UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Amendment No. 3

FORM 10-K

x  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 

For the fiscal year ended December 31, 2014

¨  TRANSITION REPORT PURSUANT TO 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)

Securities registered pursuant to Section 12(b) of the Act: 

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  ¨   No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes  ¨   No  x

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 Web site, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 CFR 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company.  See definition 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

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2014, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $118 million based on the closing sale price of the Company’s common stock on such date of U.S. $0.95 per share, as reported by the NYSE MKT LLC.

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: As of February 28, 2015, there were 155,112,785 shares of Common Stock outstanding.

EXPLANATORY NOTE

The purpose of this Amendment No. 3 (“Amendment No. 3”) to the Annual Report on Form 10-K of Elephant Talk Communications Corp. (the “Company”) for the fiscal year ended December 31, 2014, originally filed with the Securities and Exchange Commission on April 1, 2015 (the “Form 10-K”), is solely to include revised disclosure to Item 7, Item 7A and Item 8 in Part II in response to certain comments from the Securities and Exchange Commission. As such, Part I and Part III of the Form 10-K are not included in this Amendment No. 3.

Unless otherwise stated, all information contained in this amendment is as of April 1, 2015, the filing date of the original Form 10-K. Except as stated herein, this Amendment No. 3 does not reflect events or transactions occurring after such filing date or modify or update those disclosures in the Form 10-K that may have been affected by events or transactions occurring subsequent to such filing date. No information in the Form 10-K other than as set forth above is amended hereby. Currently-dated certifications from our Chief Executive Officer and our Chief Financial Officer have been included as exhibits to this amendment.

Elephant Talk Communications Corp.

Form 10-K

For the fiscal year ended December 31, 2014

TABLE OF CONTENTS

Note on Forward-Looking Statements

FORWARD LOOKING STATEMENTS

This Report, including the documents incorporated by reference in this Report, includes forward-looking statements.  We have based these forward-looking statements on our current expectations and projections about future events.   Our actual results may differ materially from those discussed herein, or implied by, these forward-looking statements.  Forward-looking statements are generally identified by words such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “plan,” “project,” “should,” “will,” “would” and other similar expressions. In addition, any statements that refer to expectations or other characterizations of future events or circumstances are forward-looking statements. The statements that contain these or similar words should be read carefully because these statements discuss our future expectations, contain projections of our future results of operations or of our financial position, or state other “forward-looking” information. Elephant Talk Communications Corp., believes that it is important to communicate our future expectations to our stockholders. However, there may be events in the future that we are not able to accurately predict or control. Forward-looking statements included in this Report or our other filings with the SEC include, but are not necessarily limited to, those relating to:

The foregoing does not represent an exhaustive list of risks. Please see “Risk Factors” for additional risks which could adversely impact our business and financial performance. Moreover, new risks emerge from time to time and it is not possible for our management to predict all risks, nor can we assess the impact of all risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ from those contained in any forward-looking statements. All forward-looking statements included in this Report are based on information available to us on the date of this Report. Except to the extent required by applicable laws or rules, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this Report.

AVAILABLE INFORMATION

We maintain a corporate website with the address www.elephanttalk.com. We intend to use our website as a regular means of disclosing material non-public information and for complying with disclosure obligations under Regulation FD promulgated by the Securities and Exchange Commission (the “SEC”). Such disclosures will be included on the website under the heading “News” and “Investors – Press Releases”. Accordingly, investors should monitor such portions of the website, in addition to following the Company’s press releases, SEC filings and public conference calls and the webcasts.

We are not incorporating information contained in the website by reference into this Annual Report on Form 10-K. We make available, free of charge, through the website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after electronically filing such material with, or furnishing such material to, the SEC.

Materials filed with the SEC can be read and copies made at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1 800 SEC 0330 for further information about the Public Reference Room. The SEC also maintains a website, www.sec.gov containing the reports, proxy and other information filed with the SEC.

Part II

Item 5.  Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

As of December 5, 2011, our Common Stock is listed for quotation on the Exchange under the symbol “ETAK.”  The following table sets forth the high and low closing prices per share for each quarterly period from March 31, 2013 through December 31, 2014 as quoted on the Exchange and published by www.nasdaq.com. These quotations reflect prices between dealers and do not include retail mark-ups, mark-downs or commissions and may not reasonably represent actual transactions.

As of December 31, 2014, we had approximately 4,074 record holders of our Common Stock.

Dividends

We have not declared any cash dividends since inception and do not anticipate paying any dividends in the foreseeable future. The payment of dividends is within the discretion of our board of directors and will depend on our earnings, capital requirements, financial condition, and other relevant factors. There are no restrictions that currently limit our ability to pay dividends on our Common Stock other than those generally imposed by applicable state law.

EQUITY COMPENSATION PLAN INFORMATION

Securities Authorized for Issuance under Equity Compensation Plans

Stock Performance Graph

The graph below compares the cumulative total stockholder return on ETAK Common Stock with the cumulative return of the NASDAQ Comp. Index (IXIC) and the NASDAQ Telecom Index (IXTC formerly known as IXUT) for each of the five fiscal years ended December 31, 2014, assuming an investment of $100 at the beginning of such period.

The table below shows $100 invested on December 31, 2009 in stock or index: 

Item 6.  Selected Financial Data

As discussed further in Note 35 of the “Notes to Consolidated Financial Statements” contained in Item 8 of this Form 10-K, we have restated our consolidated financial statements to correct certain errors in our previously issued financial statements. The error is an overstatement of revenue due to a 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 us 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.

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes to those consolidated financial statements.  The consolidated statement of operations data set forth below for the years ended December 31, 2014, 2013 and 2012 and the consolidated balance sheet data as of December 31, 2014 and 2013 are derived from, and are qualified in their entirety by reference to, the Company’s audited consolidated financial statements included elsewhere in this Form 10-K.

