10-Q 1 v409939_10q.htm 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 March 31, 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)

 

DELAWARE   95-4557538
(State or other jurisdiction of   (I.R.S. employer identification no.)
incorporation or organization)    

  

100 Park Avenue, New York City, NY 10017

USA

(Address of principal executive offices)(Zip Code)

 

+ 1 (212) 984-1096+ 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):

 

  Large Accelerated filer  ¨      Accelerated filer  x      
Non-Accelerated filer  ¨      Smaller reporting company  ¨
 

 

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 May 1, 2015, there were 155,410,343 shares of the Company’s common stock outstanding.

 

 
 

 

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

March 31, 2015

 

PART I - FINANCIAL INFORMATION 3
   
Item 1. Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets as of March 31, 2015 (unaudited) and December 31, 2014 3
Condensed Consolidated Statements of Comprehensive Loss for the three months periods ended March 31, 2015 and 2014 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the three months periods ended March 31, 2015 and 2014 (unaudited) 5
   
Notes to  Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 25
   
PART II -  OTHER INFORMATION 26
   
Item 1. Legal Proceedings 26
Item 1A. Risk Factors 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 3. Default upon Senior Securities 26
Item 4. Mine Safety Disclosure 26
Item 5. Other Information 26
Item 6. Exhibits 27
   
SIGNATURES 27

 

2
 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

 

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   March 31,   December 31, 
   2015   2014 
ASSETS           
           
CURRENT ASSETS           
           
Cash and cash equivalents  $994,693   $1,904,160 
Financing receivable   -    2,000,000 
Restricted cash   416,304    312,935 
Accounts receivable   13,562,151    8,877,213 
Prepaid expenses and other current assets   1,888,499    2,478,681 
   Total current assets   16,861,647    15,572,989 
           
NON-CURRENT ASSETS          
           
OTHER ASSETS   1,326,090    1,600,335 
           
PROPERTY AND EQUIPMENT, NET   17,796,754    19,319,202 
           
INTANGIBLE ASSETS, NET   4,111,695    5,076,208 
           
GOODWILL   3,012,954    3,352,264 
           
TOTAL ASSETS   $43,109,140   $44,920,998 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
CURRENT LIABILITIES           
Overdraft  $-   $433,366 
Accounts payable and customer deposits   2,331,938    1,856,014 
Obligations under capital leases (current portion)   1,757,809    1,831,050 
Deferred Revenue   12,891,050    8,813,385 
Accrued expenses and other payables   3,054,813    4,061,652 
Loans payable   -    962,269 
2014 10% + libor 3rd Party Loan (net of OID of  $733,353 at March 31, 2015 and $798,894 at December 31, 2014)   11,266,647    11,201,106 
   Total current liabilities   31,302,257    29,158,842 
           
LONG TERM LIABILITIES           
Warrant liabilities   1,841,290    2,087,992 
Non-current portion of obligation under capital leases   176,298    272,460 
Other long term loan   302,533    354,880 
Non-current portion of deferred revenue   1,873,088    2,434,257 
   Total long term liabilities   4,193,209    5,149,589 
           
   Total liabilities   35,495,466    34,308,431 
           
Commitments and Contingencies (See Notes)   -    - 
           
STOCKHOLDERS' EQUITY          
Preferred Stock $0.00001 par value, 50,000,000 shares authorized, 0 issued and outstanding   -    - 
Common Stock $0.00001 par value, 250,000,000 shares authorized,  154,866,885 issued and outstanding  as of March 31, 2015 and 154,671,258 shares issued and outstanding as of December 31, 2014   265,198,811    264,359,674 
Accumulated other comprehensive income (loss)   (4,839,570)   (3,127,132)
Accumulated deficit   (252,754,469)   (250,629,296)
   Elephant Talk Communications, Corp. stockholders' equity   7,604,772    10,603,246 
           
NON-CONTROLLING INTEREST   8,902    9,321 
   Total stockholders' equity   7,613,674    10,612,567 
           
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $43,109,140   $44,920,998 

 

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

 

3
 

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS

(UNAUDITED) 

 

   March 31,   March 31, 
   2015   2014 
       restated 
         
REVENUES  $5,013,016   $5,384,265 
           
COST AND OPERATING EXPENSES          
Cost of service (excluding depreciation and amortization)   1,868,846    1,635,972 
Product development   1,036,121    1,711,817 
Sales and marketing   662,160    563,835 
General and administrative   2,961,096    3,047,947 
Depreciation and amortization of intangibles assets   1,746,147    2,008,214 
  Total cost and operating expenses   8,274,370    8,967,785 
           
LOSS FROM OPERATIONS   (3,261,354)   (3,583,520)
           
OTHER INCOME (EXPENSE)          
Interest income   30,272    27,611 
Interest expense   (367,340)   (301,944)
Interest expense  related to debt discount and conversion feature   (63,972)   (884,740)
Changes in fair value of warrant liabilities   246,702    (210,272)
Gain / (Loss) on Extinguishment of Debt   2,475,799    (426)
Other income & (expense), net   (1,191,270)   3,390 
Amortization of deferred financing costs   (62,502)   (136,367)
     Total other income (expense)   1,067,689    (1,502,748)
           
LOSS BEFORE (BENEFIT) PROVISION FOR INCOME TAXES   (2,193,665)   (5,086,268)
(Benefit) / provision for income taxes   (68,492)   135,437 
NET LOSS   (2,125,173)   (5,221,705)
           
OTHER COMPREHENSIVE (LOSS) INCOME          
Foreign currency translation gain (loss)   (1,712,438)   (2,219)
COMPREHENSIVE LOSS  $(3,837,611)  $(5,223,924)
           
Net loss per common share and equivalents - basic and diluted  $(0.01)  $(0.04)
           
Weighted average shares outstanding during the period - basic and diluted   154,854,572    141,752,128 

 

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

 

4
 

  

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED) 

 

   March 31,   March 31, 
   2015   2014 
       restated 
         
CASH FLOWS FROM OPERATING ACTIVITIES:           
Net loss  $(2,125,173)  $(5,221,705)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

