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 September 30,2010





 ̈ 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, INC.


(Exact
name of small business issuer as specified in its charter)





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





19103
Centre Rose Boulevard


Lutz,
FL 33558


United
States


(Address
of principal executive offices)





+ 1 813 926 8920


(Issuer's
telephone number, including area code)





Check
whether the registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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  ̈ 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  ̈
     Non-Accelerated filer  ̈   Smaller
reporting company   x





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
November 12, 2010, there were 88,462,305 shares of the Company’s
common stock outstanding.





ELEPHANT
TALK COMMUNICATIONS, INC.


TABLE OF
CONTENTS


FORM
10-Q


September
30, 2010




PART
      I - FINANCIAL INFORMATION
                
                3Item
      1. Consolidated Financial Statements
                
                3Consolidated
      Balance Sheets as of September 30, 2010 (Unaudited) and December 31,
      2009
                
                3Unaudited
      Consolidated Statements of Operations for the nine months periods ended
      September 30, 2010 and 2009
                
                4Unaudited
      Consolidated Statements of Cash Flows for the nine months periods ended
      September 30, 2010 and 2009
                
                5Notes
      to the Consolidated Financial Statements (Unaudited)
                
                6Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                
                26Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                
                34Item
      4T. Controls and Procedures
                
                34PART
      II - OTHER INFORMATION
                
                34Item
      1. Legal Proceedings
                
                34Item
      1a. Risk Factors
                
                35Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds
                
                35Item
      3.  Defaults upon Senior Securities
                
                36Item
      4.  Submission of Matters to a Vote of Security
      Holders
                
                36Item
      5.  Other Information
                
                36Item
      6. Exhibits
                
                36SIGNATURES
                
                36Exhibit
      31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
      or Rule 15(d)-14(a)
                
                X-1Exhibit
      31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
      or Rule 15(d)-14(a)
                
                X-2Exhibit
      32.1 Certification of Chief Executive Officer pursuant to section 906 of
      the Sarbanes-Oxley Act of 2002
                
                X-3Exhibit
      32.2 Certification of Chief Financial Officer pursuant to section 906 of
      the Sarbanes-Oxley Act of 2002
                
                X-4


2


PART
I - FINANCIAL INFORMATION




Item 1. Consolidated Financial Statements





ELEPHANT TALK COMMUNICATIONS, INC. AND
SUBSIDIARIES


CONSOLIDATED
BALANCE SHEET


(UNAUDITED)





September 30,
                          
                          
                          December 31,2010
                          
                          
                          2009ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                          
                          $
                          1,632,748
                          
                          
                          $
                          1,457,900Restricted
      cash
                          
                          
                          190,976
                          
                          
                          
                          192,116Accounts
      receivable, net of an allowance for doubtful accounts of $110,595 and
      $764,302 at September 30, 2010 and December 31, 2009
      respectively
                          
                          
                          6,691,010
                          
                          
                          
                          5,071,293Prepaid
      expenses and other current assets
                          
                          
                          2,115,050
                          
                          
                          
                          2,657,019Total
      Current Assets
                          
                          
                          10,629,784
                          
                          
                          
                          9,378,328LONG
      TERM DEPOSITS
                          
                          
                          384,235
                          
                          
                          
                          330,946DEFERRED
      FINANCING COSTS
                          
                          
                          1,550,589
                          
                          
                          
                          3,033,277PROPERTY
      AND EQUIPMENT, NET
                          
                          
                          8,296,743
                          
                          
                          
                          7,773,862INTANGIBLE
      ASSETS, NET
                          
                          
                          17,506,611
                          
                          
                          
                          3,910,363GOODWILL
                          
                          
                          3,319,925
                          
                          
                          
                          —TOTAL
      ASSETS
                          
                          $
                          41,687,887
                          
                          
                          $
                          24,426,776LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)CURRENT
      LIABILITIESOverdraft
                          
                          $
                          364,185
                          
                          
                          $
                          351,589Accounts
      payable and customer deposits
                          
                          
                          4,709,375
                          
                          
                          
                          6,475,074Deferred
      revenue
                          
                          
                          -
                          
                          
                          
                          132,205Accrued
      expenses and other payables
                          
                          
                          5,275,001
                          
                          
                          
                          2,738,998Shares
      to be issued
                          
                          
                          351,788
                          
                          
                          
                          —Convertible
      14% loan - related party (net of discount of $0 and $0)
                          
                          
                          2,518,220
                          
                          
                          
                          —Advances
      from related parties
                          
                          
                          
                          
                          
                          
                          13,287Loans
      payable
                          
                          
                          880,184
                          
                          
                          
                          880,536Total
      Current Liabilities
                          
                          
                          14,098,753
                          
                          
                          
                          10,591,689LONG
      TERM LIABILITIESLoan
      from related party
                          
                          
                          459,505
                          
                          
                          
                          437,161Convertible
      12% secured note (net of discount of $ 11,752,078 and $12,333,020
      respectively)
                          
                          
                          294,942
                          
                          
                          
                          —Warrant
      liabilities
                          
                          
                          38,587,322
                          
                          
                          
                          16,626,126Conversion
      feature
                          
                          
                          16,353,793
                          
                          
                          
                          2,899,801Total
      Long term Liabilities
                          
                          
                          55,695,562
                          
                          
                          
                          19,963,088Total
      Liabilities
                          
                          
                          69,794,315
                          
                          
                          
                          30,554,777STOCKHOLDERS'
      EQUITY (DEFICIT)Common
      stock, no par value, 250,000,000 shares authorized, 73,367,458 issued and
      outstanding  as of September 30, 2010 compared to 53,695,984
      shares issued and outstanding as of December 31, 2009
                          
                          
                          86,202,663
                          
                          
                          
                          54,880,778Accumulated
      other comprehensive income (loss)
                          
                          
                          383,614
                          
                          
                          
                          1,136,897Accumulated
      deficit
                          
                          
                          (114,877,217
                          )
                          
                          
                          (62,335,076
                          )Elephant
      Talk Comunications, Inc. Stockholders' Equity
                          
                          
                          (28,290,940
                          )
                          
                          
                          (6,317,401
                          )NON-CONTROLLING
      INTEREST
                          
                          
                          184,512
                          
                          
                          
                          189,400Total
      Stockholders' Equity
                          
                          
                          (28,106,428
                          )
                          
                          
                          (6,128,001
                          )TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
                          
                          $
                          41,687,887
                          
                          
                          $
                          24,426,776





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


3


ELEPHANT TALK COMMUNICATIONS, INC.
AND SUBSIDIARIES


CONSOLIDATED
STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS


(UNAUDITED)




For the Three Months Period
                                  ended,September 30
                                
                                
                                For the Nine Months Period ended,
                                  September 302010
                                
                                
                                2009
                                
                                
                                2010
                                
                                
                                2009REVENUES
                                
                                $
                                9,040,397
                                
                                
                                $
                                11,455,489
                                
                                
                                $
                                28,657,987
                                
                                
                                $
                                32,195,771COST
      AND OPERATING EXPENSESCost
      of service
                                
                                
                                8,638,506
                                
                                
                                
                                10,874,205
                                
                                
                                
                                27,017,788
                                
                                
                                
                                30,654,206Selling,
      general and administrative expenses
                                
                                
                                2,795,572
                                
                                
                                
                                2,949,038
                                
                                
                                
                                6,780,281
                                
                                
                                
                                6,195,981Non
      cash compensation to employees, officers, consultants and directors
                                
                                
                                779,539
                                
                                
                                
                                252,521
                                
                                
                                
                                4,033,208
                                
                                
                                
                                1,272,387Depreciation
      and amortization of intangibles assets
                                
                                
                                1,481,451
                                
                                
                                
                                861,616
                                
                                
                                
                                3,841,573
                                
                                
                                
                                2,199,561Total
      cost and operating expenses
                                
                                
                                13,695,068
                                
                                
                                
                                14,937,380
                                
                                
                                
                                41,672,850
                                
                                
                                
                                40,322,135LOSS
      FROM OPERATIONS
                                
                                
                                (4,654,671
                                )
                                
                                
                                (3,481,891
                                )
                                
                                
                                (13,014,863
                                )
                                
                                
                                (8,126,364
                                )OTHER
      INCOME (EXPENSE)Interest
      income
                                
                                
                                40,566
                                
                                
                                
                                24,375
                                
                                
                                
                                105,685
                                
                                
                                
                                46,682Interest
      expense
                                
                                
                                (538,214
                                )
                                
                                
                                (323,976
                                )
                                
                                
                                (1,520,641
                                )
                                
                                
                                (531,915
                                )Other
      expenses
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                —Interest
      expense related to amortization of debt discount on promissory
      notes
                                
                                
                                (1,796,203
                                )
                                
                                
                                (1,299,365
                                )
                                
                                
                                (9,342,026
                                )
                                
                                
                                (1,299,365
                                )Change
      in fair value of warrant liabilities
                                
                                
                                (18,330,773
                                )
                                
                                
                                (507,695
                                )
                                
                                
                                (27,079,551
                                )
                                
                                
                                (507,695
                                )Amoritization
      of deferred financing costs
                                
                                
                                (566,478
                                )
                                
                                
                                (41,649
                                )
                                
                                
                                (1,688,013
                                )
                                
                                
                                (41,649
                                )Total
      other income (expense)
                                
                                
                                (21,191,102
                                )
                                
                                
                                (2,148,310
                                )
                                
                                
                                (39,524,546
                                )
                                
                                
                                (2,333,942
                                )LOSS
      BEFORE PROVISION FOR INCOME TAXES
                                
                                
                                (25,845,773
                                )
                                
                                
                                (5,630,201
                                )
                                
                                
                                (52,539,409
                                )
                                
                                
                                (10,460,306
                                )Provision
      for income taxes
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                (800
                                )
                                
                                
                                (800
                                )NET
      LOSS BEFORE NONCONTROLLING INTEREST
                                
                                
                                (25,845,773
                                )
                                
                                
                                (5,630,201
                                )
                                
                                
                                (52,540,209
                                )
                                
                                
                                (10,461,106
                                )Net
      (loss) income attributable to noncontrolling interest
                                
                                
                                (452
                                )
                                
                                
                                (432
                                )
                                
                                
                                (2,735
                                )
                                
                                
                                (1,188
                                )NET
      LOSS
                                
                                
                                (25,846,225
                                )
                                
                                
                                (5,630,633
                                )
                                
                                
                                (52,542,944
                                )
                                
                                
                                (10,462,294
                                )OTHER
      COMPREHENSIVE (LOSS) INCOMEForeign
      currency translation gain (loss)
                                
                                
                                2,937,463
                                
                                
                                
                                543,061
                                
                                
                                
                                (753,283
                                )
                                
                                
                                345,8022,937,463
                                
                                
                                
                                543,061
                                
                                
                                
                                (753,283
                                )
                                
                                
                                345,802COMPREHENSIVE
      LOSS
                                
                                $
                                (22,908,762
                                )
                                
                                $
                                (5,087,572
                                )
                                
                                $
                                (53,296,227
                                )
                                
                                $
                                (10,116,492
                                )Net
      loss per common share and equivalents - basic and diluted
                                
                                $
                                (0.36
                                )
                                
                                $
                                (0.10
                                )
                                
                                $
                                (0.83
                                )
                                
                                $
                                (0.20
                                )Weighted
      average shares outstanding during the period - basic and
      diluted
                                
                                
                                72,141,821
                                
                                
                                
                                54,373,240
                                
                                
                                
                                63,212,715
                                
                                
                                
                                53,422,421





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


4


ELEPHANT
TALK COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)


For
      the nine months period ended, September 302010
                                    
                                    
                                    2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                                    
                                    $
                                    (52,542,944
                                    )
                                    
                                    $
                                    (10,462,294
                                    )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                                    
                                    
                                    3,841,573
                                    
                                    
                                    
                                    2,199,561Provision
      for doubtful accounts
                                    
                                    
                                    (670,561
                                    )
                                    
                                    
                                    (104,521
                                    )Stock
      based compensation
                                    
                                    
                                    3,566,225
                                    
                                    
                                    
                                    1,150,512Noncontrolling
      interest
                                    
                                    
                                    2,735
                                    
                                    
                                    
                                    1,188Amortization
      of Shares issued for Consultancy
                                    
                                    
                                    466,983
                                    
                                    
                                    
                                    121,875Issuance
      of stock
                                    
                                    
                                    397,542
                                    
                                    
                                    
                                    --Change
      in fair value of warrant liabilities
                                    
                                    
                                    27,079,551
                                    
                                    
                                    
                                    507,695Amortization
      of deferred financing costs
                                    
                                    
                                    1,688,013
                                    
                                    
                                    
                                    --Interest
      expense relating to debt discount and conversion feature
                                    
                                    
                                    9,342,026
                                    
                                    
                                    
                                    1,341,014Changes
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable
                                    
                                    
                                    (1,140,166
                                    )
                                    
                                    
                                    (554,451
                                    )Decrease
      (Increase) in prepaid expenses, deposits and other
    assets
                                    
                                    
                                    (1,172,496
                                    )
                                    
                                    
                                    120,028Increase
      (decrease) in accounts payable, proceeds from related parties and customer
      deposits
                                    
                                    
                                    (1,663,837
                                    )
                                    
                                    
                                    1,255,893Increase
      (decrease) in deferred revenue
                                    
                                    
                                    (131,831
                                    )
                                    
                                    
                                    (87,853
                                    )Increase
      (decrease) in accrued expenses and other payables
                                    
                                    
                                    1,159,963
                                    
                                    
                                    
                                    753,797Net
      cash used in operating activities
                                    
                                    
                                    (9,777,224
                                    )
                                    
                                    
                                    (3,757,556
                                    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
                                    
                                    
                                    (2,448,278
                                    )
                                    
                                    
                                    (3,162,599
                                    )Restricted
      cash
                                    
                                    
                                    30
                                    
                                    
                                    
                                    (109
                                    )Cash
      received from acquisition of subsidiary
                                    
                                    
                                    48,577
                                    
                                    
                                    
                                    --Loan
      to third party
                                    
                                    
                                    --
                                    
                                    
                                    
                                    (1,237,602
                                    )Net
      cash used in investing activities
                                    
                                    
                                    (2,399,671
                                    )
                                    
                                    
                                    (4,400,310
                                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Bank
      overdraft
                                    
                                    
                                    17,926
                                    
                                    
                                    
                                    19,535Deferred
      financing costs
                                    
                                    
                                    (205,326
                                    )
                                    
                                    
                                    (845,496
                                    )Loan
      from related party QAT Bridge Loan
                                    
                                    
                                    2,518,220Loan
      from related party Bridge SPA
                                    
                                    
                                    2,885,000Proceeds
      from Private Placement Offering
                                    
                                    
                                    8,387,550Exercise
      of warrants (cash less)
                                    
                                    
                                    25,000
                                    
                                    
                                    
                                    --Placement
      fees
                                    
                                    
                                    (1,420,720
                                    )
                                    
                                    
                                    --Proceeds
      from Convertible 12% secured note
                                    
                                    
                                    --
                                    
                                    
                                    
                                    4,114,605Proceeds
      from Convertible 12% secured note - related parties
                                    
                                    
                                    --
                                    
                                    
                                    
                                    4,100,000Loan
      from related party
                                    
                                    
                                    --
                                    
                                    
                                    
                                    1,061,116Net
      cash provided by financing activities
                                    
                                    
                                    12,207,650
                                    
                                    
                                    
                                    8,449,760EFFECT
      OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
                                    
                                    
                                    144,093
                                    
                                    
                                    
                                    (64,386
                                    )NET
      DECREASE IN CASH AND CASH EQUIVALENTS
                                    
                                    
                                    174,848
                                    
                                    
                                    
                                    227,508CASH
      AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD
                                    
                                    
                                    1,457,900
                                    
                                    
                                    
                                    1,656,546CASH
      AND CASH EQUIVALENTS, END OF THE PERIOD
                                    
                                    $
                                    1,632,748
                                    
                                    
                                    $
                                    1,884,054SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the period for interest
                                    
                                    $
                                    669,523
                                    
                                    
                                    $
                                    17,468





2010
                          
                          
                          2009SUPPLEMENTAL
      DISCLOSURES OF NON-CASH INVESTING & FINANCING
    ACTIVITIES:Increase
      in Share Capital due to Aquisitions and Non-cash
    Compensation
                          
                          $
                          14,710,361
                          
                          
                          $
                          532,583Increase
      of Share Capital due to Exercsie of Warrants and Conversion of
      Notes
                          
                          $
                          673,429
                          
                          
                          
                          --Decrease
      of Net Debt due to Conversion of Notes
                          
                          $
                          3,744
                          
                          
                          
                          --Warrants
      and derivative liabilities for issuance of 12% Promissory Notes are
      considered as discount of the Promissory Notes
                          
                          $
                          --
                          
                          
                          $
                          8,214,605Changes
      in warrants liabilities
                          
                          $
                          497,536
                          
                          
                          
                          --Changes
      in convertible note
                          
                          $
                          187,443
                          
                          
                          
                          --Cash
      paid during the period for income taxes
                          
                          $
                          --
                          
                          
                          $
                          800Increase
      of Warrants due to fundraising of Convertible Notes
                          
                          
                          7,539,585
                          
                          
                          
                          --Warrants
      issued to placement agents for services, treated as deferred financing
      costs
                          
                          
                          --
                          
                          
                          
                          644,311




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


5


ELEPHANT
TALK COMMUNICATIONS, INC. AND SUBSIDIARIES


NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS





Note 1. Organization and
Nature of Operations





The
Company





Elephant
Talk Communications, Inc. (“Elephant Talk,” “we,” “us” or the “Company”), is an
international provider of business software and services to the
telecommunications and financial services industry. The company enables both
mobile network operators (“MNOs”) and virtual operators (“MVNOs”) to offer a
full suite of products, delivery platforms, support services, superior industry
expertise and high quality customer service without substantial upfront
investments from clients. Elephant Talk provides global telecommunication
companies, MNOs, banks, supermarkets, consumer product companies, media firms,
and other businesses a full suite of products and services that enables them to
fully provide telecom services as part of their business offerings. The company
offers various dynamic products that include remote health care, credit card
fraud prevention, mobile internet ID security, multi-country discounted phone
services, loyalty management services, and a whole range of other emerging
customized mobile services.





