10-Q 1 v417003_10q.htm 10-Q

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2015

 

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

 

For the transition period from ______ to ______

 

000-30061

(Commission file No.)

 

ELEPHANT TALK COMMUNICATIONS CORP.

(Exact name of registrant as specified in its charter)

 

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

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

 

 

 

 

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

June 30, 2015

 

PART I - FINANCIAL INFORMATION 3
   
Item 1. Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets as of June 30, 2015 (unaudited) and December 31, 2014 3
Condensed Consolidated Statements of Comprehensive Income / (Loss) for the three and six month periods ended June 30, 2015 and 2014 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 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 29
Item 4. Controls and Procedures 29
   
PART II -  OTHER INFORMATION 30
   
Item 1. Legal Proceedings 30
Item 1A. Risk Factors 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
Item 3. Default upon Senior Securities 30
Item 4. Mine Safety Disclosure 30
Item 5. Other Information 30
Item 6. Exhibits 30
   
SIGNATURES 31

 

 2 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

 

ELEPHANT TALK COMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   June 30,   December 31, 
   2015   2014 
   (unaudited)    
ASSETS          
           
CURRENT ASSETS          
           
Cash and cash equivalents  $1,232,525   $1,904,160 
Financing receivable   -    2,000,000 
Restricted cash   304,676    312,935 
Accounts receivable   3,720,881    8,877,213 
Prepaid expenses and other current assets   1,549,827    2,478,681 
Total current assets   6,807,909    15,572,989 
           
NON-CURRENT ASSETS          
           
OTHER ASSETS   1,105,224    1,600,335 
           
PROPERTY AND EQUIPMENT, NET   17,528,492    19,319,202 
           
INTANGIBLE ASSETS, NET   3,756,889    5,076,208 
           
GOODWILL   3,076,526    3,352,264 
           
TOTAL ASSETS  $32,275,040   $44,920,998 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
CURRENT LIABILITIES          
Overdraft  $-   $433,366 
Accounts payable and customer deposits   3,783,252    1,856,014 
Obligations under capital leases (current portion)   706,385    1,831,050 
Deferred Revenue   2,649,051    8,813,385 
Accrued expenses and other payables   3,022,436    4,061,652 
Loans payable   -    962,269 
2014 10% + libor 3rd Party Loan (net of Debt Discount of $332,304 at June 30, 2015 and $798,894 at December 31, 2014)   -    11,201,106 
Total current liabilities   10,161,124    29,158,842 
           
LONG TERM LIABILITIES          
2014 10% + libor 3rd Party Loan (net of Debt Discount of $332,304 at June 30, 2015 and $798,894 at December 31, 2014)   1,740,365    - 
Warrant liabilities   -    2,087,992 
Non-current portion of obligation under capital leases   95,532    272,460 
Other long term loan   294,632    354,880 
Non-current portion of deferred revenue   541,577    2,434,257 
Total long term liabilities   2,672,106    5,149,589 
           
Total liabilities   12,833,230    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,  159,194,181  issued and outstanding  as of June 30, 2015 and 154,671,258 shares issued and outstanding as of December 31, 2014   266,995,681    264,359,674 
Accumulated other comprehensive income (loss)   (4,330,752)   (3,127,132)
Accumulated deficit   (243,232,551)   (250,629,296)
Elephant Talk Communications, Corp. stockholders' equity   19,432,378    10,603,246 
           
NON-CONTROLLING INTEREST   9,432    9,321 
Total stockholders' equity   19,441,810    10,612,567 
           
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $32,275,040   $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 INCOME (LOSS)

(UNAUDITED)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2015   2014   2015   2014 
       restated       restated 
REVENUES  $19,244,383   $5,072,440   $24,257,399   $10,456,705 
                     
COST AND OPERATING EXPENSES                    
Cost of service (excluding depreciation and amortization)   1,440,914    1,848,687    3,309,760    3,484,659 
Product development   1,490,683    2,280,532    2,526,804    3,992,349 
Sales and marketing   336,960    664,807    999,120    1,228,642 
General and administrative   2,664,281    3,467,338    5,625,377    6,515,286 
Depreciation and amortization of intangibles assets   1,745,034    1,928,392    3,491,181    3,936,606 
Impairment for assets held and used   937,835    -    937,835    - 
Total cost and operating expenses   8,615,707    10,189,756    16,890,077    19,157,542 
                     
INCOME / (LOSS) FROM OPERATIONS   10,628,676    (5,117,316)   7,367,322    (8,700,837)
                     
