liquidation of the Company’s existingoperations. The valuations presented in the accompanying Statements of Changesin Net Assets in Liquidation represent estimates, based on present facts andcircumstances, of the net realizable values of assets and costs associated withcarrying out the dissolution and liquidation plan. The actual values and costsare expected to differ from the amounts shown herein and could be greater orlesser than the amounts recorded. Accordingly, it is not possible to predictthe aggregate amount, if any, that will ultimately be distributable toshareholders.***

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**Item 2. Plan of Operation**

ETS Payphones, Inc. owns and operatesapproximately 10,000 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 3,000 clients thatinclude Fortune 100 companies as well as single store accounts andmunicipalities.

Our primary business is to install and operatepayphones 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 of Operations***

As we have previously reported, the Company enteredinto an Asset Sale Agreement dated November 1, 2005 (the “Asset SaleAgreement”), and related agreements including a security agreement and apromissory note to sell substantially all of its operating assets to EmpirePayphones, Inc. (“Empire”), an independent third party. In addition, theCompany also entered into a Management Services Agreement effectiveNovember 1, 2005 (“Management Services Agreement”), with Empire in whichEmpire has agreed to provide management services and fund the operationallosses of the Company pending consummation of the sale transaction. A summarydescription of the transactions is below. The description below is qualified inits entirety by the more detailed description in the Current Report onForm 8-K filed on November 7, 2005, the Definitive Proxy Statementfiled on January 4, 2006 and the Form 10-KSB for the fiscal yearended December 31, 2005, filed on March 31, 2006, and to the exhibitstherein.

***Asset Sale Agreement***

Pursuant to the Asset Sale Agreement, the Company hasagreed to sell substantially all of its assets used in its payphone business toEmpire. Under the Asset Sale Agreement, the purchase price aggregates $4.5million and will be paid in installments, some prior to the consummation of thetransaction, as follows: (i) $250,000 in cash on November 1, 2005,(ii) payment of certain commissions under assigned contracts not to exceed$2.4 million in the aggregate and (iii) $1.85 million in cash, payable inmonthly installments of $132,143 commencing December 1, 2005, with anyremaining balance being paid at the closing of the transaction.

The closing of the Asset Sale Agreement is subject toa number of conditions, including compliance with regulatory requirements. TheAsset Sale Agreement also includes termination provisions that may requireus to repay certain amounts paid by Empire under this agreement and theManagement Services Agreement discussed below.

***Management Services Agreement***

In order to provide for the funding of operationallosses of our payphone business pending consummation of the Asset SaleAgreement, the Company and Empire entered into the Management Services Agreement.Under the Management Services Agreement, Empire has agreed to provide to theCompany management services and fund operational losses of our payphonebusiness, subject to the oversight of our Board of Directors. In considerationfor its management services and the use by us of Empire’s affiliates’resources, Empire shall be entitled to receive a management fee calculated atthe end of the initial term of the Management Services Agreement and at the endof any renewal term in the amount of the first $400,000 of excess revenue,after repayment of, among other amounts, all expenses of operation and anyadvances made by Empire to fund operational losses plus 50% of any excessrevenue above $400,000. We shall receive the remaining 50% of excess revenueabove $400,000. For use of Empire’s affiliates’ resources during the term ofthe Management Agreement, the affiliates shall receive a monthly resource feeof $92,000.

The Management Services Agreement has an initial termof two years and will be automatically extended for successive periods of oneyear unless Empire provides notice prior to the end of any term that theagreement will terminate at the end of such term. The Management ServicesAgreement is also subject to other termination provisions, which includes theconsummation of the Asset Sale Agreement detailed above. If the ManagementServices Agreement is terminated other than upon the consummation of the AssetSale Agreement, we will be required to repay certain amounts paid by Empireunder the Management Services Agreement.

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

As discussed in Item 4 of Part II inForm 10-KSB for the fiscal year ended December 31, 2005, filedMarch 31, 2006, pursuant to the Annual Meeting of Stockholders heldFebruary 15, 2006, the stockholders of the Company approved, among otherthings, the sale of substantially all of our assets to Empire pursuant to theAsset Sale Agreement and the winding down of our operations following the saleof substantially all of our assets to Empire. Following the consummation of theAsset Sale Agreement, it is the intention of the Board of Directors to dissolvethe Company in accordance with applicable laws and to distribute any proceedsremaining after such dissolution to its stockholders. Upon consummation of theAsset Sale Agreement, the Company intends to file a certificate of dissolutionwith the Secretary of State of Delaware and close the stock transfer books todiscontinue recording transfers of our common stock at the close of business onthe date we file the certificate of dissolution with the Delaware Secretary ofState (the “Final Record Date”).

