UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

WASHINGTON, D. C. 20549



FORM 10-Q



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



For the quarterly period ended June 30,
2012



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



For the transition period from ______ to
______



000-30061

(Commission file No.)



ELEPHANT TALK COMMUNICATIONS CORP.

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



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



Schiphol Boulevard 249

1118 BH Schiphol

The Netherlands

(Address of principal executive offices)



31 20 6535916

(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.

YesxNo ̈



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). YesxNo ̈



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 filerxNon-Accelerated filer ̈Smaller reporting company ̈



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

Yes ̈Nox



As of July 23, 2012, there were 114,320,209
shares of the Company’s common stock outstanding.













ELEPHANT TALK COMMUNICATIONS CORP. AND
SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

June 30, 2012



|PART I - FINANCIAL INFORMATION                                                                                    | 3 
|----------------------------------------------------------------------------------------------------------------- | --
|                                                                                                                  |   
|Item 1. Financial Statements                                                                                      | 3 
|Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011                                   | 3 
|Consolidated Statements of Comprehensive Income for the three and six months periods ended June 30, 2012 and 2011 | 4 
|Consolidated Statements of Cash Flows for the six months periods ended June 30, 2012 and 2011                     | 5 
|Notes to Unaudited Condensed Consolidated Financial Statements                                                    | 6 
|Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations                     | 23
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                | 32
|Item 4. Controls and Procedures                                                                                   | 32
|                                                                                                                  |   
|PART II - OTHER INFORMATION                                                                                       | 33
|                                                                                                                  |   
|Item 1. Legal Proceedings                                                                                         | 33
|Item 1A. Risk Factors                                                                                             | 34
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                                               | 34
|Item 3. Default upon Senior Securities                                                                            | 34
|Item 4. Mine Safety Disclosure                                                                                    | 34
|Item 5. Other Information                                                                                         | 34
|Item 6. Exhibits                                                                                                  | 35
|SIGNATURES                                                                                                        | 35
|Exhibit 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)              |   
|Exhibit 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)              |   
|Exhibit 32.1 Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002   |   
|Exhibit 32.2 Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002   |   





2







PART I - FINANCIAL INFORMATION



Item 1. Consolidated Financial Statements



ELEPHANT TALK COMMUNICATIONS
CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                 |  | June 30, |              |   | December 31, |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------- | ------------ | - | ------------ | -
|                                                                                                                                                                                                 |  | 2012     |              |   | 2011         |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|ASSETS                                                                                                                                                                                           |  |          |              |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|CURRENT ASSETS                                                                                                                                                                                   |  |          |              |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|Cash and cash equivalents                                                                                                                                                                        |  | $        | 4,051,777    |   |              | $
|Financing receivables                                                                                                                                                                            |  |          | -            |   |              |  
|Restricted cash                                                                                                                                                                                  |  |          | 2,613,083    |   |              |  
|Accounts receivable, net of an allowance for doubtful accounts of $546,238 and $436,546 at June 30, 2012 and December 31, 2011 respectively                                                      |  |          | 5,676,402    |   |              |  
|Prepaid expenses and other current assets                                                                                                                                                        |  |          | 1,809,532    |   |              |  
|Total current assets                                                                                                                                                                             |  |          | 14,150,794   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|OTHER ASSETS                                                                                                                                                                                     |  |          | 1,878,125    |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|DUE FROM RELATED PARTIES                                                                                                                                                                         |  |          | 1,002,153    |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|PROPERTY AND EQUIPMENT, NET                                                                                                                                                                      |  |          | 13,103,226   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|INTANGIBLE ASSETS, NET                                                                                                                                                                           |  |          | 11,434,099   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|GOODWILL                                                                                                                                                                                         |  |          | 3,062,285    |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|TOTAL ASSETS                                                                                                                                                                                     |  | $        | 44,630,682   |   |              | $
|                                                                                                                                                                                                 |  |          |              |   |              |  
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                                                             |  |          |              |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|CURRENT LIABILITIES                                                                                                                                                                              |  |          |              |   |              |  
|Overdraft                                                                                                                                                                                        |  | $        | 330,647      |   |              | $
|Accounts payable and customer deposits                                                                                                                                                           |  |          | 4,475,427    |   |              |  
|Deferred Revenue                                                                                                                                                                                 |  |          | 140,556      |   |              |  
|Accrued expenses and other payables                                                                                                                                                              |  |          | 3,758,081    |   |              |  
|8% Convertible Note                                                                                                                                                                              |  |          | 363,799      |   |              |  
|Loans payable                                                                                                                                                                                    |  |          | 962,319      |   |              |  
|Total current liabilities                                                                                                                                                                        |  |          | 10,030,829   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|LONG TERM LIABILITIES                                                                                                                                                                            |  |          |              |   |              |  
|8% Convertible Note                                                                                                                                                                              |  |          | 5,104,116    |   |              |  
|Conversion feature                                                                                                                                                                               |  |          | 1,469,226    |   |              |  
|Trade note payable                                                                                                                                                                               |  |          | 165,074      |   |              |  
|Loan from joint venture partner                                                                                                                                                                  |  |          | 534,181      |   |              |  
|Total long term liabilities                                                                                                                                                                      |  |          | 7,272,597    |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|Total liabilities                                                                                                                                                                                |  |          | 17,303,426   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|STOCKHOLDERS' EQUITY                                                                                                                                                                             |  |          |              |   |              |  
|Common stock, no par value, 250,000,000 shares authorized, 111,240,995 issued and outstanding  as of June 30, 2012 compared to 110,525,229 shares issued and outstanding as of December 31, 2011 |  |          | 220,331,381  |   |              |  
|Accumulated other comprehensive income (loss)                                                                                                                                                    |  |          | (2,052,989   | ) |              |  
|Accumulated deficit                                                                                                                                                                              |  |          | (191,124,469 | ) |              |  
|Elephant Talk Communications Corp. stockholders' equity                                                                                                                                          |  |          | 27,153,923   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|NON-CONTROLLING INTEREST                                                                                                                                                                         |  |          | 173,333      |   |              |  
|Total stockholders' equity                                                                                                                                                                       |  |          | 27,327,256   |   |              |  
|                                                                                                                                                                                                 |  |          |              |   |              |  
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                                                       |  | $        | 44,630,682   |   |              | $



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





3







ELEPHANT TALK COMMUNICATIONS CORP. AND
SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS AND
COMPREHENSIVE LOSS

(UNAUDITED)



|                                                                          |  | For the Three Months  |             |   | For the Six Months    |  
|------------------------------------------------------------------------- |  | --------------------- | ----------- | - | --------------------- | -
|                                                                          |  | Period ended June 30, |             |   | Period ended June 30, |  
|                                                                          |  | 2012                  |             |   | 2011                  |  
|REVENUES                                                                  |  | $                     | 7,084,969   |   |                       | $
|                                                                          |  |                       |             |   |                       |  
|COST AND OPERATING EXPENSES                                               |  |                       |             |   |                       |  
|Cost of service                                                           |  |                       | 5,185,048   |   |                       |  
|Selling, general and administrative expenses                              |  |                       | 4,565,181   |   |                       |  
|Non-cash compensation to officers, directors and employees                |  |                       | 1,538,982   |   |                       |  
|Depreciation and amortization of intangibles assets                       |  |                       | 1,224,888   |   |                       |  
|Total cost and operating expenses                                         |  |                       | 12,514,099  |   |                       |  
|                                                                          |  |                       |             |   |                       |  
|LOSS FROM OPERATIONS                                                      |  |                       | (5,429,130  | ) |                       |  
|                                                                          |  |                       |             |   |                       |  
|Interest income                                                           |  |                       | 174,756     |   |                       |  
|Interest expense, amortization of discount and financing costs            |  |                       | (836,580    | ) |                       |  
|Other income & (expense)                                                  |  |                       | -           |   |                       |  
|Change in fair value of conversion feature                                |  |                       | 1,226,417   |   |                       |  
|Total other income (expense)                                              |  |                       | 564,593     |   |                       |  
|                                                                          |  |                       |             |   |                       |  
|LOSS BEFORE PROVISION FOR INCOME TAXES                                    |  |                       | (4,864,537  | ) |                       |  
|Provision for income taxes                                                |  |                       | (97,288     | ) |                       |  
|NET LOSS BEFORE NONCONTROLLING INTEREST                                   |  |                       | (4,961,825  | ) |                       |  
|Net (loss) income attributable to non-controlling interest                |  |                       | -           |   |                       |  
|Equity in earnings of unconsolidated joint venture                        |  |                       | (29,084     | ) |                       |  
|NET LOSS                                                                  |  |                       | (4,990,909  | ) |                       |  
|                                                                          |  |                       |             |   |                       |  
|OTHER COMPREHENSIVE (LOSS) INCOME                                         |  |                       |             |   |                       |  
|Foreign currency translation gain (loss)                                  |  |                       | (1,779,477  | ) |                       |  
|                                                                          |  |                       | (1,779,477  | ) |                       |  
|                                                                          |  |                       |             |   |                       |  
|COMPREHENSIVE LOSS                                                        |  | $                     | (6,770,386  | ) |                       | $
|                                                                          |  |                       |             |   |                       |  
|Net loss per common share and equivalents - basic and diluted             |  | $                     | (0.04       | ) |                       | $
|                                                                          |  |                       |             |   |                       |  
|Weighted average shares outstanding during the period - basic and diluted |  |                       | 111,167,932 |   |                       |  





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





4







ELEPHANT TALK COMMUNICATIONS CORP. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



