PARETEUM Corp - Quarter Report: 2015 June (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

x   Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2015

¨   Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______ to ______

000-30061

(Commission file No.)

ELEPHANT TALK COMMUNICATIONS CORP.

(Exact name of registrant as specified in its charter)

100 Park Avenue, New York City, NY 10017

USA

(Address of principal executive offices)(Zip Code)

+ 1 (212) 984-1096

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( § 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x   No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Yes ¨   No x

 As of July 31, 2015, there were 160,488,671 shares of the Company’s common stock outstanding.

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

June 30, 2015

PART I - FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

 The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Financial Condition

As reflected in the accompanying condensed consolidated financial statements the Company reported net income of $9,521,918 and $7,396,745 for the three and six month period ended June 30, 2015 respectively, and had an accumulated deficit of $243,232,551 as of June 30, 2015.

The company’s financial statements were substantially impacted by two events, namely the settlement and termination agreement with Grupo Iusacell S.A. on June 12, 2015 and the resolution of the Atalaya/Corbin Capital credit agreement which had been in default since March 2015 which resulted in the amendment dated July 9, 2015 to the November 17 2014 credit agreement.

The termination of the relationship with Iusacell resulted in a settlement agreement on June 12, 2015 of $13.5 million, which included the forgiveness of certain liabilities that had previously been assumed by Grupo Iusacell on behalf of the Company totaling $0.9 million, resulting in a net proceeds received by the Company of $12.6 million on June 19, 2015.

In parallel the Company completed an amendment of the Atalaya/Corbin credit agreement and used $10.1 million of the $12.6 million to pay to Atalaya/Corbin in anticipation of the conclusion of the amendment, leaving the company with $2.5 million for its short term working capital needs and an outstanding debt (before debt discounts) to Atalaya/Corbin of approximately $2 million at June 30, 2015. On July 14, 2015 following the closing of the amendment to the Atalaya/Corbin credit agreement, the Company received from Atalaya/Corbin, after deduction of fees and expenses, gross proceeds of $4.5 million (net payment of $ 4.2 million), bringing the principal loan amount to $6.5 million as agreed in the amended credit agreement.

The termination of the Iusacell contract is expected to result in the loss of approximately $1.3 million in monthly billings and cash flow (based on historical monthly billings), which will have a negative impact on the results from operations (see Management Discussion and Analysis) of the Company for the same amount. This loss in monthly billings was compensated in the second quarter through the proceeds from the settlement agreement, with the result that the results from operations for the three and six months ended June 30, 2015 were not impacted yet with that monthly loss in billings.

The Company recently completed its expense reduction plan in response to the termination of the Iusacell contract and estimates this can reduce reduce the Company’s product development, selling, general and administrative cash expenses this year by approximately $ 5 million compared to the prior year.

In addition, the Company is focused on increasing sales efforts and streamlining global business operations, including a cautious policy on capital expenditures.

With a cash balance at June 30, 2015 of $1.2 million, the net receipt of funding by Atalaya/Corbin of $4.2 million in July 2015 combined with the effects of the expense reduction, the Company believes it can sustain its operational plans for the coming 12 months. However, if we are unable to meet our sales objectives and financing becomes restrictive for our capital expenditures for growth purposes, we may be required to attract additional financing. Although we have previously been able to raise capital as needed, such capital may not continue to be available to us at all, or if available, on reasonable terms as required. Further, the terms of such financing may be dilutive to our existing stockholders or otherwise on terms not favorable to us or our existing stockholders. If we are unable to secure additional capital, as circumstances require, or do not succeed in meeting our sales objectives we may be required to change or delay our operations.

As of June 30, 2015, these conditions raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Note 2. Description of Business, Basis of Presentation and Use of Estimates

Description of Business

As a mobile Software Defined Network Architecture (ET Software DNA® 2.0) vendor Elephant Talk Communications Corp. and its subsidiaries (also referred to as “Elephant Talk”, “ET” and “the Company”) provide a one stop solution for a full suite of mobile, fixed and convergent telecommunications software services. We also provide layered security services for mission critical applications in the cloud, through our wholly owned subsidiary, ValidSoft UK Limited (“ValidSoft”).

Over the last decade, Elephant Talk has developed a comprehensive virtualized (NFV & SDN) Mobile Software Platform, capable of hosting an integrated IT/BackOffice and Core Network for Mobile Network Operators (MNOs), Mobile Virtual Network Operators (MVNOs), Enablers (MVNEs) and Aggregators (MVNAs) on a fully outsourced basis. Our mobile enabling platform is either made available as an on premise solution or as a fully hosted service in ‘the cloud’, depending on the individual needs of our customers. Our mobile security services supply voice biometric and telecommunications-based multi-factor authentication, identity and transaction verification solutions for all electronic transaction channels. This integrated suite of security services provides mission critical applications in the cloud to enterprise customers in a range of industries including financial services, government, insurance, as well as electronic medical record providers and MNOs. Our company provides customers the means to effectively combat a variety of electronic fraud while at the same time protecting consumer privacy.