The impact of the restatement increased net loss by approximately $3.4 million for the year ended December 31, 2013.

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial statements, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. See “Risk Factors” in Part I, Item 1A of this Form 10-K.

Restatement of Previously Issued Financial Statements

As discussed further in Note 35 of the “Notes to Consolidated Financial Statements” contained in Item 8 of this Form 10-K, 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 this Form 10-K.

The impact of these errors on the applicable line items in the consolidated financial statements resulting from the restatement is set forth in Note 35 to the Notes to Consolidated Financial Statements. The net impact of the restatement decreased previously reported revenue of $22,827,261 by $3,375,457 or 15%, to $19,451,804, for the twelve month period ended December 31, 2013. In the same period of time, the short term portion of deferred revenue increased from $142,731 by 129,036 or 90% to $271,767. The long term portion was increased by $2,364,389. Deferred revenue will be amortized during the lifetime of the customer relationship, which has been defined to be five years. Accounts receivable decreased from $5,976,879 by $882,032 or 15%, to $5,094,847 in the same period in 2013. The restatement increased net loss by approximately $3.4 million for the year ended December 31, 2013.

Also, the Company has reclassified certain staff costs included in SG&A to Cost of Service, and it disaggregated the function SG&A into Selling and Marketing, General and Administrative and Product Development. The reclassification of operating costs are material to the annual periods ended December 31, 2012, 2013, the interim periods therein, and to the interim periods within fiscal year 2014 and are included in the restatement in Note 35. These expenses have been reclassified in the Consolidated Statements of Operations for fiscal years 2013 and 2012 to conform to the current period presentation (See Note 35 for the restatement).

As a result of our restatement and in accordance with 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.

Business overview

As a mobile Software Defined Network Architecture (Software DNA™) 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 Mobile Enabling Platform, capable of hosting an integrated IT/BackOffice and Core Network for Mobile Network Operators (MNOs) and 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 MNO and MVNO/MVNE/MVNA partners. Our mobile security services supply telecommunications-based multi-factor mutual 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 customers in industries such as financial services, government benefits, and 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.

Company milestone 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 security product line (“ValidSoft”):

Results of Operations

Although the vast majority of our cost base is carried out in Euros, we report our financial statements in U.S. dollars (“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.

The following table shows the USD equivalent of the major currencies for the year ended December 31, 2014:

Comparison of Years Ended December 31, 2014 and 2013

Revenue

Revenue for the year ended December 31, 2014 was $20,356,447 an increase of $904,643 or 5%, compared to $19,451,804 for the year ended December 31, 2013. The continued and expected market decline of landline based telecommunications caused our legacy landline business to decrease by $3,472,492 or 96%, to $153,759, as of December 31, 2014. This decrease in landline business was off-set by the increase in revenues from our mobile and security solutions business to $20,202,689 in 2014 which increased by $4,377,136 or 28%, compared to $15,825,553 in 2013. The increase in our mobile and security solutions business is mainly due to the migrations of customers onto our mobile platforms resulting in contractual billings to our customers increasing from $22,827,261 in 2013 to $28,560,240 in 2014. In 2014, total billings were $28,560,240 and $20,356,447 was recognized in revenue with the remainder deferred over the remaining contract period in accordance with ASC 605-25. In 2013, the total billings were $22,827,261 and $15,825,553 was recognized in revenue with the remainder deferred over the remaining contract period in accordance with ASC 605-25. For further details see Non-GAAP revenue discussion below.

Note 2 (Financial Condition) in this annual report discusses the likely termination of the contract with Iusacell. 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 include here the discussion of Non-GAAP revenue. 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 the investors due to the fact that most of these sales will need to be deferred over a period of 3-5 years. 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. The presentation of Non-GAAP revenue is not meant to be considered in isolation or as an alternative to GAAP revenue. 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 as changes in deferred revenue.

A reconciliation of GAAP Revenue to Non-GAAP Revenue, for each of the periods indicated, is as follows:

Total non-GAAP revenue increased by 32.8%. The phasing out of our landline activities caused our landline non-gaap revenue to be $3.5 million lower than that of the previous year. This was however more than off-set by the $10.6 million increase in the mobile and security solutions business. The vast majority of the revenue increase in our mobile and security solutions business was the result of the customer based SIM (Subscriber Identity Modules) migrations of our customer Iusacell in Mexico. The remainder of the mobile and security growth was only modest in 2014 due to the reduced revenues from non-recurring custom work projects with customers compared to 2013. Following the likely termination of the Iusacell contract and considering the size of Iusacell to our overall revenues, the termination of this contract will have a substantial impact on our revenues. We are currently evaluating the proposal of Iusacell, including assessing the impact on future revenues.

Historic quarterly overview Non-GAAP and GAAP revenue

Reclassification of cost and operating expenses

Following the transition from the Company’s Landline service to Mobile and Security solution offerings, the Company has evaluated in 2014 the structure of the two line items ‘Cost of service’ and ‘Selling, General and Administrative’. The line item SG&A included all of the Company’s staff related cost, including non-cash compensation.

Management concluded that the SG&A function should be categorized by functions of Product Development, Sales and Marketing and General and Administrative and that certain staff costs should be reclassified to Cost of Service. Management believes that these reclassifications of operating costs are material to the annual periods ended December 31, 2014, 2013 and 2012, and to the interim periods within fiscal year 2014, 2013 and 2012. Furthermore, management believes that these reclassifications reflect more accurately the nature and financial reporting of the Company. Consequently, staff costs for fiscal years 2014, 2013 and 2012 have been reallocated accordingly.

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 twelve month period ended December 31, 2014 $6,688,674, a decrease of $2,700,623 or 29%, compared to $9,389,297 for the twelve month period ended December 31, 2013.