          
 Depreciation and amortization   1,746,147    2,008,214 
 Provision for doubtful accounts   8,184    611 
 Stock based compensation   831,813    771,724 
 Change in fair value of warrant liability   (246,702)   210,272 
 Amortization of deferred financing costs   62,502    136,367 
 Interest expense relating to debt discount and conversion feature   63,972    884,740 
 Unrealized foreign currency translation gain loss   1,191,270    (3,390)
 (Profit) / Loss on Extinguishment of Debt   (2,475,799)   

426

 
 Changes in operating assets and liabilities:           
 Decrease (increase) in accounts receivable   (5,983,834)   

52,538

 Decrease (increase) in prepaid expenses, deposits and other assets   489,564    165,627 
 Increase (decrease) in accounts payable and customer deposits   626,729    319,553 
 Increase (decrease) in deferred revenue   2,981,659    

809,561

 
 Increase (decrease) in accrued expenses and other payables   296,266    

643,281

 

Net cash (used in) provided by operating activities

   (2,533,402)   777,819 
           
CASH FLOWS FROM INVESTING ACTIVITIES:           
 Purchases of property and equipment   (1,511,179)   (1,802,951)
 Net cash used in investing activities    (1,511,179)   (1,802,951)
           
CASH FLOWS FROM FINANCING ACTIVITIES:           
 Financing related fees   -    (90,000)
 Financing receivable   2,000,000    - 
 Exercise of warrants & options   5,861    4,093,480 
 Net cash provided by financing activities    2,005,861    4,003,480 
           
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS    1,129,253    (312,617)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS    (909,467)   2,665,731 
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD    1,904,160    1,252,315 
CASH AND CASH EQUIVALENTS, END OF THE PERIOD   $994,693   $3,918,046 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:           
           
Cash paid during the period for interest  $359,521   $68,190 
Cash paid during the period for income taxes   14,246    56,881 

 

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

 

5
 

 

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

 

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

 

 

Note 1. Financial Condition

 

As reflected in the accompanying consolidated financial statements the Company incurred net losses of $2,125,173 for the three month period ended March 31, 2015, and had an accumulated deficit of $252,754,469 as of March 31, 2015.

 

Cash balance of the company at March 31st 2015 was $994,693 which was negatively impacted by an increase of the accounts receivable of $5,983,834 following the increase of $3,131,407 that already occurred in the fourth quarter 2014, totaling an accounts receivable increase of $9,115,241 over the six months ended March 31, 2015. The primary cause of the accounts receivable increases are the result of Grupo lusacell, S.A.’s (“Iusacell”) deferring the payment for services performed during the fourth quarter 2014 to the first quarter 2015. The outstanding receivables of Iusacell constituted 72% and 64% of total accounts receivable at December 31st 2014 and March 31st, 2015 respectively. After Iusacell was acquired by AT&T, AT&T/Iusacell indicated its intention to terminate the five-year agreement between the Company and Iusacell dated September 10, 2013 (the “Iusacell Agreement”). The Company received a settlement proposal from Iusacell/AT&T, in exchange for the termination of the Iusacell Agreement, payment of a certain amount of cash, consisting of outstanding account payables and additional payment to compensate the Company for the loss of future fees to be due under the Iusacell Agreement.Presently management is evaluating the settlement proposal of Iusacell/AT&T. The intended termination of Iusacell Agreement has and will have a significant impact to our revenue, financial conditions and liquidity. We expect reaching a settlement agreement with AT&T/Iusacell in the near future.

 

During the three months ended March 31, 2015, if Iusacell would have paid the agreed amounts for first quarter 2015 we would have received a cash payments of $1.3 million per month. In addition to the Iusacell termination negotiations and associated expected cash inflow the Company has started to reduce cash expenses, has initiated a staff reduction program, made benefit reductions and payment of stock in lieu arrangements of cash compensation for senior management. Furthermore, sales efforts have increased in order to accelerate new customer take-on. In parallel, the Company is in discussions with its lender Atalaya Administrative LLC in order to resolve the impact of occurrence of events of default as defined in the Credit Agreement as a result of the pending Iusacell termination. The Company anticipates resolution both with AT&T/Iusacell as well as with Atalaya Administrative LLC. There can be no assurance that the outcome will be successful as the Company expected. In case the outcome falls short of the Company’s expectations, the Company will need to pursue financing and/or further scale back its operations. Even though the Company has been successful in the past to arrange for sufficient liquidity for the Company, the above conditions raise substantial doubt as to 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”).

 

6
 

 

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 Annual Report on Form 10-K filed with the SEC on April 1, 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 months ended March 31, 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 months ended March 31, 2015.

 

Use of Estimates

 

The preparation of the accompanying financial statements conforms with 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 bad debt allowance, valuation of financial instruments, useful lives and share-based compensation. Actual results may differ from these estimates under different assumptions or conditions.

  

Note 3. Supplemental Financial Information

 

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

 

Prepaid expenses and other current assets

 

   March 31,   December 31, 
   2015   2014 
Recurring prepaid expenses  $691,287   $455,529 
Non recurring prepaid expenses   202,755    731,725 
Taxes   321,700    359,087 
VAT   665,731    742,773 
Inventory SIM cards   7,026    189,567 
   $1,888,499   $2,478,681 

7
 

  

Other Assets  March 31,   December 31, 
   2015   2014 
Long term deposits  $415,571   $653,002 
Deferred Financing Costs   660,609    682,878 
Due from third parties   249,910    264,455 
   $1,326,090   $1,600,335 

Property and equipment  March 31,   December 31, 
   2015   2014 
Furniture & fixtures  $287,543   $281,214 
Computer, communications and network equipment   23,590,770    23,904,494 
Software   4,694,417    4,556,364 
Automobiles   72,183    80,860 
Construction in progress   2,438,237    4,044,932 
Acc. Depreciation Property & Equipment   (13,286,396)   (13,548,662)
   $17,796,754   $19,319,202 