Converged telecommunication services
– full MVNE solutions.The Company is a niche player in the
converged telecommunications market, providing traffic and network services as a
licensed operator, and specializing in carrier grade mobile enabling platforms
to provide outsourced solutions to the various players in the
telecommunications’ value chain, including MNOs, MVNOs and non-operator
companies in need of both mobile as well as specialized land-line
telecommunication services. In this chain we position ourselves as a Full Mobile
Virtual Network Enabler , including also customized mobile services such as our
network integrated ValidSoft security and fraud prevention
solutions.





ValidSoft
– electronic fraud prevention




Our
recent major acquisition of ValidSoft Ltd. (“ValidSoft”) gives us a position in
providing solutions to counter electronic fraud relating to card, the internet,
and telephone channels. ValidSoft's solutions are used to verify the
authenticity of both consumers and institutions (mutual authentication), and the
integrity of transactions (transaction verification) for the mass market, in a
highly cost effective and secure manner, yet easy to use and intuitive.
ValidSoft solutions are marketed under VALid-POS® and VALid®. For its biometrics
based product it trades under VALid-VSGTM.





Principles of
Consolidation





The
accompanying consolidated financial statements for September 30, 2010 and
December 31, 2009 include the accounts of Elephant Talk Communications Inc.,
including:





·
            its
      wholly-owned subsidiary Elephant Talk Europe Holding B.V., its
      wholly-owned subsidiary Elephant Talk Communication Holding AG, its
      wholly-owned subsidiaries Elephant Talk Communications S.L.U., Elephant
      Talk Mobile Services B.V., Elephant Talk Communication Austria GmbH,
      Elephant Talk Telekom GmbH (formerly Vocalis Austria GmbH), Elephant Talk
      Communications Italy S.R.L., ET-Stream GmbH, Elephant Talk Communication
      Carrier Services GmbH, Elephant Talk Communication (Europe) GmbH, Elephant
      Talk Communication Schweiz GmbH, Moba Consulting Partners B.V., Elephant
      Talk Communications France S.A.S.,its majority owned (51%) subsidiary
      Elephant Talk Communications Premium Rate Services Netherlands B.V., its
      majority owned (51%) subsidiary Elephant Talk Communications PRS U.K.
      Limited, its wholly-owned subsidiary Elephant Talk Communications
      Luxembourg SA;





·
            its
      wholly-owned subsidiary Elephant Talk Global Holding B.V., its
      wholly-owned subsidiary Elephant Talk Business Services W.L.L., its
      wholly-owned subsidiary Guangzhou Elephant Talk Information Technology
      Limited., its wholly-owned Elephant Talk Caribbean B.V., its majority
      owned (51%) subsidiary ET-UTS N.V.;





·
            its
      wholly-owned subsidiary Elephant Talk Limited, its majority owned (60%)
      subsidiary Elephant Talk Middle East & Africa (Holding) W.L.L., its
      majority owned (51%) subsidiary Elephant Talk Middle East & Africa
      (Holding) Jordan L.L.C., its majority owned (99%) subsidiary Elephant Talk
      Middle East & Africa Bahrain W.L.L and its majority owned (50.54%)
      subsidiary Elephant Talk Middle East & Africa FZ-LLC;
    and


6


·
            its
      wholly-owned subsidiary ValidSoft Ltd and its wholly-owned subsidiaries
      ValidSoft (UK) Ltd & ValidSoft (Australia) Pty
  Ltd..





Acquisitions.




On March
17, 2010, the Company acquired all of the assets of privately held ValidSoft
Ltd, an Irish company  (“ValidSoft”) for total consideration of $
16,033,689, paid by the issuance of shares of  the Company’s common
stock, as well as warrants to purchase shares of common stock. This
consideration excludes the contingent consideration payable upon ValidSoft
meeting certain performance targets. The opening balance sheet of ValidSoft has
been recorded as of  April 1 2010. The Consolidated Statement of
Income ending September 30, 2010 include the financial results of ValidSoft as
of April 1 2010.




Interim Financial
Information





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements and related
notes as included in our 2009 Form 10-K. These consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
in our Form 10-K. In the opinion of management, the accompanying unaudited
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statements and contain all adjustments (which
include only normal recurring adjustments) considered necessary for a fair
presentation of our financial position, results of operations and cash flows as
of and for the periods presented.





The
results of operations for the nine months ended September 30, 2010 are not
necessarily indicative of the results to be expected for the entire
year.





Note 2. Financial Condition
and Going Concern





The Company has an accumulated deficit of ($114,877,217) as of
September 30, 2010. Historically, the Company has relied on a combination of
debt and equity financings to fund ongoing cash requirements. In the first nine
months of 2010 the Company has received loans in the total amount of
€1,850,000 (US$ 2,518,220) from QAT II Investments, SA, a related party
investment fund (“QAT II”).





We also
raised $2,885,000 in a bridge financing of units consisting of common stock, no
par value, and warrants exercisable into common stock, with accredited investors
(the “Bridge Financing”).  Subsequent to the Bridge Financing, we
conducted a private placement (the “2010 Private Placement Offering”) of units
consisting of shares of our common stock and warrants to accredited investors
which resulted in gross proceeds of $ 6,459,800 in the second quarter 2010, $
1,927,750 in the third quarter and $ 5,612,450 in October 2010 bringing the
total gross proceeds of the Private Placement Offering to
$14,000,000.





Lastly,
following the closing of the 2010 Private Placement Offering, the promissory
notes and loans of the Company outstanding to QAT and QAT II automatically
converted into equity in the  amount of $ 8,125,571 by delivery of
units consisting of shares of our common stock and warrants to purchase shares
of common stock.





Excluding
the final closing of the 2010 Private Placement Offering on October 8, 2010
(described in Note 26), through  September 30 2010 we have raised
gross proceeds of approximately $13.8 million consisting of $2.5 million in
convertible debt and $11.3 million in equity, resulting in total net proceeds to
us of approximately $12.2 million.




We
believe that our cash balance at September 30, 2010, in combination with the
additional funding received so far in 2010, cash generated from operations,
expected additional revenues, repayment of certain debt as well as continued
investment in capital expenditures will last us until 1st quarter
2011. Considering our share price development and upcoming achievements we
expect warrants to purchase stock in our company to be exercised, which would
provide sufficient funds until at least 4th quarter
2011.


Although
the Company has previously been able to raise capital as needed, such capital
may not continue to be available at all, or if available, on reasonable
terms.  Further, the terms of such financing may be dilutive to
existing shareholders or otherwise on terms not favorable to the Company or
existing shareholders. The current global financial situation may offer
additional challenges to raising the required capital.  If we are
unable to secure additional capital, as circumstances require, or do not succeed
in meeting our sales objectives we may not be able to continue operations.
As of September 2010, these conditions raised substantial doubt from our
auditors as to our ability to continue as a going concern.


7


Note 3. Significant
Accounting Policies





Foreign Currency
Translation





The
functional currency is Euros for the Company’s wholly-owned subsidiary Elephant
Talk Europe Holding B.V. and its subsidiaries, and Euros for its wholly-owned
subsidiary Elephant Talk Global Holding B.V., and the Hong Kong Dollar for its
wholly-owned subsidiary Elephant Talk Limited and the British Pound Sterling for
its wholly-owned subsidiary ValidSoft (UK) Ltd. The financial statements of the
Company were translated to USD using period-end exchange rates as to assets and
liabilities and average exchange rates as to revenues and expenses, and capital
accounts were translated at their historical exchange rates when the capital
transaction occurred. In accordance with Accounting Standard Codification
(“ASC”) 830, Foreign Currency Matters, (formerly known as Statement of Financial
Accounting Standards (“SFAS”) No. 52), net gains and losses resulting from
translation of foreign currency financial statements are included in the
statements of shareholder’s equity as other comprehensive income (loss). Foreign
currency transaction gains and losses are included in consolidated income
(loss). The accumulated other comprehensive income (loss) as of September 30,
2010 and December 31, 2009 was $383,614 and $1,136,897, respectively. The
foreign currency translation gain/(loss) for the three months ended September
30, 2010 and 2009 was $2,937,463 and $ 543,061, respectively. The foreign
currency translation gain/(loss) for the nine months ended September 30, 2010
and 2009 was ($753,283) and $345,802, respectively.




Use of
Estimates





The
preparation of the accompanying financial statements conforms with accounting
principles generally accepted in the United States 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. Actual results could differ materially
from those estimates and assumptions.




Cash and Cash
Equivalents





For
purposes of the cash flow statements, the Company considers all highly liquid
investments with original maturities of three months or less at the time of
purchase to be cash equivalents.





Restricted
Cash





Restricted
cash represents cash deposited as bank guarantee for network interconnects with
telecommunication operators.





Accounts Receivables,
net





The
Company’s customer base is geographically dispersed. The Company maintains an
allowance for potential credit losses on accounts receivable. Management reviews
the composition of accounts receivable and analyzes historical bad debts,
customer concentrations, customer credit worthiness, current economic trends and
changes in customer payment patterns to evaluate the adequacy of these
allowances. Allowances are recorded primarily on a specific identification
basis. As of September 30, 2010 and December 31, 2009 the allowance for doubtful
accounts was $110,595 and $764,302, respectively. The allowance for doubtful
accounts largely included a provision for one former customer. This customer
declared  bankruptcy in the quarter ended September 30  2010
resulting in a write-down of this provision thus reducing the total allowance
for doubtful accounts.





Revenue Recognition and
Deferred Revenue





The
Company’s revenue recognition policies are in compliance with ASC 605, Revenue
Recognition (“ASC 605”), (formerly, Staff Accounting Bulletin (“SAB 104”).
Revenue is recognized only when the price is fixed or determinable, persuasive
evidence of arrangement exists, the service is performed and the collectability
of the resulting receivable is reasonably assured. The Company derives revenue
from activities as a landline and mobile services provider with its network and
its own switching technology. Revenue represents amounts earned for
telecommunication services provided to customers (net of value added tax and
inter-company revenue). The Company recognizes revenue from prepaid calling
cards as the services are provided. Payments received before all of the relevant
criteria for revenue recognition are satisfied are recorded as deferred revenue.
Deferred revenue represents amounts received from the customers against future
sales of services since the Company recognizes revenue upon performing the
services. Deferred revenue was $0 and $132,205 as of September 30, 2010 and
December 31, 2009, respectively.


8


Cost of
Service





Cost of
service includes origination, termination, network and billing charges from
telecommunications operators, out payment costs to content and information
providers, network costs, data center costs, facility costs of hosting network
and equipment, and costs of providing resale arrangements with long distance
service providers, costs of leasing transmission facilities and international
gateway switches for voice and data transmission services.





Reporting
Segments





ASC 820,
Segment Reporting, (Formerly SFAS No.131), defines operating segments as
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker in
deciding how to allocate resources and in assessing performances. The Company
allocates its resources and assesses the performance of its sales activities
based upon geographic locations of its subsidiaries.




Stock-based
Compensation





Effective
January 1, 2006, we adopted the provisions of ASC 718 “Compensation-Stock
Compensation” (“ASC 718”) (formerly SFAS No. 123(R)), using the prospective
approach. As a result, we recognize stock-based compensation expense for only
those awards that are granted subsequent to December 31, 2005 and any previously
existing awards that are subject to variable accounting, including certain stock
options that were exercised with promissory notes in 2003, until the awards are
exercised, forfeited, or contractually expire in accordance with the prospective
method and the transition rules of ASC 718. Under ASC 718, stock-based awards
granted after December 31, 2005, are recorded at fair value as of the grant date
and recognized as expense over the employee’s requisite service period (the
vesting period, generally three years), which we have elected to amortize on a
straight-line basis.





Income
Taxes





The
Company accounts for income taxes under ASC 740, “Accounting for Income Taxes”
(“ASC 740”) (formerly SFAS No. 109). This statement requires the recognition of
deferred tax assets and liabilities for the future consequences of events that
have been recognized in the Company’s financial statements or tax returns. The
measurement of the deferred items is based on enacted tax laws. In the event the
future consequences of differences between financial reporting bases and the tax
bases of the Company’s assets and liabilities result in a deferred tax asset,
ASC 740 requires an evaluation of the probability of being able to realize the
future benefits indicated by such asset. A valuation allowance related to a
deferred tax asset is recorded when it is more likely than not that some portion
or the entire deferred tax asset will not be realized. As part of the process of
preparing our consolidated financial statements, we are required to estimate our
income tax expense in each of the jurisdictions in which we operate. In the
ordinary course of a global business, there are many transactions and
calculations where the ultimate tax outcome is uncertain. Some of these
uncertainties arise as a consequence of revenue sharing and reimbursement
arrangements among related entities, the process of identifying items of revenue
and expenses that qualify for preferential tax treatment and segregation of
foreign and domestic income and expense to avoid double taxation. We also assess
temporary differences resulting from differing treatment of items, such as
deferred revenue, for tax and accounting differences. These differences result
in deferred tax assets and liabilities, which are included within our
consolidated balance sheet. We may record a valuation allowance to reduce our
deferred tax assets to the amount of future tax benefit that is more likely than
not to be realized. Although we believe that our estimates are reasonable and
that we have considered future taxable income and ongoing prudent and feasible
tax strategies in estimating our tax outcome and in assessing the need for the
valuation allowance, there is no assurance that the final tax outcome and the
valuation allowance will not be different than those that are reflected in our
historical income tax provisions and accruals.




ASC 740
prescribes a recognition threshold and measurement methodology to recognize and
measure an income tax position taken, or expected to be taken, in a tax return.
The evaluation of a tax position is based on a two-step approach. The first step
requires an entity to evaluate whether the tax position would “more likely than
not” be sustained upon examination by the appropriate taxing authority. The
second step requires the tax position be measured at the largest amount of tax
benefit that is greater than 50 percent likely of being realized upon ultimate
settlement. In addition, previously recognized benefits from tax positions that
no longer meet the new criteria would be derecognized.


9


The
Company has filed, or is in the process of filing, tax returns that are subject
to audit by the respective tax authorities. Although the ultimate outcome would
be unknown, we believe that any adjustments that may result from tax return
audits are not likely to have a material, adverse effect on our consolidated
results of operations, financial position or cash flows.





Comprehensive
Income/(Loss)





Comprehensive
income (loss) includes all changes in equity during a period from non-owner
sources. Other comprehensive income refers to gains and losses that under
accounting principles generally accepted in the United States are recorded as an
element of shareholders’ equity but are excluded from net income. For the first
nine months of 2010 and 2009 the Company’s comprehensive income/(loss) consisted
of its net loss and foreign currency translation adjustments.