Gross margin (excluding depreciation and amortization) as a percent of the total revenue was 67% and 52% for the twelve month periods ended December 31, 2014 and 2013, respectively. The decrease is primarily attributable to the decline in our legacy landline service solution, because the costs involved in the mobile and security business are lower compared to the landline business.

Re-allocation of the Selling, General and Administrative Expenses after the Reclassification

Following the transition from the Company’s Landline service to Mobile and Security solution offerings, the Company has evaluated in 2014 the structure of the two line items ‘Cost of service’ and ‘Selling, General and Administrative’, and reviewed all staff costs to determine which costs were directly attributable to the generation of revenue, and concluded that certain costs related to product development should be reclassified.

The line item SG&A included all of the Company’s staff related cost, including non-cash compensation. It was concluded that the SG&A should be categorized by functions of Product Development, Sales and Marketing and General and Administrative and that certain staff costs were to be reclassified to Cost of Service. It is felt that these reclassifications more accurately reflect the nature and financial reporting of the Company. Consequently, staff costs for fiscal years 2014, 2013 and 2012 have been allocated to these new functions and to Cost of Service.

The reclassification of operating costs is material to the annual periods ended December 31, 2012, 2013, the interim periods therein, and to the interim periods within fiscal year 2014.

These expenses have been reclassified in the Consolidated Statements of Operations for fiscal years 2013 and 2012 to conform to the current period presentation.

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 twelve month period ended December 31, 2014 and 2013, the Company capitalized $4,674,199 and $3,505,742, respectively.

Product Development costs for the twelve months ended December 31, 2014 and 2013 were $7,228,663 and $6,091,484, respectively, an increase of $1,137,179 or 19%. The increase is due to the expansion of our product development capabilities.

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 twelve months ended December 31, 2014 and 2013 were $2,393,676 and $3,139,015, respectively, a decrease of $745,339 or 24%. The decrease is due to a more focused marketing program approach.

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 twelve months ended December 31, 2014 and 2013 were $12,602,601 and $15,062,640, respectively, a decrease of $2,460,038 or 16%. The decrease is mainly due to share and option granting to management, in comparison to 2013.

Share-based compensation

Share-based compensation is comprised of:

For fiscal 2014 and 2013, we recognized share-based compensation expense of $3,888,275 and $8,515,391, respectively, a decrease of $4,627,116 or 54%. The decrease is mainly due to decreased or vesting of share and option to management, in comparison to 2013.

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

Depreciation and Amortization

Interest Income and Expense

Interest income for the twelve month periods ended December 31, 2014 and 2013 was $127,793 and $103,627, respectively. Interest income consists of interest received on bank balances.

Interest expense for the twelve month periods ended December 31, 2014 and 2013, was $1,240,590 and $1,064,999, respectively, an increase of $175,591 or 16%. Higher levels of interest expense were the result of the change of financing sources during 2014. Although we converted an existing note into shares during the month of July 2014 and also converted another existing note into equity for 50% of the principal, the new “Credit Facility’ which started November 17, 2014 has a higher principal value than the ones converted and/or repaid. Because the Credit Facility only started November 17, 2014 the three month period ended December 31, 2014 does not reflect a comparable future interest expense. See Notes 14 to 22 for more information. Also during fiscal 2014 we have been able to arrange capital lease financing which causes an increase of our interest expense compared to 2013.

Interest Expense Related to Debt Discount and Conversion Feature

For the twelve month periods ended December 31, 2014 and 2013, interest expenses related to debt discount and conversion feature were $3,935,839 and $2,069,649, respectively, an increase of $1,866,190 or 90%.

The increase in the twelve month periods ended December 31, 2014 and 2013 is due to the change of financing sources during 2014. We converted the affiliate note into equity by issuing additional warrants, which fair value was determined using Black Scholes, and amounted to $482,269. The conversion and early repayment of the non-affiliate note resulted in accelerated debt discount expensing and additional expensing of the exercise price adjustment.

Change in Fair Value of Conversion Feature

The change in the fair value of the conversion feature (related to the 8% Senior Secured Convertible Notes) for the twelve month periods ended December 31, 2014 and December 31, 2013 amounted to $0 and $232,267, respectively. The reason for the decrease is that the conversion feature was extinguished in June 2013 when the 8% Senior Secured Convertible Notes were repaid.

Change in Fair Value of Warrant Liabilities.

The change in the fair value of the remaining outstanding warrants (refer to Note 19) related to a registered direct public offering made by us in June 2013 was a loss of $(114,458) for the twelve months period ended December 31, 2014, compared to a gain of $479,322 for the same period in 2013.

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 $626,108 for the twelve months ended December 31, 2014, an increase of $2,631,208 or 131%, compared to the loss amounting to $2,005,100 for the twelve months ended December 31, 2013. A gain of $626,534 is a result of the management decision of discontinuing and liquidating the joint venture with the government incumbent telecom operator in Curacao, and the fact that the loan and accrued interest was forgiven (refer to Note 22). A minor loss was accounted for during 2014 for an amount of $426 relating to certain late legal fees for the finalization of extinguishment of debt which occurred in 2013.

Other Income and (Expense)

Other income & (expense) represents the change in fair value of the Euro denominated Convertible Notes due to revaluation and the tax accruals related to prior years.

In the twelve month period ended December 31, 2014, there is a gain of $176,981, an increase of $479,093 or 159%, compared to a loss of $(302,112) as of December 31, 2013. The increase is due to unrealized exchange rate losses and corporate tax adjustment of previous years.