Intangible assets  March 31,   December 31, 
   2015   2014 
Validsoft IP & Technology  $11,342,770   $14,344,604 
Customer Contracts, Licenses , Interconnect & Technology   3,282,608    1,870,523 
Accumulated amortization Validsoft IP & Technology   (8,111,372)   (9,973,063)
Accumulated amortization Customer Contracts, Licenses, Interconnect & Technology   (2,402,311)   (1,165,856)
   $4,111,695   $5,076,208 

Goodwill  March 31,   December 31, 
   2015   2014 
Goodwill ValidSoft Ltd  $2,646,301   $2,964,423 
Goodwill Morodo Ltd.   176,252    197,440 
Goodwill Telnicity   190,401    190,401 
   $3,012,954   $3,352,264 

8
 

Accrued expenses and other payables  March 31,   December 31, 
   2015   2014 
Accrued Selling, General & Administrative expenses  $2,058,157   $1,863,020 
Accrued cost of service   364,929    291,553 
Accrued taxes (including VAT)   428,988    570,616 
Accrued interest payable   106,222    1,184,418 
Other accrued expenses   96,517    152,045 
   $3,054,813   $4,061,652 

2014 10% + libor 3rd Party Term Loan Agreement  March 31,   December 31, 
   2015   2014 
2014 10% Term Loan (principal amount)  $12,000,000   $12,000,000 
Debt Discount - Original Issue Discount   (335,223)   (365,231)
Debt Discount - Warrants   (398,130)   (433,663)
   $11,266,647   $11,201,106 

 

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 have occurred and that for so long as an event of default shall be continuing, interest shall 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 will continue to monitor the default situation and reserve all their respective rights and remedies under the Credit Agreement.

  

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.

 

9
 

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 March 31, 2015 and December 31, 2014 for financial assets and liabilities measured at fair value on a recurring basis:

 

  

March 31, 2015

(Unaudited)

 
   Level 1   Level 2   Level 3   Total 
Derivative Liabilities                    
Warrant Liabilities  $-   $-   $1,841,290   $1,841,290 
Total Derivatives Liabilities  $-   $-   $1,841,290   $1,841,290 

 

   December 31, 2014 
   Level 1   Level 2   Level 3   Total 
Derivative Liabilities                    
Warrant Liabilities  $-   $-   $2,087,992   $2,087,992 
Total Derivatives Liabilities  $-   $-   $2,087,992   $2,087,992 

 

The Company has classified the outstanding warrant liabilities into level 3 due to the fact that some inputs are not published and not easily comparable to industry peers. The differences in level 3 items from December 31, 2014 to March 31, 2015 were only as a result in changes in the fair values. The Company uses the Monte Carlo valuation model to determine the value of the remaining 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 154,866,885 and 154,671,258 shares of common stock issued and outstanding as of March 31, 2015 (unaudited) and December 31, 2014, respectively, an increase of 195,627 shares, 8,668 shares were issued to employees as a result of exercised employee stock options, and a total of 186,959 shares were issued from the 2008 Option Plan as compensation to the Company’s executive officers and non-executive directors.

 

Reconciliation with Stock Transfer Agent Records:

 

The shares issued and outstanding as of March 31, 2015 and December 31, 2014 according to the Company’s stock transfer agent’s records were 155,112,785 and 154,917,158, respectively. The difference in number of issued shares recognized by the Company of 154,866,885 amounts to 245,900 and it is the result of the exclusion of the 233,900 unreturned shares from ‘cancelled’ acquisitions (pre-2006) and 12,000 treasury shares issued under the former employee benefits plan.

 

(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.

10
 

For the period ended March 31, 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 March 31, 2015 (unaudited) and December 31, 2014 have been recorded and classified as equity, except as of March 31, 2015 and December 31, 2014, the Company has recorded $1,841,290 and $2,087,992, respectively, in the balance sheet for the warrant liabilities issued in connection with the Registered Direct Offering from 2013. The Weighted Average Exercise Price for the currently outstanding warrants in the table below is $1.20. The table below summarizes the warrants outstanding as of March 31, 2015 and as of December 31, 2014:

 

Outstanding
Warrants
  Exercise/
Conversion
price(s)
 (range)
  Expiring  2015   2014 
               
Warrants – Fundraising  $0.853- $2.00  2013 – 2018   29,610,206    29,610,206 
Warrants – Other  $2.21  2016   18,659    18,659 
          29,628,865    29,628,865 

 

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

  

Total Authorized under the plan   56,000,000 
Shares issued in prior years   1,951,031 
Shares issued in 2015   186,959 
Options exercised   2,382,110 
Outstanding options   42,037,535 
Available for grant at 31 March 2015:   9,442,365 

 

During the first quarter of 2015, the Company issued 186,959 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 in shares of the Company.

 

11
 

  

Stock option activity is set forth below:

 

Options:  Number of Options   Weighted Average Exercise Price 
Outstanding as of December 31, 2014   40,056,080   $1.32 
Granted in 2015   6,685,230   $0.81 
Exercised (with delivery of shares)   (8,668)  $0.68 
Forfeitures (Pre-vesting)   (3,875,185)  $1.24 
Expirations (Post-vesting)   (819,922)  $2.20 
Exchanged for Cashless exercise   -   $- 
Outstanding as of March 31, 2015   42,037,535   $1.31 

 

At March 31, 2015, the unrecognized expense portion of stock-based awards granted to employees under the 2008 Plan was approximately $7,419,546, compared to $11,952,452 for the same period in 2014, under the provisions of ASC 718. The future expensing takes 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:

 

   March 31, 
   2015   2014 
Net (Benefit) Provision for income taxes  $

(68,492

)  $

135,437

 

 

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:

 

   Three Months Ended 
   March 31 
   2015   2014 
Two largest customers   67.4%   77.5%

 

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

 

12
 

  

   Three Months Ended 
   March 31 
   2015   2014 
Europe   64.9%   65.6%
All other (non-European) countries   35.1    34.4 
    100.0%   100.0%

 

Note 9. 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 for additional information regarding the restatement of our unaudited consolidated financial statements for the quarter ended March 31, 2014 and for information regarding the restatement in the 2012 Form 10-K of our audited consolidated financial statements for the years ended December 31, 2013 and 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 March 31, 2015 (this “Form 10-Q”) reflects the impact of the restatement on the applicable unaudited quarterly financial information for the three months ended March 31, 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 March 31, 2014 to the corresponding restated amounts as reported herein and in our 2014 Form 10-K.