|                                                                                  |  | June 30, 2012 |             |   | June 30, 2011 |  
|--------------------------------------------------------------------------------- |  | ------------- | ----------- | - | ------------- | -
|                                                                                  |  |               |             |   |               |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |               |             |   |               |  
|Net loss                                                                          |  | $             | (10,996,098 | ) |               | $
|Adjustments to reconcile net loss to net cash used in operating activities:       |  |               |             |   |               |  
|Depreciation and amortization                                                     |  |               | 2,503,357   |   |               |  
|Provision for doubtful accounts                                                   |  |               | 115,684     |   |               |  
|Non-cash compensation                                                             |  |               | 3,230,728   |   |               |  
|Equity in earnings of joint venture                                               |  |               | 192,415     |   |               |  
|Amortization of shares issued for consultancy                                     |  |               | -           |   |               |  
|Changes in operating assets and liabilities:                                      |  |               |             |   |               |  
|Decrease (increase) in accounts receivable                                        |  |               | 492,139     |   |               |  
|Increase  in prepaid expenses, deposits and other assets                          |  |               | (320,444    | ) |               |  
|Increase in accounts payable, proceeds from related parties and customer deposits |  |               | 2,339       |   |               |  
|Increase in deferred revenue                                                      |  |               | 11,250      |   |               |  
|Increase in accrued expenses and other payables                                   |  |               | 686,173     |   |               |  
|Net cash used in operating activities                                             |  |               | (4,082,457  | ) |               |  
|                                                                                  |  |               |             |   |               |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |               |             |   |               |  
|Purchases of property and equipment                                               |  |               | (1,616,811  | ) |               |  
|Restricted cash                                                                   |  |               | (2,439,408  | ) |               |  
|Loans to related party                                                            |  |               | (1,011,265  | ) |               |  
|Loans to joint venture partners                                                   |  |               | (63,447     | ) |               |  
|Loan to third party                                                               |  |               | (216,970    | ) |               |  
|Net cash used in investing activities                                             |  |               | (5,347,901  | ) |               |  
|                                                                                  |  |               |             |   |               |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |               |             |   |               |  
|Bank overdraft                                                                    |  |               | -           |   |               |  
|Deferred financing costs                                                          |  |               | (446,000    | ) |               |  
|Proceeds from 8% convertible note, net of original issue discount                 |  |               | 8,000,000   |   |               |  
|Payments on  8% convertible note installment payments and interest                |  |               | (388,358    | ) |               |  
|Proceeds from loan from related party                                             |  |               | -           |   |               |  
|Proceeds from exercise of warrants & options                                      |  |               | 742,130     |   |               |  
|Payments for share issue costs                                                    |  |               | (13,643     | ) |               |  
|Net cash provided by financing activities                                         |  |               | 7,894,129   |   |               |  
|                                                                                  |  |               |             |   |               |  
|EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS                             |  |               | (421,570    | ) |               |  
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                              |  |               | (1,957,799  | ) |               |  
|CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD                                |  |               | 6,009,576   |   |               |  
|CASH AND CASH EQUIVALENTS, END OF THE PERIOD                                      |  | $             | 4,051,777   |   |               | $
|                                                                                  |  |               |             |   |               |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                |  |               |             |   |               |  
|                                                                                  |  |               |             |   |               |  
|Cash paid during the period for interest                                          |  | $             | 118,358     |   |               | $



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





5







ELEPHANT TALK COMMUNICATIONS CORP. AND
SUBSIDIARIES

NOTES TO THE UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Description of Business, Basis of Presentation
and Principles of Consolidation



Description of Business



Elephant Talk Communications
Corp. also referred to as “we”, “us”, “Elephant Talk” and “the Company” is an international
provider of business software and services to the telecommunications and financial services industry. The company enables both
mobile carriers and virtual operators 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, mobile network operators, 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 vendor MVNE (Mobile Virtual Network Enabler) 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 (Mobile Network Operators like ATT, Verizon, Sprint, Vodafone, T-Mobile, America Movil, etc), MVNOs
(Mobile Virtual Network Operators like TracFone, Virgin Mobile, Simple Mobile, Lebara, LycaMobile, etc) and non-operator companies
(like banks, supermarkets, and utility, car, health maintenance and insurance companies), in need of both mobile as well as specialized
land-line telecommunication services. In this value chain we position ourselves as a vendor that can act as a one-stop solutions
provider as a Full Mobile Virtual Network Enabler, including also customized mobile services such as our network integrated ValidSoft
security and fraud prevention solutions.



Landline network outsourcing services



Through our fixed
line telecom infrastructure and our centrally operated and managed company owned 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



ValidSoft – Fraud Prevention and
Security Software Solutions



ValidSoft is a subsidiary
of Elephant Talk Communications Corp. and is a thought and technology leader in providing solutions to counter electronic fraud
relating to credit and debit card, the internet, and telephone channels. ValidSoft's solutions are at the cutting edge of the market
and are used to verify the authenticity of both parties to a transaction (Mutual Authentication), and the integrity of the transaction
itself (Transaction Verification) for the mass market, in a highly cost effective and secure manner, yet easy to use and intuitive.



As the banking and
payment world begin to converge onto smart telecommunications-based devices, the ValidSoft integrated security platform, built
solely on a real-time zero client-footprint model, allows organizations to leverage these convergence devices to provide visible
and invisible security layers for all transaction channels, while also providing protection where the device itself is the channel.



This integrated platform,
using proprietary technologies including Out-of-Band authentication and transaction verification, Proximity Correlation Logic,
Pseudo Device Theft detection and biometric voice verification, allows organizations to protect all of their customer transaction
channels within a single platform. This combination of technologies provides solutions from simply detecting SIM Swap fraud through
to the world’s first commercially available Four-factor authentication solution. Internet banking, M-banking, Mobile Wallet,
Mobile Payments, Card-present, card-not-present, NFC, citizen online services and more are all supported through either one or
more of these integrated telecommunications-based techniques.





6







Basis of presentation of Interim Periods



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 2011 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 three
and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the entire year.



Principles of Consolidation



The accompanying consolidated financial
statements for June 30, 2012 and December 31, 2011 include the accounts of Elephant Talk Communications Corp., including:



| | • | its wholly-owned subsidiary Elephant Talk Europe Holding B.V. and its wholly owned subsidiaries Elephant Talk Communications Luxembourg SA, Elephant Talk Communications France S.A.S., Elephant Talk Communications Italy S.R.L., ET-Stream GmbH, Elephant Talk Business Services W.L.L., Guangzhou Elephant Talk Information Technology Limited, VoiceBottle BV, Elephant Talk Deutschland GmbH, Elephant Talk Belgium BVBA, and the majority owned (51%) subsidiaries Elephant Talk Communications PRS U.K. Limited and (51%) ET-UTS NV;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | • | Elephant Talk Europe Holding B.V.’s wholly-owned subsidiary Elephant Talk Communication Holding AG and 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, Elephant Talk Communication Carrier Services GmbH, Elephant Talk Communication Schweiz GmbH, Elephant Talk Communication (Europe) GmbH and the majority owned (51%) subsidiary Elephant Talk Communications Premium Rate Services Netherlands B.V.;    
| | • | Elephant Talk Europe Holding B.V.’s majority (60%) owned subsidiary Elephant Talk Middle East & Africa (Holding) W.L.L., its wholly owned (100%) and its majority owned (99%) subsidiaries Elephant Talk Middle East & Africa (Holding) Jordan L.L.C. and Elephant Talk Middle East & Africa Bahrain W.L.L.;                                                                                                                                                                                                                               
| | • | its wholly-owned subsidiary Elephant Talk Limited and its majority owned (50.54%) subsidiary Elephant Talk Middle East & Africa FZ-LLC; and                                                                                                                                                                                                                                                                                                                                                                                                
| | • | its wholly-owned subsidiary ValidSoft Ltd and its wholly-owned subsidiaries ValidSoft (UK) Ltd and ValidSoft (Australia) Pty Ltd.                                                                                                                                                                                                                                                                                                                                                                                                          



On April 27, 2012, the Company incorporated
as a wholly owned subsidiary of Elephant Talk Communications Corp., Elephant Talk Group International B.V., based in Amsterdam,
The Netherlands.



In the second quarter 2012 we completed
the incorporation of Elephant Talk Telecomunicação do Brasil LTDA, (owned 90% by Elephant Talk Europe Holding BV
and 10% by Elephant Talk Communication Holding AG).



All intercompany balances are eliminated in consolidation.



Note 2. Significant Accounting Policies



Currency Translation



The functional currency is the Euro for
the Company’s wholly-owned subsidiary Elephant Talk Europe Holding B.V. and its subsidiaries, 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 US
Dollar 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 Financial
Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 830, Foreign Currency Matters”
(“ASC 830”), 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 June 30, 2012 and December
31, 2011 was ($2,052,989) and ($1,143,295), respectively. The foreign currency translation gain (/loss) for the six months ended
June 30, 2012 and 2011 was ($909,694) and $3,257,603, respectively. The foreign currency translation gain (/loss) for the three
months ended June 30, 2012 and 2011 was ($1,779,477) and $938,039.





7







Use of Estimates



The preparation of the accompanying financial
statements conforms with accounting principles generally accepted in the United States of America and requires management to make
certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting
period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates under different assumptions or conditions.



Cash and Cash Equivalents



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



Restricted Cash



Restricted cash of $2,613,083 consists
of $1,885,412 relating to the amount in an escrow account for installments to be made on the $8,800,000 senior convertible note
up to and including April 1, 2013. Installment payments have started on May 1, 2012 and will end on April 1, 2013. The current
balance of $1,885,412 covers the remaining 10 installment payments ranging between $181,000 and $193,000 and with an approximate
average amount of $189,000.



In addition, cash deposited as bank guarantee
for national interconnection and wholesale agreements with telecom operators and bid guarantees represents $727,671.



Accounts Receivables, net



The Company’s customer base consists
of geographically dispersed customers. The Company maintains an allowance for potential credit losses on accounts receivable. Management
reviews the composition of accounts receivable on a customer by customer basis and analyzes historical bad debt, customer concentrations,
customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these
allowances. As of June 30, 2012 and December 31, 2011, the allowance for doubtful accounts was $546,238 and $436,546, respectively.



Revenue Recognition and Deferred Revenue



The Company’s revenue recognition
policies are in compliance with ASC 605, Revenue Recognition (“ASC 605”). 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). For its security solutions under the ValidSoft brand name and technologies revenue represents amounts
earned for consultancy services, outsourcing, maintenance and licenses (net of value added tax).



Deferred revenues consist of platform fees
collected from customers. The Company recognizes revenues on the implementation fees when the platform is successfully implemented.



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.





8







Segments



ASC 820, “Segment Reporting”
(“ASC 820”), 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 operates in a single business segment because operating and strategic decisions are made by decision
makers who monitor the Company as a whole.



Stock-based Compensation



We follow the provisions of ASC 718 “Compensation-Stock
Compensation”, (“ASC 718”). Under ASC 718, stock-based awards 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 up to three years),
which we have elected to amortize on a straight-line basis.



To determine the value of our stock options
at grant date under our employee stock option plan, we currently use the Black-Scholes option-pricing model. The use of this model
requires us to make a number of subjective assumptions. The following addresses each of these assumptions and describes our methodology
for determining each assumption:



Expected Life



The expected life represents the period
that the stock option awards are expected to be outstanding. We use the simplified method for estimating the expected life of the
option, by taking the average between time to vesting and the contract life of the award. Therefore, the expected term assumption
was estimated for each individual grant using the simplified method as an average between time to vesting and the contractual term
of the award.



Cumulative Volatility



We estimate expected cumulative volatility
giving consideration to the expected life of the option of the respective award, and the calculated annual volatility by using
the continuously compounded return calculated by using the last 252 closing prices of the share price (= one year trading). The
annual volatility is used to determine the generalized (cumulative) volatility of our common stock preceding the grant (= annual
volatility x SQRT (expected life)).



Risk-Free Interest Rate



We estimate the risk-free interest rate
using the “Daily Treasury Yield Curve Rates” from the U.S. Treasury Department with a term equal to the reported rate,
or derived by using both spread in intermediate term and rates, to the expected life of the award.



Expected Dividend Yield



We estimate the expected dividend yield
by giving consideration to our current dividend policies as well as those anticipated in the future considering our current plans
and projections. We do not currently calculate a discount for any post-vesting restrictions to which our awards may be subject.



Income Taxes



The Company accounts for income taxes under
ASC 740, “Accounting for Income Taxes” (“ASC 740”). 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.





9







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.



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 is 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 condition 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 stockholders’ equity but are excluded from
net income. In the first quarters of 2012 and 2011 the Company’s comprehensive income/(loss) consisted of its net loss and
foreign currency translation adjustments.