Amortization of Deferred Financing Costs

Deferred financing cost relate to the 2013 10% Related Party Convertible Loan (see Note 14) and the 2013 10% 3^rd Party Convertible Notes (see Note 16), and the related amortization amounted to $(507,595) for the twelve months ended December 31, 2014, an increase of $258,744 or 104%, compared to $(248,851) for the twelve months ended December 31, 2013. The increase is due to the accelerated amortization on loans received in 2013 and repaid and or converted in 2014 and the 2014 deferred financing costs related to the Credit Facility received in November 2014.

Provision (Benefit) Income taxes.

Income tax provision for the twelve month periods ended December 31, 2014 was $216,931, compared to an income tax benefit of $200,301 for the same period in 2013. The change is due to the 2013 adjustment that resulted in a benefit.

Net Loss

Net loss for the twelve months period ended December 31, 2014, was $21,861,917, a decrease of $3,645,155 or 14%, compared to the loss of $25,507,072 for the same period in 2013. The decrease in net loss is primarily due to the decrease in the loss from operations. While revenues grew to $20,356,447 by $904,643 or 5%, in the twelve month period ended December 31, 2014, in comparison with the same period in 2013; cost of service and operating expenses decreased to $37,133,833 by $3,149,849 or 8% in the twelve month period ended December 31, 2014, in comparison with the same period in 2013.

Other Comprehensive (Loss) Income

We record foreign currency translation gains and losses as part of other comprehensive (loss) Income, which amounted to a loss as of December 31, 2014 of $3,397,001, compared to a gain of $1,001,959 for the year ended December 31, 2013, an increase of $4,398,960 or 439%. This change is primarily attributable to the translation effect resulting from the substantial fluctuations in the USD/Euro exchange rates in the reporting period, since our balance sheets position are largely denominated in Euro and are translated on balance sheet date.

Adjusted EBITDA (unaudited quarterly figures)

Comparison of Years Ended December 31, 2013 and 2012

This discussion has been updated to conform to the current period’s presentation, and reflect the effect of the restatement and cost reclassifications.

Revenue for the twelve month periods ended December 31, 2013 and 2012, was $19,451,804 and $29,202,188, a decrease of $9,750,384 or 33%. The continued and expected market decline of landline based telecommunications caused our legacy landline business to decrease, from $17,489,742 to $3,626,251, a decrease of $13,863,491 or 79%.

The decrease in landline business was off-set by the increase in revenues of our mobile and security solutions business in the twelve month periods ended December 31, 2013 and 2012, of $15,825,533 and $11,712,446, respectively, by $4,113,107 or 35%. The increase in our mobile and security solutions business is mainly due to the increasing revenues of new and existing customers.

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 expenses and the cost of subcontractors. Cost of service excludes depreciation and amortization.

Cost of service for the twelve month period ended December 31, 2013 and 2012 were $9,389,298 and $23,002,961, a decrease of $13,613,664 or 59%. This decrease is primarily attributable to the decline in our legacy landline service solution.

Gross margin (excluding depreciation and amortization) as a percent of the total revenue was 52% and 21% for the twelve month periods ended December 31, 2013 and 2012, respectively.

New composition of the function Selling, General and Administrative Expenses after the Reclassification

Following the transition from the Company’s Landline service to Mobile and Security solution offerings, the Company has evaluated in 2014 the structure of the two line items ‘Cost of service’ and ‘Selling, General and Administrative’, and reviewed all staff costs to determine which costs were directly attributable to the generation of revenue, and concluded that certain costs related to product development should be reclassified.

The line item SG&A included all of the Company’s staff related cost, including non-cash compensation. Management concluded that the SG&A should be categorized by functions of Product Development, Sales and Marketing and General and Administrative and that certain staff costs were to be reclassified to Cost of Service. It is felt that these reclassifications more accurately reflect the nature and financial reporting of the Company. Consequently, staff costs for fiscal years 2013 and 2012 have been allocated to these new functions and to Cost of Service.

The reclassification of operating costs is material to the annual periods ended December 31, 2012, 2013, the interim periods therein, and to the interim periods within fiscal year 2014.

These expenses have been reclassified in the Consolidated Statements of Operations for fiscal years 2013 and 2012 to conform to the current period presentation.

Product Development

Product Development costs consist primarily of salaries and related expenses, including share-based expenses, the costs of our test data center and the costs incurred in the development of the Company’s services which are expensed as incurred. Costs incurred during the application development stage of internal-use software projects, such as those used in the Company’s network 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.

Product Development costs for the twelve months ended December 31, 2013 and 2012 were $6,091,484 and $6,803,509, respectively, a decrease of $712,025 or 10%. The increase is due to the expansion of our product development capabilities.

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 twelve months ended December 31, 2013 and 2012 were $3,139,015 and $3,706,975, respectively, a decrease of $567,960 or 15%. The decrease is due to a more focused marketing program approach.

General and Administrative

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

General and Administrative expenses for the twelve months ended December 31, 2013 and 2012 were $15,062,640 and $11,492,160, respectively, an increase of $3,570,480 or 31%. The increase is mainly due to more non-cash share and option granting for management in 2013, in comparison to 2012.

Share-based compensation

Share-based compensation is comprised of:

For fiscal 2013 and 2012, we recognized share-based compensation expense of $8,515,391 and $6,302,141, respectively, an increase of $2,213,250 or 35%. The increase is because consultants were granted options in 2013 but not in 2012.

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

Depreciation and Amortization. Depreciation and amortization for the years ended December 31, 2013 and 2012, was $6,601,246 and $5,710,396 respectively. Depreciation and amortization expenses increased by $890,850 or 16% in 2013 compared to 2012. The increase was caused primarily by additions to property and equipment. In addition, we had an unfavorable impact of $192,004 arising from a higher USD/Euro exchange rate compared to the prior year.

For the year ended December 31, 2013 and 2012, interest income $103,627 and $248,017, respectively. Interest income consisted of interest received on bank balances.