Intangible
Assets





In
accordance with ASC 350, “Accounting for Goodwill and other Intangible Assets”
(“ASC 350”) (formerly SFAS No. 142), intangible assets are carried at cost less
accumulated amortization and impairment charges. Intangible assets are amortized
on a straight-line basis over the expected useful lives of the assets, between
three and ten years. Other intangible assets are reviewed for impairment in
accordance with ASC 360, Property, Plant, and Equipment,” (formerly SFAS No.
144), annually, or whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. Measurement of any
impairment loss for long-lived assets and identifiable intangible assets that
management expects to hold and use is based on the amount of the carrying value
that exceeds the fair value of the asset.





Property and Equipment,
Internally Developed and third party Software





Property
and equipment are initially recorded at cost. Additions and improvements are
capitalized, while expenditures that do not enhance the assets or extend the
useful life are charged to operating expenses as incurred. Included in property
and equipment are certain costs related to the development of the Company’s
internally developed software technology platform. The Company has adopted the
provisions of ASC 985, “Software”, (“ASC 985”) (formerly the AICPA Statement of
Position No. 98-1).





The
Company has capitalized certain computer software development costs upon the
establishment of technological feasibility. Technological feasibility is
considered to have occurred upon completion of a detailed program design that
has been confirmed by documenting the product specifications, or to the extent
that a detailed program design is not pursued, upon completion of a working
model that has been confirmed by testing to be consistent with the product
design. Depreciation applied using the straight-line method over the estimated
useful lives of the assets once the assets are placed in service. Once a new
functionality or improvement is released for operational use, the asset is moved
from the property and equipment category “projects under construction” to a
property and equipment asset subject to depreciation in accordance with the
principle described in the previous sentence.




Fair Value
Measurements





Fair
value is defined as the price that would be received upon the sale of an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. Assets and liabilities recorded at fair
value in the consolidated balance sheets are categorized based upon the level of
judgment associated with the inputs used to measure their fair value. The fair
value hierarchy distinguishes between (1) market participant assumptions
developed based on market data obtained from independent sources (observable
inputs) and (2) an entity’s own assumptions about market participant assumptions
developed based on the best information available in the circumstances
(unobservable inputs). The fair value hierarchy consists of three broad levels,
which gives the highest priority to unadjusted quoted prices in active markets
for identical assets or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3). The three levels of the fair value hierarchy are
described below:


10





Level Input:
              
              Input Definition:Level
      I
              
              Inputs
      are unadjusted, quoted prices for identical assets or liabilities in
      active markets at the measurement date.Level
      II
              
              Inputs,
      other than quoted prices included in Level I, that are observable for the
      asset or liability through corroboration with market data at the
      measurement date.Level
      III
              
              Unobservable
      inputs that reflect management’s best estimate of what market participants
      would use in pricing the asset or liability at the measurement
      date.





The
following table summarizes fair value measurements by level at September 30,
2010 for financial assets and liabilities measured at fair value on a recurring
basis:




level I
                  
                  
                  level II
                  
                  
                  level III
                  
                  
                  TotalWarrant
      liabilities
                  
                  $
                  
                  
                  
                  $
                  —
                  
                  
                  $
                  38,587,322
                  
                  
                  $
                  38,587,322Conversion
      feature
                  
                  
                  —
                  
                  
                  
                  
                  
                  
                  
                  16,353,793
                  
                  
                  
                  16,353,793Total
      liabilities
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  54,941,115
                  
                  
                  $
                  54,941,115








The
carrying value of the Company’s financial assets and liabilities, including cash
and cash equivalents, accounts payable and accrued liabilities, are carried at
historical cost basis and approximate fair value because of the short-term
nature of these instruments. The carrying value of the Company’s notes payable
approximates fair value based on management’s best estimate of the interest
rates that would be available for similar debt obligations having similar terms
at the balance sheet date.





Recently Issued Accounting
Pronouncements




In April
2009, the FASB issued guidance, which is now part of ASC 825, “Interim
Disclosures about Fair Value of Financial Instruments” (“ASC 825”), (formerly
Financial Staff Position SFAS 107-1 and Accounting Principles Board (APB)
Opinion No. 28-1). ASC 825 amends FASB Statement No. 107, Disclosures about Fair
Value of Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. This FSP also amends APB Opinion No.
28, Interim Financial Reporting, to require those disclosures in summarized
financial information at interim reporting periods. ASC 825 is effective for
interim and annual reporting periods ending after June 15, 2009. The adoption of
ASC 825 did not have an impact on the Company’s consolidated financial
statements.


11


In May
2009, the FASB issued new guidance for accounting for subsequent events. The new
guidance, which is now part of ASC 855-10, “Subsequent Events” (“ASC 855-10”)
(formerly, SFAS No. 165) is consistent with existing auditing standards in
defining subsequent events as events or transactions that occur after the
balance sheet date but before the financial statements are issued or are
available to be issued, but it also requires the disclosure of the date through
which an entity has evaluated subsequent events and the basis for that date. The
new guidance defines two types of subsequent events: “recognized subsequent
events” and “non-recognized subsequent events.” Recognized subsequent events
provide additional evidence about conditions that existed at the balance sheet
date and must be reflected in the company’s financial statements. Non-recognized
subsequent events provide evidence about conditions that arose after the balance
sheet date and are not reflected in the financial statements of a company.
Certain non-recognized subsequent events may require disclosure to prevent the
financial statements from being misleading. The new guidance was effective on a
prospective basis for interim or annual periods ending after June 15, 2009. We
adopted the provisions of ASC 855-10 as required.




In June
2009, the FASB issued new guidance which is now part of ASC 105-10, “The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles” (ASC 105-10) (formerly Statement of Financial Accounting
Standards No. 168), establishes the FASB Accounting Standards Codification as
the source of authoritative accounting principles recognized by the FASB to be
applied by nongovernmental entities in the preparation of financial statements
in conformity with generally accepted accounting principles. ASC 105-10 is
effective for interim and annual periods ending after September 15, 2009. The
adoption of ASC 105-10 did not have a material impact on the Company’s
consolidated financial statements.




In
January, 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair
Value Measurements. The standard amends ASC Topic 820, Fair Value Measurements
and Disclosures, to require additional disclosures related to transfers in and
out of Levels 1 and 2 and for activity in Level 3 and clarifies other existing
disclosures requirements. The Company adopted ASU 2010-06 beginning January 1,
2010. This update had no impact on the Company’s financial
statements.
 
 In April
2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-17, Milestone
Method of Revenue Recognition, which provides guidance on applying the milestone
method to milestone payments for achieving specified performance measures when
those payments are related to uncertain future events. However, the FASB
clarified that, even if the requirements in this ASU are met, entities would not
be precluded from making an accounting policy election to apply another
appropriate accounting policy that results in the deferral of some portion of
the arrangement consideration. The ASU is effective for periods beginning on or
after June 15, 2010. Entities can apply this guidance retrospectively as well as
prospectively to milestones achieved after adoption. This update is expected to
have no impact on the Company’s financial statements.
 
 ASU
2010-13, Effect of Denominating the Exercise Price of a Share-Based Payment
Award in the Currency of the Market in Which the Underlying Equity Security
Trades, amends Topic 718 to clarify that an employee share-based payment award
with an exercise price denominated in the currency of a market in which a
substantial portion of the entity’s equity securities trades should not be
considered to contain a condition that is not a market, performance, or service
condition.  Therefore, an entity would not classify such an award as a
liability if it otherwise qualifies as equity.  It is effective for
fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010.  The amendments should be applied by
recording a cumulative-effect adjustment to the opening balance of retained
earnings.  The cumulative-effect adjustment should be calculated for
all awards outstanding as of the beginning of the year in which the amendments
are initially applied, as if the amendments had been applied consistently since
the inception of the award.  Earlier application is
permitted.
  ASU
2010-09, Subsequent Events, amends FASB ASC 855-10 to clarify that whereas SEC
filers and conduit debt obligors for publicly-traded conduit debt securities
must evaluate subsequent events through the date that the financial statements
are issued, SEC filers need not disclose the date through which subsequent
events have been evaluated.  Non-SEC filers must evaluate subsequent
events through the date the financial statements are available to be issued, and
continue to be required to disclose that date.  The ASU also clarifies
that reissuances for which a subsequent events evaluation is required are
limited to “revised” financial statements (as defined in the
ASU).  The amendments are effective upon issuance (February 2010),
except as relating to conduit debt obligors, for which the effective date is
interim or annual periods ending after June 15, 2010.


Note 4. Long Term
Deposit





Long term
deposits to various telecommunication carriers  and office space
rental deposits amount to $384,235 as of September 30, 2010 compared with
$330,946 as of December 31, 2009. The deposits are refundable at the termination
of the business relationship with the carriers or termination of the rental
contracts.





Note 5. Prepaid Expenses and
other Current Assets





Prepaid
expenses and other current assets recorded as $ 2,115,050 as of September 30,
2010, compared with $2,657,019 as of December 31, 2009. The amounts comprise
prepaid Value Added Tax (“VAT”), unvested stock related compensation for
management & consultants and other general and administrative
expenses.





Note 6. Deferred Financing
Costs





Deferred
financing costs consist of commissions, warrants issued to placement agents,
associated expenses and legal fees for the 2009 private placement of units
consisting of notes and warrants, and for the 2010 QAT convertible loans. At
September 30, 2010 and December 31, 2009, deferred financing costs were
$1,550,589 and $3,033,277, respectively, and are amortized over the terms of
each of the notes and the 2010 QAT convertible loans, respectively.




Note 7. Property &
Equipment





The
Company’s Property & Equipment also include   the
capitalization of  its systems engineering and software programming
activities. Typically, these investments pertain to the Company’s:




·
            Intelligent Network (IN)
      platform





·
            CRM
    software





·
            Mediation, Rating & Pricing
      engine





·
            Operations
      and Business Support software





·
            Network management
      tools


12


Property
and equipment at September 30, 2010 and December 31, 2009 consist
of:





Average
                                          Estimated
                                          Useful Lives
                                        
                                        
                                        September 30,
                                          2010
                                        
                                        
                                        December 31,
                                          2009Furniture
      and fixtures
                                        
                                        5
                                        
                                        
                                        
                                        218,002
                                        
                                        
                                        
                                        219,469Computer,
      communication and network equipment
                                        
                                        3 -
      10
                                        
                                        
                                        
                                        9,164,598
                                        
                                        
                                        
                                        8,071,138Software
                                        
                                        5
                                        
                                        
                                        
                                        4,290,347
                                        
                                        
                                        
                                        4,410,714Automobiles
                                        
                                        5
                                        
                                        
                                        
                                        128,615
                                        
                                        
                                        
                                        135,455Construction
      in progress
                                        
                                        
                                        
                                        
                                        
                                        2,008,703
                                        
                                        
                                        
                                        1,009,96915,810,266
                                        
                                        
                                        
                                        13,846,745Less:
      accumulated depreciation
                                        
                                        
                                        
                                        
                                        
                                        (7,513,523
                                        )
                                        
                                        
                                        (6,072,883
                                        )$
                                        8,296,743
                                        
                                        
                                        $
                                        7,773,862




Total
depreciation expense for the three months ended September 30, 2010 and 2009 was
$494,031 and $624,499, respectively. Total depreciation expense for the nine
months ended September 30, 2010 and 2009 was $1,653,327 and $1,591,017,
respectively.




Note 8. Intangible Assets -
Customer Contracts, Licenses and Interconnects





Intangible
assets include customer contracts, telecommunication licenses and integrated,
multi-country, centrally managed switch-based interconnects as well as ValidSoft
Intellectual Property, including but not limited to software source codes,
applications, customer list & pipeline, registration & licenses, patents
and trademark/brands.





Average
                                  Estimated
                                
                                
                                September 30,
                                
                                
                                December 31,UsefulLives
                                
                                
                                2010
                                
                                
                                2009Customer Contracts, Licenses , Interconnect &Technology
                                
                                5 - 10
                                
                                
                                $
                                11,835,877
                                
                                
                                $
                                12,282,126Validsoft
      IP & Technology
                                
                                1 -
      10
                                
                                
                                
                                16,060,569
                                
                                
                                
                                —27,896,446
                                
                                
                                
                                12,282,126Less:
      Accumulated Amortization and impairment charges
                                
                                
                                
                                
                                
                                (8,652,991
                                )
                                
                                
                                (8,371,763
                                )Less:
      Accumulated Amortization Validsoft IP & Technology
                                
                                
                                
                                
                                
                                (1,736,844
                                )
                                
                                
                                —$
                                17,506,611
                                
                                
                                $
                                3,910,363





Intangible
asset amortization expense for the three months ended September 30, 2010 and
2009 was $987,420 and $237,117 respectively. Amortization expense for the nine
months ended September 30, 2010 and 2009 totaled $2,206,246 and $608,544
respectively.




Goodwill
                  
                  September
                    30,
                    2010
                  
                  
                  December 31,
                    2009Goodwill
      at acquisition (Note 9)
                  
                  $
                  3,433,833
                  
                  
                  
                  —End
      of period exchange rate translation
                  
                  
                  (113,908
                  )
                  
                  
                  —$
                  3,319,925
                  
                  
                  $
                  0




Estimated
future amortization expense related to our intangible assets is:







2010
                        remainder
                      
                      
                      2011
                      
                      
                      2012
                      
                      
                      2013
                      
                      
                      2014
                      
                      
                      2015
                      
                      
                      2015
                        thereafterInterconnect
      licenses and contracts
                      
                      
                      188,284
                      
                      
                      
                      753,136
                      
                      
                      
                      751,052
                      
                      
                      
                      728,144
                      
                      
                      
                      641,447
                      
                      
                      
                      120,823
                      
                      
                      
                      -ValidSoft
      IP & Technology
                      
                      
                      852,929
                      
                      
                      
                      3,048,804
                      
                      
                      
                      3,048,804
                      
                      
                      
                      3,048,804
                      
                      
                      
                      3,048,804
                      
                      
                      
                      843,856
                      
                      
                      
                      431,7241,041,213
                      
                      
                      
                      3,801,940
                      
                      
                      
                      3,799,856
                      
                      
                      
                      3,776,948
                      
                      
                      
                      3,690,251
                      
                      
                      
                      964,678
                      
                      
                      
                      431,724


13


Note
9   Acquisition of ValidSoft Ltd




On March
17, 2010 we issued 10,235,739 shares and 3,829,487 warrants as purchase price
consideration following the completion of the acquisition of ValidSoft of which
2,558,937 shares and 957,373 warrants are contingent upon meeting specific
targets following a stepped earn-out agreement.  Based upon a number
material  contracts not having been  concluded yet as of the
date of this report, the Company does not expect that the targets set forth in
the earn-out agreement, will be met at this point in time. Consequently, the
total value for the consideration is $16,033,688 comprising the fair market
value for the non-contingent shares of $12,129,352 and non-contingent warrants
of $3,904,336. The contingent consideration is held in escrow.  The Company
will continue to monitor the progress made and determine quarterly to what
extent  the stepped targets are likely to be met.




Consideration paid
                  
                  Total
                    Consideration
                  
                  
                  Non-
                    Contingent
                    Consideration
                  
                  
                  Contingent
                    ConsiderationNumber
      of shares
                  
                  
                  10,235,739
                  
                  
                  
                  7,676,805
                  
                  
                  
                  2,558,934Fair
      value (share price at 17 March 2010)
                  
                  $
                  1,58
                  
                  
                  $
                  12,129,352
                  
                  
                  
                  -Numer
      of warrants
                  
                  
                  3,829,487
                  
                  
                  
                  2,872,114
                  
                  
                  
                  957,373Fair
      Value (black-scholes)
                  
                  
                  
                  
                  
                  $
                  3,904,336Total
      Consideration Paid
                  
                  
                  
                  
                  
                  $
                  16,033,688




Following
the valuation of ValidSoft, we allocated the above purchase price to the
identifiable assets and liabilities of ValidSoft.





A summary
of the assets acquired and liabilities assumed for ValidSoft are:





Estimated
      fair values:Assets
      acquired
                  
                  $
                  16,677,323Liabilities
      assumed
                  
                  
                  4,077,467Net
      assets acquired
                  
                  
                  12,599,856Consideration
      paid
                  
                  
                  16,033,688Goodwill
                  
                  $
                  3,433,832




The
operating results of ValidSoft have been consolidated with those of the Company
starting April 1, 2010.