Basis of Presentation of Interim Periods

The interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and with the instructions to Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC Regulation S-X. They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2014, included in our 2014 amended Annual Report on Form 10-K/A filed with the SEC on April 3, 2015 and April 30, 2015, referred to as our 2014 Annual Report.

The interim condensed consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly our results of operations and financial position for the interim periods. The results of operations for the three and six months period ended June 30, 2015 are not necessarily indicative of the results to be expected for future quarters or the full year.

For a complete summary of our significant accounting policies, please refer to Note 2, “Business and Summary of Significant Accounting Policies,” of our 2014 Annual Report. There have been no material changes to our significant accounting policies during the three and six months period ended June 30, 2015.

Use of Estimates

The preparation of the accompanying financial statements conforms to accounting principles generally accepted in the U.S. and requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Significant areas of estimates include revenue recognition, bad debt allowance, valuation of financial instruments, useful lives of long-lived assets and share-based compensation. Actual results may differ from these estimates under different assumptions or conditions.

Basic and diluted earnings per share

Net earnings per share is calculated in accordance with ASC 260, Earnings per Share (“ASC 260”). Basic net earnings per share is based upon the weighted average number of common shares outstanding. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase Common Stock at the average market price during the period. Weighted average number of shares used to compute basic and diluted in periods with a loss situation per share are the same as basic since the effect of the dilutive securities is anti-dilutive.

Note 3. Supplemental Financial Information

The following tables present details of our condensed consolidated financial statements:

On March 26, 2015, the Company was notified by Atalaya Capital Management LP, the agent for Corbin Mezzanine Fund I, L. P. that certain events of default as defined in the Credit Agreement dated 17, November 2014 had occurred and that for so long as an event of default be continuing, interest should accrue and be payable by the Company in cash at the default rate as defined in the Credit Agreement.  Atalaya Capital Management LP indicated in the notification that they would continue to monitor the default situation and reserve all their respective rights and remedies under the Credit Agreement. In anticipation of an amendment of the original Credit Agreement combined with the receipt of the Iusacell settlement payment, the Company transferred $10,100,000 on June 22, 2015 to the lenders pending the closing of an amendment of the credit agreement, which amendment was executed on July 9, 2015. See also Note 11 subsequent events.

The $10,100,000 payment was recorded in the second quarter periodic report as a pre-payment of $5,500,000, $172,667 in prepayment of charges ($110,000) and accrued default interest ($62,667), with $4,427,333 set-off against the principal balance of the credit agreement, pending the closing of the amendment to the credit agreement. In line with the recording of the $5,500,000 prepayment, the company pro rata accelerated the corresponding deferred financing cost, original issue discount and deferred warrant valuation expense.

Note 4. Fair Value Measurements

In accordance with ASC 820, Fair Value Measurement (“ASC 820”), the Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. ASC 820 establishes a fair value hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s assumptions about the inputs that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

The fair value hierarchy is categorized into three levels based on the inputs as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level 2 – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these financial instruments include cash instruments for which quoted prices are available but are traded less frequently, derivative instruments whose fair values have been derived using a model where inputs to the model are directly observable in the market and instruments that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level 3 – Instruments that have little to no pricing observability as of the reported date. These financial instruments are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

The degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined by the lowest level input that is significant to the fair value measurement.

The Company has three asset groups that are valued at fair value categorized within Level 3: Warrant liabilities (recurring measurement), goodwill and intangibles (non-recurring measurements) for the impairment test. Below are discussions of the main assumptions used for the recurring measurements.

The following tables summarize fair value measurements by level as of June 30, 2015 and December 31, 2014 for financial assets and liabilities measured at fair value on a recurring basis:

The Company has classified the previously outstanding warrant liabilities into level 3 due to the fact that some inputs were not published and not easily comparable to industry peers. The difference in level 3 items from December 31, 2014 to June 30, 2015 was the result of the exchange of all of the outstanding warrants into common stock by the holder. . The exchange of the warrants resulted in a reclassification of the warrant liability balance of $1,692,087 to equity and a gain of $149,203 in the change in fair value of warrant liabilities. The Company used the Monte Carlo valuation model to determine the value of the previously outstanding warrants from the Registered Direct Offering of June 2013.

Note 5. Stockholders’ Equity

(A) Common Stock

The Company is presently authorized to issue 250,000,000 shares common stock. The Company had 159,194,181 and 154,671,258 shares of common stock issued and outstanding as of June 30, 2015 (unaudited) and December 31, 2014, respectively, an increase of 4,522,923 shares, 4,029,738 shares were issued pursuant to an election by the holder to exchange the warrants for shares of common stock in accordance with the warrant agreement issued in June 2013, 8,668 shares were issued to employees as a result of exercised employee stock options, and a total of 484,517 shares were issued from the 2008 Option Plan as compensation to the Company’s executive officers and non-executive directors.