 

13
 

  

    March 31,       March 31, 
   2014       2014 
   (UNAUDITED)   restatement   Restated 
       Unaudited   Unaudited 
ASSETS               
                
CURRENT ASSETS               
                
Cash and cash equivalents  $3,918,046   $-   $3,918,046 
Restricted cash   192,161    -    192,161 
Accounts receivable, net of allowance for doubtful accounts of $11,307 at March 31, 2014   6,262,041    (1,228,374)   5,033,667 
Prepaid expenses and other current assets   2,147,686    -    2,147,686 
Total current assets   12,519,934    (1,228,374)   11,291,560 
                
NON-CURRENT ASSETS               
                
OTHER ASSETS   1,357,728    -    1,357,728 
                
PROPERTY AND EQUIPMENT, NET   19,954,703    -    19,954,703 
                
INTANGIBLE ASSETS, NET   7,903,149    -    7,903,149 
                
GOODWILL   3,769,199    -    3,769,199 
                
TOTAL ASSETS  $45,504,713   $(1,228,374)  $44,276,339 
                
LIABILITIES AND STOCKHOLDERS' EQUITY               
                
CURRENT LIABILITIES               
Overdraft  $402,234   $-   $402,234 
Accounts payable and customer deposits   2,419,325    -    2,419,325 
Obligations under capital leases (current portion)   1,348,705    -    1,348,705 
Deferred revenue   203,623    468,256    671,879 
Accrued expenses and other payables   5,936,989    -    5,936,989 
Loans payable   962,269    -    962,269 
10% Related Party Loan (net of Debt Discount of $937,814 at March 31, 2014   1,812,506    -    1,812,506 
Total current liabilities   13,085,651    468,256    13,553,907 
                
LONG TERM LIABILITIES               
10% 3rd Party Loan (net of Debt Discount of $623,726 at March 31, 2014)   4,876,914    -    4,876,914 
Warrant liabilities   2,183,806    -    2,183,806 
Non-current portion of obligation under capital leases   465,954    -    465,954 
Non-current portion of deferred revenue   -    2,774,415    2,774,415 
Loan from joint venture partner   614,169    -    614,169 
Total long term liabilities   8,140,843    2,774,415    10,915,258 
                
Total liabilities   21,226,494    3,242,671    24,469,165 
                
Commitments and Contingencies               
STOCKHOLDERS' EQUITY               
Preferred Stock $0.00001 par value, 50,000,000 shares authorized, 0 issued and outstanding   -    -    - 
Common Stock $0.00001 par value, 250,000,000 shares authorized, 146,364,577 issued and outstanding  as of March 31, 2014   253,383,860    -    253,383,860 
Accumulated other comprehensive income   267,650    -    267,650 
Accumulated deficit   (229,518,039)   (4,471,045)   (233,989,084)
Elephant Talk Communications, Corp. stockholders' equity   24,133,471    (4,471,045)   19,662,426 
                
NON-CONTROLLING INTEREST   144,748    -    144,748 
Total stockholders' equity   24,278,219    (4,471,045)   19,807,174 
                
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $45,504,713   $(1,228,374)  $44,276,339 

 

14
 

  

March 31, 2014      Restatement
adjustments
   Re-classifications   Restated 
   (unaudited)   (unaudited)   (unaudited)   (unaudited) 
REVENUES  $6,479,853   $(1,095,588)  $-   $5,384,265 
                     
COST AND OPERATING EXPENSES                    
Cost of service (excluding depreciation and amortization)   983,464    -    652,508    1,635,972 
Product development   -    -    1,711,817    1,711,817 
Sales and marketing   -    -    563,835    563,835 
General and administrative   5,976,107    -    (2,928,160)   3,047,947 
Depreciation and amortization   2,008,214    -    -    2,008,214 
Total cost and operating expenses   8,967,785    -    -    8,967,785 
                     
LOSS FROM OPERATIONS   (2,487,932)   (1,095,588)   -    (3,583,520)
                     
OTHER INCOME (EXPENSE)                    
Interest income   27,611    -    -    27,611 
Interest expense   (301,944)   -    -    (301,944)
Interest expense related to Debt Discount and Conversion Feature   (884,740)   -    -    (884,740)
Change in fair value of warrant liabilities   (210,272)   -    -    (210,272)
Loss on extinguishment of debt   (426)   -    -    (426)
Other income and (expense)   3,390    -    -    3,390 
Amortization of deferred financing costs   (136,367)   -    -    (136,367)
Total other income (expense)   (1,502,748)   -    -    (1,502,748)
                     
LOSS BEFORE PROVISION FOR INCOME TAXES   (3,990,680)   (1,095,588)   -    (5,086,268)
Provision for income taxes   (135,437)   -    -    (135,437)
NET LOSS   (4,126,117)   (1,095,588)   -    (5,221,705)
                     
OTHER COMPREHENSIVE (LOSS) INCOME                    
Foreign currency translation (loss)   (2,219)   -    -    (2,219)
                     
COMPREHENSIVE LOSS  $(4,128,336)  $(1,095,588)  $-   $(5,223,924)
                     
Net loss per common share and equivalents - basic and diluted  $(0.03)   -   $-   $(0.04)
                     
Weighted average shares outstanding during the period - basic and diluted   141,752,128    -    -    141,752,128 

 

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.