UNAUDITED
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION DISCLOSURE FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 2010 AND 2009





The
following un-audited pro forma consolidated financial information for the nine
months ended September 30, 2010 and 2009, as presented below, reflects the
results of operations of the Company as of January 1, 2010 and assuming that the
acquisition occurred on January  1, 2009, respectively, and after
giving effect to the purchase accounting adjustments. These pro forma results
have been prepared for information purposes only and do not purport to be
indicative of what operating results would have been had the acquisitions
actually taken place on January 1, 2010 and 2009 respectively, and may not be
indicative of future operating results.




Pro forma consolidated
                    
                    September 30,
                    
                    
                    September 30,2010
                    
                    
                    2009Revenues
                    
                    $
                    28,714,566
                    
                    
                    $
                    32,345,902Operating
      loss
                    
                    
                    (12,563,386
                    )
                    
                    
                    (11,546,220
                    )Net
      loss
                    
                    
                    (52,142,606
                    )
                    
                    
                    (13,775,893
                    )Loss
      per share - basic and fully diluted
                    
                    
                    (0.80
                    )
                    
                    
                    (0.23
                    )


14


Note: For comparison
purposes with 2009Operating Loss
of ($12,563,386) and Net loss of ($52,142,606) are exclusive of the amortization
charge incurred of $1,676,329 in the six months ending September 30, 2010
following the Fair Market Valuation of the assets of ValidSoft.





The
Company included the financial results of ValidSoft in its consolidated 2010
financial results from the date April 1, 2010 through September 30,
2010.




Further
details on the acquisition of ValidSoft can be found in our Current Report on
Form 8-K/A filed June2,
2010.





Note 10.
Overdraft





In 2004,
Elephant Talk Ltd. executed a credit facility with a bank in Hong Kong (the
“Lender”) pursuant to which Elephant Talk Ltd. has borrowed funds from the bank.
As of September 30, 2010 the overdraft balance included accrued interest in the
amount  $271,756 compared to $250,023 as of December 31, 2009. The
interest rate and default payment interest rate were charged at 2% and 6% per
annum above the Lender’s Hong Kong Dollar Prime Rate quoted by the Lender from
time to time. The Company has not guaranteed the credit facility nor is it
otherwise obligated to pay funds drawn upon it on behalf of Elephant Talk Ltd.,
although the bank alleges otherwise (see also Note 23 litigation). As of
September 30, 2010 Moba Consulting Partners B.V. had an overdraft of $92,429
compared to $101,566 as of December 31, 2009 on one of the company’s bank
accounts. The overdraft must be reduced to zero within 24 monthly installments
commencing September 2010.




Note 11. Accrued
Expenses





As of
September 30, 2010 and December 31, 2009, the accrued expenses comprised the
following:




September
                      30,
                    
                    
                    December 31,2010
                    
                    
                    2009Accrued
      Selling, General & Administrative expenses
                    
                    $
                    1,579,696
                    
                    
                    $
                    589,631Placement
      fees
                    
                    
                    —
                    
                    
                    
                    —Accrued
      cost of sales and network
                    
                    
                    405,120
                    
                    
                    
                    307,172Accrued
      taxes
                    
                    
                    1,304,626
                    
                    
                    
                    855,370Accrued
      interest payable
                    
                    
                    1,407,492
                    
                    
                    
                    552,393Other
                    
                    
                    578,067
                    
                    
                    
                    434,432Total
      accrued expenses
                    
                    $
                    5,275,001
                    
                    
                    $
                    2,738,998




Note 12. Convertible 14%
loan – related party





The
Company received interest-bearing loans in the first quarter at 14% per annum
from QAT II . The loans are due to be repaid 180 days after the date the loans
were made available to the Company or in the event another person or entity
consummates an equity or debt securities financing with the Company in the
amount of at least $5,000,000, upon notice to the Company.





These
loans included the option of conversion into equity under certain conditions. An
amendment to the Loan Agreement dated June 10, 2010, has affected the term and
conditions of the agreement. See Note 25: Related Party Transactions, for more
information.





The
principal convertible 14% loan amount to €1,850,000 and is subject to
re-valuation on a monthly basis, the current outstanding amount is $2,518,220 as
of September 30, 2010. The conversion feature of these loans  resulted
in the capitalization of Debt Discount which has been amortized during the
initial term of 180 days by using the effective interest method and has been
fully accounted for during 2010 and has no further effect on the Net Liability
as September 30, 2010.





Subsequent
to the date of this report all of these loans were converted into equity
(see Note 26 for details).


Breakdown of Convertible 14% Note
                    
                    Principal
                    
                    
                    Discount
                    
                    
                    Net
                      LiabilityConvertible
      14% note - related party
                    
                    $
                    2,518,220
                    
                    
                    $
                    (0
                    )
                    
                    $
                    2,518,220Totals
                    
                    $
                    2,518,220
                    
                    
                    $
                    (0
                    )
                    
                    $
                    2,518,220


15


Note
13.Loans
Payable





Loans
payable at September 30, 2010 and December 31, 2009 are summarized as
follows:




September
                        30,
                        2010
                      
                      
                      December 31,
                        2009Installment
      loan payable due December 24, 2006, secured by personalguarantees
      of two shareholders, a former director, and a third party
                      
                      $
                      320,211
                      
                      
                      $
                      320,339Installment
      loan payable, bank, monthly principal and interest payments of $2,798
      including interest at bank's prime rate plus 1.5% per annum, 8.25% at
      November 30, 2008, due December 24, 2011, secured by personal guarantees
      of three shareholders and a former director
                      
                      
                      191,331
                      
                      
                      
                      191,407Installment
      loan payable, bank, monthly principal and interest payments of $1,729
      including interest at bank's prime rate plus 1.5% per annum, 8.25% at
      November 24, 2008, due June 28, 2009, secured by personal guarantees of
      three shareholders and a former director
                      
                      
                      85,071
                      
                      
                      
                      85,106Term
      loan payable, bank, monthly payments of interest at bank's prime rate,
      7.0% at June 30, 2010
                      
                      
                      283,571
                      
                      
                      
                      283,684Total
                      
                      $
                      880,184
                      
                      
                      $
                      880,536





Elephant
Talk Ltd. executed a credit facility with a bank in Hong Kong on June 29, 2004
under which Elephant Talk Ltd. has borrowed funds from the bank under three
installment loans and a term loan arrangement. Elephant Talk Ltd. is in default
of making loan payments on all the loans and has recorded an accrued interest
amounting to $626,818 as of September 30, 2010. As a result of the default, the
entire loan balance outstanding at September 30, 2010 is due and payable to the
bank. Furthermore, Elephant Talk Ltd. is obligated to pay a default interest
rate at the rate of 4.25% per annum in addition to the prescribed interest rate
of the installment loans and term loan. Elephant Talk Ltd. has recorded $4,803
and $19,535 in interest expense and default interest expense, respectively, on
loans payable as of September 30, 2010 and September 30, 2009 and $69,622 and
$86,934 in interest expense as of September 30, 2010 and September 30, 2009,
respectively. The Company has not guaranteed the credit facility nor is it
otherwise obligated to pay funds drawn upon it on behalf of Elephant Talk Ltd.,
although the bank alleges otherwise (see also Note 23 litigation).




Note 14. Long term
debt





The
Company’s 51% owned subsidiary ET-UTS N.V. has received $459,505 in interest
bearing (8% per annum) unsecured loans from United Telecommunication Services
N.V., the 49% shareholder in the subsidiary. No maturity has been
fixed.





Note 15. 12% Secured
Convertible Promissory Notes





On July
31, August 18, September 3, September 30 and October 30, 2009, the Company
consummated closings of its 2009 private placement offerings of units (the “2009
private placement”) comprised of 12% secured convertible promissory notes (the
“Notes”) and warrants (the “Warrants”) to purchase shares of common stock to
accredited investors. The securities were offered and sold pursuant to an
exemption from registration under Section 4(2) of the Securities Act. The
Company sold an aggregate of $12,333,020 principal amount of Notes and delivered
Warrants to purchase an aggregate of 12,333,020 shares of the Company’s common
stock at a purchase price of $1.00 per share. The Company used the net proceeds
from the 2009 private placement primarily for working capital.




The value
of the Warrants to the investors of the 2009 private placement has been
capitalized and off set against the liability for the Notes. This resulted in a
debt discount of $12,333,020 incurred in connection with the 2009 private
placement. The debt discount will be amortized over the term of the Notes using
the effective interest method.


16





Breakdown of Convertible 12% Secured Note
                    
                    Principal
                    
                    
                    Conversions
                    
                    
                    Net
                      Principal
                    
                    
                    Net
                      Discount
                    
                    
                    Net
                      LiabilityConvertible
      12% secured note – related party
                    
                    $
                    5,332,383
                    
                    
                    $
                    0
                    
                    
                    $
                    5,332,383
                    
                    
                    $
                    5,203,035
                    
                    
                    $
                    129,348Convertible
      12% secured note - third party
                    
                    $
                    7,000,637
                    
                    
                    $
                    286,000
                    
                    
                    $
                    6,714,637
                    
                    
                    $
                    6,549,043
                    
                    
                    $
                    165,594Totals
                    
                    $
                    12,333,020
                    
                    
                    $
                    286,000
                    
                    
                    $
                    12,047,020
                    
                    
                    $
                    11,752,078
                    
                    
                    $
                    294,942




The Notes
are convertible at the option of the holder into no par value common stock of
the Company at a conversion price equal to $1.35. During the second and third
quarter of 2010 a principal amount of $286,000 of the outstanding
Notes were converted into common stock. This has resulted in an
accelerated accretion of the relating debt discount (see “Breakdown of
Convertible 12% Secured Note Discount,” below). The related number of shares of
common stock issued is 213,789 which also included  noteholders’
accumulated interest up to their respective dates of conversion.




Breakdown of Convertible 12% Secured Note Discount
                    
                    Initial
                      Discount
                    
                    
                    Regular
                      Accretions
                    
                    
                    Accelerated
                      Accretions
                    
                    
                    Net
                      DiscountConvertible
      12% secured note - related party
                    
                    $
                    5,332,383
                    
                    
                    $
                    129,348
                    
                    
                    $
                    -
                    
                    
                    $
                    5,203,035Convertible
      12% secured note - third party
                    
                    $
                    7,000,637
                    
                    
                    $
                    169,338
                    
                    
                    $
                    282,256
                    
                    
                    $
                    6,549,043Totals
                    
                    $
                    12,333,020
                    
                    
                    $
                    298,686
                    
                    
                    $
                    282,256
                    
                    
                    $
                    11,752,078





The
conditions of the outstanding $5.3 million Note to QAT II  were
amended on June 10, 2010, to provide for  a forced conversion of their
outstanding $5.3 million Note when an aggregate amount of $11 million is raised
in connection with the 2010  Private Placement Offering. The valuation
in Note 17 of the “Conversion Feature” is based upon our expectation that
we would  raise at least $11 million in connection with the 2010
Private Placement Offering. The final closing of this offering took place in
October 2010 and did exceed a total raise of $11 million and accordingly we
met  the condition of the forced conversion of the notes.
Consequently, these related party notes were converted into equity. See also
Note 25 (Related Party Transactions) and Note 26 (Subsequent
Events).




Note 16. Warrant
liabilities




Outstanding warrants consisted of the following as of September 30, 2010:
                      
                      Initial Fair
                        Value
                      
                      
                      Fair Mark-
                        to- Market
                        Value as per
                        December
                        31, 2009
                      
                      
                      Fair Mark-
                        to- Market
                        Value as per
                        September
                        30, 2010Investor
      Warrants - Related to 2009 Prommissory Note issue
                      
                      $
                      14,284,242
                      
                      
                      $
                      14,359,363
                      
                      
                      $
                      23,237,846Placement
      Agent Warrants - Related to the 2009 Prom. Note issue
                      
                      $
                      2,285,479
                      
                      
                      $
                      2,266,762
                      
                      
                      $
                      3,388,9992010
      QAT II Loan Warrants (part I)
                      
                      $
                      3,042,617
                      
                      
                      $
                      -
                      
                      
                      $
                      3,986,8262010
      QAT II Loan Warrants (part II)
                      
                      $
                      5,718,467
                      
                      
                      $
                      -
                      
                      
                      $
                      7,973,651$
                      25,330,805
                      
                      
                      $
                      16,626,125
                      
                      
                      $
                      38,587,322




Investor
and placement agent warrants – 12% secured convertible note




We issued
Warrants in connection with the 2009 private placement. The Warrants include
conversion provisions that require us to record them at fair value as a
liability in accordance with ASC 815 (formerly EITF 00-19), with subsequent
changes in fair value recorded as a non-operating gain or loss in our statement
of operations. The fair value of the warrants is determined using a
Black-Scholes option pricing model, and is affected by changes in inputs to that
model including our stock price, expected stock price volatility, interest rates
and expected term. The fair value of the Warrants issued to investors and
placement agents in connection with the 2009 private placement was $16,569,721
upon issuance and is valued at $26,626,845 as of September 30,
2010.





During
the second and third quarter of 2010 some of the Warrants relating to the 2009
private placement were exercised. The total outstanding number of Warrants,
including the warrants issued to the selling agents has decreased by
944,828. The total outstanding Warrants, including the warrants issued to
the selling agent in connection with the 2009 private placement was reduced to
13,361,475 Warrants. The number of shares of common stock issued in connection
with the aforementioned exercises was lower than the number of warrants
exercised as the warrantsinclude a cashless exercise option.


17




Outstanding warrants consisted of the following as of September 30, 2010:
                                      
                                      Initial
                                        number of
                                        warrants
                                        issued
                                      
                                      
                                      Exercised
                                      
                                      
                                      Outstanding
                                        warrantsInvestor
      Warrants - Related to 2009 Prommissory Note issue
                                      
                                      
                                      12,333,020
                                      
                                      
                                      
                                      665,000
                                      
                                      
                                      
                                      11,668,020Placement
      Agent Warrants - Related to the 2009 Prom. Note issue
                                      
                                      
                                      1,973,283
                                      
                                      
                                      
                                      279,828
                                      
                                      
                                      
                                      1,693,45514,306,303
                                      
                                      
                                      
                                      944,828
                                      
                                      
                                      
                                      13,361,475





2010
QAT II loan warrants




In the
first quarter of 2010, 2,513,195 warrants were issued to QAT IIas part of
the loan agreements for the loans granted for a total amount of € 1,850,000. The
total value of these warrants has initially been valued at $3,042,617 and as per
September 30, 2010 they are valued at $3,986,826. The change in fair value of
$944,209 was recorded in the income statement.





During
the second quarter, we amended the convertible 14% loan agreements with QAT II,
resulting in the issuance of an additional 5,026,390 warrants to QAT II, based
on the amount of warrants originally issued in connection with the
loans.  These warrants were valued at $5,718,467 and recorded as a
warrant liability on the balance sheet and as an expense in the income
statement.





For
details on the abovementioned amendment see Note 25: “Related Party
Transactions”.





ValidSoft
acquisition warrants




In the
first quarter of 2010, we acquired ValidSoft Ltd. The former shareholders of
Validsoft were granted warrants to purchase shares of our common stock as part
of the acquisition price. The initial value of these warrants was $3,904,337 and
has been accounted for as capital in the common stock section of
the balance sheet.




Note 17. Conversion
feature





12%
secured convertible note





A
conversion feature (holders of the Notes will receive a discount of 15% when
converting the Note into shares instead of cash repayment) was recognized at
fair value on the respective issuance dates of the Notes as a discount and will
be amortized using the effective interest rate method from issuance to the
maturity date of the respective Notes. The conversion feature has been marked to
market each previous reporting dates with subsequent changes in fair value which
have been recorded as non-operating gains or losses in our income
statement.




Pursuant
to the terms of the Notes, the conversion price
is  $1.35.  This amount is equal to eighty-five percent
(85%) of the twenty (20) day average closing price of our common stock for the
twenty (20) trading days prior to March 31, 2010. Note holders may convert their
Notes into shares of common stock at the conversion price, in full or in part,
at any time before the maturity date. Since this conversion feature has the
characteristics of an option to purchase shares at a fixed price per share, the
fair market value was calculated by using the Black-Scholes option pricing
model. The fair value of the existing conversion feature was $13,178,191 as of
September 30, 2010.