(B) Preferred Stock

The Company’s Certificate of Incorporation (“Articles”) authorizes the issuance of 50,000,000 shares of preferred stock $0.00001 par value per share (the “Preferred Stock”). No shares of Preferred Stock are currently issued and outstanding. Under the Company’s Articles, the board of directors has the power, without further action by the holders of the common stock, subject to the rules of the NYSE MKT LLC, to designate the relative rights and preferences of the Preferred Stock, and issue the Preferred Stock in such one or more series as designated by the Board of Directors. The designation of rights and preferences could include preferences as to liquidation, redemption and conversion rights, voting rights, dividends or other preferences, any of which may be dilutive of the interest of the holders of the common stock or the Preferred Stock of any other series. The issuance of Preferred Stock may have the effect of delaying or preventing a change in control of the Company without further stockholder action and may adversely affect the rights and powers, including voting rights, of the holders of common stock. In certain circumstances, the issuance of Preferred Stock could depress the market price of the common stock.

For the period ended June 30, 2015, the Company did not issue any shares of Preferred Stock, and no shares of Preferred Stock are outstanding.

(C) Warrants

Throughout the years, the Company has issued warrants with varying terms and conditions related to multiple financing rounds, acquisitions and other transactions. The warrants outstanding at June 30, 2015 (unaudited) and December 31, 2014 have been recorded and classified as equity. The Weighted Average Exercise Price for the currently outstanding warrants in the table below is $1.26. The table below summarizes the warrants outstanding as of June 30, 2015 (unaudited) and as of December 31, 2014:

Note 6. 2006 Non-Qualified Stock and Option Compensation Plan and Amended and Restated 2008 Long Term Incentive Compensation Plan

2006 Non-Qualified Stock and Option Compensation Plan

The Company has a 2006 Non-Qualified Stock and Option Compensation Plan (the “2006 Plan”). Under the 2006 Plan, there are no stock options outstanding as of March 31, 2015 and December 31, 2014. All remaining outstanding options expired in December 2013.

Amended and Restated 2008 Long-Term Incentive Compensation Plan

During the first half year of 2015, the Company issued 484,517 freely tradable shares to various directors and officers under the 2008 Plan, in conjunction with their willingness to receive all or part of their cash compensation for the fourth quarter of 2014 and first quarter of 2015 in shares of the Company.

Stock option activity is set forth below:

At June 30, 2015, the unrecognized expense portion of stock-based awards granted to employees under the 2008 Plan was approximately $5,854,531, compared to $11,607,937 for the same period in 2014, under the provisions of ASC 718. The future expensing takes will take place proportionally to the vesting associated with each stock-award, adjusted for cancellations, forfeitures and returns. If there are any modifications or cancellations of the underlying unvested awards, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense.

Note 7.  Income taxes

Income Taxes

The following table presents details of the net (benefit) provision for income taxes:

As a result of our cumulative tax losses in the U.S. and certain foreign jurisdictions, and the full utilization of our loss carryback opportunities, we have concluded that a full valuation allowance should be recorded in such jurisdictions. In certain other foreign jurisdictions where we do not have cumulative losses, we had net deferred tax liabilities.

Note 8. Significant Customer and Geographical Information

Sales to our significant customers, as a percentage of net revenue were as follows:

The geographical distribution of our revenue, as a percentage of revenue, was as follows:

Note 9. Per Common Share Information

Diluted earnings per common share is calculated using net income divided by the weighted-average basic and diluted shares. Diluted weighted-average shares include weighted-average shares outstanding plus the calculated dilutive effect of employee options and outstanding warrants using the treasury stock method. The dilutive effect has been determined to be 1,551,352 shares for the three and six month periods in 2015 and no dilutive effect for the three and six months period of 2014 as such effect is anti-dilutive due to the negative earnings in the three month period and six month period of the year 2014.

Note 10. Restatement

In our 2014 Form 10-K, we restated our audited financial statements for fiscal year ended December 31, 2013 and our unaudited interim consolidated financial statements 2013 and 2014 to reflect certain corrections in the manner in which we recognize revenue related to our long term managed service contracts.

The restatement is a result of the failure to identify all delivery obligations associated with multi-element revenue arrangements and an improper interpretation of standalone value of delivered elements. The revenue recognition errors identified by the Company, do not affect the total revenues ultimately earned or to be earned, or the amount or timing of cash received or to be received from individual customer arrangements.

As a result of our restatement and in accordance with U.S. GAAP, revenues that had originally been recognized in 2013 are now being recognized ratably over an extended timeframe. The amount of revenues earned or to be earned over the entire period of recognition essentially remain unchanged from the amount we historically recognized, however the timing of when and the amount of revenues recognized for those periods discussed above were restated and certain amounts of revenues were restated. There was neither change to the cash characteristics of the transactions being restated nor the Company’s liquidity directly relating to these transactions. As a result of the restatement, the balance sheet reflects a significant increase in deferred revenue, which will be recognized in revenue over a number of years.