Intangible Assets



In accordance with ASC 350 “Goodwill
and Other” (“ASC 350”), intangible assets are carried at cost less accumulated amortization and impairment charges.
Intangible assets are amortized on a straight-line basis over the expected useful lives of the assets, between three and ten years.
Other intangible assets are reviewed for impairment in accordance with ASC 360 “Property, Plant, and Equipment”, 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 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.





10







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:



|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 June 30, 2012 for financial assets and liabilities measured at fair value
on a recurring basis:



|                   |  | Level I |   |  | Level II |   |           | Level III |  |   | Total | 
|------------------ |  | ------- | - |  | -------- | - | --------- | --------- |  | - | ----- | 
|Conversion feature |  | $       | - |  |          | $ | 1,469,226 |           |  | $ | -     | 
|Total liabilities  |  | $       | - |  |          | $ | 1,469,226 |           |  | $ | -     | 



We have classified the outstanding
conversion feature into level II due to the fact that some inputs are not published and not easily comparable to industry peers.



The carrying value
of the Company’s financial assets and liabilities, including cash and cash equivalents, other assets, due from related parties,
loans payable, 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 2011, the Financial Accounting
Standards Board (FASB) issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement
and Disclosure Requirements in U.S. GAAP and IFRS. This ASU amends current fair value measurement and disclosure guidance to
include increased transparency around valuation input and investment categorization. ASU 2011-04 is effective for fiscal years
and interim periods beginning after December 15, 2011, with early adoption not permitted. The adoption of ASU 2011-04 in the first
quarter of 2012 did not have an impact on our financial position, results of operations, or cash flows.



In June 2011, the FASB issued ASU 2011-05,
Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 allows an entity to present components
of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income,
or in two separate, but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive
income as part of the statement of changes in stockholders’ equity.



In December 2011, the FASB issued ASU 2011-12
“Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications
of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 deferred
the effective date of the specific requirement to present items that are reclassified out of accumulated other comprehensive income
to net income alongside their respective components of net income and other comprehensive income. While the new guidance changes
the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive
income under current accounting guidance. ASU 2011-05 is effective for fiscal years and interim periods beginning after December
15, 2011 and must be applied retrospectively. The adoption of ASU 2011-05 in the first quarter of 2012 did not have an impact on
our financial position, results of operations, or cash flows.





11







In December 2011, the FASB issued ASU 2011-11,
Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities, which requires companies to disclose information
about financial instruments that have been offset and related arrangements to enable users of their financial statements to understand
the effect of those arrangements on their financial position. Companies will be required to provide both net (offset amounts) and
gross information in the notes to the financial statements for relevant assets and liabilities that are offset. ASU 2011-11 is
effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. We do not expect the
adoption of ASU 2011-11 in the first quarter of 2013 to have an impact on our financial position, results of operations, or cash
flows.



Note 3. Prepaid Expenses and
Other Current Assets



Prepaid expenses and other current assets
recorded at $1,809,532 as of June 30, 2012, compared with $1,522,461 as of December 31, 2011. On June 30, 2012, $820,716 of the
prepaid expenses is related to prepaid Value Added Tax (“VAT”).



Note 4. Other assets



Other assets are long-term in nature and
consist of a financial investment in a joint venture, long term notes receivable, deferred financing costs and long-term deposits.



Financial Investment in Joint Venture



In the fourth quarter 2011, the company
acquired one third (33.33%) of equity interest of Modale BV (previously known as Elephant Security I BV), a company incorporated
on 26 October 2011 in the Netherlands. For the one-third ownership we paid in 2011 a total of $314,426, comprising $7,546 in cash
and $306,880 in loans to Modale BV, which is equal to what each of the other two joint venture partners provided to Modale BV.
The loans mature on December 31, 2014 and carry an interest rate per annum of 7% that is accrued on a monthly basis. The investment
was recorded at cost and is accounted for using the equity method.



Modale BV is deemed a related party entity
since one of the other owners of Modale BV, is Elephant Security BV, a majority owned and controlled entity by QAT Investments
SA, an affiliate of the company.



As of June 30, 2012, the financial investment
was $237,504 comprising the above mentioned outlay of $314,426, $37,731 in a loan provided in 2011 that was previously classified
under Note Receivable, $61,627 in loans provided in June 2012, increased with a total of $16,135 in accrued interest and decreased
with ($192,415) for its equity share in the losses incurred by Modale BV. Ownership interest remains at 33.33%.



Note receivable



As of June 30, 2012 the Note receivable
was $588,009 compared to $417,199 as of December 31, 2011. Note receivable as of June 30, 2012 comprises a number of loans provided
to Morodo Ltd, from the U.K and includes accrued interest of $9,756.



The loans mature on 1 April 2013 and carry
as of 1 January 2012 an interest rate of 7% per annum accrued on a monthly basis. The notes receivable are interim loans prior
to the intended acquisition.



Long-term deposits



Long-term deposits to various telecom carriers
during the course of its operations and a deposit towards the French Tax Authorities all for the total amount of $640,180 as of
June 30, 2012 compared with $651,930 as of December 31, 2011. The carrier deposits are refundable at the termination of the business
relationship with the carriers.



Deferred financing costs



In connection with the Senior Secured Convertible
Notes issued on March 29, 2012, the company incurred expenses for a total amount of $462,807 related to perfecting liens of assets,
contract review fees from lawyers, registration fees for registering underlying shares and some other smaller fees. These costs
will amortize during the life of the Senior Secured Convertible Loan using the effective-interest method calculation. The total
current amount still to be amortized is $412,432.





12







Note 5. Due from related parties



Due from related parties was $1,002,153
as of June 30, 2012 as result from loans provided to Elephant Security B.V. This amount includes $19,887 of accrued interest. Elephant
Security B.V. is a related party entity since it is majority owned and controlled by QAT Investments SA, an affiliate of the Company.
The notes receivable are interim loans prior to the potential acquisition of Elephant Security BV.



The loans matured on June 30, 2012 and
carry an interest rate of 7% per annum accrued on a monthly basis. The company is currently renegotiating the terms of these loans.



Note 6. Property and 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 provisioning Software;               
| | • | Mediation, Rating & Pricing engine;      
| | • | ValidSoft security software applications;
| | • | Operations and business support software;
| | • | Network management tools.                



Property and equipment at June 30, 2012 and December 31, 2011
consist of:



|                                              |  | Average Estimated |  | June 30, |             |   | December 31, |  
|--------------------------------------------- |  | ----------------- |  | -------- | ----------- | - | ------------ | -
|                                              |  | Useful Lives      |  | 2012     |             |   | 2011         |  
|Furniture and fixtures                        |  | 5                 |  |          | 327,751     |   |              |  
|Computer, communication and network equipment |  | 3 - 10            |  |          | 15,051,631  |   |              |  
|Software                                      |  | 5                 |  |          | 4,940,623   |   |              |  
|Automobiles                                   |  | 5                 |  |          | 95,594      |   |              |  
|Construction in progress                      |  |                   |  |          | 3,156,364   |   |              |  
|Total property and equipment                  |  |                   |  |          | 23,571,963  |   |              |  
|                                              |  |                   |  |          |             |   |              |  
|Less: accumulated depreciation                |  |                   |  |          | (10,468,737 | ) |              |  
|Total property and equipment, Net             |  |                   |  | $        | 13,103,226  |   |              | $



Total depreciation expense for the three
months ended June 30, 2012 and 2011 was $567,031 and $558,047, respectively. Total depreciation expense for the six months ended
on June 30, 2012 and 2011 was $1,145,553 and $1,088,235 respectively.



Note 7. Intangible Assets



Intangible assets include customer contracts,
telecommunication licenses and integrated, multi-country, centrally managed switch-based interconnects as well as intellectual
property held in ValidSoft which includes but is not limited to software source codes, applications, customer lists & pipeline,
registration & licenses, patents, and trademarks.





13







Intangible assets at June 30, 2012 and December 31, 2011 consist
of:



|                                                         |  | Estimated    |  | June 30, |             |  | December 31, |  
|-------------------------------------------------------- |  | ------------ |  | -------- | ----------- |  | ------------ | -
|                                                         |  | Useful Lives |  | 2011     |             |  | 2011         |  
|Customer Contracts, Licenses , Interconnect & Technology |  | 5-10         |  | $        | 11,551,805  |  |              | $
|ValidSoft IP & Technology                                |  | 1-10         |  |          | 15,006,788  |  |              |  
|Total intangible assets                                  |  |              |  |          | 26,558,593  |  |              |  
|                                                         |  |              |  |          |             |  |              |  
|Less: Accumulated Amortization                           |  |              |  |          | (9,842,137) |  |              |  
|Less: Accumulated Amortization ValidSoft IP & Technology |  |              |  |          | (5,282,357) |  |              |  
|Total intangible assets, Net                             |  |              |  | $        | 11,434,099  |  |              | $



Total amortization expense for the three
months ended June 30, 2012 and 2011 was $657,857 and $779,728, respectively. Total amortization expense for the six months ended
in June 30, 2012 and 2011 was $1,357,804 and $1,552,215 respectively.



Estimated future amortization expense related to our intangible
assets is:



|                                    |  | 2012 |           |  | 2013 |   |           | 2014 |  |   | 2015      |  |  | 2016 |           |  | 2017 and after |  
|----------------------------------- |  | ---- | --------- |  | ---- | - | --------- | ---- |  | - | --------- |  |  | ---- | --------- |  | -------------- | -
|Interconnect licenses and contracts |  | $    | 306,757   |  |      | $ | 585,392   |      |  | $ | 412,530   |  |  | $    | 79,834    |  |                | $
|ValidSoft IP & Technology           |  |      | 1,018,233 |  |      |   | 2,036,466 |      |  |   | 2,036,466 |  |  |      | 1,896,186 |  |                |  
|                                    |  | $    | 1,324,989 |  |      | $ | 2,621,858 |      |  | $ | 2,448,995 |  |  | $    | 1,976,020 |  |                | $



Note 8. Goodwill



Goodwill represents the excess of the purchase
price of acquired businesses over the estimated fair value assigned to the individual assets acquired and liabilities assumed.
The Company does not amortize goodwill, but instead is required to test goodwill for impairment in accordance with ASC 350, “Intangibles
- Goodwill and Other” (“ASC 350”) at least annually and, if necessary, we would record an impairment based on
the results of any such impairment test. The Company will perform an impairment test between scheduled annual tests if facts and
circumstances indicate that it is more likely than not that the fair value of a reporting unit that has goodwill is less than its
carrying value.



In performing a goodwill impairment test
under ASC 350, the Company may first make a qualitative assessment of whether it is more-likely-than-not that the Company’s
fair value, as a single reporting unit, is less than its carrying value to determine whether it is necessary to perform a two-step
goodwill impairment test. The qualitative impairment test includes considering various factors including macroeconomic conditions,
industry and market conditions, cost factors, a sustained share price or market capitalization decrease, and any reporting unit
specific events. If it is determined through the qualitative assessment that a reporting unit's fair value is more-likely-than-not
greater than its carrying value, the two-step impairment test is not required. If the qualitative assessment indicates it is more-likely-than-not
that a reporting unit's fair value is not greater than its carrying value, we must perform the two-step impairment test. We may
also elect to proceed directly to the two-step impairment test without considering such qualitative factors.