The 2010
valuation of the conversion feature described above is based upon our
expectation that the current equity raise of the Private Placement Offering
would be at least $11 million which would cause the automatic conversion of the
Note held by QAT II in accordance with the conversion terms equal to the 2010
Private Placement Offering of $ 1.20 per share. The final closing of this
offering took place in October 2010 and exceeded  a total raise of $11
million and were these Notes converted into equity in October 2010. See Note 26
for more details.


18


2010
QAT II loans





During
the first quarter of 2010, the company received additional loans from QAT II
aggregating a total of €1,850,000 (with a current book value of $2,518,220)
which included the right for QAT II to convert the principal and accrued
interest outstanding as of the date of the consummation of an equity or debt
financing in the amount of at least US$5,000,000 (a “Placement”) into the same
type of equity or debt securities issued in connection with the Placement and
pursuant to the same terms and conditions of such Placement. The conversion
share price was  determined at $1.20 and the conversion date for
valuation purposes has been set at August 31, 2010.  Since this
conversion feature has the characteristics of an option to purchase shares at a
fixed price per share, the fair market value was calculated by using the
Black-Scholes option pricing model. The fair value of the existing conversion
feature has been calculated at $3,175,602 as of September 30, 2010.




Outstanding Conversion Feature Liability consisted
      of the following as of September 30, 2010:
                                    
                                    Initial Fair
                                      Value
                                    
                                    
                                    Fair Mark-to-
                                      Market Value
                                      as per
                                      December 31,
                                      2009
                                    
                                    
                                    Fair Mark-to-
                                      Market Value
                                      as per
                                      September 30,
                                      2010Conversion
      Feature - Related to 15% discount on 2009 PromNote
      issue
                                    
                                    $
                                    2,418,819
                                    
                                    
                                    $
                                    2,899,801
                                    
                                    
                                    $
                                    13,178,191Conversion
      Feature - Related to conversion right 2010 QAT II Loans
                                    
                                    $
                                    250,000
                                    
                                    
                                    $
                                    0
                                    
                                    
                                    $
                                    3,175,602$
                                    2,668,819
                                    
                                    
                                    $
                                    2,899,801
                                    
                                    
                                    $
                                    16,353,793




Note 18. Stockholders’
Equity





(A)
Common Stock





The
Company is presently authorized to issue 250,000,000 shares common stock. The
Company had 73,367,458 shares of common shares issued and outstanding as of
September 30, 2010, an increase of 19,671,474 shares since December 31, 2009,
largely due to the shares issued in connection with the ValidSoft acquisition
(7,638,424), the Bridge Financing (2,885,000), and shares issued in relation
with the 2010 Private Placement Offering (6,989,638).  The number
excludes the 245,900 unreturned and the 2,558,934 escrowed contingent shares
mentioned below.  The number shares issued and outstanding as
of November 12, 2010 is 88,462,305, which includes
245,900 shares which were cancelled by the Company prior to 2006 as well as the
2,558,934 contingent shares issued for the ValidSoft acquisition. The 245,900
shares were not returned to our transfer agent and never cancelled on their
records. These shares have been blocked for trading by our transfer agent. The
contingent shares are held in escrow for the contingent consideration of the
ValidSoft consideration. The contingent consideration will be recorded when the
contingency is resolved.





ValidSoft
acquisition warrants




In the
first quarter of 2010, we acquired ValidSoft and the former shareholders of
Validsoft were granted warrants to purchase shares of  our common
stock as part of the acquisition price. The initial value of these warrants was
$3,904,337 and has been accounted for as capital in the common
stock.





(B)
Shares to be issued





Following
the sale of securities pursuant to a conversion notice of 2009 Notes and shares
issued as compensation, a total number of 209,488 shares remain to be issued,
valued at $351,788.




Note 19. Basic and Diluted
Net Loss Per Share





Net loss
per share is calculated in accordance with ASC 260 “Earnings per Share”
(formerly SFAS No.128). Basic net loss 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 loss per share is the same since the effect of
dilutive securities is anti-dilutive.


19


Note 20. Employee Benefit
Plan and Non-Qualified Stock Option and Compensation Plan





2000
Employee Benefit Plan





The
Company adopted an employee benefit plan “The 2000 Employee Benefit Plan” (the
“Plan”) on May 30, 2000. Under the Plan, the Company may issue shares or grant
options to acquire the Company’s common stock, no par value, from time to time
to employees of the Company or its subsidiaries. In addition, at the discretion
of the Board of Directors, shares may be granted under this Plan to other
individuals, including consultants or advisors, who contribute to the success of
the Company or its subsidiaries, provided that bona fide services shall be
rendered by consultants and advisors and such services must not be in
conjunction with the offer or sale of securities in a capital raising
transaction. No stock may be issued or options granted under the Plan to
consultants, advisors or other persons who directly or indirectly promote or
maintain a market for the Company’s securities. The Plan is intended to aid the
Company in maintaining and developing a management team, attracting qualified
officers and employees capable of assuring the future success of the Company,
and rewarding those individuals who have contributed to the success of the
Company. The Plan is administrated under the direction of the Board of
Directors. A total of 160,000 common shares and 160,000 stock options to acquire
common shares may be subject to, or issued pursuant to, benefits granted under
the Plan. At any time any stock option is granted under the terms of this Plan,
the Company will reserve for issuance the number of shares of stock subject to
such option until it is exercised or expired. The Plan Administrator shall
determine from time to time the terms, conditions and price of the options
granted. Options shall not be construed to be stock and cannot be exercised
after the expiration of its term. Under the Plan, 12,000 shares of common stock
and 160,000 stock options remain available for grant at September 30,
2010.





2006
Non-Qualified Stock and Option Compensation Plan





Under our
2006 plan there are, as of September 30, 2010, 341,942 stock options
outstanding. There are remaining 600,000 shares and 58,058 stock options
available for grant.





Options
granted generally vest over a three year period. Options generally expire two
years from the date of vesting.





Common
stock purchase options and warrants consisted of the following as of September
30, 2010:




Number
                                      of
                                      shares
                                    
                                    
                                    Exercise
                                      Price
                                    
                                    
                                    Initial Fair
                                      Market
                                      ValueOptions:Outstanding
      as of December 31, 2009
                                    
                                    
                                    344,342
                                    
                                    
                                    $
                                    2.25
                                    
                                    
                                    $
                                    453,917Granted
      in 2010
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —Exercised
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —Cancelled/Forfeited
                                    
                                    
                                    2,400
                                    
                                    
                                    $
                                    2.25
                                    
                                    
                                    $
                                    3,708Outstanding
      as of September 30, 2010
                                    
                                    
                                    341,942
                                    
                                    
                                    $
                                    2.25
                                    
                                    
                                    $
                                    450,209





The
options were granted with an exercise price of $2.25, the share closing price as
of September 26, 2007. The options generally vested as of December 31, 2009, or
will vest (if unvested) if there is a change of control in the
Company.





No
options have been issued or granted under this plan in 2010. Due to the fact
that an employee left the company, 2,400 options on shares have been
forfeited.




Following
is a summary of the status of options outstanding under the 2006 plan at
September 30, 2010:





Options outstanding
                                                          
                                                          
                                                          Options exercisableRange of
                                                            Exercise
                                                            Prices
                                                          
                                                          
                                                          Total
                                                            Options
                                                            Outstanding
                                                          
                                                          
                                                          Weighted
                                                            Average
                                                            Remaining
                                                            Life
                                                            (Years)
                                                          
                                                          
                                                          Weighted
                                                            Average
                                                            Exercise
                                                            Price
                                                          
                                                          
                                                          Options
                                                            Exercisable
                                                          
                                                          
                                                          Weighted
                                                            Average
                                                            Exercise
                                                            Price$
                                                          2.25
                                                          
                                                          
                                                          
                                                          341,942
                                                          
                                                          
                                                          
                                                          1.61
                                                          
                                                          
                                                          $
                                                          2.25
                                                          
                                                          
                                                          
                                                          266,942
                                                          
                                                          
                                                          $
                                                          2.25





At
September 30, 2010, the total compensation cost related to unvested stock-based
awards granted to employees under the provisions of ASC 718 and the Company’s
2006 stock award plan, but not yet recognized was approximately
$19,050.


20


2008
Long-Term Incentive Plan





The 2008
Long-Term incentive plan was adopted on January 15, 2008, and approved by our
shareholders on the same date at our annual meeting. The 2008 Long-Term
incentive authorizes awards of up to 5,000,000 shares of common stock, in the
form of incentive and non-qualified stock options, stock appreciation rights,
performance units, restricted stock awards and performance bonuses. The amount
of common stock underlying the awards to be granted remained the same after the
25 to one reverse stock-split that was effectuated on June 11, 2008. As of
September 30, 2010, a total of 4,153,600 stock options and 832,300 shares had
been granted under this plan. Options granted generally begin vesting over a
three-year period after grant date although options have been granted with a
shorter period than three years. Options granted in the beginning expire two
years from the date of vesting but the latest in 2010 issued options remain
exercisable for nine years from the date of vesting. It is expected that future
options will be awarded with the nine-year exercise period after
first vesting.





Common
stock purchase options and warrants consisted of the following as of September
30, 2010:





Number
                                    of
                                    shares
                                  
                                  
                                  Average
                                    Exercise
                                    Price
                                  
                                  
                                  Initial
                                    Fair
                                    Market
                                    ValueOptions:Outstanding
      as of December 31, 2009
                                  
                                  
                                  976,000
                                  
                                  
                                  $
                                  0.89
                                  
                                  
                                  $
                                  758,900Granted
      in 2010
                                  
                                  
                                  3,271,000
                                  
                                  
                                  $
                                  1.49
                                  
                                  
                                  $
                                  4,537,538Exercised
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —Cancelled/Forfeited
                                  
                                  
                                  93,400
                                  
                                  
                                  $
                                  1.33
                                  
                                  
                                  $
                                  104,730Outstanding
      as of September 30, 2010
                                  
                                  
                                  4,153,600
                                  
                                  
                                  $
                                  1.35
                                  
                                  
                                  $
                                  5,191.708





The
options granted pursuant to this plan in 2010 were granted with an average
exercise price of $1.49. The initial fair market value of the options granted
using the Black-Sholes options model for these options has been valued at
$4,537,538 at their initial grant-dates. In the third quarter we have
reconsidered the churn rate we use in our model for employees leaving the
company before the date of exercise. The churn rate was changed from 1.58% to
2.47% as reflecting the actual churn on staff. The result has been included
in our income statement for the period ending September 30, 2010.




Following
is a summary of the status of options outstanding under the 2008 Long-Term
Incentive Plan at September 30, 2010:





Options outstanding
                                                    
                                                    
                                                    Options exercisableRange of
                                                      Exercise
                                                      Price
                                                    
                                                    
                                                    Total
                                                      Options
                                                      Outstanding
                                                    
                                                    Weighted
                                                      Average
                                                      Remaining
                                                      Life
                                                      (Years)
                                                    
                                                    Weighted
                                                      Average
                                                      Exercise
                                                      Price
                                                    
                                                    
                                                    Options
                                                      Exercisable
                                                    
                                                    
                                                    Weighted
                                                      Average
                                                      Exercise
                                                      Price$
                                                    0.60-2.50
                                                    
                                                    
                                                    
                                                    4,153,600
                                                    
                                                    8,15
      years
                                                    
                                                    $
                                                    1.352
                                                    
                                                    
                                                    
                                                    325,000
                                                    
                                                    
                                                    $
                                                    1.09





The
weighted average assumptions used so far for the options granted in 2010 using
the Black-Scholes options model are: volatility of 136%, term of 9.95 years and
a Risk Free Interest Rate assumption of 3.663%. The expected dividend yield is
zero.




At
September 30, 2010 the total compensation cost related to unvested stock-based
awards granted to employees under the provisions of ASC 718 and the Company’s
2008 stock award plan, but not yet recognized in the profit and loss was
approximately $2,949,488





Note 21.
Commitments





As of
September 30, 2010 commitments of the Company relating to leases, co-location,
interconnect and office rents are as follows:


21





December
      31, 2010
                  
                  
                  1,227,018December
      31, 2011
                  
                  
                  3,263,192December
      31, 2012
                  
                  
                  2,638,070December
      31, 2013
                  
                  
                  2,264,046December
      31, 2014
                  
                  
                  459,821Total
                  
                  $
                  9,852,147




Note
22.Minority
interests in subsidiaries





The
Company had minority interests in several of its subsidiaries. The balance of
the minority interests as of September 30, 2010 and December 31, 2009 were as
follows:




Noncontrolling interest Balance atSubsidiary
                            
                            Noncontrolling
                              Interest%
                            
                            
                            September30,
                              2010
                            
                            
                            December31,
                              2009ETC
      PRS UK
                            
                            
                            49
                            %
                            
                            $
                            9,985
                            
                            
                            $
                            10,516ETC
      PRS Netherlands
                            
                            
                            49
                            %
                            
                            
                            133,370
                            
                            
                            
                            140,462ET
      ME&A Holding WLL
                            
                            
                            40
                            %
                            
                            
                            —
                            
                            
                            
                            —ET
      Bahrain WLL
                            
                            
                            1
                            %
                            
                            
                            5,912
                            
                            
                            
                            3,180ET
      ME&A FZ LLC
                            
                            
                            49.46
                            %
                            
                            
                            35,245
                            
                            
                            
                            35,242ET
      UTS Curacao
                            
                            
                            49
                            %
                            
                            
                            —
                            
                            
                            
                            —Total
                            
                            
                            
                            
                            
                            $
                            184,512
                            
                            
                            $
                            189,400




Note 23.
Litigation





(a)
Rescission of the Purchase Agreement of May 24, 2004 of New Times Navigation
Limited.




As
previously described in our 2004 Annual Report we and New Times Navigation
Limited mutually agreed to terminate this purchase agreement. We returned the
received shares of New Times Navigation Limited to the concerned shareholders
and received back 90,100 of our common stock out of the 204,000 issued by us for
the purchase. In addition we issued 37 unsecured convertible promissory notes
for a total amount of $3,600,000. On our request 21 notes were returned with a
total value of $2,040,000.





We are
presently seeking relief from the High Court of the Hong Kong Special
Administrative Region against the holders of the unreturned shares to return a
total of 113,900 common shares (valued at $381,565) and also to have them return
the remaining 18 unsecured convertible promissory notes representing a total
amount of $1,740,000 and rescind the purchase agreement. The case is currently
pending.




(b)
Manu Ohri Litigation





In March
2009 Manu Ohri (“Ohri”), our former Chief Financial Officer from 2002 to 2006,
commenced a lawsuit against the Company in the California Orange County Superior
Court called Manu Ohri v. Elephant Talk Communications, Inc., Case No.
30-20009-00120609.  Ohri alleges that the Company breached a 2006
written employment contract, a 2007 oral consulting contract, and otherwise owes
him the reasonable value of consulting services rendered.  Ohri seeks
damages of $446,359 under the alleged employment contract, $56,951 under the
alleged oral consulting agreement, stock options that he values at $96,960 under
the alleged oral consulting agreement, pre-judgment interest, and costs of the
litigation.  The Company denies Ohri's allegations and asserts several
affirmative defenses.





The
Company commenced a cross-complaint against Ohri to, among other things,
invalidate his alleged 2006 employment contract and stock bonus, and to recover
the stock bonus or its fair market value.





The
parties return to court on December 3, 2010, at which time the court is expected
to rule on the Company’s pending motion for summary adjudication and set a trial
date thereafter.


22


(c)
Bruce Barren Litigation





In
December 2009 Bruce Barren (“Barren”), a former director of the Company between
January 2008 and May 2009, commenced a lawsuit in the California Los Angeles
County Superior Court called Bruce Barren v. Elephant Talk Communications, Inc.,
Case No. BC429032.  Barren alleges that the Company breached a
restricted stock agreement, the implied covenant of good faith and fair dealing,
an oral employment agreement, and otherwise owes him the reasonable value of
consulting services rendered.  The Company denies Barren’s allegations
and asserts several affirmative defenses.  The Company contends that
Barren’s claims are without merit, and that a September 2009 settlement
agreement and general release between Barren and the Company bars all of his
claims as a matter of law.





The
Company has a motion for summary judgment set for hearing on December 16,
2010.  A jury trial is scheduled to start February 7,
2011.