OTHER INCOME (EXPENSE)                    
Interest income   22,587    29,545    52,859    57,156 
Interest expense   (555,826)   (333,214)   (923,166)   (635,158)
Interest expense  related to debt discount and conversion feature   (403,679)   (1,025,292)   (467,651)   (1,910,032)
Changes in fair value of warrant liabilities   149,203    38,948    395,905    (171,324)
Gain / (Loss) on Extinguishment of Debt   -    -    2,475,799    (426)
Other income & (expense), net   155,252    68,008    (1,036,018)   71,398 
Amortization of deferred financing costs   (362,845)   (113,090)   (425,347)   (249,457)
Total other income (expense)   (995,308)   (1,335,095)   72,381    (2,837,843)
                     
INCOME / (LOSS) BEFORE (BENEFIT) PROVISION FOR INCOME TAXES   9,633,368    (6,452,411)   7,439,703    (11,538,680)
(Benefit) / provision for income taxes   111,450    (2,209)   42,958    133,228 
NET INCOME / (LOSS)   9,521,918    (6,450,202)   7,396,745    (11,671,908)
                     
OTHER COMPREHENSIVE INCOME / (LOSS) INCOME                    
Foreign currency translation gain (loss)   508,818    (148,233)   (1,203,620)   (150,452)
COMPREHENSIVE INCOME / (LOSS)  $10,030,736   $(6,598,435)  $6,193,125   $(11,822,360)
                     
Net income / (loss) per common share and equivalents - basic  $

0.06

   $

(0.04

)  $

0.05

   $(0.08)
                     
Net income / (loss) per common share and equivalents - diluted  $0.06   $(0.04)  $

0.05

   $(0.08)
                     
Weighted average shares outstanding during the period - basic   156,384,740    146,482,547    155,623,883    144,130,543 
                     

Weighted average shares outstanding during the period - diluted

   

157,936,092

    

146,482,547

    

157,175,235

    

144,130,543

 

 

 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)

 

   Six Months Ended June 30, 
   2015   2014 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net Income / (loss)  $7,396,745   $(11,671,908)
Adjustments to reconcile net income / (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   3,491,181    3,936,606 
Provision for doubtful accounts   25,414    18,865 
Stock based compensation   1,584,323    2,674,261 
Change in fair value of warrant liability   (395,905)   171,324 
Amortization of deferred financing costs   425,347    249,457 
Interest expense relating to debt discount and conversion feature   467,651    1,910,032 
Unrealized foreign currency translation gain (loss)   1,036,018    (71,398)
(Gain) / Loss on Extinguishment of Debt   (2,475,799)   

426

 
Impairment for assets held and  used   937,835    - 
Changes in operating assets and liabilities:          
Decrease (increase) in accounts receivable   4,305,466    

(1,914,324

)
Decrease (increase)  in prepaid expenses, deposits and other assets   1,100,067    (346,129)
Increase (decrease) in accounts payable and customer deposits   2,027,904    210,932 
Increase (decrease) in deferred revenue   (8,889,549)   

2,537,091

 
Increase (decrease) in accrued expenses and other payables   (740,868)   

1,909,830

 
Net cash provided by (used in) operating activities   10,295,830    (384,935)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchases of property and equipment   (4,113,308)   (3,922,724)
Net cash used in investing activities   (4,113,308)   (3,922,724)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Financing related fees   (67,445)   (90,000)
Exercise of warrants & options   5,861    4,283,033 
Financing receivable   2,000,000    - 
Principal payment on 2014 10% + libor 3rd Party Loan   (9,927,333)   - 

Net cash (used in) provided by financing activities

   (7,988,917)   4,193,033 
           
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS   1,134,760    (308,301)
NET (DECREASE) IN CASH AND CASH EQUIVALENTS   (671,635)   (422,927)
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD   1,904,160    1,252,315 
CASH AND CASH EQUIVALENTS, END OF THE PERIOD  $1,232,525   $829,388 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
           
Cash paid during the period for interest  $866,432   $123,644 
Cash paid during the period for income taxes   14,481    56,881 

 

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

 

 5 

 

 

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1. Financial Condition

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

Description of Business

 

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

 

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

 

Basis of Presentation of Interim Periods

 

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

 

 6 

 

 

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

 

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

 

Use of Estimates

 

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

 

Basic and diluted earnings per share

 

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

   

Note 3. Supplemental Financial Information

 

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

 

Prepaid expenses and other current assets  June 30,   December 31, 
   2015   2014 
   (unaudited)     
Recurring prepaid expenses  $290,159   $455,529 
Non recurring prepaid expenses   293,233    731,725 
Taxes   328,708    359,087 
VAT   630,621    742,773 
Inventory SIM cards   7,106    189,567 
   $1,549,827   $2,478,681 

  