See our 2014 Form 10-K, as amended, for additional information regarding the restatement of our unaudited consolidated financial statements for the quarter ended June 30, 2014 and for information regarding the restatement of our unaudited consolidated financial statements for each of the quarters in the year ended December 31, 2013 and 2014.

This Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 (this “Form 10-Q”) reflects the impact of the restatement on the applicable unaudited quarterly financial information for the quarter ended June 30, 2014.

The combined impact of the adjustments to specified line items included in this Form 10-Q have been restated to reflect the corrections of the above errors, which impact revenues from products, revenues from services and deferred revenues (current and non-current). The following schedules reconcile the amounts as originally reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 to the corresponding restated amounts as reported herein and in our 2014 Form 10-K.

The correction of the errors described above did not impact our total cash flows from operating activities, investing activities or financing activities within our consolidated statements of cash flows.

*the Company reclassified the line items Accounts Receivable and Deferred Revenue compared to what was reported in the annual report 2014 on Form 10-K for the above quarter. Accounts Receivable decrease (increase) changed from ($2,076,250) to $414,819 and Deferred Revenue increase (decrease) changed from $5,011,166 to $2,552,097. In addition minor changes were made to Loss on Extinguishment of Debt ($426 added) and Increase in accrued expenses of 426. There was no impact of these reclassifications on Net Cash provided by (used in) operating activities, Net Loss or Equity.

Note 11. Subsequent Events

The Company’s management evaluated subsequent events through the date the financial statements were available to be issued.

On July 9, 2015 the Company entered into a First Amendment to the Credit Agreement dated November 17, 2014 with Corbin Mezzanine Fund I, L.P. (‘Lender’) and Atalaya Administrative LLC as administrative agent and collateral agent for Corbin Mezzanine Fund I.

In this amendment, Lender and Atalaya agreed to waive the existing default as defined in the November 17, 2014 credit agreement subject to certain terms and conditions in the Amendment. Upon repayment of approximately $5.7 million (including certain expenses and interest) to the Lender, the Amendment reduced the term loan facility to $6.5 million. The amended term loan facility of $ 6.5 million shall bear interest at the LIBOR rate plus an applicable margin per annum equal to eleven percent (11.00%), which may be decreased by 0.5% under certain circumstances such as the Company’s achievement of certain adjusted EBITDA during certain periods. The amended term loan facility will mature on December 31, 2017. The terms of original Credit Agreement and the ancillary agreements including the Security Agreement remain in effect unless otherwise amended in the Amendment. In accordance with the amendment to the credit agreement, the Company issued warrants to the Lender, one warrant to purchase two million shares of the Company’s common stock, exercisable upon issuance with an expiration date of 30 months from the closing of the Amendment, at a per share price of $0.38 which is $0.02 in excess of the closing bid price as of the date of execution of the Amendment of $0.36 per share, and another warrant to purchase one million shares of Common Stock exercisable upon issuance with an expiration date of 18 months from the closing of the Amendment, at a per share price of $0.38 which is $0.02 in excess of the closing bid price as of the date of execution of the Amendment of $0.36 per share.

Leading up to the amendment of the credit agreement the Company paid on June 22, 2015 $10,100,000 to Atalaya, comprising $5,500,000 pre-payment, $4,427,333 anticipatory on the conclusion of the amended credit agreement, together $9,927,333 which amount was debited against the outstanding principal of $12,000,000, resulting in an outstanding balance at June 30, 2015 of $2,072,667. The remainder of the $10,100,000 was used for default interest and prepayment charges. After closing of the First Amendment the Company received approximately $ 4.5 million from Atalaya/Corbin to bring the outstanding principal to the agreed $6,500,000.—.

Upon closing of the amendment the company performed an analysis to determine if this amendment to the Credit Agreement of November 17, 2014 constituted a substantial modification to the original credit agreement and concluded that such was not the case.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Any forward looking statements made herein are based on current expectations of the Company, involve a number of risks and uncertainties and should not be considered as guarantees of future performance. The factors that could cause actual results to differ materially include: interruptions or cancellation of existing contracts, inability to integrate acquisitions, impact of competitive products and pricing, product demand and market acceptance risks, the presence of competitors with greater financial resources than the Company, product development and commercialization risks, changes in governmental regulations, and changing economic conditions in developing countries and an inability to arrange additional debt or equity financing.