(d)
Chong Hing Bank Litigation





In
December 2009 Chong Hing Bank Limited, fka Liu Chong Hing Bank Limited, a
foreign banking services company based in Hong Kong (the “Bank”), commenced a
lawsuit in the California Orange County Superior Court called Chong Hing Bank
Limited v. Elephant Talk Communications, Inc., Case No.
30-2009-00328467.  The Bank alleges that it entered into various
installment loan agreements and an overdraft account with Elephant Talk Limited
(“ETL”), a Hong Kong subsidiary of the Company.  Several former
officers and directors of ETL personally guaranteed the loans and overdraft
account. The Bank alleges that ETL is in default on the loans and overdraft
account, and that $1,536,792.28 plus interest is currently due.  The
Bank alleges that the Company is directly liable to repay the loans and
overdraft account.  The Bank is suing the Company for breach of
contract and common counts.  The Company denies the Bank’s allegations
and asserts several affirmative defenses.  The Company contends that
as a matter of law the Bank must pursue its recourse against ETL and its
personal guarantors.





The
Company and the Bank have cross-motions for summary judgment set for hearing on
January 11, 2011.  A jury trial is scheduled to start February 14,
2011.




Note 24. Segment
Information




Nine
months ended September 30, 2010




EUROPENetherlands
                  
                  
                  Spain
                  
                  
                  Switzerland
                  
                  
                  Others
                  
                  
                  Total
                  
                  
                  FarEast
                    Hong Kong / China
                  
                  
                  MiddleEast
                  
                  
                  TheAmericas
                  
                  
                  TOTALRevenues
      from unaffiliated customers:
                  
                  $
                  21,371,865
                  
                  
                  
                  1,378,700
                  
                  
                  
                  5,011,703
                  
                  
                  
                  296,395
                  
                  
                  $
                  28,058,662
                  
                  
                  $
                  -
                  
                  
                  $
                  561,419
                  
                  
                  $
                  37,907
                  
                  
                  $
                  28,657,987Operating
      income (loss)
                  
                  $
                  (2,154,011
                  )
                  
                  $
                  (98,152
                  )
                  
                  $
                  (2,238,444
                  )
                  
                  $
                  (2,781,935
                  )
                  
                  $
                  (7,272,542
                  )
                  
                  $
                  (173,579
                  )
                  
                  $
                  52,489
                  
                  
                  $
                  (5,621,231
                  )
                  
                  $
                  (13,014,863
                  )Net
      income (loss):
                  
                  $
                  (2,126,975
                  )
                  
                  $
                  (98,152
                  )
                  
                  $
                  (2,232,100
                  )
                  
                  $
                  (2,821,309
                  )
                  
                  $
                  (7,278,537
                  )
                  
                  $
                  (871,263
                  )
                  
                  $
                  52,489
                  
                  
                  $
                  (44,445,633
                  )
                  
                  $
                  (52,542,944
                  )Identifiable
      assets
                  
                  $
                  5,443,844
                  
                  
                  $
                  1,504,281
                  
                  
                  $
                  11,087,595
                  
                  
                  $
                  18,802,062
                  
                  
                  $
                  36,837,782
                  
                  
                  $
                  831,390
                  
                  
                  
                  496,535
                  
                  
                  
                  3,522,180
                  
                  
                  $
                  41,687,887Depreciation
      and amortization
                  
                  $
                  (84,866
                  )
                  
                  $
                  (158,309
                  )
                  
                  $
                  (1,465,112
                  )
                  
                  $
                  (1,679,073
                  )
                  
                  $
                  (3,387,360
                  )
                  
                  $
                  (41,778
                  )
                  
                  $
                  (21,803
                  )
                  
                  $
                  (390,632
                  )
                  
                  $
                  (3,841,573
                  )Capital
      expenditure
                  
                  $
                  1,483
                  
                  
                  $
                  2,041
                  
                  
                  $
                  2,261,991
                  
                  
                  $
                  92,461
                  
                  
                  $
                  2,414,927
                  
                  
                  $
                  15,890
                  
                  
                  $
                  -
                  
                  
                  $
                  17,462
                  
                  
                  $
                  2,448,278


23


Nine
months ended September 30, 2009




EUROPENetherlands
                  
                  
                  Spain
                  
                  
                  Switzerland
                  
                  
                  Others
                  
                  
                  Total
                  
                  
                  Far East
                    Hong Kong / China
                  
                  
                  Middle East
                  
                  
                  The Americas
                  
                  
                  TOTALRevenues
      from unaffiliated customers:
                  
                  $
                  24,744,166
                  
                  
                  $
                  1,743,437
                  
                  
                  $
                  4,464,170
                  
                  
                  $
                  410,044
                  
                  
                  $
                  31,361,817
                  
                  
                  $
                  753
                  
                  
                  $
                  833,201
                  
                  
                  $
                  -
                  
                  
                  $
                  32,195,771Operating
      income (loss)
                  
                  $
                  (1,572,876
                  )
                  
                  $
                  243,274
                  
                  
                  $
                  (2,392,343
                  )
                  
                  $
                  (425,741
                  )
                  
                  $
                  (4,147,686
                  )
                  
                  $
                  (135,674
                  )
                  
                  $
                  (73,530
                  )
                  
                  $
                  (3,419,473
                  )
                  
                  $
                  (7,776,364
                  )Net
      income (loss):
                  
                  $
                  (1,555,380
                  )
                  
                  $
                  243,260
                  
                  
                  $
                  (2,391,930
                  )
                  
                  $
                  (424,453
                  )
                  
                  $
                  (4,128,504
                  )
                  
                  $
                  (845,023
                  )
                  
                  $
                  (75,371
                  )
                  
                  $
                  (5,063,396
                  )
                  
                  $
                  (10,112,294
                  )Identifiable
      assets
                  
                  $
                  5,758,134
                  
                  
                  $
                  1,685,012
                  
                  
                  $
                  11,348,366
                  
                  
                  $
                  514,546
                  
                  
                  $
                  19,306,058
                  
                  
                  $
                  543,273
                  
                  
                  $
                  645,461
                  
                  
                  $
                  4,099,902
                  
                  
                  $
                  24,594,694Depreciation
      and amortization
                  
                  $
                  (79,513
                  )
                  
                  $
                  (153,615
                  )
                  
                  $
                  (1,362,699
                  )
                  
                  $
                  (57,997
                  )
                  
                  $
                  (1,653,825
                  )
                  
                  $
                  (37,404
                  )
                  
                  $
                  (31,136
                  )
                  
                  $
                  (477,196
                  )
                  
                  $
                  (2,199,561
                  )Capital
      expenditure
                  
                  $
                  104,799
                  
                  
                  $
                  1,308
                  
                  
                  $
                  2,553,695
                  
                  
                  $
                  -
                  
                  
                  $
                  2,659,802
                  
                  
                  $
                  295,665
                  
                  
                  $
                  -
                  
                  
                  $
                  207,132
                  
                  
                  $
                  3,162,599





Note 25. Related Party
Transactions





12%
Secured convertible note





On June
10, 2010 and at our request, QAT II entered into an agreement with us with
respect to the mandatory conversion of the total principal amounts outstanding
under the Notes to QAT II ($4 million issued July 31, 2009 and $1.3 million
issued October 31, 2009, totaling $ 5.3 million), in the event the Company
raises a minimum of $11 million in connection with the 2010 Private Placement
Offering.





The
Company and QAT II agreed the unpaid principal due pursuant to the Notes,
excluding any accrued but unpaid interest or other fees due on such Notes, would
be exchanged for units, at a price of $1.20 per unit and on the same terms and
conditions as the 2010 Private Placement Offering, upon our raising an aggregate
of $11 million in connection with our 2010 Private Placement Offering (also see
item “Unregistered Sales of Equity Securities and Use of
Proceeds”).





Loan
agreements




On
February 2, 2010, we entered into a loan agreement with QAT II. Pursuant to this
loan agreement, QAT II Investments agreed to lend to us the sum of €350,000
($488,775 based on the February 2, 2010 exchange rate published in the Wall
Street Journal). The proceeds were made available to the Company on February 2,
2010.


24


On
February 24, 2010, we entered into a loan agreement with QAT
II.  Pursuant to this loan agreement, QAT II Investments agreed to
lend us the sum of €850,000 ($1,150,390 based on the February 24, 2010 exchange
rate published in the Wall Street Journal). The proceeds of the loan agreement
were made available to the Company on February 24, 2010.





On March
22, 2010, we entered into a loan agreement with QAT II. Pursuant to this loan
agreement, QAT II Investments agreed to lend us the sum of €150,000 ($203,280
based on the March 22, 2010 exchange rate published in the Wall Street Journal).
The proceeds of the loan agreement were made available to the Company on March
22, 2010




On March
30, 2010, we entered into a loan agreement with QAT II. Pursuant to the loan
agreement, QAT II Investments agreed to lend us the sum of €500,000 ($670,750
based on March 30, 2010 exchange rate published in the Wall Street Journal). The
proceeds of the loan agreement were made available to the Company on March 31,
2010.





Each of
the above mentioned loan agreements initially provided thatwe would pay
QAT IIinterest at
a rate of fourteen percent (14%) per annum on the outstanding balance and
provided the principal and interest shall be due and payable on the earlier of:
(i) within 180 days from the date of the loan or (ii) in the event we consummate
a Private Placement.  QAT IIhas the
ability to convert the principal and accrued interest outstanding as of the date
of the Placement into the same type of equity or debt securities issued by us
and on the same terms and conditions offered to other investors in the
Placement. The outstanding principal and interest becomes immediately due and
payable in the event we fail to make required payments of principal and
interest, or otherwise breach the loan agreement and fail to cure such breach
upon twenty days notice, or if we dispose of our properties or assets without
QAT II’s prior consent, or if we file a petition for bankruptcy or otherwise
resolves to wind up our affairs.




In
connection with the above-referenced loans, we also issued to QAT II warrants to
purchase common stock in an amount equal to one warrant per each United States
dollar loaned hereunder to the Company (using the Euro-United States dollar
conversion rate published by the Wall Street Journal at the close of business of
the loan date). Such warrants have a term of three years and an exercise price
equal to the OTCBB closing price of our common stock on the loan
date.




The loan
agreements described above were amended on June 10, 2010.  Pursuant to
the amendment, QAT II agreed to extend the existing maturity dates of the loans
to May 1, 2011. The amendment also provides for the automatic conversion of the
Notes if we raise at least $11 million in connection with the 2010 Private
Placement Offering.  The unpaid principal of such loans would convert
into units consisting of common stock and warrants at a price of $1.20 per
unit.  Further, the units will be issued on the same terms and
conditions as the units being offering in the 2010 Private Placement
Offering.   Accrued but unpaid interest and any other fees due on
the QAT II loans will not convert into units.  As additional
consideration for entering into the amendment, QAT II was issued warrants to
purchase common stock at an amount equal to two (2x) the existing warrant
coverage under the terms of such loan agreement.




Note 26. Subsequent
Events




On
October 8, 2010, we consummated the fourth and final closing of the 2010 Private
Placement Offering to accredited investors. In connection with the fourth and
final closing, we sold units having an aggregate value of $5,612,450 at a price
of $1.20 per unit and we delivered 4,677,047 shares of common stock and warrants
to purchase up to 4,677,047 shares of common stock at $1.50 per share for a five
year period
 
 The
units, consisting of common stock and warrants, were offered and sold
and/or converted pursuant to an exemption from registration under Section 4(2)
of the Securities Act.  The Company is obligated to register the common
stock underlying the units and warrants ona
registration statement to be filed after the final closing of the 2010 Private
Placement Offering.  In addition, the investors in the 2010 Private
Placement Offering are entitled to unlimited piggy-back registration rights. We
intend to use the net proceeds primarily for working capital.
 
 The
warrants, and the 2,100,005 warrants issued to Dawson James in connection with
the 2010 Private Placement, entitle the holders to purchase shares of common
stock for a period of five years from the date of issuance and contain standard
anti-dilution rights.  In the event: (i) the trading price of our
common stock exceeds $2.25 for twenty consecutive trading days and (ii) there is
an effective registration statement with a current prospectus on file with the
Securities and Exchange Commission, the Company has the option to redeem the
warrants issued in the 2010 Private Placement Offering.
 
 In the
2010 Private Placement Offering, the Company raised in the aggregate $22,125,571
in gross proceeds, including $14,000,000 in cash raised by Dawson James (with
full exercise of the $3,000,000 over-allotment option) and $8,125,571 in
automatic conversions by QAT II.  After payment of commissions,
non-accountable expenses and other fees and expenses, the Company received net
cash proceeds of $12,340,908 (and the cancellation of $8,125,571 of promissory
notes and loans held by QAT II).  The Company delivered an aggregate
of 14,437,997 shares of Common Stock and warrants to purchase an aggregate of
21,564,392 shares of Common Stock, including 17,515,552 warrants with an
exercise price of $1.50, 2,300,780 warrants with an exercise price of $1.45,
406,560 warrants with an exercise price of $1.61 and 1,341,500 warrants with an
exercise price of $1.73.


25


Conversions
of debt to equity and reclassification of related warrant
liabilities
  As a
result of the completion of the 2010 Private Placement, certain promissory notes
and loans (including accrued interest on such loans) held by QAT II Investments,
SA, an investment entity related to certain of the Company’s officers and
directors (“QAT II”) were automatically converted into units.  This
automatic conversion resulted in the ‘repayment’ of the outstanding promissory
notes and loans for an aggregate value of $8,125,571 to QAT II through the
delivery of units priced at $1.20 for  6,771,311 shares  of common
stock and warrants to purchase up to  6,771,311 shares of common stock at
$1.50 per share for a five year period.
  Prior to
conversion of the QAT II notes, the warrants attached to the notes ( valued at
$30 million) were accounted for as liabilities at fair value and will be
reclassified into equity upon conversion.
  The
company estimates the impact of the conversion  to be as
follows:
  ●
              Increase of issued common stock totaling $8.125
    million
 ●
              Reclassification into equity of associated warrant liabilities
      totaling $30 million
 ●
              Immediate expense recognition of approximately $5 million due to the
      associated and un-accreted debt discount, deferred financing charges, and
 revaluations of warrant liabilities and conversion features through date
      of conversion.
 The
estimates exclude the income statement effect resulting from the
underlying  placement agents warrants.
  Through
November 11 2011 the Company has received additional conversion notifications
from investors on the 2009 Convertible Loans for the total amount of $1,698,782
excluding accrued and deferred interest. Following these requests and including
accrued and deferred interest, the Company subsequently issued 1,275,048 shares
to these investors. These conversions also cause the associated warrants to
revert from liability to equity in the same manner as calculated for the QAT
conversions in the previous paragraph and pro rata the amounts
converted.




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. More information about factors that
potentially could affect the Company's financial results is included in the
Company's filings with the Securities and Exchange Commission, including its
Annual Report on Form 10-K for the year ended December 31, 2009, Amendment No. 1
to the Company’s Annual Report on Form 10-K and the Company’s Current Reports on
form 8-K and 8-K/A  filed in connection with its acquisition of
ValidSoft.




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.





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.





Services
and Solutions





Full-MVNE/MVNO
Mobile Services – wholesale services and managed services




As of
2007, we positioned ourselves as an MVNE to MNOs and MVNOs offering a wide range
of mobile enabling/enhancing services through sophisticated, proprietary
technology supported by multi-country operations with a focus on business to
business, outsourcing /partnering strategy. Important milestones in this respect
are:


26





·
            On September 17, 2008 a hosting
      agreement was signed between T-Mobile Netherlands BV and Elephant Talk
      Holding AG, a 100% affiliate of Elephant Talk Europe Holding BV. T-Mobile
      is one of the three MNOs in the Netherlands. Elephant Talk will, as
      exclusive MVNE for T-Mobile, connect MVNOs in the Netherlands to its
      platform, making use of the mobile network of
    T-Mobile.





·
            In
      June 2009 we signed a hosting agreement with Vizzavi Spain (part of
      Vodafone Group). Elephant Talk to be the exclusive provider to Vizzavi for
      MVNE services in Spain.·
            In
      the course of 2010 we signed a framework hosting agreement with KPN Group
      Belgium NV. Elephant Talk will connect MVNO’s in Belgium to its platform,
      making use of the mobile network of KPN in Belgium. We are currently in
      the process of implementing this platform in
Belgium.