Other Assets  June 30,   December 31, 
   2015   2014 
   (unaudited)     
Long term deposits  $487,442   $653,002 
Deferred Financing Costs   347,586    682,878 
Due from third parties   270,196    264,455 
   $1,105,224   $1,600,335 

  

Property and equipment  June 30,   December 31, 
   2015   2014 
   (unaudited)     
Furniture & fixtures  $301,441   $281,214 
Computer, communications and network equipment   24,142,700    23,904,494 
Software   5,941,981    4,556,364 
Automobiles   73,809    80,860 
Construction in progress   1,886,575    4,044,932 
Acc. Depreciation Property & Equipment   (14,818,014)   (13,548,662)
   $17,528,492   $19,319,202 

  

 7 

 

 

Intangible assets  June 30,   December 31, 
   2015   2014 
Validsoft IP & Technology  $13,181,868   $14,344,604 
Customer Contracts, Licenses , Interconnect & Technology   1,807,074    1,870,523 
Accumulated amortization Validsoft IP & Technology   (9,966,097)   (9,973,063)
Accumulated amortization Customer Contracts, Licenses, Interconnect & Technology   (1,265,956)   (1,165,856)
   $3,756,889   $5,076,208 
           

  

Goodwill  June 30,   December 31, 
   2015   2014 
Goodwill ValidSoft Ltd  $2,705,903   $2,964,423 
Goodwill Morodo Ltd.   180,222    197,440 
Goodwill Telnicity   190,401    190,401 
   $3,076,526   $3,352,264 

  

Accrued expenses and other payables  June 30,   December 31, 
   2015   2014 
Accrued Selling, General & Administrative expenses  $2,049,441   $1,863,020 
Accrued cost of service   265,965    291,553 
Accrued taxes (including VAT)   563,721    570,616 
Accrued interest payable   43,052    1,184,418 
Other accrued expenses   100,257    152,045 
   $3,022,436   $4,061,652 

  

2014 10% + libor 3rd Party Term Loan Agreement  June 30,   December 31, 
   2015   2014 
2014 10% Term Loan (principal amount)  $2,072,669   $12,000,000 
Debt Discount - Original Issue Discount   (165,286)   (365,231)
Debt Discount – Warrants   (167,018)   (433,663)
   $1,740,365   $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 dated 17, November 2014 had occurred and that for so long as an event of default be continuing, interest should accrue and be payable by the Company in cash at the default rate as defined in the Credit Agreement.  Atalaya Capital Management LP indicated in the notification that they would continue to monitor the default situation and reserve all their respective rights and remedies under the Credit Agreement. In anticipation of an amendment of the original Credit Agreement combined with the receipt of the Iusacell settlement payment, the Company transferred $10,100,000 on June 22, 2015 to the lenders pending the closing of an amendment of the credit agreement, which amendment was executed on July 9, 2015. See also Note 11 subsequent events.

 

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

  

Note 4. Fair Value Measurements

 

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

 

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

 

 8 

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

   

June 30, 2015

(Unaudited)

 
    Level 1     Level 2     Level 3     Total  
Derivative Liabilities                                
Warrant Liabilities   $ -     $ -     $ -     $ -  
Total Derivatives Liabilities   $ -     $ -     $ -     $ -  

 

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

 

 9 

 

 

Note 5. Stockholders’ Equity

 

(A) Common Stock

 

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

 

(B) Preferred Stock

 

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

 

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

 

(C) Warrants

 

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

 

Outstanding
Warrants
  Exercise/
Conversion
price(s)
 (range)
  Expiring   2015     2014  
                     
Warrants – Fundraising   $0.700- $1.50   2015 – 2018     25,320,386       29,610,206  
Warrants – Other   $2.21   2016     18,659       18,659  
              25,339,045       29,628,865  

 

 10 

 

 

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   484,517 
Options exercised   2,382,110 
Outstanding options   42,136,739 
Available for grant at June 30, 2015 (unaudited):   9,045,603 

 

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

 

Stock option activity is set forth below:

 

Options:  Number of Options   Weighted Average Exercise Price 
Outstanding as of December 31, 2014   40,056,080   $1.32 
Granted in 2015   11,014,402   $0.70 
Exercised (with delivery of shares)   (8,668)  $0.68 
Forfeitures (Pre-vesting)   (6,481,215)  $1.09 
Expirations (Post-vesting)   (2,443,860)  $1.74 
Outstanding as of June 30, 2015 (unaudited)   42,136,739   $1.28 

 

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

 

Note 7.  Income taxes

 

Income Taxes

 

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

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
(Benefit) Provision for income taxes  $111,450   $(2,209)  $42,958   $133,228 

  

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.