Interest expense for the years ended December 31, 2013 and December 31, 2012 was $1,064,999 and $780,852, respectively. Interest expense increased by $284,147, or 36% in 2013 compared to 2012. Higher levels of interest expense in 2013 were the result of convertible notes issued in 2013 to an affiliate investor and an accredited investor. See Item 8, Note 14 and 15 to the Financial Statements for more information.

As of December 31, 2013 and 2012, interest expenses related to debt discount and conversion feature were $2,069,649 and $1,089,126, respectively. Interest expenses related to debt discount and conversion features increased by $980,523 or 90%. This increase was due to the convertible notes issued in 2013. See Notes 14 and 16 to the Financial Statements for more information.

Change in Fair Value in Conversion Feature. As of December 31, 2013, the fair value changes of the conversion feature of the convertible notes was a gain of $232,267, compared to a gain of $2,387,326 as of December 31, 2012. The change in fair value of the conversion feature decreased by 2,155,059 or 90%. The decrease is because the amount recognized as a gain was the remaining amount of the conversion feature related to the 8% Senior Secured Convertible Note issued on March 29, 2012, that was extinguished when the convertible note was repaid in June 2013. See Note 18 of the Financial Statements for more information.

Change in Fair Value of Warrant Liabilities. As of December 31, 2013, the change in the fair value of the remaining outstanding warrants related to a registered direct public offering by us on June 2013, which amounted to $479,322. The fair value of the remaining warrants was determined using a Monte-Carlo Simulation model.

Loss on Extinguishment of Debt. As of December 31, 2013, we entered into a Purchase Agreement pursuant to which we purchased certain Convertible Notes we issued on March 29, 2012, and this resulted in accelerated amortization expense of the original issue discount (OID), the conversion feature and the remaining financing costs of the Convertible Note. The loss on extinguishment of debt amounted to $1,960,594. Refer to Item 8, Note 18 of the Financial Statements. Additionally, on July 14, 2013, the Company entered into an amendment to terminate the Loan Agreement and cancel the Warrant we had with a member of the board of directors. In exchange for termination of the Loan Agreement, we entered into a Stock Purchase Agreement, dated July 15, 2013, pursuant to which the Company agreed to convert the Principal Amount of the loan into restricted shares of the Company’s Common Stock. Upon conversion and termination of the loan agreement, we accelerated the debt discount amortization, which resulted in an additional loss on extinguishment of debt of $44,506 in July 2013. Refer to Item 8, Note 17 of the Financial Statements. The total amount of loss on extinguishment of debt recognized as of December 31, 2013 amounted to $2,005,100.

Equity in Earnings of Unconsolidated Joint Venture. As of December 31, 2012, we incurred expenses of $501,776 as a result of the loss from our equity investment in the Modale B.V. joint venture. This expense follows a full impairment of the investment in this joint venture following the bankruptcy of Modale B.V. on January 30, 2013.

Impairment of Related Party Loans. As of December 31, 2013 and December 31, 2012, we had impaired loans with a value of $0 and $1,060,784, respectively. These loans were provided in 2012 to Elephant Security B.V., which filed for bankruptcy on December 19, 2012. Elephant Security B.V. was a related party since it was majority owned by QAT, one of our affiliates.

Provision for income taxes. Provision for income taxes for the years ended December 31, 2013 and December 31, 2012 was $200,301 and ($289,136), respectively. In the ordinary course of our business there are transactions where the ultimate income tax determination is uncertain. We believe that we have adequately provided for income tax issues not yet resolved with federal, state, local and foreign tax authorities. In the event that actual results differ from these estimates or we adjust these estimates in future periods, an additional expense would be recorded.

Net Loss. Net loss for the year ended December 31, 2013, net loss was $25,507,072, an increase of $2,375,136 or 10%, compared to $23,131,936 from the year ended December 31, 2012. The increase in loss was due to the decreased revenues from our landline business. General and Administrative expenses for the year ended December 31, 2013 increased by $3,570,480 or 31%, compared to $11,492,160 for the year ended December 31, 2012. Depreciation and amortization of intangibles assets for the year ended December 31, 2013 increased by $890,850 or 16%, from $5,710,396 for the year ended December 31, 2012. Other expenses for the year ended December 31, 2013 increased by $3,456,508 or 267%, compared to $1,328,987 for the year ended December 31, 2012. The reason for the increase was due to higher interest expense, higher interest expense related to debt discount and conversion feature, revaluation of euro based loans and the loss on extinguishment of debt.

Other Comprehensive (Loss). We record foreign currency translation gains and losses as other comprehensive income or loss, which amounted to gains of $1,001,959 and $411,205 for the years ended December 31, 2013 and December 31, 2012, respectively. This change is primarily attributable to the translation effect resulting from the substantial fluctuations in the USD/Euro exchange rates.

Liquidity and Capital Resources   

As reflected in the accompanying consolidated financial statements, the Company incurred net losses of $21,861,917 and $25,507,072 (as adjusted) for the twelve month periods ended December 31, 2014 and 2013, respectively, and had an accumulated deficit of $250,629,296 as of December 31, 2014.

On November 17, 2014 (the “Atalaya Closing Date”), the Company and certain of its subsidiaries entered into a term loan credit agreement with Atalaya Administrative LLC, as the administrative agent and collateral agent, and the lenders party thereto (the “Credit Agreement”). The Credit Agreement provides for a twelve million dollar term loan facility (the “Term Loan Facility”) with an advance of $10,000,000 made on Atalaya Closing Date. The Term Loan Facility will mature on December 31, 2017. An amount of $3,114,066 (€2,498,849) of these proceeds has been used to repay the then outstanding principal and accrued interest of the 10% 3rd Party Convertible Note as existent in November 2014. The remaining $2,000,000 of the loan was held back subject to the Company fulfilling post-closing obligations. In January 2015 the Company fulfilled the post-closing conditions and received the remaining $2,000,000.