·
            Following
      the start of our MVNE services in the Netherlands in the fourth quarter of
      2008, we  entered into heads of terms agreements with MVNOs
      for wholesale services in the Netherlands and  started servicing
      these companies while currently implementing additional ones.
      By  the end of  the September 2010  quarter
      we successfully implemented and brought live for T-Mobile one of their
      best known brands in The
Netherlands.





In Spain,
we have provided since June 2009, managed services to Vizzavi (part of the
Vodafone Group) and migrated at the end of this quarter a large MVNO of Vizzavi
to our platform and are in the process of preparing and implementing new
ones.






Customized
Mobile Solutions – integrated fraud and security solutions
(ValidSoft)




In line
with our strategy to develop and market customized mobile solutions, we acquired
ValidSoft on March 17, 2010. ValidSoft provides strong authentication and
transaction verification capabilities that allow organizations to quickly
implement solutions that protect against certain of the latest forms of credit
and debit card fraud and on-line transaction and identity theft. By correlating
the relative location of a person’s credit card with the location of their
mobile phone, this service can, for example, tell a bank or card issuer in less
than half a second if the transaction is likely genuine or fraudulent. We
anticipate generating revenues on a per transaction basis (per
verification). This acquisition combines what we believe to be ValidSoft’s best
in class proprietary software with our superior telecommunication platform to
create what we believe is the best integrated electronic fraud prevention
solution available. A number of milestones:





·
            ValidSoft
      has been granted the European Privacy Seal in regards to its anti-fraud
      technology software, VALid-POS®, which is designed to detect and prevent
      card related fraud, a global multibillion dollar problem for financial
      institutions.


·
            The
      Company launched VALid-SVPTM (Speaker Verification Platform), a voice
      biometric technology to improve secure
  authentication.


·
            ValidSoft
      was successful in a joint bid for the provision of a Self Certification
      project to an EU Government in the area of citizen benefit payments. The
      solution will evaluate the use of technology and incorporate ValidSoft’s
      Speaker Verification Platform, VALid-SVPTM to provide automation in the
      processing of citizen benefits with a view to achieving cost reduction and
      efficiencies.


·
            ValidSoft
      has filed applications for two new patents in the Card Not Present fraud
      prevention area.


·
            ValidSoft
      announced an agreement with Cumberland Building Society
      (www.cumberland.co.uk), the 15th largest building society in the UK with
      assets exceeding £1.5billion, to incorporate ValidSoft's VALid® solution
      technology into a new secure transaction service (Cumberland Building
      Society is a mutual organization owned by its current account holders, and
      borrowers which follows a similar model of community banks in the
      US).





Landline
network outsourcing services




Through
our fixed line telecom infrastructure and our centrally operated and managed
IN-CRM-Billing platform, we also provide traditional telecom services like
Carrier Select and Carrier Pre-Select Services, Toll Free and Premium Rate
Services to the business market.


27


Support
technology





Telecom
infrastructure & network




We
currently operate a switch-based telecom network with national licenses and
direct fixed line interconnects with the Incumbents/National Telecom Operators
in seven (7) European countries, one (1) in the Middle East (Bahrain), and
partnerships with telecom operators in Scandinavia, Poland and Germany, and
France. To this we have added mobile access coverage in order to cater for our
mobile services and solutions. Our first mobile partners are T-Mobile in the
Netherlands and Vizzavi (a Vodafone company) in Spain.




Business
Support and Operational Support System (“ET BOSS”) and Intelligent Network – IN
– (“ Infitel”)




Through
our European and Chinese development centers, we develop in-house telecom and
media related systems and software, centered around two of the companies’
proprietary platforms ET BOSS and Infitel.





Electronic
fraud prevention products: VALid-POS®,  VALid® and
VALid-VSGTM.





Our
recent acquisition of ValidSoft has given us ownership of technology and
intellectual property to combat fraud relating to card, the internet, and
telephone channels. ValidSoft solutions are marketed under VALid-POS® and
VALid®. For its biometrics based product it trades under
VALid-VSGTM.




Results of
Operations





Our
results of operations for the nine months ended September 30, 2010, consisted of
the operations of Elephant Talk , its wholly-owned subsidiaries, Elephant Talk
Limited and its subsidiaries, Elephant Talk Europe Holding BV and its
subsidiaries, Elephant Talk Global Holding BV and its subsidiaries and Validsoft
Ltd and its subsidiaries





Although
the vast majority of our business activities are carried out in Euros, we report
our financial statements in US dollars (“USD”), The conversion of Euros to USD
leads to period-to-period fluctuations in our reported USD results arising from
changes in the exchange rate between the USD and the Euro. Generally, when the
USD strengthens relative to the Euro, it has an unfavorable impact on our
reported revenue and income and a favorable impact on our reported expenses.
Conversely, when the USD weakens relative to the Euro, it produces a favorable
impact on our reported revenue and income, and an unfavorable impact on our
reported expenses. The above fluctuations in the USD/Euro exchange rate
therefore result in currency translation effects (not to be confused with real
currency exchange effects), which impact our reported USD results and may make
it difficult to determine actual increases and decreases in our revenue and
expenses which are attributable to our actual operating activities. In addition
to reporting changes in our financial statements in USD’s as per the
requirements of United States generally accepted accounting principles, we also
highlight the impact of any material currency translation effect by providing a
comparison between periods on a constant currency basis, where the most recent
USD/Euro exchange rate is applied to previous periods. Management believes that
this allows for greater insight into the trends and changes in our business for
the reported periods. Also, since we carry out our business activities primarily
in Euros we do not currently engage in hedging activities.




Three
& Nine Month Periods Ended September 30, 2010 compared to the Three &
Nine Month Periods Ended September 30, 2009





Revenue




Revenue
for the three months ended September 30, 2010 was $9,040,397, a decrease of
$2,415,092 or (21.1%), compared to $11,455,489 for the three months ended
September 30, 2009. The decrease was the result of the lower sales during the
period as well as the unfavorable impact of a $1,043,001 currency translation
effect arising from a higher USD/Euro exchange rate.





Revenue
for the nine months ended September 30, 2010 was $28,657,987, a decrease of
$3,537,784 or (11.0%), compared to $32,195,771 for the nine months ended
September 30, 2009. The decrease was the result of lower sales and to some
extent the unfavorable impact of a $1,157,324 currency translation effect
arising from a higher USD/Euro exchange rate.





More
detailed explanations of variations between reporting periods are provided in
the constant currency notes below.


28





Revenue
- Constant currency








The
decrease in the first nine months of 2010 revenue of $2,380,460 over the first
nine months of 2009, in constant currency, was attributable to a decline in our
premium rate services (“PRS”) of ($509,756), Mobile revenue of ($1,718,984) and
Middle East pre-paid calling cards revenue of ($271,037) compared to the same
period in 2009. Other revenue increased with $119,317. The roll-out of mobile
managed services and wholesale customers was delayed and therefore could not
compensate yet for the loss in revenue compared with the nine months in the
previous year following the departure in 2009 of a mobile customer in financial
disarray.




September 30,
                        2010
                      
                      
                      September 30,
                        2009
                      
                      
                      September 30,
                        2009
                      
                      
                      Variance 2010
                        versus 2009Revenue
                      
                      
                      
                      
                      
                      
                      
                      constant
                        currency
                      
                      
                      constant
                        currencyPremium
      Rate Services
                      
                      $
                      25,126,297
                      
                      
                      $
                      26,617,673
                      
                      
                      $
                      25,636,053
                      
                      
                      $
                      -509,756Mobile
      Services
                      
                      
                      2,209,236
                      
                      
                      
                      4,078,634
                      
                      
                      
                      3,928,220
                      
                      
                      
                      -1,718,984Middle
      East Calling Cards
                      
                      
                      561,419
                      
                      
                      
                      833,201
                      
                      
                      
                      832,456
                      
                      
                      
                      -271,037Other
      revenue
                      
                      
                      761,035
                      
                      
                      
                      666,263
                      
                      
                      
                      641,718
                      
                      
                      
                      119,317Total
      Revenue
                      
                      $
                      28,657,987
                      
                      
                      $
                      32,195,771
                      
                      
                      $
                      31,038,447
                      
                      
                      $
                      -2,380,460




Cost
of service




Cost of
service includes origination, termination, network and billing charges from
telecommunications operators, out payment costs to content and information
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, and data transmission services.





Cost of
service for the three months ended September 30, 2010 was $8,638,506, a decrease
of $2,235,699 (or 20.6%), compared to $10,874,205 for the three months ended
September 30, 2009. The decrease in cost of service was the result of lower
sales volumes and a favorable impact of a $993,017 currency translation effect
arising from a higher USD/Euro exchange rate.





Cost of
service for the nine months ended September 30, 2010 was $27,017,788, a decrease
of $3,636,418 (or 11.9%), compared to $30,654,206 for the nine months ended
September 30, 2009. The decrease in cost of service was the result of lower
sales volumes and a favorable impact of a $1,104,944 currency translation effect
arising from a higher USD/Euro exchange rate.





Cost
of service – constant currency





In
constant currency, the cost of service for the three months ended September
30, of 2010 decreased by $1,242,682 (or 12.4%) compared to the same period
in 2009. Cost of service, as a percent of revenue, expressed in constant dollar
terms was 95.5% and 94.9% for the three-month period ended September 30, 2010
and 2009, respectively.





In
constant currency, the cost of service for the first nine months of 2010
decreased by $2,531,475 (or 8.6%) compared to the same period in 2009. Cost of
service, as a percent of revenue, expressed in constant dollar terms was 94.3%
and 95.2% for the nine-month periods ended September 30, 2010 and 2009,
respectively.





The
decrease in cost of services is primarily the result of lower levels of PRS
revenue and Mobile revenues on a constant currency
basis.




Management
expects cost of service to decline as a percent of revenue as a greater
proportion of future revenue is comprised of our mobile services and ValidSoft
solutions, which have a substantially lower cost of service than our traditional
PRS business.


29


Selling,
general and administrative





Selling,
general and administrative (“SG&A”) expense for the three months ended
September 30, 2010 was $2,795,572, a decrease of $153,466 or 5.2 % compared to
$2,949,038 for the same period in 2009.





For the
nine months ended September 30, 2010, SG&A expense was $6,780,281, an
increase of $584,300 or 9.4%, compared to $6,195,981 in the same period in
2009.





Selling,
general and administrative – constant currency




In
constant currency, total SG&A for the three months ended September 30, 2010
decreased by  $15,628 or 0.1% compared to the same period in
2009.  The decrease  in expenses was largely the result
of  the release of accounting provisions made primarily related to the
Validsoft acquisition balance sheet.





In
constant currency, total SG&A for the nine months ended September 30, 2010
increased with $728,270 or 12.0 % compared to the same period in
2009.  The increase in expenses was mainly attributable to increased
staffing levels and the inclusion of Validsoft into our financials as of 1 April
2010.




Non-cash
compensation to officers, directors, employees and consultants




Non-cash
compensation for the three and nine months ended September 30, 2010, was
$779,539 and $4,033,208, respectively, compared to $252,521 and $1,272,387, for
the corresponding 2009 periods. The increase in both periods is primarily
attributable to the restricted stock issuance in lieu of cash compensation for
management salaries and board compensation (including a new board and a new
management team member) and more options granted under the 2008 Incentive Plan
to employees and consultants, due to higher staffing levels especially through
the acquisition of Validsoft.





Depreciation
and amortization




Depreciation
and amortization for the three and nine months ended September 30, 2010, was
$1,481,451 and $3,841,573, respectively, compared to $861,616 and $2,199,561 for
the comparable periods in 2009.





Depreciation
and amortization expenses increased due to the consolidation into our financials
as of 1 April 2010 of the amortization of $ 1,676,329  for the
ValidSoft intangibles assets.





Other
Income and Expenses




Interest
income for the three months ended September 30, 2010 was $40,566 compared to
$24,375 for the same period in 2009. Interest income was $105,685 and $46,682
for the nine months ended September 30, 2010 and 2009 respectively.





For the
three months ended September 30, 2010, interest expense was $538,214 compared to
$323,976 in 2009. Interest expense was $1,520,641 and $531,915, for the nine
months ended September 30, 2010 and 2009, respectively.





For the
three months ended September 30, 2010, the amortizations related to
the  debt discount on the promissory notes, fair value expenses of ,
associated Warrants and deferred financing costs were $20,693,454 compared to
$1,848,709 in 2009. For the nine months ended September 30, 2010 and 2009 the
amounts were $38,109,590 and $1,848,709, respectively. The substantial increases
in these expenses were primarily caused by the increase of our share price
($1.14 at September 30 2009 and $2.60 at September 30 2010) as well as
additional issuances of warrants attached to the 2010 convertible
notes.





Non-controlling
Interest




Our
majority owned subsidiaries are Elephant Talk Communications PRS U.K. Limited,
Elephant Talk Communications Premium Rate Services Netherlands B.V., Elephant
Talk Middle East & Africa (Holding) W.L.L., Elephant Talk Middle East &
Africa (Holding) Jordan L.L.C., Elephant Talk Middle East & Africa Bahrain
W.L.L., Elephant Talk Middle East & Africa FZ-LLC and ET-UTS
NV.


30


During
the three and nine months ended September 30, 2010, we incurred a
non-controlling interest charge of $452 and $2,735 respectively. During the same
period in 2009, we incurred losses of $432 and $1,188 attributable to minority
shareholders’ interest.





Other
comprehensive income (loss)




We record
foreign currency translation gains and losses as comprehensive income or loss.
Comprehensive Income (Loss) for the first nine months ended September 30, 2010
and 2009 was ($753,283) and $345,802 respectively. This change is primarily
attributable to the translation effect resulting from the substantial
fluctuations in the USD/Euro exchange rates.




Adjusted
EBITDA




We employ
Adjusted EBITDA, defined as earnings before derivative accounting, such as
warrant liabilities and conversion feature expensing, income taxes, depreciation
and amortization and stock-based compensation, for several purposes, including
as a measure of our operating performance. We use Adjusted EBITDA because it
removes the impact of items not directly resulting from our core operations,
thus allowing us to better assess whether the elements of our growth strategy
are yielding positive results.




A
reconciliation of Adjusted EBITDA to net loss, the most directly comparable
measure under U.S. GAAP, for each of the fiscal periods indicated, is as
follows:




Nine months endedSeptember,302010
                  
                  
                  2009
                  
                  
                  2009in
                    constant
                    currency(unaudited)
                  
                  
                  (unaudited)
                  
                  
                  (unaudited)Net
      loss
                  
                  $
                  (52,542,944
                  )
                  
                  $
                  (10,462,294
                  )
                  
                  $
                  (10,307,292
                  )Provision
      for income taxes
                  
                  
                  800
                  
                  
                  
                  800
                  
                  
                  
                  800Net
      loss attributable to noncontrolling interest
                  
                  
                  2,735
                  
                  
                  
                  1,188
                  
                  
                  
                  1188Depreciation
      and amortization
                  
                  
                  3,841,573
                  
                  
                  
                  2,199,561
                  
                  
                  
                  2,137,687Stock-based
      compensation
                  
                  
                  4,033,208
                  
                  
                  
                  1,272,387
                  
                  
                  
                  1,272,387Interest
      income and expenses
                  
                  
                  1,414,956
                  
                  
                  
                  485,233
                  
                  
                  
                  483,696Other
      non-cash financing charges
                  
                  
                  38,109,590
                  
                  
                  
                  1,848,709
                  
                  
                  
                  1,848,709Adjusted
      EBITDA
                  
                  $
                  (5,140,082
                  )
                  
                  $
                  (4,654,416
                  )
                  
                  $
                  (4,562,825
                  )




(Note to Adjusted EBITDA:


Liquidity
and Capital Resources




We have
an accumulated deficit of $114,877,217 including a net loss of $52,542,944 for
the nine months ended September 30, 2010.





Excluding
the final closing of the 2010 Private Placement Offering on October 8, 2010
(described in Note 26), we raised in 2010 through September 30 2010 gross
proceeds of approximately $ 13.8 million consisting of $2.5 million in
convertible debt and $11.3 million in equity, resulting in total net proceeds to
us of approximately $12.2 million.





In
addition to the capital raising debt was converted into equity for a total
amount of $ 8,125,571, excluding additional debt to equity conversions that took
place after September 30 2010.