 

 11 

 

 

Note 8. Significant Customer and Geographical Information

 

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

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
Two largest customers   87.4%   77.4%   83.3%   77.4%

 

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

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
Europe   16.6%   65.4%   26.3%   65.5%
All other (non-European) countries   83.4%   34.6%   73.7%   34.5%
    100.0%   100.0%   100.0%   100.0%

 

Note 9. Per Common Share Information

 

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

 

Note 10. Restatement

 

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

 

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

 

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

 

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

 

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

 

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

 

 12 

 

 

   June 30,       June 30, 
   2014       2014 
   (unaudited)   restatement   Restated 
       Unaudited   Unaudited 
ASSETS               
                
CURRENT ASSETS               
                
Cash and cash equivalents  $829,388   $-   $829,388 
Restricted cash   191,703    -    191,703 
Accounts receivable, net of allowance for doubtful accounts of $29,547 at June 30, 2014   8,223,963    (1,299,207)   6,924,756 
Prepaid expenses and other current assets   2,619,882    -    2,619,882 
Total current assets   11,864,936    (1,299,207)   10,565,729 
                
NON-CURRENT ASSETS               
                
OTHER ASSETS   1,288,246    -    1,288,246 
                
PROPERTY AND EQUIPMENT, NET   20,711,832    -    20,711,832 
                
INTANGIBLE ASSETS, NET   7,122,940    -    7,122,940 
                
GOODWILL   3,740,646    -    3,740,646 
                
TOTAL ASSETS  $44,728,600   $(1,299,207)  $43,429,393 
                
LIABILITIES AND STOCKHOLDERS' EQUITY               
                
CURRENT LIABILITIES               
Overdraft  $413,958   $-   $413,958 
Accounts payable and customer deposits   2,305,933    -    2,305,933 
Obligations under capital leases (current portion)   1,898,346    -    1,898,346 
Deferred revenue   163,848    468,256    632,104 
Accrued expenses and other payables   6,592,945    -    6,592,945 
Loans payable   963,051    -    963,051 
10% Related Party Loan   -    -    - 
Total current liabilities   12,338,081    468,256    12,806,337 
                
LONG TERM LIABILITIES               
10% 3rd Party Loan (net of Debt Discount of $518,463 at June 30, 2014 and $726,695 at December 31, 2013)   4,940,798    -    4,940,798 
10% Related Party Loan (net of Debt Discount of $17,786 at June 30, 2014)   2,711,844    -    2,711,844 
Warrant liabilities   2,144,858    -    2,144,858 
Non-current portion of obligation under capital leases   487,728    -    487,728 
Non-current portion of deferred revenue        4,542,910    4,542,910 
Loan from joint venture partner   626,534    -    626,534 
Total long term liabilities   10,911,762    4,542,910    15,454,672 
                
Total liabilities   23,249,843    5,011,166    28,261,009 
                
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   255,328,306    -    255,328,306 
Accumulated other comprehensive income   121,636    -    121,636 
Accumulated deficit   (234,115,159)   (6,310,373)   (240,425,532)
Elephant Talk Communications, Corp. stockholders' equity   21,334,783    (6,310,373)   15,024,410 
                
NON-CONTROLLING INTEREST   143,974    -    143,974 
Total stockholders' equity   21,478,757    (6,310,373)   15,168,384 
                
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $44,728,600   $(1,299,207)  $43,429,393 

 

 13 

 

 

Three months period ended June 30, 2014      Restatement
adjustments
   Re-classifications   Restated 
   (unaudited)   (unaudited)   (unaudited)   (unaudited) 
REVENUES  $6,911,768   $(1,839,328)  $-   $5,072,440 
                     
COST AND OPERATING EXPENSES                    
Cost of service (excluding depreciation and amortization)   828,581    -    1,020,107    1,848,687 
Product development   -    -    2,280,532    2,280,532 
Sales and marketing   -    -    664,807    664,807 
General and administrative   7,432,784    -    (3,965,446)   3,467,338 
Depreciation and amortization   1,928,392    -    -    1,928,392 
Total cost and operating expenses   10,189,757    -    -    10,189,757 
                     
LOSS FROM OPERATIONS   (3,277,989)   (1,839,328)   -    (5,117,316)
                     
OTHER INCOME (EXPENSE)                    
Interest income   29,545    -    -    29,545 
Interest expense   (333,214)   -    -    (333,214)
Interest expense related to Debt Discount and Conversion Feature   (1,025,292)   -    -    (1,025,292)
Change in fair value of warrant liabilities   38,948    -    -    38,948 
Loss on extinguishment of debt   -    -    -    - 
Other income and (expense)   68,008    -    -    68,008 
Amortization of deferred financing costs   (113,090)   -    -    (113,090)
Total other income (expense)   (1,335,095)   -    -    (1,335,095)
                     