During the fourth quarter of 2011, we commenced
our annual goodwill impairment test for 2011 and after considering qualitative factors including our market capitalization and
the Company’s 2012 outlook announced in the Company concluded that a two-step goodwill impairment test was not required.



In performing the first step of the two-step
goodwill impairment test, the Company determined that the fair value of the Company, as a single reporting unit, exceeded the carrying
value by a significant amount indicating no impairment was necessary.





14







The carrying value of the Company’s
goodwill for the six months ended June 30, 2012 was as follows:



|Goodwill                                 |  | June 30, |           |   | December 31, |  
|---------------------------------------- |  | -------- | --------- | - | ------------ | -
|                                         |  | 2012     |           |   | 2011         |  
|Goodwill at acquisition of ValidSoft Ltd |  | $        | 3,433,833 |   |              | $
|End of period exchange rate translation  |  |          | (371,548  | ) |              |  
|Total                                    |  | $        | 3,062,285 |   |              | $



Note 9. Overdraft



In 2004, Elephant Talk Ltd, a subsidiary
of the Company executed a credit facility with a bank in Hong Kong pursuant to which Elephant Talk Ltd. borrowed funds. As of June
30, 2012, the overdraft balance, including accrued interest totaled, $330,647 compared to $312,236 as of December 31, 2011. 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 or is otherwise obligated to pay
funds drawn upon it on behalf of Elephant Talk Ltd. Further detail can be found in Note 21, Litigation.



Note 10. Deferred Revenue



Deferred revenue represents amounts received
from the customers against future sales of services since the Company recognizes revenue upon performing the services. They typically
represent implementation fees. Deferred revenue was $140,556 and $132,467 as of June 30, 2012 and December 31, 2011, respectively.



Note 11. Accrued Expenses



As of June 30, 2012 and December 31, 2011,
the accrued expenses comprised of the following:



|                                                   |  | June 30,
 2012 |           |  | December 31,
 2011 |  
|-------------------------------------------------- |  | -------------- | --------- |  | ------------------ | -
|Accrued Selling, General & Administrative expenses |  | $              | 1,394,060 |  |                    | $
|Accrued cost of service                            |  |                | 687,254   |  |                    |  
|Accrued taxes (including VAT)                      |  |                | 527,345   |  |                    |  
|Accrued interest payable                           |  |                | 821,919   |  |                    |  
|Other accrued expenses                             |  |                | 327,502   |  |                    |  
|Total accrued expenses                             |  | $              | 3,758,081 |  |                    | $



Note 12.Loans Payable



|                                                                                                                                                                                                                                                                             |  | June 30, |         |  | December 31, |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------- | ------- |  | ------------ | -
|                                                                                                                                                                                                                                                                             |  | 2012     |         |  | 2011         |  
|Installment loan payable due December 24, 2006, secured by personal guarantees of two shareholders, a former director, and a third party                                                                                                                                     |  | $        | 320,247 |  |              | $
|Installment 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 |  |          | 254,607 |  |              |  
|Installment 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     |  |          | 103,861 |  |              |  
|Term loan payable, bank, monthly payments of interest at bank’s prime rate, 7.0% at December 31, 2007                                                                                                                                                                        |  |          | 283,604 |  |              |  
|Total                                                                                                                                                                                                                                                                        |  | $        | 962,319 |  |              | $



In December 2009 Chong Hing Bank Limited,
fka Liu Chong Hing Bank Limited, a foreign banking services company based in Hong Kong (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.





15







The Bank alleged that it entered into various
installment and term loan agreements and an overdraft account with Elephant Talk Limited (ETL), a wholly-owned Hong Kong subsidiary
of the Company. Various former officers and directors of ETL personally guaranteed the loans and overdraft account.



The Bank alleged that ETL was in default
on the loans and overdraft account, and that approximately $1,933,308 including interest and default interest was due. The Bank
alleged that the Company was directly liable to repay the loans and overdraft account as a successor in interest to ETL or because
the Company expressly or impliedly assumed direct liability for the loans and overdraft account. The Company denied the Bank’s
allegations and asserted several affirmative defenses. The Company contended that it had no direct liability to the Bank, and that
the Bank must pursue its recourse against ETL and its personal guarantors.



The Bank and the Company tried the case
to the court without a jury between October, 5 and 12, 2011. The court found, among other things, that

| | • | The Company was not liable as a successor in interest or otherwise on the Bank loans and overdraft account to ETL;                                              
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | • | The Company was not liable on the Bank’s claims because the Bank filed its action after the applicable California 4-year statute of limitations had expired; and
| | • | The Company was not liable to the Bank under the alternative theories of negligent or intentional misrepresentation.                                            



The court entered judgment in favor of
Elephant Talk Communications Corp. and against the Bank on December 14, 2011, and awarded the Company $5,925 in costs. The judgment
became final on February 16, 2012. We continue to accrue for these loans since our subsidiary ETL in Hong Kong may be still held
liable for these loans.



Note 13. Trade note payable



The company entered into an arrangement
with a vendor for the supply of telecommunication equipment whereby extended credit terms were agreed over and above normal credit
terms. The extended credit terms stipulate a repayment of the outstanding purchase price consideration over a period of 24 months
starting October 2011. The trade note payable amount as of June 30, 2012 was $165,074 and it relates to the portion of this outstanding
price consideration due after one year.



Note 14. 8% Senior Secured Convertible
Note



On March 29, 2012, the Company issued certain
senior secured convertible notes (“8% Convertible Note”) to a number of investors (“Holders”) in the principal
amount of $8,800,000 with the Company whereby the Holders agreed to provide the Company with net proceeds of $7,537,193, after
an $800,000 Original Issue Discount and after a deduction of $462,807 for financing costs such as various advisory fees and contract
preparation fees. According to the terms, the Note will bear an interest rate of 8%, compounded annually and matures May 1, 2014.
The monthly installment payments (constituting principal and interest) total $ 2,273,718 for the first year and $7,180,000 for
the second year through to maturity.



Of the $8 million in gross proceeds, the
amount equal to the first year installments, being $2,273,718, has been placed in escrow and is classified as restricted cash on
the balance sheet and will be applied on a monthly basis for the payment of the monthly installments. The amount held in escrow
will cover all necessary installments up to and including April 2013. As of June 30th, 2012 the balance in the escrow
account amounts to $1,885,412 after two installments being made during Q2-2012. At the election of the Company the Company can
pay the full installment amount or parts thereof in common stock at an amount equal to 90% of the average of the five lowest volume
weighted average price (“VWAP”) of the common stock during the twenty (20) Trading Days immediately prior to such installment
on the trading day payment date.



In the first year, when the Company elects
to pay a monthly installment in common stock, the equivalent cash installment amount will be released from the escrow and becomes
available to the Company. The Notes are convertible at the option of the Holder into the Company’s common stock at a fixed
conversion price of $2.61 (“fixed conversion price”). After a period of 12 months the Note automatically converts at
the fixed conversion price, if the shares of the Company, for any consecutive 30 days, close at or above 150% of the fixed conversion
price. The Notes are secured by a first priority security interest in all of the assets of the Company.



8% Senior Secured Convertible Loan Agreement Payable as of June 30, 2012:



|8% Convertible Note                                 |  | Short Term |           |  | Long Term |   |           | Total | 
|--------------------------------------------------- |  | ---------- | --------- |  | --------- | - | --------- | ----- | 
|8% Convertible Note                                 |  | $          | 2,454,618 |  |           | $ | 6,075,382 |       | 
|Less:                                               |  |            |           |  |           |   |           |       | 
|Original Issue Discount (OID) (net of amortization) |  | $          | 477,996   |  |           | $ | 222,047   |       | 
|Conversion Feature (net of amortization)            |  | $          | 1,612,823 |  |           | $ | 749,219   |       | 
|                                                    |  | $          | 363,799   |  |           | $ | 5,104,116 |       | 





16







The remaining unamortized life of the OID
and Conversion feature is approximately 22 months and total remaining amortizations until the end of the loan are $3,062,085.



The Company has identified the conversion
feature in the above instruments as an embedded derivative that requires evaluation and accounting under the guidance applicable
to financial derivatives.  The conversion feature is bifurcated from the host debt contract and accounted for as a liability.
The conversion feature is recorded at fair value at the date of issuance and marked-to-market each reporting period with changes
in fair value recorded to the Company’s statements of operations and classified into “Change fair value in conversion
feature” which is part of Other income and expenses. As of March 29, 2012 (“Closing date”) the company recognized
a “Fair Market Value” using a lattice model of $2,699,312 and evaluated the value of the conversion feature as per
June 30, 2012 at a fair market value of $1,469,226. During 2012, the conversion feature liability was neither reduced by any conversion
and redemption transactions associated with the convertible notes nor any repayment of the principal amount.



Conversion Feature valuation as per June 30, 2012:



|                                                 |  |         |  | Conversion Feature at fair market value |            |   | Conversion Feature remaining value netted in Convertible Note Payables |   |           | Number of Outstanding  Conversion Rights | 
|------------------------------------------------ |  | ------- |  | --------------------------------------- | ---------- | - | ---------------------------------------------------------------------- | - | --------- | ---------------------------------------- | 
|At Closing March 29, 2012 (Initial Value)        |  |         |  | $                                       | 2,699,312  |   |                                                                        | $ | 2,699,312 |                                          | 
|Repayment of Principal                           |  |         |  | $                                       | (82,820    | ) |                                                                        | $ | -         |                                          | 
|Revaluation as of June 30, 2012 (Movement only)  |  | Gain    |  | $                                       | (1,147,266 | ) |                                                                        | $ | -         |                                          | 
|Amortization as of June 30, 2012 (Movement only) |  | Expense |  | $                                       | -          |   |                                                                        | $ | (337,270  | )                                        | 
|As of June 30, 2012 (remaining balances/number)  |  |         |  | $                                       | 1,469,226  |   |                                                                        | $ | 2,362,042 |                                          | 



The conversion feature associated with
the Note is recorded at fair value using quoted market prices adjusted for historical volatility and future expectations of conversion
that use observable market inputs including quoted market prices. We classify these instruments in Level II when quoted market
prices can be corroborated utilizing observable current market prices on active exchanges.



Note 15. Loan from joint venture partner



The Company’s 51% owned subsidiary
ET-UTS N.V. has received $534,181 in interest bearing (8% per annum) unsecured loans from the 49% shareholder in the joint venture,
United Telecommunication Services N.V., the government owned incumbent telecom operator of Curaçao. The amount is inclusive
of accumulated accrued interest. No maturity date has been fixed.