31


We
believe that our cash balance at September 30, 2010, in combination with the
additional funding received so far in 2010, cash generated from operations,
expected additional revenues, repayment of certain debt as well as continued
investment in capital expenditures will last us until 1st quarter 2011.
Considering our share price development and upcoming achievements we expect
warrants to purchase stock in our company to be exercised, which would provide
sufficient funds until at least 4th quarter 2011.


Although
the Company has previously been able to raise capital as needed, such capital
may not continue to be available at all, or if available, on reasonable terms at
the moments we need it.  Further, the terms of such financing may be
dilutive to existing shareholders or otherwise on terms not favorable to the
Company or existing shareholders. The current global financial situation may
offer additional challenges to raising the required capital.  If we
are unable to secure additional capital, as circumstances require, or do not
succeed in meeting our sales objectives we may not be able to continue
operations. As of September 30 2010, these conditions raised substantial doubt
from our auditors as to our ability to continue as a going concern.





Our
financial statements assume that we will continue as a going concern. If we are
unable to continue as a going concern, we may be unable to realize our assets
and discharge our liabilities in the normal course of business. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or to the amounts and classification of
liabilities that may be necessary should we be unable to continue as a going
concern.




Operating
activities




Net cash
used in operating activities for the nine months ended September 30, 2010 was
$9,777,224 compared to $3,757,556 third quarter of 2009, an increase of
$6,019,668. This increase is primarily attributable to expenses related to the
consolidation of ValidSoft as of April 1, 2010 and substantial reduction in
accounts payable.




Investment
activities




Net cash
used in investment activities for the nine months ended September 30, 2010 was
$2,399,671 a decrease of $2,000,639 (or 45%) compared to $4,400,310 in the first
half year of 2009. The increase was primarily attributable to less purchase of
equipment and the elimination of the loans to ValidSoft.





Financing
activities




Net cash
received by financing activities for the nine months ended September 30, 2010
was $12,207,650.  Please see footnotes 2 and 26 for more information.
In addition, for a total amount of $ 8,125,571 debt was converted into equity.
That had no influence on the cash in the quarter ended September 30
2010.





As a
result of the above activities, the Company had a cash and cash equivalents
balance of $1,632,748 as of September 30, 2010, a net decrease in cash and cash
equivalents of $251,306, for the nine months ended September 30,
2009.





Application of Critical
Accounting Policies and Estimates





Revenue
Recognition and Deferred Revenue




The
Company’s revenue recognition policies are in compliance with ASC 605, Revenue
Recognition (“ASC 605”) (formerly, Staff Accounting Bulletin (SAB) 104). Revenue
is recognized only when the price is fixed or determinable, persuasive evidence
of arrangement exists, the service is performed and the collectability of the
resulting receivable is reasonably assured. The Company derives revenue from
activities as a fixed-line and mobile services provider with its network and its
own switching technology. Revenue represents amounts earned for
telecommunication services provided to customers (net of value added tax and
inter-company revenue). The Company recognizes revenue from prepaid calling
cards as the services are provided. Payments received before all of the relevant
criteria for revenue recognition are satisfied are recorded as deferred revenue.
Deferred revenue represents amounts received from the customers against future
sales of services since the Company recognizes revenue upon performing the
services.


32


Stock-based
Compensation




Effective
January 1, 2006, we adopted the provisions of ASC 718 “Compensation-Stock
Compensation”,” (“ASC 718”) (formerly SFAS No. 123(R)), using the prospective
approach. As a result, we recognize stock-based compensation expense for only
those awards that are granted subsequent to December 31, 2005 and any previously
existing awards that are subject to variable accounting, including certain stock
options that were exercised with notes in 2003, until the awards are exercised,
forfeited, or contractually expire in accordance with the prospective method and
the transition rules of ASC 718. Under ASC 718, stock-based awards granted after
December 31, 2005, are recorded at fair value as of the grant date and
recognized as expense over the employee’s requisite service period (the vesting
period, generally three years), which we have elected to amortize on a
straight-line basis.





Business
Combinations




We
use the purchase method of accounting for business combinations and the results
of the acquired businesses are included in the income statement from the date of
acquisition. The purchase price includes the direct costs of the
acquisition.  However, beginning in fiscal 2009, acquisition-related
costs will be expensed as incurred, in accordance with Financial Accounting
Standards Board (FASB) issued revision to Statement of Financial Accounting
Standards  No. 141R, “Business Combinations”. Amounts allocated to
intangible assets are amortized over their estimated useful lives; no amounts
are allocated to in-progress research and development. Goodwill represents the
excess of consideration paid over the net identifiable business assets
acquired.




Intangible
Assets and Impairment of long Lived Assets




In
accordance with ASC 350 (formerly SFAS No. 142), intangible assets are carried
at cost less accumulated amortization and impairment charges. Intangible assets
are amortized on a straight-line basis over the expected useful lives of the
assets, between three and ten years. Other intangible assets are reviewed for
impairment in accordance with ASC 360, “Property, Plant, and Equipment”
(formerly SFAS No. 144), annually, or whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be
recoverable. Measurement of any impairment loss for long-lived assets and
identifiable intangible assets that management expects to hold and use is based
on the amount of the carrying value that exceeds the fair value of the
asset.




Impact of Accounting
Pronouncements





In April
2009, the FASB issued guidance, which is now part of ASC 825, “Interim
Disclosures about Fair Value of Financial Instruments” (“ASC 825”) (formerly
Financial Staff Position SFAS 107-1 and Accounting Principles Board (APB)
Opinion No. 28-1). ASC 825 amends FASB Statement No. 107, Disclosures about Fair
Value of Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. This FSP also amends APB Opinion No.
28, Interim Financial Reporting, to require those disclosures in summarized
financial information at interim reporting periods. ASC 825 is effective for
interim and annual reporting periods ending after June 15, 2009. The adoption of
ASC 825 did not have an impact on the Company’s consolidated financial
statements.




In May
2009, the FASB issued new guidance for accounting for subsequent events. The new
guidance, which is now part of ASC 855-10, “Subsequent Events” (“ASC 855-10”)
(formerly, SFAS No. 165) is consistent with existing auditing standards in
defining subsequent events as events or transactions that occur after the
balance sheet date but before the financial statements are issued or are
available to be issued, but it also requires the disclosure of the date through
which an entity has evaluated subsequent events and the basis for that date. The
new guidance defines two types of subsequent events: “recognized subsequent
events” and “non-recognized subsequent events.” Recognized subsequent events
provide additional evidence about conditions that existed at the balance sheet
date and must be reflected in the company’s financial statements. Non-recognized
subsequent events provide evidence about conditions that arose after the balance
sheet date and are not reflected in the financial statements of a company.
Certain non-recognized subsequent events may require disclosure to prevent the
financial statements from being misleading. The new guidance was effective on a
prospective basis for interim or annual periods ending after June 15, 2009. We
adopted the provisions of ASC 855-10 as required.





In June
2009, the FASB issued new guidance which is now part of ASC 105-10, “The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles” (ASC 105-10) (formerly Statement of Financial Accounting
Standards No. 168), which establishes the FASB Accounting Standards Codification
as the source of authoritative accounting principles recognized by the FASB to
be applied by nongovernmental entities in the preparation of financial
statements in conformity with generally accepted accounting principles. ASC
105-10 is effective for interim and annual periods ending after September 15,
2009. The adoption of ASC 105-10 did not have a material impact on the Company’s
consolidated financial statements.




In
January, 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair
Value Measurements. The standard amends ASC Topic 820, Fair Value Measurements
and Disclosures, to require additional disclosures related to transfers in and
out of Levels 1 and 2 and for activity in Level 3 and clarifies other existing
disclosures requirements. The Company adopted ASU 2010-06 beginning January 1,
2010. This update had no impact on the Company’s financial
statements.
 
 In April
2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-17, Milestone
Method of Revenue Recognition, which provides guidance on applying the milestone
method to milestone payments for achieving specified performance measures when
those payments are related to uncertain future events. However, the FASB
clarified that, even if the requirements in this ASU are met, entities would not
be precluded from making an accounting policy election to apply another
appropriate accounting policy that results in the deferral of some portion of
the arrangement consideration. The ASU is effective for periods beginning on or
after June 15, 2010. Entities can apply this guidance retrospectively as well as
prospectively to milestones achieved after adoption. This update is expected to
have no impact on the Company’s financial statements.
 
 ASU
2010-13, Effect of Denominating the Exercise Price of a Share-Based Payment
Award in the Currency of the Market in Which the Underlying Equity Security
Trades, amends Topic 718 to clarify that an employee share-based payment award
with an exercise price denominated in the currency of a market in which a
substantial portion of the entity’s equity securities trades should not be
considered to contain a condition that is not a market, performance, or service
condition.  Therefore, an entity would not classify such an award as a
liability if it otherwise qualifies as equity.  It is effective for
fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010.  The amendments should be applied by
recording a cumulative-effect adjustment to the opening balance of retained
earnings.  The cumulative-effect adjustment should be calculated for
all awards outstanding as of the beginning of the year in which the amendments
are initially applied, as if the amendments had been applied consistently since
the inception of the award.  Earlier application is
permitted.
 
 ASU
2010-09, Subsequent Events, amends FASB ASC 855-10 to clarify that whereas SEC
filers and conduit debt obligors for publicly-traded conduit debt securities
must evaluate subsequent events through the date that the financial statements
are issued, SEC filers need not disclose the date through which subsequent
events have been evaluated.  Non-SEC filers must evaluate subsequent
events through the date the financial statements are available to be issued, and
continue to be required to disclose that date.  The ASU also clarifies
that reissuances for which a subsequent events evaluation is required are
limited to “revised” financial statements (as defined in the
ASU).  The amendments are effective upon issuance (February 2010),
except as relating to conduit debt obligors, for which the effective date is
interim or annual periods ending after June 15, 2010.


33


Item
3. Quantitative and Qualitative Disclosure About Market Risks





Not
applicable.





Item
4T. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures




Under the
supervision and with the participation of our management, including our chief
executive officer and our chief financial officer, we carried out an evaluation
of the effectiveness of the design and operation of our disclosure controls and
procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). Based on the foregoing,
our chief executive officer and our chief financial officer concluded that our
disclosure controls and procedures were not effective as of the end of the
period covered by this quarterly report due to the significant deficiencies
described below.





Our
management has identified a material weakness in our disclosure controls and
procedures due to a lack of personnel and technological resources. This material
weakness restricts our ability to ensure that information required to be
disclosed in our reports filed or submitted under the Exchange Act is
accumulated and communicated to management and that information is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms.




Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed in our reports
filed or submitted under the Exchange Act is accumulated and communicated to
management, including our chief executive officer and chief financial officer,
or persons performing similar functions, as appropriate, to allow timely
decisions regarding required disclosure.




Changes
in Internal Control over Financial Reporting




There
have not been any other changes in our internal control over financial reporting
during the three months  ended September 30, 2010 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.





PART
II - OTHER INFORMATION





Item
1. Legal Proceedings





(a)
Rescission of the Purchase Agreement of May 24, 2004 of New Times Navigation
Limited.




As
previously described in our 2004 Annual Report we and New Times Navigation
Limited mutually agreed to terminate this purchase agreement. We returned the
received shares of New Times Navigation Limited to the concerned shareholders
and received back 90,100 of our common stock out of the 204,000 issued by us for
the purchase. In addition we issued 37 unsecured convertible promissory notes
for a total amount of $3,600,000. On our request 21 notes were returned with a
total value of $2,040,000.





We are
presently seeking relief from the High Court of the Hong Kong Special
Administrative Region against the holders of the unreturned shares to return a
total of 113,900 common shares (valued at $381,565) and also to have them return
the remaining 18 unsecured convertible promissory notes representing a total
amount of $1,740,000 and rescind the purchase agreement. The case is currently
pending.




(b)
Manu Ohri Litigation





In March
2009 Manu Ohri (“Ohri”), our former Chief Financial Officer from 2002 to 2006,
commenced a lawsuit against the Company in the California Orange County Superior
Court called Manu Ohri v. Elephant Talk Communications, Inc., Case No.
30-20009-00120609.  Ohri alleges that the Company breached a 2006
written employment contract, a 2007 oral consulting contract, and otherwise owes
him the reasonable value of consulting services rendered.  Ohri seeks
damages of $446,359 under the alleged employment contract, $56,951 under the
alleged oral consulting agreement, stock options that he values at $96,960 under
the alleged oral consulting agreement, pre-judgment interest, and costs of the
litigation.  The Company denies Ohri's allegations and asserts several
affirmative defenses.


34


The
Company commenced a cross-complaint against Ohri to, among other things,
invalidate his alleged 2006 employment contract and stock bonus, and to recover
the stock bonus or its fair market value.





The
parties return to court on December 3, 2010, at which time the court is expected
to rule on the Company’s pending motion for summary adjudication and set a trial
date thereafter.





(c)
Bruce Barren Litigation





In
December 2009 Bruce Barren (“Barren”), a former director of the Company between
January 2008 and May 2009, commenced a lawsuit in the California Los Angeles
County Superior Court called Bruce Barren v. Elephant Talk Communications, Inc.,
Case No. BC429032.  Barren alleges that the Company breached a
restricted stock agreement, the implied covenant of good faith and fair dealing,
an oral employment agreement, and otherwise owes him the reasonable value of
consulting services rendered.  The Company denies Barren’s allegations
and asserts several affirmative defenses.  The Company contends that
Barren’s claims are without merit, and that a September 2009 settlement
agreement and general release between Barren and the Company bars all of his
claims as a matter of law.





The
Company has a motion for summary judgment set for hearing on December 16,
2010.  A jury trial is scheduled to start February 7,
2011.





(d)
Chong Hing Bank Litigation





In
December 2009 Chong Hing Bank Limited, fka Liu Chong Hing Bank Limited, a
foreign banking services company based in Hong Kong (the “Bank”), commenced a
lawsuit in the California Orange County Superior Court called Chong Hing Bank
Limited v. Elephant Talk Communications, Inc., Case No.
30-2009-00328467.  The Bank alleges that it entered into various
installment loan agreements and an overdraft account with Elephant Talk Limited
(“ETL”), a Hong Kong subsidiary of the Company.  Several former
officers and directors of ETL personally guaranteed the loans and overdraft
account. The Bank alleges that ETL is in default on the loans and overdraft
account, and that $1,536,792.28 plus interest is currently due.  The
Bank alleges that the Company is directly liable to repay the loans and
overdraft account.  The Bank is suing the Company for breach of
contract and common counts.  The Company denies the Bank’s allegations
and asserts several affirmative defenses.  The Company contends that
as a matter of law the Bank must pursue its recourse against ETL and its
personal guarantors.





The
Company and the Bank have cross-motions for summary judgment set for hearing on
January 11, 2011.  A jury trial is scheduled to start February 14,
2011.





Item
1a. Risk Factors





In
addition to the other information set forth in this Quarterly Report on Form
10-Q, you should carefully consider the Risk Factors included in Part I, “Item
1A. — “Risk Factors” of our Annual Report on Form 10-K for the year ended
December 31, 2009, and the additional, if any, Risk Factors set forth below.
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





During
the three months ending September 30, 2010, we issued an aggregate of 365,815
shares to various parties for (i) services provided and (ii) with respect to
contingent condition due pursuant to a stock purchase agreement. We received no
proceeds from the issuance of these securities.




The
above-referenced securities were offered and sold pursuant to exemptions from
registration provided by the Securities Act.


35


Item
3. Defaults upon Senior Securities.




None.





Item
4. Submission of Matters to a Vote of Security Holders




None.





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) on page
  X-1.





31.2
            Certification of the CFO pursuant
      to Rule 13a-14(a) or Rule 15(d)-14(a) on page
  X-2.





32.1
            Certification pursuant to 18
      U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
      of 2002 on page X-3.





32.2
            Certification pursuant to 18
      U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
      of 2002 on page X-4.




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, INC.November
      16, 2010
              By
              /s/ Steven van der VeldenSteven
      van der VeldenPresident
      and Chief Executive Officer
                (Principal
      Executive Officer)November
      16, 2010
              By
              /s/ Mark NijeMark
      NijeChief
      Financial Officer
                (Principal
      Financial and Accounting Officer)


36


Index to
Exhibits




Number
              
              Exhibit
              
              Page31.1
              
              Certification
      of the CEO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)
              
              X-131.2
              
              Certification
      of the CFO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)
              
              X-232.1
              
              Certification
      pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002
              
              X-332.2
              
              Certification
      pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002
              
              X-4


37