Restatement of Previously Issued Financial Statements

As discussed in the Form 10-K for the fiscal year ended December 31, 2014, we have restated our consolidated financial statements for the year ended December 31, 2013 and our unaudited quarterly financial information (i) for each of the quarters in the year ended December 31, 2013 and (ii) for the first three quarters in the year ended December 31, 2014 (collectively, the “Restated Periods”). We have restated the revenues and deferred revenues as a result of (i) an overstatement of revenue due to a failure to identify and determine whether contracts that were negotiated as a package with a single customer should have been combined (ASC 605-35-25); and (ii) the application of accounting guidance for multi-element arrangements, specifically an improper interpretation of standalone value of delivered elements. These errors resulted in earlier recognition of the contracted revenue on certain contracts.

The Company has corrected the manner in which it records revenue for its arrangements with multiple-element features and will also enhance its documentation related to its revenue recognition policies and practices. See “Controls and Procedures” included in Part II, Item 9A of the 2014 Form 10-K.

As a result of our restatement and in accordance with U.S. GAAP, revenue that had originally been recognized in 2013 is now being recognized ratably over an extended timeframe. The amount of revenue earned or to be earned over the entire period of recognition essentially remains unchanged from the amount we historically recognized. There was neither a change to the cash characteristics of the transactions being restated nor the Company’s liquidity directly relating to these transactions. As a result of the restatement, the balance sheet reflects a significant increase in deferred revenue, which will be recognized as revenue over a number of years.

Overview

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and notes thereto and the other financial information included elsewhere in this document.

Recent milestones for mobile product line:

Recent milestones for the ValidSoft security product line:

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to revenue recognition, rebates, allowances for doubtful accounts, sales returns and allowances, warranty reserves, inventory reserves, stock-based compensation expense, long-lived asset valuations, strategic investments, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, self-insurance, restructuring costs, litigation and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. For a description of our critical accounting policies and estimates, please refer to the “Critical Accounting Policies and Estimates” section in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2014 Annual Report. There have been no material changes in any of our critical accounting policies and estimates during the six months ended June 30, 2015.

Comparison of three and six months ended June 30, 2015 and 2014.

Revenue

Revenue for the three and six months ended June 30, 2015 was $19,244,383 and $24,257,399, an increase of $14,171,943 or 279%, compared to $5,072,440 for the three months ended June 30, 2014 and $13,800,694 or 132% compared to $10,456,705 for the six months ended June 30, 2014. This increase was mainly caused by the full release of deferred revenue of $11,571,458 related to the termination of the contract with Iusacell as well as compensation paid by Iusacell in June 2015 for the termination of the contract.

Non-GAAP Revenue

In order to provide investors additional information regarding our revenue, we include here the discussion of Non-GAAP revenue. Our non-GAAP financial measure is defined as GAAP revenue adjusted for changes in deferred revenue. We believe this Non-GAAP measure provides useful information regarding our actual billings to our customers during the period which generally reflect the usage rates of our hosted platforms and security solutions. The presentation of Non-GAAP revenue is not meant to be considered in isolation or as an alternative to GAAP. A reconciliation of GAAP Revenue to Non-GAAP Revenue, for each of the periods indicated, is as follows:

Non-GAAP Revenue for the three months ended June 30, 2015 was $ 7,373,175, an increase of $573,205 or 8.4%, compared to $6,799,970 for the three months ended June 30, 2014.

The negative impact on revenue of the lower EUR versus USD exchange rate in 2015 for the three months ended June 30, 2015 was $633,365. Revenue adjusted for this exchange rate effect increased for these three months by $1,206,570 compared with the same period prior year.

Non-GAAP Revenue for the six months ended June 30, 2015 was $ 15,367,850, an increase of $2,374,054 or 18.3%, compared to $12,993,796 for the six months ended June 30, 2014.

The negative impact on revenue of the lower EUR versus USD exchange rate in 2015 for the six months ended June 30, 2015 was $ $1,426,289. Revenue adjusted for this exchange rate effect increased for the six months by $3,800,343 compared with the six months ended June 30, 2014.

The three and six month revenue increases were primarily caused by the increased usage rates of our Iusacell platform as well as the Iusacell settlement proceeds.

Historic quarterly overview Non-GAAP and GAAP revenue

Historic development mobile and security revenues

The following table illustrates historic revenues (excluding landline services) for the quarters ended:

Cost of Service

Cost of service includes origination, termination, network and billing charges from telecommunications operators, costs of telecommunications service providers, network costs, data center costs, facility cost of hosting network and equipment and cost in providing resale arrangements with long distance service providers, cost of leasing transmission facilities, international gateway switches for voice, data transmission services, and the cost of professional services of staff directly related to the generation of revenues, consisting primarily of employee-related costs associated with these services, including share-based compensation and the cost of subcontractors. Cost of service excludes depreciation and amortization.

Cost of service for the three month period ended June 30, 2015 was $1,440,914, a decrease of $(407,773) or 22%, compared to $1,848,687 for the three month period ended March 31, 2014.

The positive impact of the lower EUR versus USD exchange rate in 2015 for the three months ended June 30, 2015 was $214,437.