 

15
 

  

   For the three months          
   ended March 31, 2014   Restatement   Restated 
       Unaudited*   Unaudited* 
CASH FLOWS FROM OPERATING ACTIVITIES:               
Net loss  $(4,126,117)  $(1,095,588)  $(5,221,705)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:               
Depreciation and amortization   2,008,214    -    2,008,214 
Provision for doubtful accounts   611    -    611 
Stock based compensation   771,724    -    771,724 
Change in the fair value of the warrant liability   210,272    -    210,272 
Amortization of deferred financing costs   136,367    -    136,367 
Interest expense relating to debt discount and conversion feature   884,740    -    884,740 
Unrealized foreign currency translation gain/(loss)   (3,390)   -    (3,390)

(Profit)/Loss on Extinguishment of Debt*

   -         

426

 
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:               
Decrease (increase) in accounts receivable*   (293,435)   345,973    52,538 
Decrease (increase)  in prepaid expenses, deposits and other assets   165,627    -    165,627 
Increase (decrease) in accounts payable, proceeds from related parties  and customer deposits   319,553    -    319,553 
Increase (decrease) in deferred revenue*   59,946    749,615    809,561 
Increase (decrease) in accrued expenses and other payables*   643,707    -    

643,281

 
Net cash provided by (used in) operating activities   777,819    -    777,819 
                
CASH FLOWS FROM INVESTING ACTIVITIES:               
Purchases of Property and Equipment   (1,802,951)   -    (1,802,951)
Net cash used in investing activities   (1,802,951)   -    (1,802,951)
                
CASH FLOWS FROM FINANCING ACTIVITIES:               
Financing related fees   (90,000)   -    (90,000)
Exercise of warrants and Options   4,093,480    -    4,093,480 
Net cash provided by financing activities   4,003,480    -    4,003,480 
                
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS   (312,617)   -    (312,617)
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS   2,665,731    -    2,665,731 
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD   1,252,315    -    1,252,315 
CASH AND CASH EQUIVALENTS, END OF THE PERIOD  $3,918,046   $-   $3,918,046 

 

*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 ($2,440,518) to $52,538, and Deferred Revenue increase (decrease) changed from $3,302,617 to $809,561. 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 10. Subsequent Events

 

The Company’s management evaluated subsequent events through the date the financial statements were available to be issued, and concluded that there are no reportable events.

 

16
 

  

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 for each of the 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:

 

  · On April 29-30, 2015 Elephant Talk North America was invited to be present at the Verizon Partner Summit in Miami as one of three vendors participating, along with Coriant and Cisco. Elephant Talk North America was highlighted from the stage as the intended partner to power VPS’s new pre-paid MVNO offerings in North America. In the United States ETNA will, if selected, provide the platform for VPS’s Pre-Paid program as a branded “Powered by Elephant Talk” solution.

 

  · On January 29, 2015 we announced the appointment of Dr. Armin G. Hessler (formerly Vodafone) and Martin Zuurbier, the current CTO of Elephant Talk, as co-Presidents of our mobile platform business effective on April 1, 2015. Both will report to Mr. Steven van der Velden, Chairman and CEO.

 

  · On January 21, 2015 we announced that LOWI, the Low–Cost Brand of Vodafone has been launched on Elephant Talk’s fully redundant mobile platform in Spain, joining virtual operators like Lebara, BT, Eroski, NEO and HITS.

 

  · On December 22, 2014 Affirmed Networks and Elephant Talk Communications Corp. (NYSE MKT: ETAK), global leaders in virtualized mobile networks, announced the deployment of Affirmed Networks’ Network Functions Virtualization (NFV) solution, called the Affirmed Mobile Content Cloud™, as part of Elephant Talk’s Software Defined Network Architecture mobile Software DNA® 2.0 platform with mobile operators in Europe and the Middle East. Affirmed Networks and Elephant Talk are providing current and future clients with a fully virtualized Evolved Packet Core, encompassing a breadth of capability and services for 3G and 4G core networks.

 

17
 

 

Recent milestones for the ValidSoft security product line:

 

  ·

On May 12, 2015 ValidSoft announced that the Company has been selected as the preferred voice biometrics technology provider for ImageWare Systems going forward. ImageWare® Systems, Inc. (OTCQB: IWSY) is a market leader in providing identity management solutions, delivering a single platform of best in class biometric solutions to manage millions of identities worldwide with a varied client and partner portfolio including TransUnion, Fujitsu, IBM and CA Technologies.

 

On April 1, 2015 ValidSoft announced the signing of a significant new commercial customer contract for its newly enhanced User Authentication platform featuring its Voice Biometric technology with a large US-based corporation.

 

  · On February 24, 2015 ValidSoft announced that it has launched its Device Trust solution with another major UK retail bank with its partner FICO (NYSE:FICO). This is the second such agreement announced for this solution in the UK and continues building on the successful partnership with FICO. The new client, unnamed for security reasons, is the largest UK deployment of this solution to date for ValidSoft.

 

  · On January 14, 2015, research group Technavio highlighted ValidSoft as one of the 3 leading vendors for voice biometrics, a market that Opus Research predicts to be worth $574 million by 2017.

 

  · On November 2, 2014 ValidSoft expanded its business to Northern America and appointed Shawn Edmunds as Vice-President Northern America.

 

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 three months ended March 31, 2015.

 

18
 

 

Comparison of three months ended March 31, 2015 and March 31, 2014.

 

Revenue

 

Revenue for the three months ended March 31, 2015 was $ 5,013,016, a decrease of $371,249 or 7%, compared to $5,384,265 for the three months ended March 31, 2014. This decrease was caused by the negative exchange rate impact of $739,730 as a result of a decrease of the exchange rate of the euro against the US (dollar).

 

   Three months ended     
   2015   2014 restated   Variance 
Revenues  $5,013,016   $5,384,265   $ (371,249)

 

Note 2 (Financial Condition) in this report mentions the likely termination of the contract with one of our customers. Future revenues will be impacted in a material manner, following the release of all of the deferred revenue related to this customer upon formal termination of the contract and release of any outstanding obligations of the Company towards the customer. The release of these deferred amounts will however have no cash impact.