In 2014 the Company improved its cash generating activities compared with the year before. However, due to the very strong buildup of accounts receivable in the fourth quarter, there was a net cash used for operating activities of $ 2.1 million in 2014.

The primary cause of the accounts receivable increases are the result of Group Iusacell, S.A.’s (“Iusacell”) deferring the payment for services performed during the fourth quarter 2014. The outstanding receivables of Iusacell constituted 72% of total accounts receivable at December 31,2014. 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. During the three months ended December 31, 2014, if Iusacell would have paid the agreed amounts for fourth quarter 2014 we would have received cash payments of around $1 million per month. Once termination and settlement payments have been consummated the impact compared to the three months ended December 31, 2014 non-gaap revenues would have been approximately $1 million per month. We expect reaching a settlement agreement with AT&T/Iusacell in the near future.

However, 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 conduct 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.

Operating activities

Net cash used in operating activities, for the twelve month period ending December 31, 2014 versus the prior year, was reduced from $(5,967,686) to $(2,102,935), which is a decrease of $3,864,751 or 65%. The decrease in cash used is mainly caused by the strong increase in revenues from the mobile and security solutions. Net cash used for operating activities in 2012 was $8,799,272.

Net cash used in operating activities for the year ended December 31, 2014 was negatively affected by increased accounts receivable and also due to having reduced the accounts payable debt that was built-up in earlier periods. These effects, combined with other working capital changes, resulted in cash used by changes in operating assets and liabilities of $3,878,275 for 2014.

Investing activities

Net cash used in investing activities for year ended December 31, 2014 was $7,987,925 an increase of $1,926,214 or 32%, compared to $6,061,711 in 2013. The higher net cash used in investing activities in 2014, in comparison with 2013 and 2012, was primarily attributable to a higher level of equipment and software purchase in 2014 compared to 2013.

Financing activities

Net cash received by financing activities for the year ended December 31, 2014 was $10,775,048, compared to $12,280,154 and $7,481,061 for the year ended December 31, 2013 and December 31, 2012, respectively. See Notes 15 to 22 of the Financial Statements for more information.

As a result of the above activities, we had a cash and cash equivalents balance of $1,904,160 as of December 31, 2014, a net increase in cash and cash equivalents of $651,845 since December 31, 2013.

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.

Contractual obligations

The following table summarizes the payments due by fiscal year for our outstanding commercial obligations as of December 31, 2014.

Application of Critical Accounting Policies and Estimates

Revenue Recognition and Deferred Revenue

Revenue represents amounts earned for (non-software) arrangements consisting of hosting subscriptions for mobile and security solutions. We also offer customer support and professional services related to implementing and supporting our suite of applications. Revenues generally are recognized net of any taxes collected from customers and subsequently remitted to governmental authorities.

Hosting subscriptions provide customers access to our software on a subscription basis, and support services (e.g. Network operating costs and second line helpdesk) related to those arrangements. Hosting subscriptions are recognized ratably over the contract term commencing with the date our service is made available to customers and when all of the following conditions have been met: (i) there is persuasive evidence of an arrangement; (ii) delivery has occurred; (iii) the fee is fixed or determinable; and (iv) collectability of the fee is reasonably assured.  Revenue is recorded as deferred revenue before all of the relevant criteria for revenue recognition are satisfied.

Beginning in 2013, when our business was transitions form the landline business to the mobile and security solutions business, the Company entered multiple element arrangements which are accounted in accordance with ASC 605-25 “Revenue Recognition-Multiple Element Arrangements”.

The elements in a multiple element arrangement are identified and are separated into separate units of accounting when both of the following criteria are met: The delivered item or items have value to the customer on a stand-alone basis, meaning the delivered item or items have value on a standalone basis if it sold separately by any vendor or the customer could resell the delivered item or items on a stand-alone basis. And if the arrangement includes a general right of return related to the delivered item, delivery or performance of the undelivered item or items are considered probably and substantially in the control of the Company. Total consideration of a multiple-element arrangement is then allocated using the relative selling price method using the hierarchy prescribed in ASC 605-25. In accordance with that hierarchy if fair value of the vendor specific objective evidence (VSOE) or, third-party evidence (TPE) does not exist for the element, then the best estimated selling price (BESP) is used.

Since the Company does not have neither VSOE nor TPE the Company determines BESP for all deliverables in their hosting arrangements. In determining the BESP, the Company considers multiple factors which include, and are not limited to, the following: i) gross margin objectives and internal costs for services; ii) pricing practices, market conditions, iii) competitive landscape and iv) growth strategy .

Accordingly, management’s judgment is applied regarding, among other aspects, conformance with acceptance criteria and if delivery of services has occurred and the degree of completion.

In the paragraphs below we explain the revenue recognition policy for each element.

For the mobile solutions services the Company recognizes revenues from customers accessing our cloud-based application suite in two different service offerings, namely managed services and bundled services.

For managed services, revenues are recognized for network administration services provided to end users on behalf of Mobile Network Operators (MNO) and virtual Mobile Network Operators (MVNO’s). Managed service revenues are recognized monthly based on an average number of end-users managed and calculated on a pre-determined service fee per user. For bundled services, the Company provides both network administration as well as mobile airtime management services. Revenues for bundled services are recognized monthly based on an average number of end-users managed and mobile air time and calculated based on a pre-determined service fee. Technical services that meet the criteria to be separated as a separate unit of accounting are recognized as the services are performed. Otherwise they are deferred and recognized over the contract term.. Our arrangements with customers do not provide the customer with the right to take possession of the software supporting the cloud-based application service at any time.