Cost of service expenses adjusted for this exchange rate effect decreased for the three months ended June 30, 2015 by $193,336 compared to three months ended June 30, 2014.

The decrease was the net result of decrease in staff expenses of $54,287 and $449,228 lower stock based compensation expenses. These decreases were partly offset by the increase in cost of mobile bundled service business and network of $310,179.

Margin (excluding depreciation and amortization and impairment for assets held and used) as a percent of the total revenue was 93% and 64% for the three month period ended June 30, 2015 and 2014, respectively. This increase was primarily related to the increased revenue as discussed below.

The negative impact on margin of the lower EUR versus USD exchange rate in 2015 for the three months was $418,928. Margin adjusted for this exchange rate effect increased for the three months by $14,998,644. This increase was mainly caused by the full release of deferred revenue of $11,571,458 related to the termination of the contract with Iusacell as well as compensation paid by Iusacell for termination of the contract.

Cost of service for the six month period ended June 30, 2015 was $3,309,760, a decrease of $174,899 or 14%, compared to $3,484,659 for the six month period ended June 30, 2014.

The positive impact of the lower EUR versus USD exchange rate in 2015 for the six months was $440,364. Cost of service expenses adjusted for this exchange rate effect increased for the six months by $265,466 compared to the same period last year.

The increase was primarily related to an increase in cost of mobile bundled service business and network of $616,484, increase in cost of service related management & personnel expenses of $264,598 and an off-setting $615,616 reduction of non-cash related expenses.

Margin (excluding depreciation and amortization) as a percent of the total revenue was 86% and 67% for the six month period ended June 30, 2015 and 2014, respectively. The negative impact on margin of the lower EUR versus USD exchange rate in 2015 for the six months was $985,925. Margin adjusted for this exchange rate effect increased for the six months by $14,961,518. This increase was mainly caused by the full release of deferred revenue of $11,571,458 related to the termination of the contract with Iusacell as well as compensation paid by Iusacell for termination of the contract.

Product Development

Product Development costs consist primarily of salaries and related expenses, including share-based expenses, of employees involved in the development of the Company’s services, which are expensed as incurred. Costs such as database architecture, and ET BOSS & IN platform development and testing are included in this function.

Costs incurred during the application development stage of internal-use software projects, such as those used in the Company’s operations, are capitalized in accordance with the accounting guidance for costs of computer software developed for internal use. Capitalized costs are amortized on a straight-line basis. When assigning useful lives to internal-use software, the Company considers the effects of obsolescence, competition, technology, and other economic factors. During the three month period ended June 30, 2015 and 2014, the Company capitalized $1,114,332 and $1,231,889, respectively. For the six month period ended June 30, 2015 and 2014, the Company capitalized $2,289,359 and $2,287,851, respectively.

Product Development costs for the three month period ended June 30, 2015 and 2014 were $1,490,683 and $ 2,280,532, respectively, a decrease of $789,849 or 35%. The decrease was primarily related to $777,085 less non cash related expenses versus the three month period ended June 30, 2014 (see also table below under Share-based compensation).

For the six month period ended June 30, 2015 and 2014 product developments costs were $2,526,804 and $3,992,349, respectively, a decrease of $1,465,545 or 37%. The decrease is mainly due to the $982,448 reduction in non-cash related expenses and the reduced use of specialist consultants and re-allocation of certain staff to other functions.

The positive impact of the lower EUR versus USD exchange rate in 2015 for the three months ended June 30, 2015 was $221,754 and for the six months ended June 30, 2015 $430,254. Product Development expenses adjusted for this exchange rate effect decreased for the three months and six months periods by $568,095 and $1,035,292, respectively.

Sales and Marketing

Sales and Marketing expenses consist primarily of salaries and related expenses, including share-based expenses, for our sales and marketing staff, including commissions, payments to partners and marketing programs. Marketing programs consist of advertising, events, corporate communications and brand building.

Sales and Marketing expenses for the three month period ended June 30, 2015 and 2014 were $336,960 and $664,807, respectively, a decrease of $327,847 or 49%. For the six month period ended June 30, 2015 and 2014 were $999,120 and $1,228,642, respectively, a decrease of $229,522 or 19%. The decrease was primarily related to $77,781 lower non cash related expenses versus the six month period ended June 30, 2014 (see also table below under Share-based compensation) and less PR and general marketing related expenses.

The positive impact of the lower EUR versus USD exchange rate in 2015 for the three months ended June 30, 2015 was $80,848 and for the six months ended June 30, 2015 $151,556. Sales and Marketing expenses adjusted for this exchange rate effect decreased for the three months and six months periods by $246,999 and $77,965, respectively

General and Administrative

General and administrative expenses are our largest cost and consist primarily of salaries and related expenses, including share-based compensation, for non-employee directors, finance and accounting, legal, internal audit and human resources personnel, legal costs, professional fees and other corporate expenses.