LOSS BEFORE PROVISION FOR INCOME TAXES   (4,613,084)   (1,839,328)   -    (6,452,411)
(Benefit) / Provision for income taxes   (2,209)   -    -    (2,209)
NET LOSS   (4,610,875)   (1,839,328)   -    (6,450,202)
                     
OTHER COMPREHENSIVE (LOSS) INCOME                    
Foreign currency translation (loss)   (148,233)   -    -    (148,233)
                     
COMPREHENSIVE LOSS  $(4,759,108)  $(1,839,328)   -   $(6,598,436)
                     
Net loss per common share and equivalents - basic and diluted  $(0.03)   -    -   $(0.04)
                     
Weighted average shares outstanding during the period - basic and diluted   146,482,547    -    -    146,482,547 

 

 14 

 

 

Six months period ended June 30, 2014      Restatement
adjustments
   Re-classifications   Restated 
   (unaudited)   (unaudited)   (unaudited)   (unaudited) 
REVENUES  $13,391,621   $(2,934,916)  $-   $10,456,705 
                     
COST AND OPERATING EXPENSES                    
Cost of service (excluding depreciation and amortization)   1,812,045    -    1,672,614    3,484,659 
Product development   -    -    3,992,349    3,992,349 
Sales and marketing   -    -    1,228,642    1,228,642 
General and administrative   13,408,891    -    (6,893,605)   6,515,286 
Depreciation and amortization   3,936,606    -    -    3,936,606 
Total cost and operating expenses   19,157,542    -    -    19,157,542 
                     
LOSS FROM OPERATIONS   (5,765,921)   (2,934,916)   -    (8,700,837)
                     
OTHER INCOME (EXPENSE)                    
Interest income   57,156    -    -    57,156 
Interest expense   (635,158)   -    -    (635,158)
Interest expense related to Debt Discount and Conversion Feature   (1,910,032)   -    -    (1,910,032)
Change in fair value of warrant liabilities   (171,324)   -    -    (171,324)
Loss on extinguishment of debt   (426)   -    -    (426)
Other income and (expense)   71,398    -    -    71,398 
Amortization of deferred financing costs   (249,457)   -    -    (249,457)
Total other income (expense)   (2,837,843)   -    -    (2,837,843)
                     
LOSS BEFORE PROVISION FOR INCOME TAXES   (8,603,764)   (2,934,916)   -    (11,538,680)
Provision for income taxes   133,228    -    -    133,228 
NET LOSS   (8,736,992)   (2,934,916)   -    (11,671,908)
                     
OTHER COMPREHENSIVE (LOSS) INCOME                    
Foreign currency translation (loss)   (150,452)   -    -    (150,452)
                     
COMPREHENSIVE LOSS  $(8,887,444)  $(2,934,916)  $-   $(11,822,360)
                     
Net loss per common share and equivalents - basic and diluted  $(0.06)  $-   $-   $(0.08)
                     
Weighted average shares outstanding during the period - basic and diluted   144,130,543    -    -    144,130,543 

 

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 six months         
   ended June 30, 2014   Restatement   Restated 
   Unaudited   Unaudited*   Unaudited* 
CASH FLOWS FROM OPERATING ACTIVITIES:               
Net loss  $(8,736,992)  $(2,934,916)  $(11,671,908)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:               
Depreciation and amortization   3,936,606    -    3,936,606 
Provision for doubtful accounts   18,865    -    18,865 
Stock based compensation   2,674,261    -    2,674,261 
Change in the fair value of the warrant liability   171,324    -    171,324 
Amortization of deferred financing costs   249,457    -    249,457 
Interest expense relating to debt discount and conversion feature   1,910,032    -    1,910,032 
Unrealized foreign currency translation gain/(loss)   (71,398)   -    (71,398)
(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*   (2,329,143)   414,819    (1,914,324)
Decrease (increase)  in prepaid expenses, deposits and other assets   (346,129)   -    (346,129)
Increase (decrease) in accounts payable, proceeds from related parties  and customer deposits   210,932    -    210,932 
Increase (decrease) in deferred revenue*   16,994    2,552,097    2,537,091 
Increase (decrease) in accrued expenses and other payables*   1,910,256    -    1,909,830 
Net cash provided by (used in) operating activities   (384,935)   -    (384,935)
                
CASH FLOWS FROM INVESTING ACTIVITIES:               
Purchases of Property and Equipment   (3,922,724)   -    (3,922,724)
Net cash used in investing activities   (3,922,724)   -    (3,922,724)
                