Note 16. Stockholders’ Equity



(A) Common Stock



The Company is presently authorized to
issue 250,000,000 shares common stock. The Company had 111,240,995 shares of common shares issued and outstanding as of June 30,
2012, an increase of 715,766 shares since December 31, 2011, largely due to the shares issued in connection with the exercise of
595,000 warrants (of which 510,000 at $1.00 and 35,000 at $1.50); the issuance of 50,000 shares due to a double issuance of shares
after a warrant exercise by our stock agent in 2011 which received board approval afterwards; 221,251 shares issued as consideration
for management and board compensation; 199,515 shares issued to employees as a result of exercised employee stock options and 300,000
shares returned after a settlement agreement with a former executive officer of the Company.





17







The following table summarizes the shares issued for the six
months ended June 30, 2012:



|Computation of Full Dilution - June 30, 2012                     |  | Number of shares issued |            
|---------------------------------------------------------------- |  | ----------------------- | -----------
|December 31, 2011 Total number of shares issued                  |  |                         | 110,525,229
|Shares issued for D&O compensation                               |  |                         | 221,251    
|Shares issued for warrant exercises                              |  |                         | 595,000    
|Shares issued for employee stock option exercises                |  |                         | 199,515    
|Shares returned after settled court case/dispute with former CFO |  |                         | (300,000   
|June 30, 2012 Total number of shares issued                      |  |                         | 111,240,995



Reconciliation with stock transfer agent records:



The number of 111,240,995 excludes the
245,900 unreturned and the 2,558,938 escrowed contingent shares (see below). The shares issued and outstanding as per June 30,
2012 according to the stock transfer agent’s records are 114,045,833, include 2,558,938 contingent shares for the ValidSoft
acquisition and include 245,900 shares which were cancelled by the Company prior to 2006. However, the 245,900 shares were not
returned to the stock transfer agent and never cancelled on the Company’s records. These shares have been blocked for trading
by the Stock Transfer Agent. Finally, in the above table we included the elimination of a rounding difference of two shares between
the Company’s shares issued and the stock transfer agent’s records.



(B) Preferred Stock



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



During 2011 and in the first six months
2012 the Company did not issue any shares of Preferred Stock.



Note 17. Basic and Diluted Net Loss per Share



Net loss per share is calculated in accordance
with ASC 260, Earnings per Share (“ASC 260”). 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.



Note 18. Employee Benefit Plan and Non-Qualified Stock
Option and Compensation Plan



2006 Non-Qualified Stock and Option
Compensation Plan



Under this plan there are, as of June 30,
2012, 75,000 stock options outstanding. There are remaining 600,000 shares and 14,490 stock options available for grant.



Options granted generally vest over a 3
year period. Options generally expire 2 years from the date of vesting.





18







Common stock purchase options consisted
of the following as of June 30, 2012:



|                                        |  | Number of shares |        |  | Average Exercise Price |   |      | Initial Fair Market Value | 
|--------------------------------------- |  | ---------------- | ------ |  | ---------------------- | - | ---- | ------------------------- | 
|Options:                                |  |                  |        |  |                        |   |      |                           | 
|Outstanding as of December 31, 2011     |  |                  | 75,000 |  |                        | $ | 2.25 |                           | 
|Granted in 2012                         |  |                  | -      |  |                        | $ | 2.25 |                           | 
|Exercised                               |  |                  | -      |  |                        | $ | 2.25 |                           | 
|Cancelled/Forfeited/Returned to reserve |  |                  | -      |  |                        | $ | 2.25 |                           | 
|Outstanding as of June 30, 2012         |  |                  | 75,000 |  |                        | $ | 2.25 |                           | 



No grants were made during the first six
months of 2012. Also no exercises and or cancellations/forfeitures have occurred.



The current 75,000 outstanding options
will expire in 2013 with various expiration dates.



Following is a summary of the status of
options outstanding at June 30, 2012:





|                                     |      |  | Options outstanding       |  |        | Options exercisable                                  
|------------------------------------ | ---- |  | ------------------------- |  | ------ | -----------------------------------------------------
|Range     of     Exercise
    Prices |      |  | Total Options Outstanding |  |        | Weighted Average Remaining Contractual  Life  (Years)
|$                                    | 2.25 |  |                           |  | 75,000 |                                                      



At June 30, 2012, 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 $0.



2008 Long-Term Incentive Plan



The 2008 plan was adopted on January 15,
2008. This incentive plan 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.



On October 6, 2011 the company filed, after
approval of the shareholders, an “Amended and Restated 2008 Long-Term Incentive Compensation Plan” which basically
provided in the increase of the existing 5,000,000 shares of common stock into 23,000,000 shares of common stock in order to cover
future grants under this Plan.



As of 2012 the company decided, in order
to avoid costly separate registrations for the quarterly recurring share issues and the obligatory registration of such shares,
to issue the non-cash compensation to directors and officers under this plan. During the first six months of 2012 the company issued
221,251 restricted shares to various directors and officers which were issued in conjunction with their willingness to receive
their total or part of their compensation in shares of the company. Those shares are issued with a 25% discount on the 10 day average
share price preceding the quarter of their relating services as per the term agreed by the compensation committee dated February
11, 2011.



On March 27, 2012 the compensation committee
of the board of directors approved the issuance of 5,419,167 options and additionally authorized the CEO of the company to grant
options during 2012 for a maximum number of 75,000 options per individual for future incentive shares, stock options etc. for newly
hired staff and /or consultants.





19







As of June 30, 2012, a total of 12,787,056
stock options were outstanding under the Plan and 325,000 shares of restricted common stock together with 728,551 shares of restricted
common stock had been granted under this plan. Options granted generally begin vesting over a three-year or ten-year period after
grant date although options have been granted with a shorter period than three years. Options generally expire between two and
ten years from date of vesting.



Common stock purchase options consisted of the following
as of June 30, 2012:

|                                    |  | Number of Options |            |  | Average Exercise Price |   |      | Initial Fair Market Value | 
|----------------------------------- |  | ----------------- | ---------- |  | ---------------------- | - | ---- | ------------------------- | 
|Options:                            |  |                   |            |  |                        |   |      |                           | 
|Outstanding as of December 31, 2011 |  |                   | 7,793,989  |  |                        | $ | 1.78 |                           | 
|Granted in 2012                     |  |                   | 5,994,548  |  |                        | $ | 2.27 |                           | 
|Exercised (with delivery of shares) |  |                   | 146,515    |  |                        | $ | 0.98 |                           | 
|Forfeitures (Pre-vesting)           |  |                   | 795,547    |  |                        | $ | 2.28 |                           | 
|Expirations (Post-vesting)          |  |                   | 29,313     |  |                        | $ | 2.22 |                           | 
|Exchanged for cashless exercise     |  |                   | 30,106     |  |                        | $ | 1.76 |                           | 
|Outstanding as of June 30, 2012     |  |                   | 12,787,056 |  |                        | $ | 1.84 |                           | 





The options granted in 2012 were granted
with a weighted average exercise price of $2.27. The grant date fair market value of the options is $5,986,078.



Following is a summary of the status of
options outstanding at June 30, 2012:



|2008 Plan                |      |   | Options outstanding |   |      | Options exercisable       | 
|------------------------ | ---- | - | ------------------- | - | ---- | ------------------------- | 
|Range of
Exercise
Prices |      |   |                     |   |      | Total
Options
Outstanding | 
|$                        | 0.60 | - |                     | $ | 3.39 |                           | 



The weighted average assumptions used for
the options granted in 2012 using the Black-Scholes options model are: expected volatility of 116%, expected option life 2.69 years
(using the simplified method) and a Risk Free Interest Rate of 0.284%. The expected dividend yield is zero.



The weighted average remaining expected
life of the outstanding options is not reported as our calculation method does not include an adjustment for out-of-the-money options
which represent the majority of the current granted options.



At June 30, 2012 the not yet recognized
expense portion of stock-based awards granted to employees under the provisions of ASC 718 and the Company’s 2008 stock
award plan, was approximately $5,358,111. The future expensing takes place proportionally to the vesting associated with each stock-award,
adjusted for cancellations, forfeitures and returns. The forfeiture rate has been adjusted from 6.50% at closing 2011 to 9.13%
as per closing June 2012 and the corresponding profit and loss effect has been accounted for in 2012.



Stock-Based Compensation Expense



Under the provisions of ASC 718, the Company
recorded for the quarter ended June 30, 2012, $3,162,282 in stock-based compensation expense for the 2008 Long-Term Incentive Plan,
management shares and shares issued for consultancy and employee compensation. For the comparable period in 2011 the expensing
was $1,944,308. The comparison does not fully match as the Board and Management shares were not issued out of the 2008 Long - Term
Incentive Plan but separately issued as unregistered restricted shares. The Company utilized the Black-Scholes valuation model
for estimating the fair value of the stock-options at grant.





20







Note 19. Commitments



Commitments of the Company relating to
co-location, network and office rents, regulatory and interconnection fees are as follows:



|Year |  | Office |         |  | Co-location |   |         | Interconnect |  |   | Service/Support |  |  | Network |        |  | Total |  
|---- |  | ------ | ------- |  | ----------- | - | ------- | ------------ |  | - | --------------- |  |  | ------- | ------ |  | ----- | -
|2012 |  | $      | 324,661 |  |             | $ | 254,174 |              |  | $ | 2,019,889       |  |  | $       | 64,520 |  |       | $
|2013 |  |        | 328,007 |  |             |   | 368,081 |              |  |   | 1,699,018       |  |  |         | 26,915 |  |       |  
|2014 |  |        | 234,664 |  |             |   | 246,475 |              |  |   | 63,347          |  |  |         | -      |  |       |  
|2015 |  |        | 234,664 |  |             |   | 123,237 |              |  |   | 50,759          |  |  |         | -      |  |       |  
|2016 |  | $      | 234,664 |  |             | $ | -       |              |  | $ | 12,994          |  |  | $       | -      |  |       | $
|     |  |        |         |  |             |   |         |              |  |   |                 |  |  |         |        |  |       |  



Note 20. Non-controlling Interest



The Company had non-controlling interests
in several of its subsidiaries. The balance of the non-controlling interests as of June 30, 2012 and December 31, 2011 were as
follows:



|                    |  |                            |  | Noncontrolling interest Balance at |        
|------------------- |  | -------------------------- |  | ---------------------------------- | -------
|Subsidiary          |  | Non-controlling Interest % |  | June 30, 2012                      |        
|                    |  |                            |  |                                    |        
|ETC PRS UK          |  | 49%                        |  | $                                  | 9,228  
|ETC PRS Netherlands |  | 49%                        |  |                                    | 123,255
|ET Bahrain WLL      |  | 1%                         |  |                                    | 3,759  
|ET ME&A FZ LLC      |  | 49.46%                     |  |                                    | 37,091 
|                    |  |                            |  |                                    |        
|Total               |  |                            |  | $                                  | 173,333



Note 21. Litigations



(a) Chong Hing Bank Litigation



In December 2009 Chong Hing Bank Limited,
fka Liu Chong Hing Bank Limited (Bank), a foreign banking services company based in Hong Kong , 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 alleged that it entered into various installment and term loan agreements and an overdraft account with Elephant Talk
Limited (ETL), a wholly-owned Hong Kong subsidiary of Elephant Talk Communications Corp. (Company). Various former officers and
directors of ETL personally guaranteed the loans and overdraft account.