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. As a result ofcontingent 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. Any distributions made by us shall be made solelyto the stockholders of record at the close of business on the Final RecordDate, except as may be necessary to reflect subsequent transfers recordedon our books as a result of assignments by will, intestate succession oroperation of law.

***Liquidation Basis of Accounting***

The condensed financial statements for the three andsix months ending June 30, 2006 were prepared on the liquidation basis ofaccounting. Under the liquidation basis of accounting, assets are stated attheir estimated net realizable values and liabilities are stated at theirestimated settlement amounts. Estimates will be periodically reviewed andadjusted. Since the Company is in liquidation, the need to present futurequarterly Statements of Operations and Statements of Cash Flows is eliminated.

***Thevaluation of assets at their net realizable value and liabilities at theiranticipated settlement amounts necessarily requires many estimates andassumptions. In addition, there are substantial risks and uncertaintiesassociated with carrying out the liquidation of the Company’s existingoperations. The valuations presented in the accompanying Statements of Changesin Net Assets in Liquidation represent estimates, based on present facts andcircumstances, of the net realizable values of assets and costs associated withcarrying out the dissolution and liquidation plan based on the assumptions setforth below. The actual values and costs are expected to differ from theamounts shown herein and could be greater or lesser than the amounts recorded.Accordingly, it is not possible to predict the aggregate amount, if any, thatwill ultimately be distributable to shareholders.***

***Factors to Consider***

The following characteristics of our operations orindustry may have a material impact upon our future financial performance.

# ***1. Dissolution; Winding Down andLiquidation***

Pursuant to the Annual Meeting of Stockholders heldFebruary 15, 2006, the stockholders of the Company approved, among otherthings, the sale of substantially all of our assets to Empire pursuant to theAsset Sale Agreement and the winding down of our operations following the saleof substantially all of our assets to Empire. After consummation of the AssetSale Agreement our activities will be limited to collecting proceeds fromassets not included in the sale, paying off creditors, performing requirementsunder applicable law and distributing any remaining proceeds to stockholders ofrecord. As a result of contingent or unmature liabilities thatmay materialize or mature, dissolution and liquidation may not createvalue to our stockholders or result in any remaining capital for distributionto our stockholders. In addition, claims, liabilities and expenses during thewinding down of our company will continue to be incurred which will reduce theamount of assets available for distribution. We will close our stock transferbooks and discontinue recording transfers of our common stock at the close ofbusiness on the date we file the certificate of dissolution with the DelawareSecretary of State which is anticipated to be filed promptly following theconsummation of the Asset Sale Agreement. Any distributions made by us shall bemade solely to the stockholders of record at the close of business on the FinalRecord Date, except as may be necessary to reflect subsequent transfersrecorded on our books as a result of assignments by will, intestate successionor operation of law. We cannot assure the stockholders of the amount, if any, ortiming of any distribution to our stockholders as a result of the dissolution.

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# ***2.**Possible discontinuance of operations***

If we are unable to consummate the sale transaction toEmpire pursuant to the Asset Sale Agreement we may not be able to remain aviable company and may have to discontinue operations. Our expenses havehistorically exceeded our revenues and we have sustained losses since ourbankruptcy reorganization in December 2002. Based on continued erosion ofrevenue and despite management’s reduction of operating expenses, there issubstantial doubt about the Company’s ability to continue as a going concern.

# ***3.**RegulatoryIssues***

The enactment of the Telecommunications Actsignificantly altered the regulatory landscape in which payphone companiesoperate. Although we believe that the Telecommunications Act, as implemented bythe FCC, addressed certain historical inequities in the payphone marketplace,uncertainties relating to the impact and timing of the implementation of thenew regulatory framework still exist. The uncertainty with the greatestpotential financial impact relates to revenue from access code calls andtoll-free dialed calls, also referred to as dial-around compensation.Dial-around compensation accounts for a material percentage of our revenues.Additionally, the March 2004 Court of Appeals decision to vacate the FCCUnbundled Network Element rules will have an unknown effect on local lineaccess pricing, but is expected to increase prices to payphone serviceproviders.