CASH FLOWS FROM FINANCING ACTIVITIES:               
Financing related fees   (90,000)   -    (90,000)
Exercise of warrants and Options   4,283,033    -    4,283,033 
Net cash provided by financing activities   4,193,033    -    4,193,033 
                
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS   (308,301)   -    (308,301)
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS   (422,927)   -    (422,927)
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD   1,252,315    -    1,252,315 
CASH AND CASH EQUIVALENTS, END OF THE PERIOD  $829,388   $-   $829,388 

 

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

 

 16 

 

 

Note 11. Subsequent Events

 

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

 

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

 

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

 

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

 

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

 

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

 

Forward-Looking Statements

 

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

 

Restatement of Previously Issued Financial Statements

 

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

 

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

 

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

 

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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:

 

·Early August 2015 the Company, jointly with its technology partner HP (Hewlett Packard), published a new case study on its collaboration with the Company entitled, “Elephant Talk Communications transforms mobile service enablement with HP iHSS.” The case study examines the many benefits resulting from the integration of its new HP Integrated Home Subscriber Server (iHSS) technology into the ET Software DNA® 2.0 Software Defined Networking platform currently deployed with mobile network operator (MNO) and mobile virtual network operator (MVNO) customers.

 

·

On July 22, 2015 the Company announced that it has completed its initial restructuring efforts as part of its strategic plan to improve operational efficiencies, increase sales efforts and reduce expenditures. The plan includes eliminating approximately $5 million in 2015 from its annual cash operating SG&A budget consisting of a reduction in staff, elimination of office locations and a focus towards securing and supporting a growing number of Mobile Network Operator (MNO) and Mobile Virtual Network Operator (MVNO) customers in the Americas, Europe, the Middle East and Asia. The Board-approved restructuring plan was the result of the need to refocus the business following the end of the Company’s relationship with Iusacell its acquisition by AT&T earlier this year, the subsequent financial settlement and the resulting restructuring and reduction of its outstanding debt obligations.As part of the restructuring, the Company has divided its operations into two organizations - Delivery & Operations led by Co-President Dr. Armin Hessler and Sales & Innovation led by Co-President Martin Zuurbier. Delivery & Operations will be responsible for platform architecture, implementation and operations and Sales & Innovation will be responsible for all commercial activities, vendor management and R&D. With this business realignment, both divisions have made adjustments to their respective organizations to improve operational efficiencies and reduce costs.

 

·On June 16, 2015 the Company announced that after a productive commercial relationship lasting several years, Grupo Iusacell (“Iusacell”) and Elephant Talk have ended their relationship, agreeing to a global settlement worth approximately $13.5 million in favor of Elephant Talk, consisting of 12.6 million in cash and the remaining balance in exchange for certain obligations of Elephant Talk to Iusacell. The cash payment will be reflected as revenue on the Company’s financial statements for the quarter ended June 30, 2015. The reason for the termination was to allow for AT&T to ensure consistency of infrastructure suppliers in its businesses. The amicable parting of the companies in no way reflects on the performance of Elephant Talk or its technology and neither parties rule out the possibility of future business relationships.

 

·On May 28, 2015 the Company announced that the Company’s software platform was chosen by OpenMobile, a new MVNO in the Netherlands, to support its commercial launch. OpenMobile (www.openmobile.nl) specializes in offering secure connectivity services to the consumer and enterprise markets.

 

  · 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.

 

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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.

 

Critical Accounting Policies and Estimates

 

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

 

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

 

Revenue

 

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

 

   Three Months Ended June 30,     
   2015   2014 restated   Variance 
Landline Services  $-   $42,499   $(42,499)
Mobile & Security Solutions   19,244,383    5,029,941    14,214,442 
Total Revenue  $19,244,383   $5,072,440   $14,171,943 

 

   Six Months Ended June 30,     
   2015   2014 restated   Variance 
Landline Services  $-   $141,230   $(141,230)
Mobile & Security Solutions   24,257,399    10,315,475    13,941,924 
Total Revenue  $24,257,399   $10,456,705   $13,800,694 

 

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Non-GAAP Revenue

 

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

  

   Three Months Ended June 30,     
   2015   2014 restated   Variance 
Revenue  $19,244,383   $5,072,440   $14,171,943 
Deferred Revenue adjustments   (11,871,208)   1,727,530    (13,598,738)
Non-GAAP Revenue  $7,373,175   $6,799,970   $573,205 

 

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

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

 

   Six Months Ended June 30,     
   2015   2014 restated   Variance 
Revenue  $24,257,399   $10,456,705   $13,800,694 
Deferred Revenue adjustments   (8,889,549)   2,537,091    (11,426,640)
Non-GAAP Revenue  $15,367,850   $12,993,796   $2,374,054 