The Bank alleged that ETL was in default
on the loans and overdraft account, and that approximately $1,933,308 including interest and default interest was due. The Bank
alleged that the Company was directly liable to repay the loans and overdraft account as a successor in interest to ETL or because
the Company expressly or impliedly assumed direct liability for the loans and overdraft account. The Company denied the Bank’s
allegations and asserted several affirmative defenses. The Company contended that it had no direct liability to the Bank, and that
the Bank must pursue its recourse against ETL and its personal guarantors.



The Bank and the Company tried the case
to the court without a jury between October, 5 and 12, 2011. The court found, among other things, that



| | • | The Company was not liable as a successor in interest or otherwise on the Bank loans and overdraft account to ETL;
| | - | ------------------------------------------------------------------------------------------------------------------



| | • | The Company was not liable on the Bank’s claims because the Bank filed its action after the applicable California 4-year statute of limitations had expired; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------





21







| | • | The Company was not liable to the Bank under the alternative theories of negligent or intentional misrepresentation.
| | - | --------------------------------------------------------------------------------------------------------------------



The court entered judgment in favor of
the Company and against the Bank on December 14, 2011, and awarded the Company $5,925.41 in costs. The judgment became final on
February 16, 2012.



(b) Rescission of the Purchase Agreement
of March 31, 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.



Note 22. Geographic Information



Quarter ended June 30, 2012



|                                     |  | Europe |            |  | Other foreign countries |   |           | Total | 
|------------------------------------ |  | ------ | ---------- |  | ----------------------- | - | --------- | ----- | 
|Revenues from unaffiliated customers |  | $      | 15,665,936 |  |                         | $ | 82,812    |       | 
|                                     |  |        |            |  |                         |   |           |       | 
|Identifiable assets                  |  | $      | 35,825,355 |  |                         | $ | 8,805,327 |       | 



Quarter ended June 30, 2011



|Revenues from unaffiliated customers |  | $ | 16,222,830 |  |  | $ | 76,160    |  |  | $ | 16,298,990 | 
|------------------------------------ |  | - | ---------- |  |  | - | --------- |  |  | - | ---------- | 
|                                     |  |   |            |  |  |   |           |  |  |   |            | 
|Identifiable assets                  |  | $ | 47,307,939 |  |  | $ | 3,933,762 |  |  | $ | 51,241,701 | 



Note 23. Related Party Transactions



In anticipation of a potential acquisition,
the Company provided on April 2, 2012 a loan to Elephant Security BV, from the Netherlands, for the amount of $550,874 (€438,000).
The loan carries an interest rate of 7% per annum and has a maturity date of June 30, 2012. Elephant Security BV is an entity that
is majority owned by QAT Investments SA, a related party of the Company. The Company is currently renegotiating the terms of this
loan.



On June 11 and 29, 2012 the Company entered
into loan agreements with Modale BV (previously known as Elephant Security I BV), a company in which the Company holds a 33.33%
ownership interest, to provide loans of $42,762 (€34,000) and $18,866 (€15,000) respectively, increased with a total
accrued interest of $133. The loans carry an interest rate of 7% per annum and have a maturity date of December 31, 2012.



Note 24. Subsequent Events



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



Investment in joint venture

In anticipation of a potential acquisition,
the Company provided on July 2, 2012 the company provided a loan of $44,020 to related party Modale BV (previously named Elephant
Security I B.V.). The loan carries an interest rate of 7% per annum and has a maturity date of December 31, 2012.





22







Departure and appointment of directors

On July 9, 2012, Mr. Jacques Kerrest resigned
from the Board of Directors of Elephant Talk Communications Corp. At the time of his resignation, Mr. Kerrest was the Chairman
of the Audit and Finance Committee, a member of the Nominating and the Corporate Governance Committee and a member of the Compensation
Committee of the company.



On July 11, 2012, the Board unanimously
appointed Mr. Phil Hickman, a member of the Board of Directors, the Audit Committee and the Compensation Committee, to serve as
the Chairman of the Audit Committee.



On July 27, 2012, Mr. Martin Zuurbier resigned
from the Board of Directors (the “Board”) of Elephant Talk Communications Corp. (the “Company”). Mr. Zuubier
will continue to serve as the Chief Technical Officer of the Company and an observer to the Board.



Mr. Zuurbier’s resignation is to
ensure the Company’s compliance with the corporate governance requirement of NYSE MKT that at least a majority of directors
are independent directors. Mr. Zuurbier did not resign from the Board as a result of any disagreement with the Company on any matter
relating to the Company’s operations, policies or practices



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.



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.



Our Business



Services and Solutions



Elephant Talk is an international provider
of business software and outsourced services to the telecommunications and financial services industry.



Full-MVNE/MVNO Mobile Services –
wholesale services and managed services to Mobile Network Operators and Virtual Network Operators.



The company enables both mobile carriers
and virtual operators to offer a full suite of products, delivery platforms, and support services with superior industry expertise
and high quality customer service without substantial upfront investments from clients. Elephant Talk provides global telecommunication
companies, mobile network operators, banks, supermarkets, consumer product companies, media firms, and other businesses a full
suite of products and services that enables them to provide a full set of 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 wide range of other emerging customized mobile services.





23







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



| | • | On September 17, 2008, we signed a hosting agreement with T-Mobile in the Netherlands. T-Mobile is one of three MNOs in the Netherlands. Using the mobile network of T-Mobile, Elephant Talk connects MVNOs in the Netherlands to its own platform.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | Beginning in June 2009, we have provided managed services to Vodafone Enabler in Spain.
| | - | ---------------------------------------------------------------------------------------



| | • | In the course of 2010 we signed a framework hosting agreement with KPN Group Belgium NV. Elephant Talk will connect MVNOs in Belgium to its platform, making use of the mobile network of KPN in Belgium. The platform is ready for services.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | In 2011 the company closed a contract with Zain KSA in Saudi Arabia to provide its mobile platform which is now ready for service.
| | - | ----------------------------------------------------------------------------------------------------------------------------------



| | • | In November 2011 we executed a mass migration of SIMs on to our platform in Spain. This live migration – without having to replace the SIM cards – was believed to be a significant achievement and milestone for the Company.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | In February 2012 we acquired out of liquidation proceedings the assets of Ensercom, a small MVNE in Germany giving us instant footprint in the German market.                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                 
| | • | Following the Ensercom take-over and wholesale partner agreement
with Telekom Deutschland, we signed an MVNO contract for 55,000 sims in Germany, using the network of Telekom Deutschland. In July
2012 we have activated 10,000 of these sims.





ValidSoft – Fraud Prevention and Security Software
Solutions



ValidSoft is a subsidiary of Elephant Talk
Communications Corp. and is a thought and technology leader in providing solutions to counter electronic fraud relating to card,
the internet, and telephone channels. ValidSoft's solutions are at the cutting edge of the market and are used to verify the authenticity
of both parties to a transaction (Mutual Authentication), and the integrity of the transaction itself (Transaction Verification)
for the mass market, in a highly cost effective and secure manner, yet easy to use and intuitive.



As the banking and payments world, in particular,
begins to converge onto smart telecommunications-based devices, the ValidSoft integrated security platform, built solely on a real-time
zero client-footprint model, allows organizations to leverage these convergence devices to provide visible and invisible security
layers for all transaction channels, whilst also providing protection where the device itself is the channel.



This integrated platform, using proprietary
technologies including Out-of-Band authentication and transaction verification, Proximity Correlation Logic, Pseudo Device Theft
detection and biometric voice verification, allows organizations to protect all of their customer transaction channels within a
single platform. This combination of technologies provides solutions from simply detecting SIM Swap fraud through to the world’s
first commercially available Four-factor authentication solution. Internet banking, M-banking, Mobile Wallet, Mobile Payments,
Card-present, card-not-present, NFC, citizen online services and more are all supported through either one or more of these integrated
telecommunications-based techniques. The key operational highlights:



| | • | In September 2011 ValidSoft and Adeptra (www.adeptra.com) form partnership to Extend Global Fraud Detection and Customer Communications. The partnership provides financial organizations with best-in-class fraud detection and prevention functionality, as well as total control over their customer communications.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | Following a pilot project at a long-standing Adeptra client, one of the ten largest international financial institutions has now implemented the SIM Swap solution and is now in live production. The institution’s adoption of the application is another step toward securing all transaction channels, using leading edge technology and communications to benefit its customers.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | ValidSoft successfully concluded the live-trials for a Self-Certification project to an EU Government in the area of citizen benefit payments. The proposed solution is based on ValidSoft’s own IP and specialised technology and incorporates 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. We now await a decision to be taken by the EU Government in terms of next steps, including potential deployment and timing.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





24







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



| | • | ValidSoft has filed applications for three new patents in the Card Not Present fraud prevention area and the high end security area.
| | - | ------------------------------------------------------------------------------------------------------------------------------------



| | • | ValidSoft successfully renewed 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.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | ValidSoft was awarded its Second European Privacy Seal for its VALid-4FTMsolution and continues to be the only Security Software Company in the world to be certified to the EuroPriSe standards. The European Privacy Seal certifies IT products and IT-based services privacy compliance with European data protection regulations.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Landline network outsourcing services



Through our fixed line telecom infrastructure
and our centrally operated and managed ET Boss and Infitel platform, the Company also provides traditional landline services like
Carrier Select and Carrier Pre-Select Services, Toll Free and Premium Rate Services to the business market.



Support technology



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, related to companies’ proprietary platforms
ET BOSS and IN



Electronic fraud prevention products:
VALid-POS®, VALid®, VALid-SVPTM and VALid-4F®



Our subsidiary 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®, VALid® and VALid-4F®. For its biometrics based product it trades under VALid-SVPTM.



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 and one (1) in the Middle East (Bahrain). 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, Vodafone Enabler in Spain, KPN in
Belgium and wholesale partner Telekom Deutschland in Germany. In Saudi Arabia we partnered with Zain KSA to provide our mobile
platform services.



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.





25







Stock-based Compensation



Effective January 1, 2006, we adopted the
provisions of ASC 718 “Compensation-Stock Compensation”, using the prospective approach. As a result, we recognize
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 ASC 805 “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, 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 and Equipment”, 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.



Goodwill Impairment



On September 15, 2011, the FASB issued
ASU 2011-08, Intangibles – Goodwill and Other, which simplifies how an entity is required to test goodwill for impairment.
This ASU would allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step
quantitative goodwill impairment test. Under the ASU, an entity would not be required to calculate the fair value of a reporting
unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less
than its carrying amount. The ASU includes a number of factors to consider in conducting the qualitative assessment. The ASU is
effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption
of this accounting standard in 2011 had no material impact on the Company’s financial statements.