  

Non-GAAP Revenue

 

In order to provide investors additional information regarding our revenue, we are disclosing Non-GAAP revenue, a non-GAAP financial measures which is defined as GAAP revenue adjusted for changes in deferred revenue. A reconciliation of Revenue to Non-GAAP Revenue, for each of the periods indicated, is as follows:

  

   Three months ended     
Non-GAAP Revenue  2015   2014 restated   Variance 
Revenues  $5,013,016   $5,384,265   $ (371,249)
Deferred Revenue adjustments   2,981,659    1,095,588    1,886,071 
   $7,994,675   $6,479,853   $1,514,822 

 

Non-GAAP Revenue for the three months ended March 31, 2015 was $ 7,994,675, an increase of $1,514,822 or 23.4%, compared to $6,479,853 for the three months ended March 31, 2014. This increase was caused by increased usage by our customers of our technology platforms as well as increased monthly fixed pricing with one of our customers. This increase in revenue will not continue for the coming quarters following the likely termination of the contract with one of our customers as mentioned in Note 2. Compared to the three months ended 2015 this termination could lead to a revenue loss of $ 1.3 million per month depending on final settlement negotiations with the customer.

 

19
 

Historic quarterly overview Non-GAAP and GAAP revenue

 

Non-GAAP and GAAP Revenue (quarterly figures
unaudited)
   Q1 2013     Q2 2013     Q3 2013     Q4 2013  
Non-GAAP Revenue  $6,596,500   $4,994,145   $5,204,982   $6,031,634 
Deferred Revenue adjustments   (356,386)   (1,429,896)   (1,081,188)   (507,987)
GAAP Revenue  $6,240,114   $3,564,249   $4,123,794   $5,523,647 

 

Non-GAAP and GAAP Revenue (quarterly figures
unaudited)
   Q1 2014     Q2 2014     Q3 2014     Q4 2014     Q1 2015  
Non-GAAP Revenue  $6,479,853   $6,911,768   $7,298,988   $7,869,631   $7,994,675 
Deferred Revenue adjustments   (1,095,588)   (1,839,328)   (2,853,749)   (2,415,128)   (2,981,659)
GAAP Revenue  $5,384,265   $5,072,440   $4,445,239   $5,454,503   $5,013,016 

 

Historic development mobile and security revenues

 

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

 

Mobile and Security (Unaudited) Reported Revenue (non-gaap and gaap)
               % of Total 
       ($ in   % of Total   Company 
   ($ in   millions)   Company   Revenue 
Quarter  Millions non-
gaap)
   Restated - gaap   Revenue (non-
gaap)
   Restated
(gaap)
 
2Q12   2.8    2.8    39.3    39.3 
3Q12   2.9    2.9    43.8    43.8 
4Q12   3.6    3.6    52.1    52.1 
1Q13   3.9    3.5    58.5    56.1 
2Q13   4.5    3    89.5    85.2 
3Q13   5    3.9    95.9    94.8 
4Q13   5.9    5.4    97.6    97.3 
1Q14   6.4    5.3    98.5    98.2 
2Q14   6.9    5    99.4    99.2 
3Q14   7.3    4.4    99.9    99.8 
4Q14*   7.9    5.4    99.9    99.9 
1Q15*   8.0    5.0    100    100 

 

*not restated

 

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.

 

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   Three months ended     
   2015   2014 restated   Variance 
Revenues  $5,013,016   $5,384,265   $(371,249)
Cost of service (excluding depreciation and amortization)   1,868,846    1,635,972    232,874 
Margin (excluding depreciation and amortization)  $3,144,170   $3,748,293   $(604,123)

 

Cost of service for the three month period ended March 31, 2015 was $1,868,846, an increase of $232,874 or 14%, compared to $1,635,972 for the three month period ended March 31, 2014. The increase was primarily related to airtime cost for our mobile bundled services.

 

Margin (excluding depreciation and amortization) as a percent of the total revenue was 63% and 70% for the three month period ended March 31, 2015 and 2014, respectively. This decrease was primarily caused by the negative exchange rate impact of $739,730 as a result of a decrease of the exchange rate of the euro against the US (dollar).

  

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 March 31, 2015 and 2014, the Company capitalized $1,175,027 and $1,055,962, respectively.

 

Product Development costs for the three month period ended March 31, 2015 and 2014 were $ 1,036,121 and $ 1,711,817, respectively, a decrease of $675,696 or 39%. The decrease is due to reduced use of specialist consultants and re-allocation of certain staff to other functions.

 

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 March 31, 2015 and 2014 were $ 662,160 and $ 563,835, respectively, an increase of $98,325 or 17%. The increase is due to increased staffing for these functions.

 

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.

 

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General and Administrative expenses for the three month period ended March 31, 2015 and 2014 were $2,961,096 and $3,047,947, respectively, a decrease of $86,851 or 3%. The decrease was caused by a $778,672 favorable exchange rate impact.

 

Share-based compensation

 

Share-based compensation is comprised of:

 

  · the expensing of the options granted under the 2008 Plan to staff and management;
  · the expensing of the shares issued under the 2006 and 2008 Plans to the directors and executive officers in lieu of cash compensation;
  · the expensing of restricted shares issued for consultancy services.

 

For the three month period ended March 31, 2015 and 2014, we recognized share-based compensation expense of $831,813 and $ $771,724, respectively, an increase of $60,089 or 8%.

  

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

 

   March 31,
2015
   March 31,
2014
 
Cost of service  $51,363   $217,751 
Product Development   193,142    398,505 
Sales and Marketing   33,348    40,368 
General and Administrative   553,960    115,100 
Total  $831,813   $771,724 

 

Depreciation and Amortization

 

Depreciation and amortization expenses for the three month period ended March 31, 2015 was $1,746,147, a decrease of $262,067 or 13%, compared to $2,008,214 for the same period in 2014. The decrease is primarily due to the effects of fully depreciated or amortized assets.