For the security solutions we recognize revenues primarily from SIM (Subscriber Identity Module) lookup services using the VALid-SSD platform. Security solutions revenue is recognized based on the number of SIM lookups performed and calculated based on a pre-determined service fee per lookup. Other revenues recognized in the security business include consulting services which are recognized as the services are performed.

Telecommunication revenues were recognized when delivery occurred based on a pre-determined rate and number of user minutes and number of calls that the Company has managed in a given month.

Professional services and other revenue include fees from consultation services to support the business process mapping, configuration, data migration, integration and training. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Revenue for professional and consulting services in connection with an implementation or implantation of a new customer that is deemed not to have stand-alone value is recognized over the contractual period commencing when the subscription service is made available to the customer. Revenue from other professional services that provide added value such as new features or enhancements to the platform, are deferred and begin revenue recognition when the feature is activated over the longer of the estimated customer life or contract term

Our consideration of whether our hosted solutions and the associated professional services/consulting or other services are to be accounted separately or as one combined element of the arrangement includes the following:

Cost of service and Operating Expenses

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 expenses and the cost of subcontractors. Cost of service excludes depreciation and amortization.

Prior to December 31, 2012, all staff costs were included in the line item “Selling, General and Administrative” (SG&A). Management analyzed in fiscal 2014 the structure and composition of staff costs (cash and non-cash) and operating costs in general, in order to identify all costs which could be considered directly attributable to the generation of revenue, following the transition process from the Landline business to the Mobile and Security Services business that started in 2012 and completed in 2014. Management concluded that certain staff costs should be reclassified to Cost of Service. Furthermore, the SG&A cost was reclassified by functions: Product Development, Sales and Marketing and General and Administrative. Staff costs for fiscal years 2014, 2013 and 2012 have been reallocated accordingly to conform to the current period presentation.

The reclassification of operating costs is not material to the annual periods ended December 31, 2012, 2013, the interim periods therein, or to the interim periods within fiscal year 2014. Therefore the Company believes that it is not necessary to amend prior filings since such reclassification has no impact on the reported Loss from Operations or Net Loss for any of the periods ended December 31, 2012, 2013, and the interim periods therein.

Share-based Compensation

Effective January 1, 2006, we adopted the provisions of ASC 718 “Compensation-Stock Compensation”, using the prospective approach. As a result, we recognize share-based compensation expense for only those awards that are granted subsequent to December 31, 2005 and any previously existing awards that are subject to variable accounting, including certain share options that were exercised with convertible notes in 2003, until the awards are exercised, forfeited, or contractually expire in accordance with the prospective method and the transition rules of ASC 718. Under ASC 718, share-based awards granted after December 31, 2005, are recorded at fair value as of the grant date and recognized as expense over the employee’s requisite service period (the vesting period, generally three years), which we have elected to amortize on a straight-line basis.

For both the long term contractors and advisory board members, we recognize the guidance for share-based compensation awards to non-employees in accordance with ASC 505-50 “Equity-Based Payments to Non-Employees” ("ASC 505-50"). Under ASC 505-50, we determine the fair value of the options or share-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

Share-based compensation (cash and non-cash) related to equity plans for employees and non-employee directors is included within our cost of revenues and operating expenses.

Business Combinations

We generally recognize the identifiable assets acquired, the liabilities assumed, and any non-controlling interests in an acquiree at their fair values as of the date of acquisition, under the purchase method of accounting. We measure goodwill as the excess of consideration transferred, which we also measure at fair value, over the net of the acquisition date fair values of the identifiable assets acquired and liabilities assumed. The acquisition method of accounting requires us to exercise judgment and make significant estimates and assumptions regarding the fair values of the elements of a business combination as of the date of acquisition, including the fair values of identifiable intangible assets, deferred tax asset valuation allowances, liabilities related to uncertain tax positions, and contingencies. This method also requires us to refine these estimates over a one-year measurement period to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. If we are required to retroactively adjust provisional amounts that we have recorded for the fair value of assets and liabilities in connection with acquisitions, these adjustments could materially decrease our operating income and net income and result in lower asset values on our balance sheet.

Significant estimates and assumptions that we must make in estimating the fair value of acquired technology, customer lists, and other identifiable intangible assets include future cash flows that we expect to generate from the acquired assets. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could record impairment charges. In addition, we have estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expenses could be accelerated or slowed.

Intangible Assets and Impairment of long Lived Assets

In accordance with ASC 350, intangible assets are carried at cost less accumulated amortization and impairment charges. Intangible assets are amortized on a straight-line basis over the expected useful lives of the assets, between three and ten years. Other intangible assets are reviewed for impairment in accordance with ASC 350, on an annual basis, or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Measurement of any impairment loss for long-lived assets and identifiable intangible assets that management expects to hold and use is based on the amount of the carrying value that exceeds the fair value of the asset. This is a critical accounting policy because of the judgement and estimates involved.

Impact of Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in US auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). For all entities, the new requirements are effective for annual periods ending after December 15, 2016. Early application is permitted. Management does not expect that the adoption of this standard will have a material effect on the Company´s financial statements.

In May 2014, as part of its ongoing efforts to assist in the convergence of US GAAP and International Financial Reporting Standards, the FASB issued a new standard related to revenue recognition. Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard will be effective for the Company beginning January 1, 2017 and early adoption is not permitted. Management is currently evaluating the methods of adoption allowed and the effect the standard is expected to have on the Company´s financial statements and related disclosures.