Results of Operations



Our results of operations for the six months
ended June 30, 2012, consisted of the operations of Elephant Talk Communications Corp., its wholly-owned subsidiaries, Elephant
Talk Limited and its subsidiaries, Elephant Talk Europe 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
and USD leads to period-to-period fluctuations in our reported USD results arising from changes in the exchange rate between the
USD and the Euro. Generally, when the USD strengthens relative to the Euro, it has an unfavorable impact on our reported revenue
and income and a favorable impact on our reported expenses. Conversely, when the USD weakens relative to the Euro, it produces
a favorable impact on our reported revenue and income, and an unfavorable impact on our reported expenses. The above fluctuations
in the USD/Euro exchange rate therefore result in currency translation effects (not to be confused with real currency exchange
effects), which impact our reported USD results and may make it difficult to determine actual increases and decreases in our revenue
and expenses which are attributable to our actual operating activities. In addition to reporting changes in our financial statements
in USD as per the requirements of United States generally accepted accounting principles (“US GAAP”), 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 Euro’s we do not currently engage in hedging activities.





26







The constant currency analysis presented
within the comparison of the year-to-year results is calculated by using the average exchange rates over the six months ended June
30, 2012. The same exchange rates are used in the income statement of the six months ended June 30, 2012. The following table shows
the USD equivalent of the major currencies for the six months ended June 30, 2012:



|              |  | US Dollars |       
|------------- |  | ---------- | ------
|              |  | equivalent |       
|Euro          |  | $          | 1.2972
|British Pound |  | $          | 1.5766



Adjusted EBITDA



In order to provide investors additional
information regarding our financial results, we are disclosing Adjusted EBITDA, a non-GAAP financial measure. 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 the desired results. Accordingly, we believe
that Adjusted EBITDA provides useful information for investors and others, which allows them to better understand and evaluate
our operating 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:



|                                                   |  | Six months ended June 30, |            
|-------------------------------------------------- |  | ------------------------- | -----------
|EBITDA Adjusted                                    |  | 2012                      |            
|                                                   |  |                           |            
|Net loss                                           |  | $                         | (10,996,098
|Provision for income taxes                         |  |                           | 97,288     
|Depreciation and amortization                      |  |                           | 2,503,357  
|Stock-based compensation                           |  |                           | 3,230,728  
|Other income & expenses                            |  |                           | (571,157   
|Equity in earnings of unconsolidated joint venture |  |                           | 192,415    
|Adjusted EBITDA                                    |  | $                         | (5,543,467 



|                                                   |  | Three months ended June 30, |           
|-------------------------------------------------- |  | --------------------------- | ----------
|EBITDA Adjusted                                    |  | 2012                        |           
|                                                   |  |                             |           
|Net loss                                           |  | $                           | (4,990,909
|Provision for income taxes                         |  |                             | 97,288    
|Net loss attributable to non-controlling interest  |  |                             | -         
|Depreciation and amortization                      |  |                             | 1,224,888 
|Stock-based compensation                           |  |                             | 1,538,982 
|Other income & expenses                            |  |                             | (564,593  
|Equity in earnings of unconsolidated joint venture |  |                             | 29,084    
|Adjusted EBITDA                                    |  | $                           | (2,665,260





27







Comparison of Three and Six months
Ended June 30, 2012 and December 31, 2011



This quarter the effects of the devaluation
of the Euro against the US Dollar have been substantial on the financials we report.



Despite the growth in our business, which
is primarily Euro-based, the financials as we report show a decrease in our revenues, following the devaluation of the euro and
the requirement to report in US Dollars.



For purposes of comparison and clarification
we have added ‘constant currency’ calculations below in order to remove the reporting currency effects from the revenues
and results derived in the functional currencies.



Revenue

Revenue for the three months ended June
30, 2012 was $7,084,969, a decrease of $706,007 or 9.1%, compared to $7,790,976 for the three months ending June 30, 2011. The
landline services revenue for the three months ended June 30, 2012 and 2011 was $4,301,249 and $6,841,551 and the mobile and security
solutions revenue was $2,783,720 and $949,425 respectively.

The total revenue decrease of $706,007
was the result of an unfavorable impact of the currency translation effect of $864,958 arising from a lower US Dollar/Euro exchange
rate.



Revenue for the six months ended June 30,
2012 was $15,665,937, a decrease of $633,053 or 3.9%, compared to $16,298,990 for the six months ended June 30, 2011. This decrease
of $633,053 was the result of an unfavorable impact of the currency translation effect of $1,208,075 arising from a lower US Dollar/Euro
exchange rate.



|                            |  | Six months ended June 30, |           
|--------------------------- |  | ------------------------- | ----------
|                            |  |                           |           
|Revenue                     |  | 2012                      |           
|Landline Services           |  | $                         | 10,454,510
|Mobile & Security Solutions |  |                           | 5,211,427 
|Total Revenue               |  | $                         | 15,665,937



Revenue - constant currency

In constant currency, the revenue
for the three months ended June 30, 2012 increased by $158,951 or 2.3% compared to the same period 2011. In constant currency,
the revenue for the six months ended June 30, 2012 increased by $575,022 or 3.8% compared to the same period 2011. The increase
in revenue was led by an increase of $2,934,523 (or 128.9%) in our revenues in the higher margin mobile and security solutions
business, which was partially off-set by the expected continued decrease in our lower margin legacy landline business by $2,359,501
(or 18.4%).



Cost of service

Cost of service for the three months ended
June 30, 2012 was $5,185,048, a decrease of $2,309,631 or 30.8%, compared to $7,494,679 for the three months ending June 30, 2011.
Cost of service for the six months ended June 30, 2012 was $12,074,265, a decrease of $2,977,899 or 19.8%, compared to $15,052,164
for the six months ended June 30, 2011.This decrease is related to the decline in landline revenue. Cost of service as a percent
of the total revenue was 77.1% and 92.4% for the six months ended June 30, 2012 and 2011, respectively.



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.





28







The following tables summarize the
Company’s quarterly mobile and security revenue and Elephant Talk’s total margin since 2011. Mobile and security revenue
increased as a percentage of total Company revenue to 39.3% in the second quarter of 2012 from 12.2% in the prior year period.





Total margin as a percentage of total Company
revenue increased to 26.8% in the second quarter of 2012 from 3.8% in the prior year period.



|Mobile and Security
|-------------------
|Quarter            
|Q211               
|Q311               
|Q411               
|Q112               
|Q212               





|Total Company Margin*
|---------------------
|Quarter              
|Q211                 
|Q311                 
|Q411                 
|Q112                 
|Q212                 

* Revenues minus Cost of Service



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





Cost of service– constant
currency

In constant currency, the cost
of service for the three months ended June 30, 2012 decreased by $1,514,115 or 22.4% compared to the same period in 2011. In constant
currency, the cost of service for the six months ended June 30, 2012 decreased by $1,862,473 or 13.4% compared to the same period
in 2011. The decrease was primarily as a result of lower levels of revenue in our landline business and the lower cost of service
associated with our mobile and security solutions business.





Selling, general and administrative
expenses

Selling, general and administrative (“SG&A”)
expense for the three months ended June 30, 2012 and 2011 were $4,565,181 and $3,824,756, respectively. SG&A expenses increased
$740,425, or 19.4%, in the three months ending June 30, 2012 when compared to the same period in 2011. Selling, general and administrative
expense for the six months ended June 30, 2012 and 2011, were $9,135,139 and $7,241,113, respectively. SG&A expenses increased
by $1,894,026, or 26.2%, in the first six months 2012 compared to the same period 2011. Higher year-over-year SG&A expenses
in the second quarter of 2012 were mainly the result of a 22.2% year-over-year increase in staffing levels, largely European (mobile
and security) hires, as well as higher investor relations and sales, marketing & communication related staffing and expenses.



Selling, general and administrative
expenses – constant currency

In constant currency, SG&A
for the three months ended June 30, 2012 increased by $1,253,413 or 38.3%, compared to the same period in 2011. In constant currency,
SG&A for the six months ended June 30, 2012 increased by $2,541,947 or 38.6%, compared to the same period in 2011. The increase
in expenses was mainly attributable to increased staffing levels.



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

Non-cash compensation for the three months
ended June 30, 2012 was $1,538,982, a decrease of $498,921 or 24.5%, compared to $2,037,903 for the three months ended June 30,
2011. Non-cash compensation for the six months ended June 30, 2012 and 2011 was $3,230,728 and $3,167,966, respectively. The year
to date increase was of $62,762 or 2.0%.



Non-cash compensation is comprised of:



| | • | the stock options expenses related to
the companywide 2008 Long-Term Incentive Compensation Plan;
| | - | -------------------------------------------------------------------------------------------------

| | • | expenses related to shares of common stock
that were issued to directors and officers in lieu of cash compensation.
| | - | -------------------------------------------------------------------------------------------------------------------



Depreciation and amortization

Depreciation and amortization expenses
for the three months ended June 30, 2012 was $1,224,888, a decrease of $112,887 or 8.4%, compared to $1,337,775 for the three months
ended June 30, 2011. Depreciation and amortization for the six months ended June 30, 2012 and 2011, was $2,503,357 and $2,640,450
respectively. Depreciation and amortization expenses decreased by $137,093 or 5.2% in the first six months 2012 compared to the
same period 2011.



Depreciation and amortization
– constant currency

In constant currency, the depreciation
and amortization expenses for the three months ended June 30, 2012 increased by $20,018 or 1.6% compared to the same period in
2011. In constant currency, the depreciation and amortization expenses for the six months ended June 30, 2012 increased by $45,758
or 1.9% compared to the same period in 2011.



Intangible assets impairment charge

The June 30, 2012 consolidated balance
sheet includes: $11.4 million of intangible assets, net, and $3.1 million of goodwill. Management updated its analysis of intangible
assets and long-lived assets as of June 30, 2012 and we determined that for the first six months 2012 no asset impairment charges
are necessary.



We have acquired several companies in the
last few years and our current business strategy includes continuing to make additional acquisitions in the future. These acquisitions
may continue to give rise to goodwill and other intangible assets which will need to be assessed for impairment from time to time.





29







Other Income
and Expenses

Interest income
for the three months ended June 30, 2012 was $174,756, an increase of $150,611 or 623.8%, compared to $24,145 for the three months
ended June 30, 2011. Interest income was $279,918 and $47,131 for the six months ended June 30, 2012 and 2011. Interest income
was interest received on bank balances and interest on loans to related and third parties.



Interest expense,
amortization of debt discount and financing cost for the three month ended June 30, 2012 and 2011 were $836,580 and $71,511, respectively.
The amount of $71,511 for the three months ended June 30, 2011 is entirely related to interest expenses, whereas the amount of
$836,580 for the three months ended June 30, 2012 is composed of interest expenses in the amount of $360,639, interest expenses
related to debt discount in the amount of $329,587 and of the amortization of deferred financing costs in the value of $146,354.
Interest expense, amortization of debt discount and financing cost for the six month ended June 30, 2012 and 2011were $938,847
and $138,275, respectively. The $138,275 for the six months ended June 30, 2011 is entirely related to interest expenses, whereas
the amount of $836,580 for the six months ended June 30, 2012 is composed of interest expenses in the amount of $451,246, interest
expenses related to debt discount in the amount of $337,270 and of the amortization of deferred financing costs in the value of
$150,331. Interest expenses for the three and six months ended June 30, 2012 include the interest expenses on the 8% convertible
note of $175,225.



Other expense for the three months ended
June 30, 2012 was $0 compared to $230,000 for the three months ending June 30, 2011. Other expense was $0 and $460,000 for the
six months ended June 30, 2012 and 2011 respectively. The other income for 2011 was related to the release of an accrual for a
tax provision, following a successful abatement.