 

Interest Income and Expense

 

Interest income for the three month periods ended March 31, 2015 and 2014 was $30,272 and $27,611, respectively. Interest income consists of interest received on bank balances.

 

Interest expense for the three month periods ended March 31, 2015 and 2014, was $ 367,340 and $301,944, respectively, an increase of $65,396 or 22%. Higher levels of interest expense were the result of the change of financing sources during 2014.

 

Interest Expense Related to Debt Discount and Conversion Feature

 

For the periods ended March 31, 2015 and 2014, interest expenses related to debt discount and conversion feature were $63,972 and $884,740, respectively. Interest expenses related to debt discount and conversion features decreased by $820,768 or 93%. This significant decrease was due to the convertible notes issued in 2013 which were converted and/or repaid in 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 $246,702 for the three month period ended March 31, 2015, compared to a loss of $210,272 for the same period in 2014.

 

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Such changes were primarily due to the decreased value of our stock price, because this is 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.

 

Gain/(Loss) on extinguishment of debt

 

There is a net gain on extinguishment of debt amounting to $2,475,799 for the three month period ended March 31, 2015, an increase of $2,476,225,compared to the loss amounting to $426 for the three month period ended March 31, 2014. The gain is the result of the extinguishment of debt 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 cost relate to the 2013 10% Related Party Convertible Loan (see Note 14 of the 2014 Annual Report) and the 2013 10% 3rd Party Convertible Notes (see Note 16 of the 2014 Annual Report), and the related amortization amounted to $62,502 for the three month period ended March 31, 2015, an decrease of $ 73,865 or 54%, compared to $136,367 for the three month period ended March 31, 2014.

The decrease is due to the accelerated amortization on loans received in 2013 and repaid and or converted in 2014 and the 2015 deferred financing costs related to the Credit Facility received in November 2014.

 

Other Income and (Expense)

 

Other income & (expense) for the three month period ended March 31, 2015 is an expense of $1,191,270 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 (Benefit) for the three month period ended March 31, 2015was $(68,492), compared to an income tax provision of $135,437 for the same period in 2014.

 

Net Loss

 

Net loss for the three month period ended March 31, 2015, was $2,125,173, a decrease of $3,096,532 or 59%, compared to the loss of $5,221,705 for the same period in 2014. The decrease in Net Loss was primarily caused by the gain on extinguishment of debt.

 

Other Comprehensive (Loss) Income

 

We record foreign currency translation gains and losses as other comprehensive income or loss, which amounted to losses of $1,712,438 and $2,219 for the three month periods ended March 31, 2015 and 2014, respectively. 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, and impairments of related party 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. A reconciliation of Net Loss to Non-GAAP Adjusted EBITDA, for each of the periods indicated, is as follows:

 

   2015   2014 
EBITDA (adjusted)  Q1   Q1 restated 
Net loss  $(2,125,173)   (5,221,705)
(Benefit) / provision for income taxes   (68,492)   135,437 
Depreciation and amortization   1,746,147    2,008,214 
Stock-based compensation   831,813    771,724 
Interest income and expenses   337,068    274,333 
Interest expense related to debt discount and conversion feature   63,972    884,740 
Changes in fair value of warrant liabilities   (246,702)   210,272 
(Gain)/Loss on extinguishment of debt   (2,475,799)   426 
Other income & (expense)   1,191,270    (3,390)
Amortization of deferred financing costs   62,502    136,367 
Changes in deferred revenue   2,981,659    809,561 
Adjusted EBITDA  $

2,298,265

    5,979 

    

Liquidity and Capital Resources

 

As reflected in the accompanying consolidated financial statements the Company incurred net losses of $2,125,173 for the three month period ended March 31, 2015, and had an accumulated deficit of $252,754,469 as of March 31, 2015.

 

Cash balance of the company at March 31st 2015 was $994,693 which was negatively impacted by an increase of the accounts receivable of $5,983,834 following the increase of $3,131,407 that already occurred in the fourth quarter 2014, totaling an accounts receivable increase of $9,115,241 over the six months ended March 31, 2015. The primary cause of the accounts receivable increases are the result of Grupo lusacell, S.A.’s (“Iusacell”) deferring the payment for services performed during the fourth quarter 2014 to the first quarter 2015. The outstanding receivables of Iusacell constituted 72% and 64% of total accounts receivable at December 31st 2014 and March 31st, 2015 respectively. After Iusacell was acquired by AT&T, AT&T/Iusacell indicated its intention to terminate the five-year agreement between the Company and Iusacell dated September 10, 2013 (the “Iusacell Agreement”). The Company received a settlement proposal from Iusacell/AT&T, in exchange for the termination of the Iusacell Agreement, payment of a certain amount of cash, consisting of outstanding account payables and additional payment to compensate the Company for the loss of future fees to be due under the Iusacell Agreement.Presently management is evaluating the settlement proposal of Iusacell/AT&T. The intended termination of Iusacell Agreement has and will have a significant impact to our revenue, financial conditions and liquidity. We expect reaching a settlement agreement with AT&T/Iusacell in the near future.

 

During the three months ended March 31, 2015, if Iusacell would have paid the agreed amounts for first quarter 2015 we would have received a cash payments of $1.3 million per month. In addition to the Iusacell termination negotiations and associated expected cash inflow the Company has started to reduce cash expenses, has initiated a staff reduction program, made benefit reductions and payment of stock in lieu arrangements of cash compensation for senior management. Furthermore, sales efforts have increased in order to accelerate new customer take-on. In parallel, the Company is in discussions with its lender Atalaya Administrative LLC in order to resolve the impact of occurrence of events of default as defined in the Credit Agreement as a result of the pending Iusacell termination. The Company anticipates resolution both with AT&T/Iusacell as well as with Atalaya Administrative LLC. There can be no assurance that the outcome will be successful as the Company expected. In case the outcome falls short of the Company’s expectations, the Company will need to pursue financing and/or further scale back its operations. Even though the Company has been successful in the past to arrange for sufficient liquidity for the Company, the above conditions raise substantial doubt as to 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.