# ***4.**LimitedFinancial Resources***

Our future performance and liquidity will depend on anumber of factors, including industry performance, general business andeconomic conditions, the absence of contingencies, and other matters, many ofwhich are beyond our control. We have limited financial resources, and itmay be the case that we will not have the funds to make capitalimprovements arising in the ordinary course of business.

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

We assemble payphones from components provided byoutside suppliers. In addition, we rely on outside suppliers for local lineaccess, billing and collection services, and long-distance and operatorservices. We believe that multiple suppliers are available to meet all of ourproduct and service needs at competitive prices and rates and expect theavailability of such products and services to continue in the future. However,we cannot assure the continuing availability of alternative sources.

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

We compete with other telecommunications providers,including providers of wireless services, other payphone providers andlong-distance carriers. Many of these competitors have substantially greaterfinancial, marketing, and other resources than the Company.

# ***7.**TechnologicalChange and New Services***

Continuous technological change, frequent service andproduct innovations, and evolving industry standards characterize thetelecommunications industry. We believe that our future success will depend inpart on our ability to anticipate technological changes and respond in atimely and effective manner to meet new industry standards. Any failure to keeppace with technological change (including the technical support componentrequired to operate payphones) and new customer service demands could have amaterial adverse effect on our business.

# ***8.**Impact ofSeasonality***

Our revenue from payphone operations is affected byseasonal variations. Because many of our payphones are located outdoors,weather patterns have differing effects on our revenue depending on the regionof the country where the payphones are located and the enclosure housing of thephone. For example, our payphones throughout the Midwestern and Eastern UnitedStates produce their highest call volumes during the second and third quarters,when the climate tends to be more favorable. Seasonal variations in revenuescould have a material adverse effect on our business. Changes in the geographicdistribution of our payphones may in the future result in differentseasonal variations in our results.

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# ***9.**No established marketfor the Common Stock***

Our Common Stock is not listed on any stock exchange.Our Common Stock was issued to approximately 12,500 individuals and entitiesthat entered into agreements with Old ETS to purchase payphones. Ownershipinterests are tracked by the transfer agent, American Stock Transfer and TrustCompany (“AST&T”), and transfers of ownership may be documentedthrough AST&T. The Common Stock is not traded on any recognized stockexchange, stock market or bulletin board system and there are no market makersfor 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 formulamay not be indicative of the market price for the Common Stock followingregistration.

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**Item 3. Controls and Procedures**

Our Chief Executive Officer and Chief FinancialOfficer (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 indicated that therewere no significant changes in our internal controls or other factors thatcould significantly affect such controls subsequent to the date of theirevaluation, and there were no corrective actions with regard to significantdeficiencies and material weaknesses.

Our management, including each of the CertifyingOfficers, does not expect that our disclosure controls or our internal controlswill prevent all error and fraud. A control system, no matter how wellconceived 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 that breakdownscan occur because of simple error or mistake. Additionally, controls can becircumvented by the individual acts of some persons, by collusion of two ormore people or by management override of the control. The design of any systemof controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions.Over time, control may become inadequate because of changes in conditions,or the degree of compliance with the policies or proceduresmay deteriorate. Because of these inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

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**PART II.OTHER INFORMATION**

**Item 1.  Legal Proceedings**

The Company is involved from time to time in lawsuitsthat arise in the ordinary course of our business. In March 2006Commercial Payphones, Inc., a Florida corporation, initiated a lawsuit againstthe Company  in state court in Dade County, Florida for an allegedviolation of a non-compete agreement alleging damages in excess of$15,000.  We do not believe the allegations have legal merit and arevigorously defending the action and have filed a motion to quash service or, inthe alternative, to dismiss the complaint for lack ofjurisdiction. However, we cannot predict with certainty the outcome oreffect of this or other litigation in which the Company is or may becomeinvolved.

**Item 5.Other Information**

***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**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                        | ETS PAYPHONES, INC. |
|------------------------|--------------------------|
|                   |                     |   |
| Date: August 14,  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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