 

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

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

 

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

 

Historic quarterly overview Non-GAAP and GAAP revenue

 

Total Revenue (quarterly figures unaudited)  Q1 2013   Q2 2013   Q3 2013   Q4 2013   2013 
Revenues non-GAAP  $6,240,114   $3,564,249   $4,123,794   $5,523,647   $19,451,804 
Changes in deferred revenue   395,122    120,771    1,544,864    313,882    2,374,639 
Revenue  $6,635,236   $3,685,020   $5,668,658   $5,837,529   $21,826,443 

 

Total Revenue (quarterly figures unaudited)  Q1 2014   Q2 2014   Q3 2014   Q4 2014   2014 
Revenues  $5,384,265   $5,072,440   $4,445,239   $5,454,503   $20,356,447 
Deferred revenue adjustments   809,561    1,727,530    3,217,974    2,868,895    8,623,960 
Revenue - non gaap  $6,193,826   $6,799,970   $7,663,213   $8,323,398   $28,980,407 

 

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Total Revenue (quarterly figures unaudited)  Q1 2015   Q2 2015   2015 (YTD) 
Revenues  $5,013,016   $19,244,383   $24,257,399 
Deferred revenue adjustments   2,981,659    (11,871,208)   (8,889,549)
Revenue - non gaap  $7,994,675   $7,373,175   $15,367,850 

 

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 
           % of Total   Company 
   ($ in   ($ in   Company   Revenue 
Quarter  Millions non-
gaap)
   millions)
Restated - gaap
   Revenue (non-
gaap)
   Restated
(gaap)
 
2Q12   2.8    2.8    39    39 
3Q12   2.9    2.9    44    44 
4Q12   3.6    3.6    52    52 
1Q13   3.9    3.5    59    56 
2Q13   4.5    3.0    90    85 
3Q13   5.0    3.9    96    95 
4Q13   5.9    5.4    98    97 
1Q14   6.4    5.3    99    98 
2Q14   6.9    5.0    99    99 
3Q14   7.3    4.4    100    100 
4Q14   7.9    5.4    100    100 
1Q15   8.0    5.0    100    100 
2Q15   7.4    19.2    100    100 

 

Cost of Service

 

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

 

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

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

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

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

 

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

 

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

 

   Three Months Ended June 30,     
   2015   2014 restated   Variance 
Revenues  $19,244,383   $5,072,440   $14,171,943 
Cost of service   1,440,914    1,848,687    (407,773)
Margin (excluding depreciation and amortization)  $17,803,469   $3,223,753   $14,579,716 

 

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

 

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

 

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

 

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

 

   Six Months Ended June 30,     
   2015   2014 restated   Variance 
Revenues  $24,257,399   $10,456,705   $13,800,694 
Cost of service   3,309,760    3,484,659    (174,899)
Margin (excluding depreciation and amortization)  $20,947,639   $6,972,046   $13,975,593 

 

Product Development

 

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

 

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

 

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

 

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

 

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

 

Sales and Marketing

 

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

 

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

 

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

 

General and Administrative

 

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

 

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

 

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

 

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

 

Share-based compensation

 

Share-based compensation is comprised of:

 

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

 

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

 

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

 

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

 

   Three months ended     
   2015   2014 restated   Variance 
Cost of service  $31,016   $480,244   $(449,228)
Product Development   101,803    878,888    (777,085)
Sales and Marketing   18,269    89,030    (70,761)
General and Administrative   601,422    454,375    147,047 
Total  $752,510   $1,902,537   $(1,150,027)

 

   Six months ended     
   2015   2014 restated   Variance 
Cost of service  $82,379   $697,995   $(615,616)
Product Development   294,945    1,277,393    (982,448)
Sales and Marketing   51,617    129,398    (77,781)
General and Administrative   1,155,382    569,475    585,907 
Total  $1,584,323   $2,674,261   $(1,089,938)

 

Depreciation and Amortization

 

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

 

Impairment for assets held and used

 

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

 

Interest Income and Expense

 

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

 

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

 

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

 

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Interest Expense Related to Debt Discount and Conversion Feature

 

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

 

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

 

Change in Fair Value of Warrant Liabilities

 

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

 

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

 

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

 

Gain/(Loss) on extinguishment of debt

 

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

 

Amortization of Deferred Financing Costs

 

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

 

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

 

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

 

Other Income and (Expense)

 

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

 

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Provision (Benefit) Income taxes

 

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

 

Net Income / (Loss)

 

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

 

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

 

Other Comprehensive (Loss) Income

 