General and Administrative expenses for the three month period ended June 30, 2015 and 2014 were $2,664,281 and $3,467,338, respectively, a decrease of $803,057 or 23%. For the six month period ended June 30, 2015 and 2014 were $5,625,377 and $6,515,286, respectively, a decrease of $889,909 or 14%.

The positive impact of the lower EUR versus USD exchange rate in 2015 for the three months ended June 30, 2015 was $346,158 and for the six months ended June 30, 2015 $745,452. General and Administrative expenses adjusted for this exchange rate effect decreased for the three months and six months periods by $456,896 and $144,454, respectively.

The decrease in General and Administrative expenses is primarily the result of the cost reduction measures that started during the second quarter of 2015, including reductions in staff levels and corporate expenses

Share-based compensation

Share-based compensation is comprised of:

For the three month period ended June 30, 2015 and 2014, we recognized share-based compensation expense of $752,510 and $ $1,902,537, respectively, a decrease of $1,150,027 or 60%.

For the six month period ended June 30, 2015 and 2014, we recognized share-based compensation expense of $1,584,323 and $ $2,674,261, respectively, a decrease of $1,089,938 or 41%.

During the first six months of 2015 the Company did not grant bonus options for staff. In the first six months of 2014 the granting of bonus options to staff resulted in a share-based compensation expense of $1,053,000. For the three and six months ended June 30, 2015 the decreased share price over the past year resulted in lower option expensing. A further decrease of approximately $ 230,000 was the result of forfeiture gains due to staff reductions.

In the following tables we show the allocation of share-based compensation according to functions in the Consolidated Statement of Comprehensive Loss:

Depreciation and Amortization

Depreciation and amortization expenses for the three month period ended June 30, 2015 was $1,745,034, a decrease of $183,358 or 10%, compared to $1,928,392 for the same period in 2014. The total depreciation and amortization expenses for the six month period ended June 30, 2015 was $3,491,181, a decrease of $445,425 or 11%, compared to $3,936,606 for the same period in 2014. The decrease for the three and six month period is primarily the result of the lower EUR versus USD exchange rate in 2015. The positive impact for the three months was $334,053 and for the six months period $676,781. Depreciation and amortization expenses adjusted for this exchange rate effect increased for the three months and six months period by $150,695 and $231,356, respectively.

Impairment for assets held and used

In the Company’s review of the carrying amounts of its assets it was determined that following the termination of the Iusacell contract certain of the assets classified under Construction in Progress and Computer, communications and network equipment needed to be impaired. As a result there was an impairment charge of $ 937,835 for the three months ended June 30, 2015.

Interest Income and Expense

Interest income for the three month periods ended June 30, 2015 and 2014 was $22,587 and $29,545, respectively. Interest income for the six month periods ended June 30, 2015 and 2014 was $52,859 and $57,156, respectively. Interest income consists of interest received on bank balances.

Interest expense for the three month periods ended June 30, 2015 and 2014 was $555,826 and $333,214, respectively. Interest expense for the six month periods ended June 30, 2015 and 2014 was $923,166 and $635,158, respectively.

Higher levels of interest expense were the result of the change of financing sources at the end of 2014, default interest payments in 2015 and a prepayment penalty of $110,000 due to the early repayment of $5,500,000 on our credit facility.

Interest Expense Related to Debt Discount and Conversion Feature

For the three month periods ended June 30, 2015 and 2014, interest expenses related to debt discount and conversion feature were $403,679 and $1,025,292, respectively, a decrease of $621,613 or 61%. The majority ($340,807) of this quarter expense is the result of the early repayment of $5,500,000 of our Credit Facility and the subsequent accelerated pro-rated amortization of the debt discount.

For the six month periods ended June 30, 2015 and 2014, interest expenses related to debt discount and conversion feature were $467,651 and $1,910,032, respectively, a decrease of $1,442,381 or 76%. The decrease was the result of the extinguishments of two convertible notes in the third and fourth quarter of 2014.

Change in Fair Value of Warrant Liabilities

The change in the fair value of the remaining outstanding warrants related to a registered direct public offering made by us in June 2013 was a gain of $149,203 for the three month period ended June 30, 2015, compared to a gain of $38,948 for the same period in 2014.

Such changes were primarily due to the decreased value of our stock price, one of the major variables of the valuation. The value of the warrants was determined by a third party valuation expert using a Monte-Carlo Simulation model.

Due to the fact that the relating warrant has been exercised and no further warrants liabilities exist there will be no further fair value gains or losses for this particular registered direct offering which took place in 2013.

Gain/(Loss) on extinguishment of debt

There is a net gain on extinguishment of debt amounting to $2,475,799 for the six month period ended June 30, 2015 an increase of $2,475,373 compared to the loss amounting to $426 for the six month period ended June 30, 2014. The gain is the result of the extinguishment of debt accounted for in the first quarter of 2015 related to the Chong Hing Bank debt of our subsidiary Elephant Talk Ltd in Hong Kong following the expiry of the statute of limitations in Hong Kong as well as the verdict by California courts in 2011 that the Company was not liable as a successor in interest or otherwise on the bank loans and overdraft account to Elephant Talk Ltd. The amounts released from the balance sheet were $433,480 (overdraft), $962,522 (loan payable) and $1,079,796 (accrued interest).