In April 2014, the FASB issued ASU-2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”, which amends the definition of a discontinued operation in Accounting Standards Codification Topic 205-20 (Presentation of Financial Statements – Discontinued Operations) and requires entities to disclose additional information about disposal transactions that do not meet the discontinued operations criteria. The ASU redefines a discontinued operation as a component or group of components of an entity that (1) has been disposed of by sale or other than by sale or classified as held for sale and (2) represents a strategic shift that has (or will have) a major effect on an entity’s operations and results includes the disposal of a major geographic area, a major line of business, a major equity investment, or other major parts of an entity. The ASU is effective prospectively for disposals of components classified as held for sale in periods on or after December 15, 2014. The adoption of this standard did not have a material effect on the Company´s financial statements.

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 measure. Adjusted EBITDA is defined as earnings before 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:

* in prior years the company did not include deferred revenue in its reconciliation table of adjusted ebitda since the deferred revenue constituted only a minor component in the Company’s revenues. Following the changed revenue recognition policies to multiple element accounting, the deferred revenue has become a large factor which we feel should be an adjusting item to the table.

* Previous adjusted EBITDA definition did not include ‘changes in deferred revenue’  

Item 7A.  Quantitative and Qualitative Disclosures about Market Risk

We do not believe that we currently have material exposure to interest rate or foreign currency transaction risks except with respect to our long term debt obligations since our financial assets instruments consist primarily of operating assets and liabilities and the Company does no use hedging instruments.

Interest rate and market risk. Our $ 12 million debt, the 3 year credit agreement dated November 17, 2014, bears a fixed interest rate, and therefore would not be subject to interest rate risk. However, since the majority of our business is denominated in the EURO currency the debt is exposed to market risk for changes in exchange rates. For the quantitative disclosure we have chosen the sensitivity alternative. A hypothetical 10% increase (decrease) in the value of the US$ against the euro in a reporting period would result in an unrealized loss (gain) of $ 1.2 million for that period. We expect to reduce our exposure through future settlements in accordance with the agreed amortization schedule of the debt. At each balance sheet date or upon settlement the Company remeasures the $ 12 million debt and reports the foreign currency realized and unrealized gain or loss in other income and expense.

Foreign Currency Transaction Risk. Fluctuations in the rate of exchange between the U.S. dollar and the Euro or the British Pound Sterling, the three primary currencies in which we operate may affect our results of operations and the period-to-period comparisons of our operating results. Foreign currency transaction gains and losses are caused by transactions denominated in a currency other than the functional currency and must be remeasured at each balance sheet date or upon settlement. Foreign currency transaction realized and unrealized gains and losses was a gain of $ 251,969 that was included in determining net income.

The company currently does not use currency hedging instruments.

Item 8.  Financial Statements and Supplementary Data

ELEPHANT TALK COMMUNICATIONS CORP.

AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Elephant Talk Communications Corp.

We have audited the accompanying consolidated balance sheet of Elephant Talk Communications Corp. (the “Company”) as of December 31, 2014, and the related consolidated statements of comprehensive loss, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Elephant Talk Communications Corp. as of December 31, 2014, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has accumulated deficit of $251 million and continues to generate negative operating cash flows. In addition, as more fully discussed in Note 34, the Company was notified by its lender effective March 18, 2015 that settlement discussions related to the pending termination of its contract with Iusacell constitute an event of default under the Credit Agreement. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters also are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Elephant Talk Communications Corp.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Our report dated April 1, 2015 expressed an opinion that Elephant Talk Communications Corp. had not maintained effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013).

/s/ Squar, Milner, Peterson, Miranda & Williamson, LLP

Los Angeles, California

April 1, 2015

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Elephant Talk Communications Corp.

We have audited Elephant Talk Communications Corp.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013). Elephant Talk Communications Corp.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in Item 9A, Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management has identified a material weakness in internal controls over financial reporting relating to accounting for multiple-element revenue arrangements. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2014 financial statements, and this report does not affect our report dated April 1, 2015 on those financial statements.

In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Elephant Talk Communications Corp.has not maintained effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013).

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Elephant Talk Communications Corp. as of December 31, 2014, and the related consolidated statements of comprehensive loss, stockholders’ equity, and cash flows for the year then ended and our report dated April 1, 2015 expressed an unqualified opinion.

SQUAR, MILNER, PETERSON, MIRANDA & WILLIAMSON, LLP

/s/ Squar, Milner, Peterson, Miranda & Williamson, LLP

Los Angeles, California

April 1, 2015

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Elephant Talk Communications Corp.

We have audited the accompanying consolidated balance sheet of Elephant Talk Communications Corp. (“Company”) as of December 31, 2013 (restated) and the related consolidated statements of comprehensive loss, stockholders’ equity, and cash flows for the year ended December 31, 2013 (restated) and the year ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Elephant Talk Communications Corp. at December 31, 2013 (restated), and the results of its operations and its cash flows for the year ended December 31, 2013 (restated) and the year ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 35 to the consolidated financial statements, the 2013 financial statements have been restated to correct a misstatement in the area of revenue recognition and reclassifications of financial statement line items.

The accompanying consolidated financial statements as of and for the year ended December 31, 2013 were prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements as of and for the year ended December 31, 2013, the Company had suffered recurring losses from operations, had an accumulated deficit as of December 31, 2013 of $225.4 million and continued to generate negative cash flows. These factors, among others discussed in Note 2 to the consolidated financial statements as of and for the year ended December 31, 2013 raised substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters were also described in Note 2 to the consolidated financial statements as of and for the year ended December 31, 2013.

The consolidated financial statements do not include any adjustments that might result from this uncertainty.

/s/ BDO USA, LLP

Los Angeles, California

March 31, 2014, except for Note 35 which is as of April 1, 2015

ELEPHANT TALK COMMUNICATION CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS AT DECEMBER 31, 2014 AND 2013

The accompanying notes are an integral part of these consolidated financial statements

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012

The accompanying notes are an integral part of these consolidated financial statements.

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012

The accompanying notes are an integral part of these consolidated financial statements.

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012