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

 

Reconciliation of Net Loss to Non-GAAP Adjusted EBITDA

 

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

 

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

 

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

 

   Three Months Ended June 30, 
EBITDA (adjusted)  2015   2014 (restated) 

Net income (loss)

  $9,521,918    (6,450,202)
(Benefit) / provision for income taxes   111,450    (2,209)
Depreciation and amortization   1,745,034    1,928,392 
Stock-based compensation   752,510    1,902,537 
Interest income and expenses   533,239    303,669 
Interest expense related to debt discount and conversion feature   403,679    1,025,292 
Changes in fair value of warrant liabilities   (149,203)   (38,948)
Other (expense)   (155,252)   (68,008)
Amortization of deferred financing costs   362,845    113,090 
Changes in deferred revenue   (11,871,208)   1,727,530 
Impairment for assets held and used   937,835    - 
Adjusted EBITDA  $2,192,847    441,143 

 

   Six Months Ended June 30, 
EBITDA (adjusted)  2015   2014 (restated) 
Net income (loss)   7,396,745    (11,671,908)
(Benefit) / provision for income taxes   42,958    133,228 
Depreciation and amortization   3,491,181    3,936,606 
Stock-based compensation   1,584,323    2,674,261 
Interest income and expenses   870,307    578,002 
Interest expense related to debt discount and conversion feature   467,651    1,910,032 
Changes in fair value of warrant liabilities   (395,905)   171,324 
(Gain)/Loss on extinguishment of debt   (2,475,799)   426 
Other income (expense)   1,036,018    (71,398)
Amortization of deferred financing costs   425,347    249,457 
Changes in deferred revenue   (8,889,549)   2,537,091 
Impairment for assets held and used   937,835    - 
Adjusted EBITDA  $4,491,112    447,121 

 

Liquidity and Capital Resources

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

Operating activities

 

Largely as a result of the settlement agreement with Iusacell as discussed also in Note 3 and Note 11,and the Company’s strict management of accrued expenses and accounts payable the operating activities provided net cash of $10,295,830 for the six months ended June 30, 2015 an increase of $10,680,765 compared to the same period last year.

 

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Investing activities

 

Net cash used in investing activities for the six months ended June 30, 2015 was $4,113,308, an increase of $190,584, or 5% compared to $3,922,724 in the same period in 2014. This change is resulted from the increased spending on hardware, software licenses and includes capitalized product development costs. The total amount of product development costs (internal use software costs) that are capitalized in Property & Equipment during the six months ended June 30, 2015 and 2014 was $ $2,289,359 and $2,287,851, respectively.

 

Financing activities

 

Net cash (used in) provided by financing activities for the six months ended June 30, 2015 and 2014 was ($7,988,917) and $4,193,033, respectively, a decrease of $12,181,950.

 

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. Anticipatory to an amendment of the original credit agreement combined with the receipt of the Iusacell settlement payment, the company transferred $10,100,000 on June 22, 2015 towards the lenders pending the closing of the amendment of the credit agreement, which amendment was executed on July 9, 2015. See also Note 3 (2014 10% + Libor 3rd party Term Loan Agreement) as well as Note 11 subsequent events for details on the allocation of the payment of $10,100,000 as well as the amended agreement.

 

During the month of January 2015 we received the $2,000,000 proceeds of the financing receivable that we had recorded as a current asset as per December 31, 2014.

 

As a result of the above operating, investing and financing activities, for the six months ended June 30, 2015, we had cash and cash equivalents of $1,232,525, a net decrease in cash and cash equivalents of $671,635 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

 

Interest rate and market risk.

Our $ 12 million Atalaya/Corbin 3 year credit agreement dated 17 November 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 as occurred subsequent to this quarter on July 9, 2015 with the reduction of the outstanding debt from $ 12 million to $ 6.5 million.

At each balance sheet date or upon settlement the Company remeasures the 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 $120,392 that was included in determining net income for the three months ended June 30, 2015 and for the six months ended June 30, 2015 a loss of $176,128.

 

We do not currently engage in hedging activities.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

As of June 30, 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 June 30, 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 June 30, 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.

 

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;

 

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  · 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

 

There were no material changes to the risk factors included in the Company’s annual report on Form 10-K for year ended December 31, 2014, as amended, originally filed with the SEC on April 1, 2015.

 

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.

 

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

 

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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: August 10, 2015 By /s/ Steven van der Velden
    Steven van der Velden
    President and Chief Executive Officer
    (Principal Executive Officer)
     
Date: August 10 , 2015 By /s/ Mark Nije
    Mark Nije
    Chief Financial Officer
    (Principal Financial and Accounting Officer)

 

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