Change in fair value conversion feature

The company issued an 8% convertible note
on March 29, 2012. The Company has identified the conversion feature in the above instruments as an embedded derivative that requires
evaluation and accounting under the guidance applicable to financial derivatives.  The conversion feature is bifurcated from
the host debt contract and accounted for as a liability. The conversion feature is recorded at fair value at the date of issuance
and marked-to-market each reporting period. As of March 29, 2012 (“Closing date”) the company recognized a “Fair
Market Value” using a lattice model of $2,699,312 and evaluated the value of the conversion feature as per June 30, 2012
at a “Fair Market Value” of $1,469,226. During 2012, the conversion feature liability was neither reduced by any conversion
and redemption transactions associated with the convertible notes nor any repayment of the principal amount. The conversion feature
associated with the Note is recorded at fair value using updated quoted share prices, treasury discount rates, remaining contractual
life and recalculated historical volatility by using  observable market inputs including quoted market prices.



Equity in earnings of unconsolidated
joint venture

In the three and six months ended June
30, 2012, the company incurred expenses of $29,084 and $192,415, respectively, as a result of the company’s equity share
in the losses of its financial investment in a joint venture.



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.



We incurred a non-controlling interest
charge attributable to minority shareholders’ interest for the three months ended June 30, 2012 and 2011 of $0 and $80, respectively.
For the six months ended June 30, 2012 and June 30, 2011, the non-controlling interest charge was $0.



Provision for Income Taxes

Provision for income taxes for the three
and six months ended June 30, 2012 was $97,288. In the ordinary course of the Company's business there are transactions where the
ultimate income tax determination is uncertain, the Company believes that is has adequately provided for income tax issues not
yet resolved with federal, state, local and foreign tax authorities. In the event that actual results differ from these estimates
or we adjust these estimates in future periods, an additional charge to expense would result.



Net Loss

Net loss for the three months ended June
30, 2012 was $4,990,909, a decrease of $1,730,514 (or 25.7%), compared to $6,721,423 for the three months ending June 30, 2011.
Net Loss was $10,996,098, a decrease of $438,549 (or 3.84%)compared to $11,424,647 for the
six months ended June 30, 2012 and 2011. The decreases in loss of $1,730,514 for the three months ended June 30, 2012 and $438,549for the six months ended June 30, 2012 were led by the decrease in the loss from operations by $1,475,007 and $525,151 for
the three and six months ended June 30, 2012, as well as by the other income of $381,959 and $202,301 for the three and six months
ended June 30, 2012, respectively. Moreover, the provision for income taxes, the decrease in net income attributable to non-controlling
interest and the equity in earnings of unconsolidated joint venture of a total of $126,452 and $288,903 for the three and six months
ended June 30, 2012 had an adverse impact on the net loss. The decrease in loss from operations was primarily driven by the increase
of our Mobile & Security business.





30







Other Comprehensive Income (Loss)

We record foreign currency translation
gains and losses as other comprehensive income or loss. Other comprehensive Income (Loss) for the six months ended June 30, 2012
and 2011 was ($909,694) and $3,257,603 respectively. This change is primarily attributable to the translation effect resulting
from the substantial fluctuations in the US Dollars/Euro exchange rates.



Liquidity and Capital Resources



We
have an accumulated deficit of $191,124,469 as of June 30, 2012. Historically, we have relied on a combination of debt and equity
financings to fund our ongoing cash requirements. The Company’s
operations have not yet resulted in positive cash flow and accordingly, management may need to raise additional financing. 
The Company anticipates that they may need substantial additional financing in the future to continue our operations.  Although
we have previously been able to raise capital as needed, including our recent private placement of certain senior secured convertible
notes in the principal amount of $8,800,000, such capital may not continue to be available to us at all, or if available, on reasonable
terms as required. Further, the terms of such financing may be dilutive to our existing stockholders or otherwise on terms not
favorable to us or our existing stockholders. If we are unable to secure additional capital, as circumstances require, or do not
succeed in meeting our sales objectives we may be required to change or delay our operations.



Operating activities



Net cash used in operating activities for
the six months ended June 30, 2012 was $4,082,457 compared to $6,031,323 in the same period 2011, a decrease of $1,948,866. This
decrease is primarily attributable to working capital changes.



Investment activities



Net cash used in investment activities
for six months ended June 30, 2012 was $5,347,901 a decrease of $406,969, (or 7.1%) compared to $5,754,870 in the same period 2011.
The decrease was primarily attributable to a lower level of equipment and software purchases.



We advanced in the first half year of 2012
an amount of $1,011,265 as loans to a related party named Elephant Security BV from the Netherlands and $216,970 as a loan to a
third party to Morodo Ltd, from the U.K. The loans are interim loans prior to the potential acquisitions.



Financing activities



Net cash received by financing activities
for the six months ended June 30, 2012 was $7,894,129 compared to $13,597,666 for the six months ended June 30, 2011. In the first
half year of 2012 we received a total of $8,000,000 in gross proceeds from the 8% convertible note and $742,130 from the exercise
of warrants and options. After the deduction of deferred financing costs and expenses attributable to share issuances of ($459,643)
the net proceeds from financing activities amounted to $7,894,129. In the second quarter of 2012 $388,358 was paid for installment
payments and interest related the 8% convertible note.



As a result of the above activities, the
Company had the cash and cash equivalents balance of $4,051,777 as of June 30, 2012, a net decrease in cash and cash equivalents
of $1,957,799 since December 31, 2011.



Off- Balance Sheet Arrangements



We did not have any off-balance sheet arrangements
that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.





31







Item 3. Quantitative and Qualitative Disclosure about Market
Risks



Foreign
currency exchange rate

As the vast majority
of our business activities are carried out in Euros and we report our financial statements in US dollars, fluctuations in foreign
currencies impact the total amount of assets and liabilities that we report for our foreign subsidiaries upon the translation of
those amounts in US dollars. Since we carry out our business activities primarily in Euro’s we have not engaged in foreign
currency exchange rate hedging activities for our operational activities.



However, since
we concluded in the first quarter 2012 a convertible a loan agreement with gross proceeds of $8.8 million whereby we will be obliged
to pay monthly interest and repayment in United States dollars, we evaluate on a regular basis if hedging is appropriate for the
company. So far, this has not resulted in the company engaging in hedging activities for this particular convertible loan agreement.



Contractual
obligations

The contractual
obligations are presented in the Note 19, Commitments to the financial statements. Changes in our business needs, cancellation
provisions and other factors may result in actual payments differing from these estimates.



The company does
not recognize any risks caused by fluctuations in prices for commodity, equity (other than its own share price) or other items
other than above described.







Item 4. Controls and Procedures



Changes in Internal Control over Financial
Reporting



During the reporting period, management
has continued her efforts to establish a framework to improve internal controls over financial reporting, particularly as they
related to the material weaknesses previously disclosed in our 2011 Annual Report on Form 10-K. We continued to commit resources
to the design, implementation, documentation, and testing of our internal controls. Our management believes that these efforts
have improved our internal control over financial reporting.



Under the direction of the Audit Committee,
management will continue to review and make any changes it deems necessary to the overall design of the Company's internal control
over financial reporting, including implementing improvements in policies and procedures.



There has been no change in the Company's
internal control over financial reporting that occurred during the Company's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company's internal control over financial reporting, except for the remediation
steps and improvements made to address the material weakness in its internal control over financial reporting as described in the
2011 Annual Report.







32









PART II - OTHER INFORMATION



Item 1. Legal Proceedings



(a) Chong Hing Bank Litigation



In December 2009 Chong Hing Bank Limited,
fka Liu Chong Hing Bank Limited (Bank), a foreign banking services company based in Hong Kong , 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 alleged that it entered into various installment and term loan agreements and an overdraft account with Elephant Talk
Limited (ETL), a wholly-owned Hong Kong subsidiary of Elephant Talk Communications Corp. (Company). Various former officers and
directors of ETL personally guaranteed the loans and overdraft account.



The Bank alleged that ETL was in default
on the loans and overdraft account, and that approximately $1,933,308 including interest and default interest was due. The Bank
alleged that the Company was directly liable to repay the loans and overdraft account as a successor in interest to ETL or because
the Company expressly or impliedly assumed direct liability for the loans and overdraft account. The Company denied the Bank’s
allegations and asserted several affirmative defenses. The Company contended that it had no direct liability to the Bank, and that
the Bank must pursue its recourse against ETL and its personal guarantors.



The Bank and the Company tried the case
to the court without a jury between October, 5 and 12, 2011. The court found, among other things, that



| | • | The Company was not liable as a successor in interest or otherwise on the Bank loans and overdraft account to ETL;
| | - | ------------------------------------------------------------------------------------------------------------------



| | • | The Company was not liable on the Bank’s claims because the Bank filed its action after the applicable California 4-year statute of limitations had expired; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| | • | The Company was not liable to the Bank under the alternative theories of negligent or intentional misrepresentation.
| | - | --------------------------------------------------------------------------------------------------------------------



The court entered judgment in favor of
the Company and against the Bank on December 14, 2011, and awarded the Company $5,925.41 in costs. The judgment became final on
February 16, 2012.



(b) Rescission of the Purchase Agreement
of March 31, 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.





33







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, 2011 and the “Risk Factors”
in our Form S-3 filed on April 26, 2012. These Risk Factors could materially impact our business, financial condition and/or operating
results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially
adversely impact our business, financial condition and/or operating results.



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



None.



Item 3. Defaults upon Senior Securities.



None.



Item 4. Mine Safety Disclosures



Not applicable.



Item 5. Other Information



None.





34







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 32. *                                       
|---- | ----------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                             
|31.2 | Certification of the CFO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) on page 33. *                                       
|     |                                                                                                                             
|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 34. *
|     |                                                                                                                             
|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 35. *



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



* filed herein.

** XBRL (Extensible Business Reporting Language) information
is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities
Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and
otherwise is not subject to liability under these sections.



SIGNATURES



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



|               | ELEPHANT TALK COMMUNICATIONS CORP.                                          
|-------------- | ----------------------------------------------------------------------------
|               |                                                                             
|August 1, 2012 | By                                                                          
|               | Steven van der Velden                                                       
|               | President and Chief Executive Officer
        (Principal Executive Officer) 
|               |                                                                             
|August 1, 2012 | By                                                                          
|               | Mark Nije                                                                   
|               | Chief Financial Officer
        (Principal Financial and Accounting Officer)





35







Index to Exhibits



|Number |  | Exhibit                                                                                                        |  | Page
|------ |  | -------------------------------------------------------------------------------------------------------------- |  | ----
|       |  |                                                                                                                |  |     
|31.1   |  | Certification of the CEO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)                                        |  | 37  
|       |  |                                                                                                                |  |     
|31.2   |  | Certification of the CFO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)                                        |  | 38  
|       |  |                                                                                                                |  |     
|32.1   |  | Certification pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |  | 39  
|       |  |                                                                                                                |  |     
|32.2   |  | Certification pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |  | 40  





36