 

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Operating activities

  

   March 31,
2015
   March 31,
2014
 
         
Net loss  $(2,125,173)  $(5,221,705)
Adjustments to reconcile net loss to net cash used in operating activities:   1,181,387    4,008,538 
    (943,786)   (1,213,167)
           
Changes in operating assets and liabilities:   (1,589,616)   1,990,986 
Net cash (used) (in) provided by operating activities  $(2,533,402)  $777,819 

 

Net cash used in operating activities for the period ended March 31, 2015 was heavily impacted by the increase of accounts receivable of almost $ 6 million, largely caused by the intended termination of Iusacell/AT&T contract and their settlement proposal , causing changes in operating assets and liabilities to be negative $1,589,616.

 

As a result of the above, cash used in operating activities was $2,533,402 for the three months ended March 31, 2015 compared to net cash provided by operating activities of $777,819 for the three months ended March 31, 2014.

 

Investing activities

 

Net cash used in investing activities for the three months ended March 31, 2015 was $1,511,179, a decrease of $291,772, or 16% compared to $1,802,951 in the same period in 2014. This change is resulted from the reduced spending on hardware and software licenses.

 

Financing activities

 

Net cash provided by financing activities for the three months ended March 31, 2015 and 2014 was $2,005,861 and $4,003,480, respectively, a decrease of $1,997,619.

 

As a result of the above activities, for the three months ended March 31, 2015, we had cash and cash equivalents of $994,693, a net decrease in cash and cash equivalents of $909,467 since December 31, 2014.

 

Off- Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that have or are reasonably likely to have either a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors, nor we have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

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Item 3. Quantitative and Qualitative Disclosure about Market Risks

 

Foreign currency exchange rate

 

Although the vast majority of our business activities are carried out in Euros, we report its financial statements in USD. The conversion of Euros and USD leads to period-to-period fluctuations in our reported USD results arising from changes in the exchange rate between the USD and the Euro. Generally, when the USD strengthens relative to the Euro, it has an unfavorable impact on our reported revenue and income and a favorable impact on our reported expenses. Conversely, when the USD weakens relative to the Euro, it produces a favorable impact on our reported revenue and income, and an unfavorable impact on our reported expenses. The above fluctuations in the USD/Euro exchange rate therefore result in currency translation effects (not to be confused with real currency exchange effects), which impact our reported USD results and may make it difficult to determine actual increases and decreases in our revenue and expenses which are attributable to our actual operating activities. We carry out our business activities primarily in Euros, and we do not currently engage in hedging activities. As the vast majority of our business activities are carried out in Euros and we report our financial statements in USD, fluctuations in foreign currencies impact the total amount of assets and liabilities that we report for our foreign subsidiaries upon the translation of those amounts in USD. Since we carry out our business activities primarily in Euros, we do not currently engage in hedging activities.

 

We do not believe that we have currently material exposure to interest rate or other market risk

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

As of March 31, 2015, the Company carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the our disclosure controls and procedures, as defined in Rule 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that its disclosure controls and procedures are effective as of March 31, 2015. Disclosure controls and procedures are necessary to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.

 

Limitations on the Effectiveness of Disclosure Controls. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

Previously Reported Material Weakness in Internal Control over Financial Reporting

 

A "material weakness" is defined as a significant deficiency or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. A “significant deficiency” is defined as a control deficiency, or combination of control deficiencies, that adversely affects the Company’s ability to initiate, authorize, record, process, or report external financial information reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the Company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected.

 

For the accounting and financial reporting period ended March 31, 2015 management continues to implement measures to remediate material weaknesses in internal controls over financial reporting relating to the complex revenue accounting involving delivery of multi-element arrangements.

 

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Changes in Internal Control over Financial Reporting

 

In response to the material weaknesses identified related to the financial reporting of all the quarters in 2013 and the three quarters ended September 30, 2014, the Company restated the 2013 quarters and full year financials, as well as the financials of three quarters ended September 30th 2014. The Company implemented the following measures in the fourth quarter 2014 and first quarter of 2015 in order to remediate this weakness:

 

·The Company consulted an accounting firm to assist us in respect of selected contracts on revenue recognition aspects under US GAAP and will continue to do so;

 

·The Company has instituted a review group in the finance and control department, independent from the sales and operations functions, which will be responsible for the assessment and evaluation of all customer contracts, including the collection of these documents and associated invoicing. The files will include all documents related to revenue recognition. The review group will apply the revenue recognition rules, policies, and procedures to every transaction and prepare a “deal sheet” for each transaction that provides a basic analysis of its impact on revenue recognition.

 

The Company believes that the abovementioned measure remediated the material weakness identified for the periods mentioned above.

 

Under the direction of the Audit Committee, management continues to review and make any changes it deems necessary to the overall design of the Company's internal control over financial reporting, including implementing improvements in policies and procedures. The Company will continue to assess the effectiveness of our remediation efforts in connection with management's future evaluations of internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Company is involved in various claims and lawsuits incidental to our business.  In the opinion of management, the ultimate resolution of such claims and lawsuits will not have a material effect on the Company’s financial position, liquidity, or results of operations.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the Risk Factors included in Part I, “Item 1A. — “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2014. These Risk Factors could materially impact our business, financial condition and/or operating results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely impact our business, financial condition and/or operating results.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

None.

 

26
 

  

Item 6. Exhibits

 

(a) Exhibits

 

31.1   Certification of the CEO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)
     
31.2   Certification of the CFO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)
     
32.1   Certification pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2  

Certification pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101.INS     XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

SIGNATURES

 

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

 

  ELEPHANT TALK COMMUNICATIONS CORP.
     
Date: May 11, 2015 By /s/ Steven van der Velden
    Steven van der Velden
    President and Chief Executive Officer
    (Principal Executive Officer)
     
Date: May 11 , 2015 By /s/ Mark Nije
    Mark Nije
    Chief Financial Officer
    (Principal Financial and Accounting Officer)

 

27