Amortization of Deferred Financing Costs

Deferred financing costs relate to the “2014 10% + libor 3rd Party Term Loan Agreement”, the “2013 10% Related Party Convertible Loan” and the “2013 10% 3^rd Party Convertible Notes”, the latter two having been extinguished in the third and fourth quarter of 2014 and replaced by the ‘2014 10% + libor 3^rd Party Term Loan Agreement’.

Amortization of deferred financing cost were $362,845 for the three month period ended June 30, 2015, an increase of $249,755 or 221%, compared to $113,090 for the three month period ended June 30, 2014. For the six month period ended June 30, 2015 and 2014, the deferred financing costs were $425,347 and $249,457 respectively.

In both cases the increases were the result of the higher amortizations of the 2014 10% + libor loan agreement compared with the other two notes. Also, as a result of the pre-payment of $ 5,500,000 this quarter on the 10% term loan, caused a pro rata accelerated amortization of the deferred financing cost.

Other Income and (Expense)

Other income & (expense) for the three month period ended June 30, 2015 is a gain of $155,252 and the six month period ended June 30, 2015 is a loss of $1,036,018 and represents the unrealized exchange rate losses related to the 2014 10% + libor 3rd Party Loan against the primary functional currency (EURO) of the company.

Provision (Benefit) Income taxes

Income tax provision for the three month period ended June 30, 2015 was $111,450, compared to an income tax provision (Benefit) of $(2,209) for the same period in 2014. Income tax provision for the six month period ended June 30, 2015 was $42,958, compared to an income tax provision of $133,228 for the same period in 2014.

Net Income / (Loss)

Net Income for the three month period ended June 30, 2015, was $9,521,918, an increase of $15,972,120 compared to the loss of $(6,450,202) for the same period in 2014.

Net Income for the six month period ended June 30, 2015, was $7,396,745, an increase of $19,068,653, compared to the loss of $(11,671,908) for the same period in 2014. This increase was mainly caused by the full release of deferred revenue of $11,571,458 related to the termination of the contract with Iusacell as well as compensation paid by Iusacell for termination of the contract. The positive impact of the lower EUR versus USD exchange rate in 2015 for the three months was $569,075 and for the six months period $1,023,766. Net Income adjusted for this exchange rate effect decreased for the three months and six months period by $456,896 and $144,454, respectively. Net Income adjusted for this exchange rate effect increased for the three months and six months period by $15,515,224 and $18,924,199, respectively.

Other Comprehensive (Loss) Income

We record foreign currency translation gains and losses as part of other comprehensive (loss) Income, which amounted to an income of $508,818 and a loss of ($148,233) for the three month periods ended June 30, 2015 and 2014, respectively. The foreign currency translation for the six month periods ended June 30, 2015 was a loss of $1,203,620, compared to a loss of $150,452 for the same period in 2014. This change is primarily attributable to the translation effect resulting from the strong fluctuations in the USD/Euro exchange rates.

Reconciliation of Net Loss to Non-GAAP Adjusted EBITDA

In order to provide investors additional information regarding our financial results, the Company is disclosing Adjusted EBITDA, a non-GAAP financial measures. Adjusted EBITDA is defined as earnings before income and income taxes, depreciation and amortization, share-based compensation, changes in deferred revenue, income interest and expenses, expenses from derivative accounting, such as debt discount and conversion feature expensing, changes in fair value of the conversion feature and warrant liabilities, amortization of deferred financing cost, loss on extinguishment of debt, impairment of tangible and intangible assets and impairments of loans. Adjusted EBITDA further eliminates share-based compensation. Adjusted EBITDA is designed to show a measure of the Company’s operating performance. The Company uses Adjusted EBITDA because it removes the impact of items not directly resulting from the Company’s core operations, allowing the Company to better assess whether the elements of the Company’s growth strategy are yielding the desired results. Accordingly, the Company believes that Adjusted EBITDA provide useful information for investors and others which allow them to better understand and evaluate the Company’s operating results.

In particular, as a result of the characteristics of our services, the long term nature of the contracts and the small customer base, new and substantial sales will remain unnoticed to investors due to the fact that most of these sales will need to be deferred over a period of 3-5 years. The Company therefore adds back to the revenue in the income statement the revenues that were invoiced in the reporting period. At the same time the Company removes from the revenue in the income statement the revenues that have been recognized as a result of sales prior to the reporting period. These two adjustments we refer to us as changes in deferred revenue.

A reconciliation of Net Loss to Non-GAAP Adjusted EBITDA, for each of the periods indicated, is as follows: