UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON,
D. C. 20549
 FORM
10-Q
 
 x  Quarterly report under
Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the
quarterly period ended September30, 2009
 
  ̈  
Transition report under Section 13 or 15(d) of the Securities Exchange Act of
1934
 For the
transition period from ______ to ______
 
 000-30061
 ( Commission file
No.)
 
 ELEPHANT
TALK COMMUNICATIONS, INC.
 (Exact
name of small business issuer as specified in its charter)
 CALIFORNIA
              
              95-4557538(State
      or other jurisdiction of
              
              (I.R.S.
      employer identification no.)incorporation
      or organization)
 
 Schiphol
Boulevard 249
 1118
BH Schiphol
 The
Netherlands
 (Address
of principal executive offices)
 +31(0)20 653 5916
 (Issuer's
telephone number, including area code)
 
 Check
whether the registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
 Yes x    
No  ̈.
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 Large
Accelerated filer  ̈ 
   Accelerated filer  ̈ 
   Non-Accelerated filer  ̈  Smaller
reporting company   x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes  ̈  No x
 
 Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Website, if any, every Interactive Date File required to
be submitted and posted pursuant to Rule 405 of Regulation S-T ( § 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such
files).     Yes  ̈  No
 ̈
 
 As of
October 31, 2009, there were 53,941,885shares of the
Company’s common stock outstanding.




ELEPHANT TALK COMMUNICATIONS,
INC.


TABLE OF
CONTENTS


FORM
10-Q


September
30, 2009




PART
      I – FINANCIAL INFORMATION
                      
                      
                      3Item
      1. Consolidated Financial Statements
                      
                      
                      3Unaudited
      Consolidated Balance Sheets as of September 30, 2009  and
      December 31, 2008
                      
                      
                      3Unaudited
      Consolidated Statements of Operation for the three and nine months periods
      ended
                      
                      
                      4September
      30, 2009 and 2008Unaudited
      Consolidated Statements of Cash Flows for the nine months periods
      ended
                      
                      
                      5September
      30, 2009 and 2008Notes
      to the Unaudited Consolidated Financial Statements
                      
                      
                      6Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                      
                      
                      22Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                      
                      
                      28Item
      4T. Controls and Procedures
                      
                      
                      28PART
      II - OTHER INFORMATION
                      
                      
                      29Item
      1. Legal Proceedings
                      
                      
                      29Item
      1a. Risk Factors
                      
                      
                      29Item
      2.  Unregistered Sales of Equity Securities and Use of Proceeds
                      
                      
                      29Item
      3.  Defaults upon Senior Securities
                      
                      
                      29Item
      4.  Submission of Matters to a Vote of Security
      Holders
                      
                      
                      29Item
      5.  Other Information
                      
                      
                      30Item
      6. Exhibits
                      
                      
                      30SIGNATURES
                      
                      
                      30Exhibit
      31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
      or Rule 15(d)-14(a)
                      
                      
                      X-1Exhibit
      31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
      or Rule 15(d)-14(a)
                      
                      
                      X-2Exhibit
      32.1 Certification of Chief Executive Officer pursuant to section 906 of
      the Sarbanes-Oxley Act of 2002
                      
                      
                      X-3Exhibit
      32.2 Certification of Chief Financial Officer pursuant to section 906 of
      the Sarbanes-Oxley Act of 2002
                      
                      
                      X-4





2





PART I - FINANCIAL
INFORMATION




Item 1. Consolidated Financial
Statements





ELEPHANT
TALK COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEET


(UNAUDITED)




September
      30,
              
              
              December
      31,2009
              
              
              2008ASSETSCURRENT
      ASSETSCash
      and cash equivalents
              
              $
              1,884,054
              
              
              $
              1,656,546Restricted
      cash
              
              
              192,555
              
              
              
              191,209Accounts
      receivable, net of allowance for doubtful accounts of
      $758,974  and $503,102 at September 30, 2009 and December 31,
      2008 respectively
              
              
              5,464,048
              
              
              
              4,574,013Prepaid
      expenses and other current assets
              
              
              2,969,980
              
              
              
              1,916,967Total
      Current Assets
              
              
              10,510,637
              
              
              
              8,338,735LONG
      TERM DEPOSITS
              
              
              331,390
              
              
              
              310,356DEFERRED
      FINANCING COSTS
              
              
              1,448,158
              
              
              
              --PROPERTY
      AND EQUIPMENT, NET
              
              
              7,893,474
              
              
              
              6,345,113INTANGIBLE
      ASSETS, NET
              
              
              4,061,035
              
              
              
              4,461,869TOTAL
      ASSETS
              
              $
              24,244,694
              
              
              $
              19,456,073LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIESOverdraft
              
              $
              345,941
              
              
              $
              322,903Accounts
      payable and customer deposits
              
              
              7,322,076
              
              
              
              5,809,211Deferred
      revenue
              
              
              132,205
              
              
              
              220,058Accrued
      expenses and other payables
              
              
              2,575,638
              
              
              
              1,890,004Shares
      to be issued
              
              
              --
              
              
              
              619,057Advances
      from third parties
              
              
              202,358
              
              
              
              274,762Loans
      payable
              
              
              881,070
              
              
              
              881,035Due
      to related parties
              
              
              1,041,012
              
              
              
              --Current
      liabilities
              
              
              12,500,300
              
              
              
              10,017,030LONG
      TERM LIABILITIESLoan
      from related party
              
              
              422,529
              
              
              
              402,425Convertible
      12% secured note (net of discount of $ 4,076,395 and $0,
      respectively)
              
              
              38,210
              
              
              
              --Convertible
      12% secured note - related party (net of discount of $ 4,061,926 and $0,
      respectively)
              
              
              38,074
              
              
              
              --Warrant
      liabilities
              
              
              9,058,970
              
              
              
              --Conversion
      feature
              
              
              1,526,406
              
              
              
              --TOTAL
      LIABILITIES
              
              
              23,584,489
              
              
              
              10,419,455STOCKHOLDERS'
      EQUITYCommon
      stock, no par value, 250,000,000 shares authorized, 53,941,884 issued and
      outstanding  as of September 30, 2009 compared to 50,433,260
      shares issued and outstanding as of December 31, 2008
              
              
              54,673,528
              
              
              
              52,933,209Accumulated
      other comprehensive income
              
              
              1,292,636
              
              
              
              946,834Accumulated
      deficit
              
              
              (55,497,486
              )
              
              
              (45,035,192
              )Elephant
      Talk Comunications, Inc. Stockholders' Equity
              
              
              468,678
              
              
              
              8,844,851NON-CONTROLLING
      INTEREST
              
              
              191,527
              
              
              
              191,767Total
      Stockholders' Equity
              
              
              660,205
              
              
              
              9,036,618TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
              
              $
              24,244,694
              
              
              $
              19,456,073




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





3





ELEPHANT
TALK COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS


(UNAUDITED)




For
      the three Months ended September 30,
              
              
              For
      the nine Months ended September 30,2009
              
              
              2008
              
              
              2009
              
              
              2008REVENUES
              
              $
              11,455,489
              
              
              $
              11,346,417
              
              
              $
              32,195,771
              
              
              $
              35,024,987COST
      AND OPERATING EXPENSESCost
      of service
              
              
              10,874,205
              
              
              
              11,142,192
              
              
              
              30,654,206
              
              
              
              34,128,327Selling,
      general and administrative expenses
              
              
              2,949,038
              
              
              
              2,153,544
              
              
              
              6,195,981
              
              
              
              5,575,047Non
      cash compensation to officers, directors and employees
              
              
              252,521
              
              
              
              199,886
              
              
              
              1,272,387
              
              
              
              589,958Depreciation
      and amortization of intangibles assets
              
              
              861,616
              
              
              
              725,943
              
              
              
              2,199,561
              
              
              
              2,152,124Total
      cost and operating expenses
              
              
              14,937,380
              
              
              
              14,221,565
              
              
              
              40,322,135
              
              
              
              42,445,456LOSS
      FROM OPERATIONS
              
              
              (3,481,891
              )
              
              
              (2,875,148
              )
              
              
              (8,126,364
              )
              
              
              (7,420,469
              )OTHER
      INCOME (EXPENSE)Interest
      income
              
              
              24,375
              
              
              
              529,307
              
              
              
              46,682
              
              
              
              38,877Interest
      expense
              
              
              (323,976
              )
              
              
              (210,779
              )
              
              
              (531,915
              )
              
              
              (452,957
              )Other
      expenses
              
              
              --
              
              
              
              (147,132
              )
              
              
              --
              
              
              
              (156,101
              )Interest
      expense related to amortization of debt discount on promissory
      notes
              
              
              (1,299,365
              )
              
              
              --
              
              
              
              (1,299,365
              )
              
              
              --Change
      in fair value of warrant liabilities
              
              
              (507,695
              )
              
              
              --
              
              
              
              (507,695
              )
              
              
              --Amoritization
      of deferred financing costs
              
              
              (41,649
              )
              
              
              
              
              
              
              (41,649
              )Note
      beneficial conversion feature
              
              
              --
              
              
              
              (1,200,000
              )
              
              
              --
              
              
              
              (1,200,000
              )Total
      other income (expense)
              
              
              (2,148,310
              )
              
              
              (1,028,604
              )
              
              
              (2,333,942
              )
              
              
              (1,770,181
              )LOSS
      BEFORE PROVISION FOR INCOME TAXES
              
              
              (5,630,201
              )
              
              
              (3,903,752
              )
              
              
              (10,460,306
              )
              
              
              (9,190,650
              )Provision
      for income taxes
              
              
              -
              
              
              
              -
              
              
              
              (800
              )
              
              
              (800
              )NET
      LOSS
              
              
              (5,630,201
              )
              
              
              (3,903,752
              )
              
              
              (10,461,106
              )
              
              
              (9,191,450
              )Net
      income (loss) attributable to noncontrolling interest
              
              
              (432
              )
              
              
              21,160
              
              
              
              (1,188
              )
              
              
              80,409NET
      LOSS
              
              
              (5,630,633
              )
              
              
              (3,882,592
              )
              
              
              (10,462,294
              )
              
              
              (9,111,041
              )OTHER
      COMPREHENSIVE (LOSS) INCOMEForeign
      currency translation gain (loss)
              
              
              543,061
              
              
              
              (1,331,411
              )
              
              
              345,802
              
              
              
              (117,064
              )543,061
              
              
              
              (1,331,411
              )
              
              
              345,802
              
              
              
              (117,064
              )COMPREHENSIVE
      LOSS
              
              $
              (5,087,572
              )
              
              $
              (5,214,003
              )
              
              $
              (10,116,492
              )
              
              $
              (9,228,105
              )Net
      loss per common share and equivalents - basic and diluted
              
              $
              (0.104
              )
              
              $
              (0.089
              )
              
              $
              (0.196
              )
              
              $
              (0.388
              )Weighted
      average shares outstanding during the period - basic and
      diluted
              
              
              54,373,240
              
              
              
              43,381,660
              
              
              
              53,422,421
              
              
              
              23,508,587




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





4





ELEPHANT
TALK COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)




For
      the nine months periods ended September 30,2009
              
              
              2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
              
              $
              (10,462,294
              )
              
              $
              (9,111,041
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
              
              
              2,199,561
              
              
              
              2,152,124Provision
      for doubtful accounts
              
              
              (104,521
              )
              
              
              --Stock
      based compensation
              
              
              1,150,512
              
              
              
              589,958Noncontrolling
      interest
              
              
              1,188
              
              
              
              (80,409
              )Amortization
      of Shares issued for Consultancy
              
              
              121,875
              
              
              
              45,139Change
      in fair value of warrant liabilities
              
              
              507,695
              
              
              
              --Interest
      expense relating to debt discount and conversion feature
              
              
              1,341,014
              
              
              
              --Note
      beneficial conversion feature
              
              
              --
              
              
              
              1,200,000Changes
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable
              
              
              (554,451
              )
              
              
              (130,625
              )Decrease
      (Increase)  in prepaid expenses, deposits and other
      assets
              
              
              120,028
              
              
              
              159,281Increase
      (decrease) in accounts payable, proceeds from related parties and customer
      deposits
              
              
              1,255,893
              
              
              
              705,647Increase
      (decrease) in deferred revenue
              
              
              (87,853
              )
              
              
              --Increase
      (decrease) in accrued expenses and other payables
              
              
              753,797
              
              
              
              (403,099
              )Net
      cash used in operating activities
              
              
              (3,757,556
              )
              
              
              (4,873,025
              )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
              
              
              (3,162,599
              )
              
              
              (1,171,652
              )Restricted
      cash
              
              
              (109
              )
              
              
              --Cash
      paid for acquisition of subsidiary
              
              
              --
              
              
              
              (1
              )Net cash used in investing activities
              
              
              (3,162,708
              )
              
              
              (1,171,653
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Bank
      overdraft
              
              
              19,535
              
              
              
              122,358Issuance
      of Common Stock
              
              
              --
              
              
              
              7,511,729Placement
      fees
              
              
              --
              
              
              
              (981,682
              )Proceeds
      from bank loans
              
              
              --
              
              
              
              (33,302
              )Proceeds
      from Convertible 12% secured note
              
              
              4,114,605
              
              
              
              --Proceeds
      from Convertible 12% secured note - related parties
              
              
              4,100,000
              
              
              
              --Deferred
      financing costs
              
              
              (845,496
              )
              
              
              --Loan
      to third party
              
              
              (1,237,602
              )
              
              
              --Loan
      from related party
              
              
              1,061,116
              
              
              
              --Net cash provided by financing activities
              
              
              7,212,158
              
              
              
              6,619,103EFFECT
      OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
              
              
              (64,386
              )
              
              
              (176,927
              )NET
      DECREASE IN CASH AND CASH EQUIVALENTS
              
              
              227,508
              
              
              
              397,498CASH
      AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD
              
              
              1,656,546
              
              
              
              4,366,312CASH
      AND CASH EQUIVALENTS, END OF THE PERIOD
              
              $
              1,884,054
              
              
              $
              4,763,810SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the period for interest
              
              $
              17,468
              
              
              $
              36,864SUPPLEMENTAL
      DISCLOSURES OF NON-CASH INVESTING & FINANCING
    ACTIVITIES:Shares
      issued to convert the notes payable to related parties and accrued
      interest
              
              $
              532,583
              
              
              $
              7,939,171Cash
      paid during the period for income taxes
              
              
              800
              
              
              
              800Deemed
      Dividend as a result of loss on conversion of the above Note to related
      party
              
              
              --
              
              
              
              1,200,000Warrants
      and derivative liabilities for issuance of 12% Promissory Notes are
      considered as discount of the Promissory Notes
              
              
              8,214,605
              
              
              
              --Warrants
      issued to placement agents for services, treated as deferred financing
      costs
              
              
              644,311
              
              
              
              --





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





5





ELEPHANT
TALK COMMUNICATIONS, INC. AND SUBSIDIARIES


NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1. Organization and
Nature of Operations





We were
incorporated on February 5, 1962 under the laws of the state of California as
Altius Corporation and involved in the manufacturing of freeway signs. In March
1997, Altius acquired Starnet Universe Internet, Inc., a web developer and
Internet Service Provider (ISP) and we changed our name to Staruni Corporation.
On January 4, 2002, Staruni Corporation merged with Elephant Talk, Limited, a
company incorporated in Hong Kong, and filed a Certificate of Amendment of
Articles of Incorporation to amend the corporate name to Elephant Talk
Communications, Inc.





Elephant
Talk Communications is positioning itself as an international telecom operator
and enabler to the multimedia industry by facilitating the distribution of all
forms of content as well as Mobile and Fixed telecom services to its global
telecommunications customers.





The
Company currently provides traditional telecom services, media streaming, and
distribution services primarily to the business-to-business (B2B) community as
well as Mobile Virtual Network Enabler (MVNE) and Mobile Virtual Network
Operator (“MVNO”) services within the telecommunications market where it has a
presence. Historically, the Company has primarily derived its revenues from
traditional fixed-line services, but since 2006, significant investments have
been made in mobile enabling services and platforms. The first revenues from
these mobile services (MVNE/MVNO) started during the fourth quarter of
2008.





Our
service offerings can be grouped around:




·
            Customized mobile
      services




·
            Mobile enabling
      platforms





·
            Fixed network
      outsourcing





We view
ourselves as a specialized enabler, offering various parts of the back office
network including messaging platforms, data platforms and billing
solutions.  As a result, we are positioning ourselves as the MVNE
partner of choice for the larger, global Mobile Network Operators (MNO’s) and a
one-stop convergent solutions provider for specialized MVNO
customers.





We have
leveraged our fixed network capabilities, streaming technology and Premium Rate
Services experience to offer an integrated solution for content distribution and
associated payment resolution. The (mobile and fixed) technology, software and
systems set-up is supported by a switch-based telecom network with full national
licenses and direct fixed line interconnections with the Incumbents/National
Telecom Operators in seven (7) European countries, and one (1) in the Middle
Eastern (Bahrain), complimented with partnerships with telecom operators in
France, Germany, Scandinavia and Poland.





2. Financial Condition
and Going Concern





The
Company has an accumulated deficit of $55,497,486 as of September 30,
2009.  Historically, the Company has relied on a combination of debt
and equity financings to fund ongoing cash requirements.  As of
November 11, 2009, the Company received a total of $5.4 million in loans
(including accrued interest) from QAT II Investments SA (“QAT II”), a related
party, which were subsequently converted into the Company’s private placement of
convertible notes (“the Notes”) and warrants (the “Warrants” and together with
the Notes, the “Securities”), and the Company received an additional $6.9
million in gross proceeds from the sale of Securities to other accredited
investors.  Management believes that the cash balance at September 30,
2009, in combination with the net proceeds received from the sale of the
Securities in October of  2009, will provide the Company with
sufficient funds through the fourth quarter  of 2009.





6





Although
QAT II and other related parties have invested, or have arranged for the
investment of, a total of $35.4 million between 2005 through December 31, 2008,
and have since January 2009 funded the Company’s short-term capital requirements
with an additional $5.4 million (through November 11, 2009) through the Notes,
there can be no assurance that they will continue to do so.  Further,
although the Notes for $6.9 million were purchased by unaffiliated accredited
investors, there can be no assurance that the Company will continue to raise
sufficient capital to operate its business. Although the Company has previously
been able to raise capital as needed, such capital may not continue to be
available at all, or if available, that the terms of such financing may be
dilutive to existing shareholders or otherwise on terms not favorable to the
Company or existing shareholders. Further, the current global financial
situation may offer additional challenges to raising the required
capital.  If the Company is unable to secure additional capital, as
circumstances require, it may not be able to continue operations.





As of
September 30, 2009, these conditions raise substantial doubt about the Company’s
ability to continue as a going concern.  The financial statements
filed as part of this Quarterly Report on Form 10-Q do not include any
adjustments that might result from the outcome of this uncertainty.





3. Significant
Accounting Policies





Basis of Presentation -
Interim Financial Information





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with 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 the Company's 2008 Form 10-K. These consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements on 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 the Company’s financial position, results of operations and
cash flows as of and for the periods presented.





The
results of operations for the three and nine months ended September 30, 2009,
are not necessarily indicative of the results to be expected for the entire
year.





Principles of
Consolidation





The
accompanying consolidated financial statements for the three and nine months
ended September 30, 2009 and December 31, 2008 include the accounts of Elephant
Talk Communications, Inc., its wholly-owned subsidiary Elephant Talk Europe
Holding B.V., its wholly-owned subsidiary Elephant Talk Communication Holding
AG, its wholly-owned subsidiary Elephant Talk Communications S.L.U., its
wholly-owned subsidiary Elephant Talk Mobile Services B.V. (formerly known as
Cardnet Clearing Services B.V), its wholly-owned subsidiary Elephant Talk
Communication Austria GmbH, its wholly-owned subsidiary Vocalis Austria GmbH,
its wholly-owned subsidiary Elephant Talk Communications Italy S.R.L., its
wholly-owned subsidiary ET-Stream GmbH, its wholly-owned subsidiary Elephant
Talk Communication Carrier Services GmbH, its wholly-owned subsidiary Elephant
Talk Communication (Europe) GmbH, its wholly-owned subsidiary Elephant Talk
Communication Schweiz GmbH, its wholly-owned subsidiary Moba Consulting Partners
B.V.,its majority owned (51%) subsidiary Elephant Talk Communications Premium
Rate Services Netherlands B.V., its wholly-owned subsidiary Elephant Talk
Communications France S.A.S., its majority owned (51%) subsidiary Elephant Talk
Communications PRS U.K. Limited, its wholly-owned subsidiary Elephant Talk
Communications Luxembourg SA, its wholly-owned subsidiary Elephant Talk Global
Holding B.V., its wholly-owned subsidiary Elephant Talk Business Services
W.L.L., its wholly-owned subsidiary Guangzhou Elephant Talk Information
Technology Limited., its wholly-owned Elephant Talk Caribbean B.V., its majority
owned (51%) subsidiary ET-UTS N.V., its wholly-owned subsidiary Elephant Talk
Limited, its majority owned (51%) subsidiary Elephant Talk Middle East &
Africa (Holding) W.L.L., its majority owned (51%) subsidiary Elephant Talk
Middle East & Africa (Holding) Jordan L.L.C., its majority owned (50.49%)
subsidiary Elephant Talk Middle East & Africa Bahrain W.L.L and its majority
owned (50.54%) subsidiary Elephant Talk Middle East & Africa
FZ-LLC.





For
comparative purposes, certain prior period amounts have been reclassified to
facilitate comparisons with the current year financial reporting.





7





Foreign Currency
Translation





The
functional currency was Euros for the Company’s wholly-owned subsidiary Elephant
Talk Europe Holding B.V. and subsidiaries, and Euros for its wholly-owned
subsidiary Elephant Talk Global Holding B.V., and the Hong Kong Dollar for its
wholly-owned subsidiary Elephant Talk Limited. The financial statements of the
Company were translated to USD using period-end exchange rates as to assets and
liabilities and average exchange rates as to revenues and expenses, and capital
accounts were translated at their historical exchange rates when the capital
transaction occurred. In accordance with Accounting Standard Codification
(“ASC”) 830, Foreign Currency Matters, (formerly known as Statement of Financial
Accounting Standards (“SFAS”) No. 52), net gains and losses resulting from
translation of foreign currency financial statements are included in the
statements of stockholder’s equity as other comprehensive income (loss). Foreign
currency transaction gains and losses are included in consolidated income
(loss). The accumulated other comprehensive income as of September 30, 2009 and
December 31, 2008 was $1,292,636 and $946,834, respectively. The foreign
currency translation gain/(loss) for the three months ended September 30, 2009
and 2008 was $543,061 and ($1,331,411), respectively. The foreign currency
translation gain/(loss) for the nine months ended September 30, 2009 and 2008
was $345,802 and ($117,064), respectively.





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.  Actual results
could differ materially from those estimates and assumptions.





Cash and Cash
Equivalents





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





Restricted
Cash





Restricted
cash represents cash deposited as bank guarantee for interconnects.





Accounts Receivables,
net





The
Company’s customer base consists of a geographically dispersed customer base.
The Company maintains an allowance for potential credit losses on accounts
receivable. Management reviews the composition of accounts receivable and
analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
evaluate the adequacy of these allowances. Allowances are recorded primarily on
a specific identification basis.  As of September 30, 2009 and
December 31, 2008, the allowance for doubtful accounts was $758,974 and
$503,102, respectively.





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. Deferred revenue was $132,205 and $220,058
as of September 30, 2009 and December 31, 2008, respectively.





8





Cost of
Service





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





Reporting
Segments





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





Stock-based
Compensation





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





Income
Taxes





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





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





9





We have
filed or are 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 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. For the nine months ended
September 30, 2009 and 2008 the Company’s comprehensive income/(loss) consisted
of its net loss and foreign currency translation adjustments.





Intangible
Assets





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





Property and Equipment,
Internally Developed and Third Party Software





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





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





Fair Value
Measurements





Fair
value is defined as the price that would be received to sell 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.





10





The
following table summarizes fair value measurements by level at September 30,
2009 for financial assets and liabilities measured at fair value on a recurring
basis:




Level I
                      
                      Level II
                      
                      
                      Level III
                      
                      TotalWarrant
      liabilities
                      $
                      -
                      
                      $
                      9,058,970
                      
                      
                      $
                      -
                      
                      $
                      9,058,970Conversion
      feature
                      
                      -
                      
                      
                      1,526,406
                      
                      
                      
                      -
                      
                      
                      1,526,406Total
      liabilities
                      $
                      -
                      
                      $
                      10,585,376
                      
                      
                      $
                      -
                      
                      $
                      10,585,376





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





Recently
Issued Accounting Pronouncements





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





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





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





11





4. Long-term Earnest
Deposit





Long-term
earnest deposits to various telecom carriers during the course of its operations
totaled $331,390 at September 30, 2009, compared with $310,356 at December 31,
2008.  The deposits are refundable at the termination of the business
relationship with the carriers.





5. Prepaid Expenses and
Other Current Assets





Prepaid
expenses and other current assets recorded at $2,969,980 as of September 30,
2009, compared with $1,916,967 as of December 31, 2008.  The 2009
amount consists primarily of prepaid Value Added Tax (“VAT”), unvested stock
related compensation for management and consultants and advances to Validsoft
Limited (“Validsoft”) made pursuant to the Bridging Loan Agreement (see also
Note 28).





6. Deferred Financing
Costs





Deferred
financing costs consist of commissions, warrants issued to placement agents and
legal fees for the convertible 12% secured notes. At September 30, 2009 deferred
financing costs were $1,448,158, and are amortized over the term of the
convertible 12% secured notes.





7. Property &
Equipment





The
Company has evaluated the nature of its systems engineering and software
programming activities and relevance to its business activities and has
concluded that the reclassification of these investments from Intangibles to
Property and Equipment more accurately reflects the nature and financial
reporting of the Company. These investments typically pertain to the
Company’s:





·
            Intelligent
      Network (IN) platform


·
            CRM
      software


·
            Mediation,
      Rating & Pricing engine


·
            Operations
      and Business Support software


·
            Network
      management tools





Property
and equipment at September 30, 2009 and December 31, 2008 consists
of:





AverageEstimated
      Useful
                                          
                                          
                                          September
      30,
                                          
                                          
                                          December
      31,Lives
                                          
                                          
                                          2009
                                          
                                          
                                          2008Leasehold
      improvements
                                          
                                          3
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          10,433Furniture
      and fixtures
                                          
                                          5
                                          
                                          
                                          
                                          168,312
                                          
                                          
                                          
                                          78,278Computer,
      communication and network equipment
                                          
                                          3 -
      10
                                          
                                          
                                          
                                          7,466,172
                                          
                                          
                                          
                                          6,395,032Software
                                          
                                          5
                                          
                                          
                                          
                                          4,139,616
                                          
                                          
                                          
                                          4,632,430Automobiles
                                          
                                          5
                                          
                                          
                                          
                                          137,885
                                          
                                          
                                          
                                          133,202Construction
      in progress
                                          
                                          
                                          
                                          
                                          
                                          
                                          1,523,731
                                          
                                          
                                          
                                          1,047,24813,435,716
                                          
                                          
                                          
                                          12,296,623Less:
      accumulated depreciation
                                          
                                          
                                          
                                          
                                          
                                          
                                          (5,542,242
                                          )
                                          
                                          
                                          (5,951,510
                                          )$
                                          7,893,474
                                          
                                          
                                          $
                                          6,345,113





Total
depreciation expense for the three months ended September 30, 2009 and 2008 was
$624,499 and $228,555, respectively. Total depreciation expense for the nine
months ended September 30, 2009 and 2008 was $1,591,017 and $698,135,
respectively.





12





8. Intangible Assets -
Customer Contracts, Licenses and Interconnects





Intangible
assets include customer contracts, telecommunication licenses and integrated,
multi-country, centrally managed switch-based interconnects.


AverageEstimated Useful
                              
                              
                              September 30,
                              
                              
                              December 31,Lives
                              
                              
                              2009
                              
                              
                              2008Customer
      Contracts, Licenses & Interconnect
                              
                              5 -
      10
                              
                              
                              $
                              12,329,617
                              
                              
                              $
                              12,104,634Less:
      Accumulated Amortization and impairment charges
                              
                              
                              
                              
                              
                              
                              (8,268,582
                              )
                              
                              
                              (7,642,765
                              )$
                              4,061,035
                              
                              
                              $
                              4,461,869


Intangible
asset amortization expense for the three months ended September 30, 2009 and
2008 was $237,117 and $471,247 respectively. Amortization expense for the nine
months ended September 30, 2009 and 2008 totaled $608,544 and $1,433,795
respectively.





9. Overdraft





In 2004,
Elephant Talk Ltd. executed a credit facility with a bank in Hong Kong pursuant
to which Elephant Talk Ltd. borrowed funds. As of September 30, 2009, the
overdraft balance, including accrued interest totaled, $243,212 compared to
$223,663 as of December 31, 2008.  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.  As of September 30,
2009, Moba Consulting Partners B.V., a subsidiary of the Company, had an
overdraft of $102,729 compared to $99,240 as of December 31, 2008 on one of the
company’s bank accounts.





10. Accrued
Expenses





As of
September 30, 2009 and December 31, 2008, accrued expenses were comprised of the
following:





September
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008Accrued
      Selling, General & Administrative expenses
                    
                    $
                    504,870
                    
                    
                    $
                    513,722Placement
      fees
                    
                    
                    -
                    
                    
                    
                    491,100Accrued
      cost of sales and network
                    
                    
                    86,543
                    
                    
                    
                    14,140Accrued
      taxes
                    
                    
                    937,093
                    
                    
                    
                    227,896Accrued
      interest payable
                    
                    
                    799,709
                    
                    
                    
                    439,290Other
                    
                    
                    247,422
                    
                    
                    
                    203,856Total
      accrued expenses
                    
                    $
                    2,575,638
                    
                    
                    $
                    1,890,004




11. Advances from Third
Parties





As of
September  30, 2009 and December 31, 2008 the Company had $202,358 and
$274,762, respectively as payable to third parties, related to litigation
matters detailed in Note 23.





13





12.Loans
Payable





Loans
payable at September 30, 2009 and December 31, 2008 are summarized as
follows:





September 30,
                        2009
                      
                      
                      December 31, 2008Installment loan payable
      due December 24, 2006, secured by personal guarantees of two shareholders,
      a former director, and a third party
                      
                      $
                      320,532
                      
                      
                      $
                      320,520Installment
      loan payable, bank, monthly principal and interest payments of $2,798
      including interest at bank's prime rate plus 1.5% per annum, 8.25% at
      November 30, 2008, due December 24, 2011, secured by personal guarantees
      of three shareholders and a former director
                      
                      
                      191,524
                      
                      
                      
                      191,516Installment
      loan payable, bank, monthly principal and interest payments of $1,729
      including interest at bank's prime rate plus 1.5% per annum, 8.25% at
      November 24, 2008, due June 28, 2009, secured by personal guarantees of
      three shareholders and a former director
                      
                      
                      85,157
                      
                      
                      
                      85,154Term
      loan payable, bank, monthly payments of interest at bank's prime rate,
      7.0% at September 30, 2009
                      
                      
                      283,857
                      
                      
                      
                      283,845Total
                      
                      $
                      881,070
                      
                      
                      $
                      881,035





Elephant
Talk Ltd has executed a credit facility with a bank in Hong Kong since June 29,
2004, under which Elephant Talk Ltd has borrowed funds from the bank under three
installment loans and a term loan arrangement. Elephant Talk Ltd is in default
of making loan payments on all the loans and has recorded an accrued interest
amounting to $522,843 as of September 30, 2009. As a result of the default, the
entire loan balance outstanding at December 31, 2008 is due and payable to the
bank. Furthermore, Elephant Talk Ltd is obligated to pay a default interest rate
at the rate of 4.25% per annum in addition to the prescribed interest rate of
the installment loans and term loan. Elephant Talk Ltd has recorded $19,535 and
$7,160 in interest expense and default interest expense, respectively, on loans
payable as of September 30, 2009 and September 30, 2008 and $86,934 and $37,697
in interest expense as of September 30, 2009 and September 30, 2008,
respectively. The Company has not guaranteed the credit facility or is otherwise
obligated to pay funds drawn upon it on behalf of Elephant Talk
Ltd.





13. Due to Related
Parties





During
2009, the Company had received secured, interest bearing loans at 12% per annum,
from QAT II totaling $5.2 million (excluding accrued interest).  In
July 2009, QAT II converted $4.1 million of these loans into the Company’s
Convertible Notes and Warrant offering (see also Note 15). As of September 30,
2009 due to related parties was $ 1,014,012 compared with none at December 31,
2008.





14. Loan from related
parties





The
Company’s 51% owned subsidiary ET-UTS N.V. has received $422,529 in interest
bearing (8% per annum) unsecured loans from UTS N.V., the 49% shareholder in the
subsidiary. No maturity date has been fixed.





15. Convertible 12%
secured note





On July
31, August 18, September 3 and September 30, 2009, the Company consummated
closings of its private placement offerings of Units comprised of 12%
secured convertible promissory notes (the ‘Notes”) and warrants to purchase
shares of no par value common stock to accredited investors. The Securities were
offered and sold pursuant to an exemption from registration under Section 4(2)
of the Securities Act of 1933, as amended. The Company sold an aggregate of
$8,214,605 principal amount of Notes and delivered Warrants to purchase an
aggregate of 8,214,605 shares of the Company's no par value common stock at a
purchase price of $1.00 per share. The Company intends to use the net proceeds
from the Offering primarily for working capital.





The Notes
are convertible at the option of the holder into no par value common stock, of
the Company at a conversion price equal to eighty five percent (85%) of the
price at which shares are sold in a future public offering currently
contemplated by the Company if consummated; provided, however, that if the
public offering is not consummated on or before March 31, 2010, the conversion
price shall be equal to eighty five percent (85%) of the twenty (20) day average
closing price of the Common Stock for the twenty (20) trading days prior to
March 31, 2010 (the “March 31, 2010 Conversion Price”); provided further,
however, that if at any time following the earlier of the closing of the Public
Offering or March 31, 2010, the twenty (20) day average closing price of the
Common Stock for any twenty (20) consecutive trading days exceeds two hundred
percent (200%) of the Public Offering closing price or of the twenty (20) day
average closing price of the Common Stock for the twenty (20) trading days prior
to March 31, 2010, as applicable, that any Notes which remain unconverted shall
automatically convert into shares of the Common Stock at the Conversion Price or
the March 31, 2010 Conversion Price, as applicable. For further details see also
Note 26.





14





The
Company recognized interest expense from the 12% convertible promissory notes of
$1,299,365 for the three months ended September 30, 2009, which was comprised of
$76,284, for the amortization of the debt discount, $1,223,081
for  the conversion feature on the convertible 12% secured
notes  relating to these Notes.





16. Warrant
liabilities





We have
issued warrants in connection with the private placements of our common stock
during the three months ended September 30, 2009. The warrants include
provisions that require us to record them at fair value as a liability in
accordance with ASC 815 (formerly EITF 00-19), with subsequent changes in fair
value recorded as a non-operating gain or loss in our statement of operations.
The fair value of the warrants is determined using a Black-Scholes option
pricing model, and is affected by changes in inputs to that model including our
stock price, expected stock price volatility, interest rates and expected term.
The fair value of the warrants issued to investors in connection with the
September 2009 private placement offerings amounted to $7,999,723 at issuance
and was revalued at $8,388,239 as of September 30, 2009. The fair value of
the warrants issued to placement agents in connection with the the three months
ended September 30, 2009 private placement offerings amounted to $644,311 at
issuance and was revalued at $670,731 as of September 30, 2009.





17. Conversion
feature





A
conversion feature was recognized at fair value on the respective issuance dates
of the Notes as a discount and will be amortized using the effective interest
rate method from issuance to the maturity date of the respective Notes. The
conversion feature will be marked to market each reporting date with subsequent
changes in fair value recorded as a non-operating gain or loss in our statement
of operations. The fair value of the conversion feature at issuance totaled
$1,433,647 which exceeded the remaining face value of the Notes issued after
deducting the warrant liability by $1,223,081 which was expensed in the current
quarter as interest expense. The fair value of the conversion feature was
$1,526,406.





18. Stockholders’
Equity





(A)
Common Stock





The
Company is presently authorized to issue 250,000,000 shares of no par value
Common Stock. The Company currently has 53,695,984 common shares issued and
outstanding as of September 30, 2009. The shares issued and outstanding as per
the stock transfer agent’s records are 53,941,884, and include 245,900 shares
which were cancelled by the Company prior to 2006.  However, these
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.




19. Basic and Diluted Net
Loss Per Share





Net loss
per share is calculated in accordance with ASC 260, Earnings per Share,
(formerly SFAS No.128). Basic net loss per share is based upon the weighted
average number of common shares outstanding. Dilution is computed by applying
the treasury stock method. Under this method, options and warrants are assumed
to be exercised at the beginning of the period (or at the time of issuance, if
later), and as if funds obtained thereby were used to purchase common stock at
the average market price during the period. Weighted average number of shares
used to compute basic and diluted loss per share is the same since the effect of
dilutive securities is anti-dilutive.





15





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





2000
Employee Benefit Plan





The
Company adopted an employee benefit plan “The 2000 Employee Benefit Plan” (the
“Plan”) on May 30, 2000. Under the Plan, the Company may issue shares or grant
options to acquire the Company’s common stock, no par value, from time to time
to employees of the Company or its subsidiaries. In addition, at the discretion
of the Board of Directors, shares may be granted under this Plan to other
individuals, including consultants or advisors, who contribute to the success of
the Company or its subsidiaries, provided that bona fide services shall be
rendered by consultants and advisors and such services must not be in
conjunction with the offer or sale of securities in a capital raising
transaction. No stock may be issued or options granted under the Plan to
consultants, advisors or other persons who directly or indirectly promote or
maintain a market for the Company’s securities. The Plan is intended to aid the
Company in maintaining and developing a management team, attracting qualified
officers and employees capable of assuring the future success of the Company,
and rewarding those individuals who have contributed to the success of the
Company. The Plan is administrated under the direction of the Board of
Directors. A total of 160,000 common shares and 160,000 stock options to acquire
common shares may be subject to, or issued pursuant to, benefits granted under
the Plan. At any time any stock option is granted under the terms of this Plan,
the Company will reserve for issuance the number of shares of Stock subject to
such option until it is exercised or expired. The Plan Administrator shall
determine from time to time the terms, conditions and price of the options
granted. Options shall not be construed to be stock and cannot be exercised
after the expiration of its term. Under the Plan, 12,000 shares of common stock
and 160,000 stock options remain available for grant at September 30,
2009.





2006
Non-Qualified Stock and Option Compensation Plan





Under
this plan there are, as of September 30, 2009, 344,342 stock options
outstanding. There are remaining 600,000 shares and 55,658 stock options
available for grant.





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


Common
stock purchase options and warrants consisted of the following as of September
30, 2009:


Number of
                    shares
                  
                  
                  Exercise
                    Price
                  
                  
                  Fair ValueOptions:Outstanding
      as of December 31, 2008
                  
                  
                  366,009
                  
                  
                  $
                  2.25
                  
                  
                  
                  —Granted
      in 2009
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Exercised
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Cancelled/Forfeited
                  
                  
                  21,667
                  
                  
                  
                  —
                  
                  
                  
                  —Outstanding
      as of September 30, 2009
                  
                  
                  344,342
                  
                  
                  $
                  2.25
                  
                  
                  $
                  0





The
options were granted with an exercise price of $2.25, the share closing price as
of September 26, 2007. The options will generally vest on December 31, 2009, or
if there is a change of control in the Company. The options will expire on
December 31, 2011 or later depending on granting date.


The
cancelled/forfeited options during 2009 were granted in 2007 (9,667) and 2008
(12,000).





Following
is a summary of the status of options outstanding at September 30,
2009:


Options outstanding
                                      
                                      
                                      Options exercisableRange of Exercise Prices
                                      
                                      Total
                                        Options
                                        Outstanding
                                      
                                      Weighted
                                        Average
                                        Remaining
                                        Life
                                        (Years)
                                      
                                      Weighted
                                        Average
                                        Exercise
                                        Price
                                      
                                      
                                      Options
                                        Exercisable
                                      
                                      
                                      Weighted
                                        Average
                                        Exercise
                                        Price$
                                      2.25
                                      
                                      344,342
                                      
                                      2.61
      years
                                      
                                      $
                                      2.25
                                      
                                      
                                      
                                      0
                                      
                                      
                                      $
                                      2.25





At
September 30, 2009, the total compensation cost related to unvested stock-based
awards granted to employees under the provisions of ASC 718 and the Company's
2006 stock award plan, but not yet recognized was approximately $0.89
million.





2008
Long-Term Incentive Plan





The 2008
plan was adopted on January 15, 2008, and approved by our shareholders on the
same date at our annual meeting. 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.  As of September
30, 2009, a total of 716,500 stock options and 507,300 shares had been granted
under this plan. Options granted generally begin vesting over a three (3) year
period after grant date although already Options have been granted with a
shorter period than three (3) years. Options generally expire two (2) years from
the date of vesting.





16





Common stock purchase options and
warrants consisted of
the following as of September30, 2009:


Number of
                      shares
                    
                    
                    Exercise
                      Price
                    
                    
                    Fair ValueOptions:Outstanding
      as of December 31, 2008
                    
                    
                    366,009
                    
                    
                    $
                    0.807
                    
                    
                    $
                    121,881Granted
      in 2009
                    
                    
                    372,158
                    
                    
                    $
                    0.807
                    
                    
                    $
                    123,929Exercised
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Cancelled/Forfeited
                    
                    
                    21,667
                    
                    
                    $
                    0.807
                    
                    
                    $
                    7.215Outstanding
      as of September 30, 2009
                    
                    
                    716,500
                    
                    
                    $
                    0.807
                    
                    
                    $
                    238,595





At
September 30, 2009 the share-price at closing was $1.14 which, results in a
$0.333 fair value per stock option and $238,595 for all common stock options
granted in this plan.





Following
is a summary of the status of options outstanding at September 30,
2009:


Options outstanding
                                  
                                  
                                  Options exercisableRange of Exercise Price
                                  
                                  Total
                                    Options
                                    Outstanding
                                  
                                  Weighted
                                    Average
                                    Remaining
                                    Life
                                    (Years)
                                  
                                  Weighted
                                    Average
                                    Exercise
                                    Price
                                  
                                  
                                  Options
                                    Exercisable
                                  
                                  
                                  Weighted
                                    Average
                                    Exercise
                                    Price$
                                  0.60-1.09
                                  
                                  716,500
                                  
                                  3.69
      years
                                  
                                  $
                                  0.807
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —





The
weighted average assumptions used so far for the options granted in 2009 using
the Black-Scholes options model are: volatility of 155%, term (grant-date to
vesting-date) of 1.22 years and a Risk Free Interest Rate assumption of 1.53%.
The expected dividend yield is zero.





At
September 30, 2009 the total compensation cost related to unvested stock-based
awards granted to employees under the provisions of ASC 718 and the
Company's 2008 stock award plan, but not yet recognized was approximately
$312,000.





Stock-Based
Compensation Expense





Under the
provisions of ASC 718, the Company recorded for the three months ended September
30, 2009, $272,311 in stock-based compensation expense for management
shares, Non-Qualified Stock and Option Compensation Plan and shares issued for
consultancy and employee compensation. For the comparable period in 2008 the
expensing was $199,886. The Company utilized the Black-Scholes valuation model
for estimating the fair value of the stock-based compensation granted after the
adoption of ASC 718.





21. Commitments





As of
September 30, 2009 commitments of the Company relating to leases, co-location,
interconnect and office rents,





December
      31, 2009
                      
                      $
                      822,787December
      31, 2010
                      
                      
                      2,527,101December
      31, 2011
                      
                      
                      1,916,723December
      31, 2012
                      
                      
                      1,916,723December
      31, 2013
                      
                      
                      195,103Total
                      
                      $
                      7,378,437





22.Non-controlling
Interest





The
Company had non-controlling interests in several of its subsidiaries. The
balance of the non-controlling interests as of September 30, 2009 and December
31, 2008 were as follows:


Noncontrolling
      interest Balance at Subsidiary
                        
                        %
                        
                        
                        September
                          30, 2009
                        
                        
                        December 31, 2008ETC
      PRS UK
                        
                        
                        49
                        %
                        
                        $
                        10,705
                        
                        
                        $
                        10,807ETC
      PRS Netherlands
                        
                        
                        49
                        %
                        
                        
                        142,982
                        
                        
                        
                        144,344ET
      Bahrain WLL
                        
                        
                        1
                        %
                        
                        
                        2,596
                        
                        
                        
                        1,388ET
      ME&A FZ LLC
                        
                        
                        49.46
                        %
                        
                        
                        35,244
                        
                        
                        
                        35,227Total
                        
                        
                        
                        
                        
                        $
                        191,527
                        
                        
                        $
                        191,767





17




23.Litigation





(a)
Beijing Chinawind





On
September 25, 2006, Beijing Zhongrun Chuantou Technology Co., Ltd., a company
organized and existing under the laws of the People’s Republic of China
(“Beijing Zhongrun”) and a minority shareholder of Beijing Chinawind
Telecommunication Information Technology Company Limited, a company organized
and existing under the laws of the People’s Republic of China (“CW”), filed two
lawsuits against Guangdong Elephant Talk Network Consulting Limited, a company
organized and existing under the laws of the People’s Republic of China and an
agent of the Company (“ETGD”), in the Beijing Civil Courts. The lawsuit alleged
that a.) ETGD failed to pay the remaining consideration of $787,748 under an
Equity Transfer Agreement, dated January 4, 2006 (the “CW Agreement”), between
ETGD and Beijing Zhongrun, which provided for the acquisition by ETGD from
Beijing Zhongrun of 60% of the registered capital of Beijing Chinawind; and b.)
ETGD induced the minority shareholders of Beijing Chinawind to accept, pursuant
to the CW Agreement, consideration of $1,000,000 through the issuance of 400,000
common shares of the Company valued at $2.25 per common share. The lawsuit
further alleged that Chinese law prohibits citizens of the People’s Republic of
China from accepting shares of companies listed on the United States
Over-The-Counter Bulletin Board Quotation Service, which is regulated by the
National Association of Securities Dealers, Inc., as compensation in an
acquisition transaction.




The
judgment of the Beijing Haiding Civil Court was received. On October 18, 2007
the verdict was given in the two cases.  The CW Agreement was
confirmed to be effective. All requests from CW are rejected.  In
addition, the Court confirmed the opinion of ETGD: that the resolutions of the
shareholders meeting of China Wind held on January 27, 2007 are invalid, as the
meeting was not conducted in a proper way.





On
February 4, 2009, our board of directors decided to no longer pursue our
interests in the concerned company.





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





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





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





(c)
Russelle Choi Litigation





On or
about September 12, 2008, an action was commenced against the Company by
Russelle Choi ("Choi"), our former CEO and director, in the California Superior
Court, Orange County, in a matter entitled Choi v. Elephant
Talk Communications, Inc., Case No. 30-2008-00111874.  The complaint
alleges that we breached a termination agreement and a consultancy agreement
entered into between the Company and Choi.  On August 19th, the
Company had settled both the dispute on the termination agreement as well as the
complaint regarding the alleged breach of the consulting agreement. The entire
action was dismissed by Choi with prejudice.





(d)
Manu Ohri Litigation





On March
26, 2009, an action was commenced against the Company in the state of California
by Manu Ohri (“Ohri”), our former Chief Financial Officer, alleging a breach of
written contract, a breach of oral contract, and a common count for services
rendered. The suit claims, among other things, $427,816 in unpaid severance
payments, $56,951 owed under an oral consulting agreement, and stock options
payable under the oral consulting agreement with a net value of
$622,000.  We deny all material allegations of Ohri's complaint and
assert various affirmative defenses. We also filed and served a cross-complaint
against Ohri, who then filed and served an answer, denying the material
allegations of our cross-complaint.





18


24.SegmentInformation





Nine months ended September 30,
2009





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





Nine
months ended September 30, 2008





EUROPENetherlands
                      
                      
                      Spain
                      
                      
                      Switzerland
                      
                      
                      Others
                      
                      
                      Total
                      
                      
                      Far East
                        HongKong/
                        China
                      
                      
                      Middle East
                      
                      
                      The Americas
                      
                      
                      TOTALRevenues
      from unaffiliated customers:
                      
                      $
                      25,799,839
                      
                      
                      $
                      2,233,145
                      
                      
                      $
                      6,537,867
                      
                      
                      $
                      402,679
                      
                      
                      $
                      34,973,530
                      
                      
                      $
                      6,314
                      
                      
                      $
                      45,143
                      
                      
                      $
                      -
                      
                      
                      $
                      35,024,987Operating
      income (loss)
                      
                      $
                      (2,598,113
                      )
                      
                      $
                      257,093
                      
                      
                      $
                      (1,421,135
                      )
                      
                      $
                      (647,027
                      )
                      
                      $
                      (4,409,182
                      )
                      
                      $
                      (696,731
                      )
                      
                      $
                      (176,127
                      )
                      
                      $
                      (2,138,429
                      )
                      
                      $
                      (7,420,469
                      )Net
      income (loss):
                      
                      $
                      (2,650,892
                      )
                      
                      $
                      256,442
                      
                      
                      $
                      (1,451,434
                      )
                      
                      $
                      (656,083
                      )
                      
                      $
                      (4,501,967
                      )
                      
                      $
                      (1,252,530
                      )
                      
                      $
                      (177,075
                      )
                      
                      $
                      (3,179,470
                      )
                      
                      $
                      (9,111,041
                      )Identifiable
      assets
                      
                      $
                      3,992,129
                      
                      
                      $
                      1,717,271
                      
                      
                      $
                      10,682,581
                      
                      
                      $
                      1,283,174
                      
                      
                      $
                      17,675,155
                      
                      
                      $
                      275,539
                      
                      
                      $
                      605,000
                      
                      
                      $
                      6,076,849
                      
                      
                      $
                      24,632,543Depreciation
      and amortization
                      
                      $
                      (154,871
                      )
                      
                      $
                      (179,180
                      )
                      
                      $
                      (1,438,547
                      )
                      
                      $
                      (20,429
                      )
                      
                      $
                      (1,793,027
                      )
                      
                      $
                      (35,158
                      )
                      
                      $
                      (1,337
                      )
                      
                      $
                      (322,602
                      )
                      
                      $
                      (2,152,124
                      )Capital
      expenditure
                      
                      $
                      48,172
                      
                      
                      $
                      1,291
                      
                      
                      $
                      1,684,217
                      
                      
                      $
                      -
                      
                      
                      $
                      1,733,680
                      
                      
                      $
                      9,525
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      1,743,205





25.Concentrations




Customers
in excess of 10% of total revenues were as follows:




For the
three and nine months ended September 30, 2009, the Company had a customer in
the Netherlands, which accounted for revenue of $5,381,106 and $16,155,864
respectively. For the same periods in 2008, this same customer accounted for
$5,821,665 and $17,790,213 respectively.




26.Loans andConvertible Notes (Private
Placement)





On July
1, 2009 and July 8, 2009 QAT II, a closed-end fund of QAT Investments,
entered into a loan agreement with the Company whereby QAT II provided the
Company with $ 213,795 and $ 142,530.  According to the terms, the loans
will bear interest at a rate of twelve percent (12%) per annum and shall be
repaid either: (1) if QAT II and the Company sign an investment agreement, the
amount due under the loan will be reduced by the investment amount pursuant to
the investment agreement, or (2) if no investment agreement is executed, the
principal amount of the loan plus interest is due and payable by August 31,
2009. The agreement and amount were entered in Euro’s, which means that currency
differences may occur in filings made and this Report.  An investment
agreement was made October 31st 2009,
converting these loans into the convertible 12% secured notes. See note
15.




Separately,
on July 31, 2009, the Company consummated the first closing (the "First
Closing") of its private placement offering (the "Offering") of Units comprised
of 12% secured convertible promissory notes (the "Notes") and warrants to
purchase shares of common stock, no par value (the “Common Stock”) (the
"Warrants", and together with the Notes, the "Securities" to accredited
investors ("Investors"). The Securities were offered and sold pursuant to an
exemption from registration under Section 4(2) of the Securities Act of 1933, as
amended (the "Securities Act"). In the First Closing the Company sold an
aggregate of $5,111,000 principal amount of Notes and delivered Warrants to
purchase an aggregate of 5,111,000 shares of the Company's common stock at a
purchase price of $1.00 per share. After taking into consideration the
conversion of $4.1 million of existing QAT II loans into the First Closing, the
Company received cash proceeds of $1.0 million.


19




The Notes
are convertible at the option of the holder into Common Stock, of the
Company  at a conversion price (the "Conversion Price") equal to
eighty five percent (85%) of the price at which shares are sold in a future
public offering (the "Public Offering") currently contemplated by the Company if
consummated; provided, however, that if the Public Offering is not consummated
on or before March 31, 2010, the Conversion Price shall be equal to eighty five
percent (85%) of the twenty (20) day average closing price of the Common Stock
for the twenty (20) trading days prior to March 31, 2010 (the "March 31, 2010
Conversion Price"); provided further, however, that if at any time following the
earlier of the closing of the Public Offering or March 31, 2010, the twenty (20)
day average closing price of the Common Stock for any twenty (20) consecutive
trading days exceeds two hundred percent (200%) of the Public Offering closing
price or of the twenty (20) day average closing price of the Common Stock for
the twenty (20) trading days prior to March 31, 2010, as applicable, that any
Notes which remain unconverted shall automatically convert into shares of the
Common Stock at the Conversion Price or the March 31, 2010 Conversion Price, as
applicable.




Certain
Investors that invested through their individual retirement accounts received
Class B Notes. All other Investors received Class A Notes. The Class B Notes are
identical to the Class A Notes in all respects except that the Class A Notes are
secured by a first priority security interest in all of the assets of the
Company and certain subsidiaries whereas the Class B Notes are secured by all
the current assets of the Company and its consolidated subsidiaries including
cash, cash equivalents and accounts receivable. In addition, the Class B Notes
provide for simple interest as opposed to the Class A Notes, which provide for
compounded interest.




The
Warrants entitle the holders to purchase shares of Common Stock reserved for
issuance thereunder (the "Warrant Shares") for a period of five years from the
date of issuance and contain certain anti-dilution rights and a cashless
exercise feature on terms specified in the Warrants. In the event the trading
price of the Common Stock exceeds $2.00 for twenty (20) consecutive trading
days, the Company has the option to require that the Investors exercise the
Warrants. In the event the Investor chooses not to exercise the Warrants in this
case, the Investor will receive such number of Warrant Shares as the Investor
would be entitled to receive pursuant to a cashless exercise.




On August
18, 2009, the Company consummated the second closing (the “Second Closing”) of
the Offering.  In the Second Closing the Company sold an aggregate of
$1,185,000 principal amount of Notes and delivered Warrants to purchase an
aggregate of 1,185,000 shares of the Company's common stock at a purchase price
of $1.00 per share.




On
September 3, 2009, the Company consummated the third closing (the “Third
Closing”) of the Offering.  In the Third Closing the Company sold an
aggregate of $1,269,843 principal amount of Notes and delivered Warrants to
purchase an aggregate of 1,269,843 shares of the Company's Common Stock at a
purchase price of $1.00 per share.




On
September 30, 2009, the Company consummated the fourth closing (the “Fourth
Closing”) of the Offering.  In the Fourth Closing the Company sold an
aggregate of $650,000 principal amount of Notes and delivered Warrants to
purchase an aggregate of 650,000 shares of the Company's common stock at a
purchase price of $1.00 per share.




Subsequent
to September 30, 2009, on October 30, 2009, the Company consummated the fifth
closing (the “Fifth Closing”) of the Offering.  In the Fifth Closing,
the Company sold an aggregate of $4,116,383 principal amount of Notes and
delivered Warrants to purchase an aggregate of 4,116,383 shares of the Company’s
Common Stock at a purchase price of $1.00 per share.  Of this amount,
$1,332,383 was the result of the non-cash conversion of certain loans and
accrued interest of one of the Company’s affiliates.




The
Company intends to use the net proceeds from the offering for working
capital purposes. The Company is obligated to register the shares of Common
Stock underlying the Notes and Warrants pursuant to unlimited piggy-back
registration rights granted to the Investors.


20





27. Related Party
Transactions




On July
1, 2009 and July 8, 2009 QAT II, a closed-end fund of QAT Investments, entered
into a loan agreement with the Company whereby QAT II provided the Company with
$ 213,795 and $ 142,530.  According to the terms, the loans will bear
interest at a rate of twelve percent (12%) per annum and shall be repaid either:
(1) if QAT II and the Company sign an investment agreement, the amount due under
the loan will be reduced by the investment amount pursuant to the investment
agreement, or (2) if no investment agreement is executed, the principal amount
of the loan plus interest is due and payable by August 31, 2009. The agreement
and amount were entered in Euro’s, which means that currency differences may
occur in filings made and this Report.




On July
31, 2009, QAT II converted $4,100,000 provided under the loan agreements
into  $4,100,000 in Notes and  Warrants as part of the First
Closing with respect to the Offering. On October 30, 2009, QAT II converted
$1,332,383 into Notes and Warrants as part of the Fifth Closing with respect to
the Offering.





Quercus
Management Group N.V. (“QMG”), an entity affiliated with certain officers and
directors of the Company served as European placement agent for the
Offering.  In the aggregate, QMG raised $4,837,632, entitling it to
774,022 Warrants (equal to 8% of the aggregate amount of Notes and Warrants sold
in the Offering, including those Notes and Warrants sold to affiliates of the
Company), an 8% selling concession equal to $387,010.56 and 2% non-accountable
expenses and fees equal to $96,752.64.  Of the $4,837,632 raised by
QMG, $4,399,995.10 (or 91% of the total) was raised from parties affiliated with
the Company (including the $4,100,000 conversion by QAT II).





28. Validsoft, Limited
Transactions





On June
17, 2009, the Company and Validsoft Limited a company organized under the laws
of the Republic of Ireland entered into a Collaboration Agreement (the
"Collaboration Agreement"). Pursuant to the Collaboration Agreement, the Company
and Validsoft will bundle and sell products offered by the Companies. The
Companies have granted each other worldwide licenses for their intellectual
property in connection with the distribution, marketing and sale of products to
be offered. The Companies have agreed to terms regarding the allocation of
revenue generated by the sale of the bundled products, and to indemnify the
other party in the event of losses arising from a breach of the Collaboration
Agreement by either the Company or Validsoft. The Agreement has a term of ten
years.





On
November 2, 2009, the Company entered into a generally non-binding heads of
terms agreement (the “HOT Agreement”) with ValidSoft Limited (“ValidSoft”), a
company organized under the laws of the Republic of Ireland, and the
shareholders of ValidSoft.  The HOT Agreement replaces a previous
agreement entered into on February 23, 2009, between Registrant and
ValidSoft.





Under the
HOT Agreement, the Company expects to enter into a definitive agreement to
acquire 100% of the issued and outstanding securities of ValidSoft for
consideration consisting of 20% of the issued and outstanding common shares of
the Company as of February 1, 2009 and warrants to purchase common shares of
Company equal to (i) 20% of the issued and outstanding warrants of the Company
as of February 1, 2009; and (ii) 20% of the issued and outstanding options of
the Company as of February 1, 2009.  Twenty-five percent of the
foregoing consideration shall be placed into escrow and, in the event certain
revenue milestones (as set forth the in the HOT Agreement) have not been
achieved, is subject to forfeiture and cancellation.





The HOT
Agreement includes the payment of a binding break-up fee of € 2,000,000 by
a party if (i) such party breaches the exclusivity and conduct of business
provisions described in the HOT Agreement; (ii) such party terminates
negotiations before December 31, 2009 without good cause (as defined in the HOT
Agreement); or (iii) such party is unable to complete the proposed transactions
substantially upon the terms set forth in the HOT Agreement by December 31,
2009.





Pursuant
to the earlier HOT Agreement of February 23, 2009,  a Bridging Loan
Agreement, and subsequent amendments, on September 30 2009, the Company had
advanced a total of $1,237,456 excluding accrued interest, to
ValidSoft.




29.Subsequent
Events





On
October 30, 2009, the Company consummated the fifth closing (the “Fifth
Closing”) of the Offering.  In the Fifth Closing the Company sold an
aggregate of $4,116,383 principal amount of Notes and delivered Warrants to
purchase an aggregate of 4,116,383 shares of the Company’s common stock at a
purchase price of $1.00 per share.  Of the Fifth Closing amount,
$1,407,383 was raised from parties affiliated with the Company, with $1,332,383
resulting from the conversion by QAT II of interest payments due from the
Company and $75,000 from an officer of the Company and his family.  As
a result of the Fifth Closing, the United States-based selling agent received
354,240 Warrants, commission and non-accountable expenses and fees of $221,400,
and an expense reimbursement of $940.63 and QMG will receive 304,382 Warrants
and commissions and non-accountable expenses and fees of
$190,238.28.


21


On
November 2, 2009, the Company entered into a generally non-binding HOT
Agreement with ValidSoft, a company organized under the laws of the Republic of
Ireland, and the shareholders of ValidSoft. Under the HOT Agreement, the
Company expects to enter into a definitive agreement to acquire 100% of the
issued and outstanding securities of ValidSoft. See also Note 24 (Validsoft,
Limited Transactions).





The
Company's management evaluated subsequent events through November 16, 2009, the
date the financial statements were issued on this Form 10-Q.





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





Forward-Looking
Statements


Any
forward looking statements made herein are based on current expectations of the
Company, involve a number of risks and uncertainties and should not be
considered as guarantees of future performance. The factors that could cause
actual results to differ materially include: interruptions or cancellation of
existing contracts, inability to integrate acquisitions, impact of competitive
products and pricing, product demand and market acceptance risks, the presence
of competitors with greater financial resources than the Company, product
development and commercialization risks, changes in governmental regulations,
and changing economic conditions in developing countries and an inability to
arrange additional debt or equity financing. More information about factors that
potentially could affect the Company's financial results is included in the
Company's filings with the Securities and Exchange Commission, including its
Annual Report on Form 10-K for the year ended December 31, 2008.





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements and notes
thereto and the other financial information included elsewhere in this
document.





Overview





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements and notes
thereto, and the other financial information included elsewhere in this
document.





Telecom
infrastructure & network





We
currently operate a switch-based telecom network with national licenses and
direct fixed line interconnects with the Incumbents/National Telecom Operators
in seven (7) European countries, one (1) in the Middle East (Bahrain), and
partnerships with telecom operators in Scandinavia, Poland and Germany, and
France. Codec and media streaming servers are currently located in six centers
geographically spread around the world.




Business
Support and Operational Support System/IN/CRM-Billing platform





Together
with the centrally operated and managed IN-CRM-Billing platform, we offer
geographical, premium rate, toll free, personal, nomadic and Voice over internet
protocol (“VOIP”)  numbers. Services are primarily provided to the
business market and include traditional telecom services, VOIP, media streaming
and distribution including the necessary billing and collection. Through our
European and Chinese development centers, we develop in-house telecom and media
related systems and software.





Mobile
Services (MVNE/MVNO)





Beginning
in 2007, we positioned ourselves in Europe as a Mobile Virtual Network Enabler
(“MVNE”) to Mobile Network Operators (“MNO”) and Mobile Virtual Network
Operators (“MVNO”) offering a wide range of Mobile Enabling/Enhancing services
through sophisticated, proprietary technology supported by multi-country
operations with a focus on business to business (“B-B”), outsourcing /partnering
strategy. Important milestones in this respect are:


22





1. On
September 17, 2008, a hosting agreement was signed between T-Mobile Netherlands
BV and Elephant Talk Holding AG, a 100% affiliate of Elephant Talk Europe
Holding BV. T-Mobile is one of the 3 Mobile Network Operators in the
Netherlands. Elephant Talk will, as exclusive MVNE for T-Mobile, connect MVNO’s
in the Netherlands to its platform, utilizing T-Mobile’s  mobile
network .





2. On May
20, 2009, Elephant Talk Communication Holding, AG, a wholly-owned subsidiary of
the Company, entered into a definitive agreement with Vizzavi Espana, S.L. for
the supply of operation and technical services through a comprehensive
technological platform.  The Company, through Elephant Talk
Communication Holding, AG, will offer exclusive operation and technical support
services to Vizzavi, a Vodafone Group company.





3.
Following the start of our Mobile (MVNE) services in the Netherlands in the
fourth quarter of 2008, we have been able to enter into a number of Heads of
Agreement ( “HOT Agreement”) with MVNO’s in the Netherlands and
implemented the first Vizzavi (a Vodafone Group company) MVNO in Spain as of
June 2009.





4. In
line with the expected convergence of applications and bundling of services, we
intend to integrate our services with offerings bythirdparty
providers with a uniquely specialized or compatible technology. Although there
can be no assurance as to the completion of the agreement, on November 2, 2009,
we entered into a HOT Agreement to acquire all of the outstanding shares in
Validsoft Limited (“Validsoft”). Validsoft provides telecommunications based
credit card fraud identification and detection solutions combined with fully
automated customer service resolution capability, which is ideally suited for
mass consumer deployment via banks. The HOT
Agreement replaces a previous agreement between the Company and ValidSoft, with
respect to this transaction.Before that, we had entered into a
collaboration agreement  (“collaboration”) with Validsoft on June 17, 2009.
Pursuant
to the collaboration, the Company and ValidSoft will bundle and sell products
offered by the two Companies. The collaboration has a term of ten
years.





Nature of use of funding
received by the Company (2006 – 2008); mobile investment
estimate.





Since new
management was hired in late 2006, approximately $30 million of investments have
been made into the Company through the end of 2008. The following is a general
description of the use of such proceeds during this period. Management believes
that the Company’s traditional fixed line business (“old business”) could be
operated by approximately 15 people, which is much smaller number of people
compared to the total employees and long term contractors the Company currently
employs.





However,
in order to expand our capabilities to create our mobile platform and the
underlying footprint (“new business”), including all related capabilities in the
areas of customer relationship management (“CRM”), Billing, intelligent network
(“IN”), and the integration of all mobile network components, we have on average
required approximately 45 employees and consultants.  During the
period of 2006  to 2008, we spent approximately $ 2.9 million in network
costs and $13.9 million in selling general & administration expenses
(excluding $1.4 million in capitalized development compensation cost). When
allocating roughly 25% of the network costs and 75% of the selling general &
administration costs (based upon the average amount of people working for the
old and new business; in 2007 we had a headcount of 53, as opposed to 72 in
2008), we estimate that a total of $11.2 million was spent on developing these
new capabilities.  In addition, we invested approximately $9.3 million
in the acquisition of the Benoit Telecom Group in addition to other smaller
acquisitions in order to build our footprint in Europe.  In addition,
we spent approximately $4.5 million plus $1.43 million (in capitalized
development compensation costs), or a total of $5.9 million in capital
expenditures over the last two years.  In total we have invested
approximately $26.4 million in building our mobile platform
capabilities.  When costs of raising capital are included, in addition
to certain deposits made, a total of $30 million has been expended in
positioning us in our new business. Throughout 2009 we have continued this
pattern and level of investment.





Results of
Operations





Our
results of operations for the three months and nine months ended September 30,
2009, consisted of the operations of Elephant Talk Communications, Inc., its
wholly-owned subsidiary Elephant Talk Limited and its subsidiaries, its
wholly-owned subsidiary Elephant Talk Europe Holding BV and its subsidiaries,
and its wholly-owned subsidiary Elephant Talk Global Holding BV and its
subsidiaries.


23


We report
our financial statements in US dollars (“USD”), although the majority of our
business activates are denominated in Euro’s.  Conversion of Euro to
USD  may lead to period-to-period fluctuations in our reported USD results
arising from changes in the exchange rate between the USD and the
Euro.  Generally speaking, when the USD strengthens relative to the
Euro it has an unfavorable impact on our revenue and income accounts and a
favorable impact on our expense accounts.  Conversely, when the USD
weakens relative to the Euro, it produces a favorable impact on our revenue and
income accounts, and an unfavorable impact on our expense
accounts.  The fluctuations in the USD/Euro exchange rate can result
in currency translation effects, which impact our reported USD results and may
make it difficult to determine actual increases and decreases in our revenue and
expense accounts 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
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.




Revenue
  Revenue
for the three months ended September 30, 2009 was $11,455,489, an increase of
$109,072 or 1.0%, compared to $11,346,417 for the same period in 2008. The
increase for the three months ended September 30,  2009 period was
primarily limited by the result of the unfavorable impact of a $ 1,045,525
currency exchange translation effect arising from a lower USD/Euro exchange
rate.
  Revenue
for the nine months ended September 30, 2009 was $32,195,771, a decrease of
$2,829,216 or 8.1%, compared to $35,024,987 for the nine months ended September
30, 2008. The decrease in revenue for the nine months ended September 30, 2009
was primarily the result of the unfavorable impact of a $ 3,601,524
currency exchange translation effect arising from a lower USD/Euro exchange
rate.
  Revenue
- Constant currency
  In
constant currency, total revenue for the three months ended September 30, 2009
increased with  $1,154,597 or 11.2% compared to the same period
in 2008.  The increase in revenue was attributable to an increase in
our MVNO revenue of $ 1,887,096 compared to $0 in 2008, partly offset by a
decline in our (lower margin) premium rate services (“PRS”)  of
$568,220, or 5.8%, compared to the same period in 2008.
  In
constant currency, total revenue for the nine months ended September 30,
2009 increased $772,308 or 2.5% compared to the same period in
2008.  The increase in revenue was attributable to an increase in our
MVNO revenue of $4,078,634 compared to $0 in the same period in 2008, partly
offset by a decline in our PRS revenue of $3,385,098 or 11.3%, compared to the
same period in 2008.
 
 Management
believes that our PRS services revenue may  continue to decline in
future quarters, however, we expect revenue from our MVNO operations will more
than offset those declines.
 
 Cost
of service
  Cost of
service includes origination, termination, network and billing charges from
telecommunications operators, outpayment costs to content and information
providers, network costs, data center costs, facility cost of hosting network
and equipment and cost in providing resale arrangements with long distance
service providers, cost of leasing transmission facilities, international
gateway switches for voice, and data transmission services.
 
 Cost of
service for the three months ended September 30, 2009 was $10,874,205, a
reduction of $267,987 or 2.4%, compared to $11,142,192 for the same period in
2008.  The decrease in cost of service was primarily the result
of the favorable impact of a $ 1,025,384 currency exchange translation effect
arising from a lower USD/Euro exchange rate.
 
 Cost of
service for the nine months ended September 30, 2009 was $30,654,206, a
reduction of $3,474,121 or 10.2%, compared to $34,128,327 for the same period in
2008.  This decrease in cost of service was primarily the result of a
favorable impact of a $3,500,222 currency exchange translation effect arising
from a lower USD/Euro exchange rate.
 Cost
of service – constant currency
  In
constant currency, cost of service for the three months ended September 30,
2009 increased $757,397 or 7.5% compared to the same period in 2008
primarily as a result of higher levels of revenue.
 
 In
constant currency, cost of service for the nine months ended September 30, 2009
only increased with  $26,101 or 0.1%, compared to the same period in
2008.
 24
 Cost of
service, as a percent of revenue, expressed in constant dollar terms was 94.9%
and 98.2% for the three month periods ended September 30 in 2009 and 2008,
respectively, and 95.2% to 97.5% for the nine month periods ended September 30
in 2009 and 2008, respectively.
  Management
expects cost of service will continue to decline as a percent of revenue,
subject to certain quarterly fluctuations, in constant currency terms compared
to previous quarters as a greater proportion of future revenue is comprised of
our MVNO services which have a substantially lower cost of service than our
traditional PRS business.
  Selling,
general and administrative
 
 Selling,
general and administrative (“SG&A”) expense for the three months ended
September 30, 2009 was $2,949,038, an increase of $795,494 or 36.9 % compared to
$2,153,544 for the same period in 2008.
 
 For the
nine months ended September 30, 2009, SG&A expense was $ 6,195,981,
an increase of 11.1%, compared to $5,575,047 in the same period in
2008.
 
 Selling,
general and administrative – constant currency
 In
constant currency, total SG&A for the three months ended September 30,
2009  increased with  $925,396 or 45.7% compared to the
same period in 2008.  The increase in expenses was mainly attributable
to an increase in indirect fundraising costs related to the Convertible 12%
secured note, bad debt allowance and staffing levels.
 
 In
constant currency, total SG&A for the nine months ended September 30, 2009
increased with  $ 985,443 or 17.6 % compared to the same period
in 2008.  The increase in expenses was mainly attributable to an
increase in indirect fundraising costs related to the Convertible 12% secured
note, bad debt allowance and staffing levels.


Non-cash
compensation to officers, directors and employees


Non-cash
compensation for the three and nine months ended September 30, 2009, was
$252,521 and $1,272,387, respectively, compared to $199,886 and $589,958, for
the corresponding 2008 periods. The increase in both periods is primarily
attributable to higher staffing levels, and awards made under the 2008 Incentive
Plan. Non-cash compensation is comprised of:





·
            the
      expense related to shares of restricted common stock that were issued to
      management in connection with a compensation plan originated in the first
      quarter of 2007;





·
            the
      2006 Non-Qualified Stock and Option Compensation Plan and  the
      2008 Long-Term Incentive Plan; and





·
            the
      expense related to shares issued to consultants for
    services.





Depreciation
and amortization


Depreciation
and amortization for the three and nine months ended September 20, 2009, was
$861,616 and $2,199,561, respectively, compared to $725,943 and $2,152,124 for
the comparable periods in 2008.





Other
Income and Expenses:


Interest
income for the three months ended September 30, 2009 was $24,375 compared to
$529,307 for the same period in 2008. Interest income was $46,682 and $38,877
for the nine months ended September 30, 2009 and 2008 respectively.





For the
three months ended September 30, 2009, interest expense was $323,967 compared to
$210,779 in 2008. Interest expense was $531,915 and $452,957, for the nine
months ended September 30, 2009 and 2008, respectively.





For the
three months ended September 30, 2009, fair value expenses and amortizations
related to the Convertible Notes, associated Warrants and deferred financing
cost was $ 1,848,709 compared to $ 0.— in 2008.,  For the nine months
ended September 30, 2009 and 2008, $ 1,848,709 and $ 0.— respectively. For the
three months ended September 2008 as well as for the nine months ended September
2008, a Note beneficial conversion feature was expensed for $
1,200,000.—.





Non-controlling
Interest


Our
majority owned subsidiaries 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.





During
the three and nine months ended September 30, 2009, we incurred a
non-controlling interest charge of $432 and $1,188 respectively. During the same
period in 2008, we incurred income of $21,160 and $80,409 attributable to
minority shareholders’ interest.


25


Comprehensive
Income (Loss)


We record
foreign currency translation gains and losses as comprehensive income or loss.
Comprehensive Income (Loss) for the three and nine months ended September 30,
2009 was $543,061 and $345,802 respectively, compared to losses of ($1,331,411)
and ($117,064) for the three and nine months ended September 30, 2008. The
decrease in the 2009 periods compared to the same periods in 2008 is primarily
attributable to the translation effect resulting from the substantial
fluctuations in the USD/Euro exchange rates.





Liquidity
and Capital Resources


We have
an accumulated deficit of $55,497,486 as of September 30,
2009.  Historically, we have relied on a combination of debt and
equity financings to fund our ongoing cash requirements.  In the first
nine months of 2009, we received a total of $4.3 million in loans from QAT II
Investments SA (“QAT II”), a related party.  In July and August of
2009, QAT II converted $4.1 million of loans into our private placement of
convertible notes (“the Notes”) and warrants (the “Warrants” and together with
the Notes, the “Securities”)., As described in our Current Reports filed on Form
8-K, we held five closing of the private placement of our Securities for the
three months ended September 30, 2009, as follows: (i) we closed on
approximately $5.1 million of Securities on July 31, 2009, of which
approximately $4.1 million consisted of the conversion described above; (ii) we
closed on approximately $1.2 million on August 18, 2009; (iii) we closed on
approximately $1.3 million on September 3, 2009; (iv) we closed on $650,000 on
September 30, 2009; and (iv) we closed on approximately $4.1 million of which
approximately $1.3 million was the result of the conversion of certain notes and
interest to QAT II. We believe that the cash balance at September 30, 2009, in
combination with the net proceeds received from the sale of the Securities
between  July and October  of 2009, will provide us with
sufficient funds through the end of the fourth quarter of 2009.





Although
QAT II and other related parties have invested, or have arranged for the
investment of, a total of $35.4 million between 2005 through December 31, 2008,
and have since January 2009 funded our short-term capital requirements with an
additional $ 5.4 million (through October 31, 2009) and non-related accredited
investors have invested $ 6.9 million (through October 31, 2009), there can be
no assurance that they will continue to do so.  Although we have
previously been able to raise capital as needed, such capital may not continue
to be available at all, or if available, that the terms of such financing may be
dilutive to existing shareholders or otherwise on terms not favorable to us or
our existing shareholders. Further, the current global financial situation may
offer additional challenges to raising the required capital.  If we
are unable to secure additional capital, as circumstances require, we may not be
able to continue operations.





As of
September 30, 2009, these conditions raise substantial doubt about our ability
to continue as a going concern.  The financial statements filed as
part of this Quarterly Report on Form 10-Q do not include any adjustments that
might result from the outcome of this uncertainty.




Operating
activities


Net cash
used in operating activities for the nine months ended September 30, 2009 was
$3,757,556 compared to $ 4,873,025 in 2008, a decrease of
$1,115,469.





Investment
activities


Net cash
used in investment activities for the nine months ended September 30, 2009 was
$3,162,708, an increase of $1,991,055 or 170 % compared to $1,171,653 in
the same period in 2008. The increase was primarily attributable to increase in
property plant & equipment  required to develop and support the
expansion of our MVNE and MVNO business.





Financing
activities


Net cash
received by financing activities for the nine months ended September 30, 2009
was $ 7,212,158  compared to $6,619,103, the nine months ended
September 30, 2008.





As a
result of the above activities, the Company had a cash and cash equivalents
balance of $1,884,054 as of September 30, 2009, a net increase in cash and cash
equivalents of $227,508, for the nine months ended September 30,
2009.





Application
of Critical Accounting Policies and Estimates
 
 Revenue
Recognition and Deferred Revenue
 
 The Company's revenue recognition
policies are in compliance with ASC 605, Revenue Recognition (“ASC 605”), (formerly, Staff Accounting Bulletin (SAB) 104).
Revenue is recognized only when the price is fixed or determinable, persuasive
evidence of arrangement exists, the service is performed and the collectability
of the resulting receivable is reasonably assured.  TheCompany 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.


26





Stock-based
Compensation
 
 Effective January 1, 2006, we adopted
the provisions of ASC 718 "Compensation-Stock Compensation”," (“ASC 718”) (formerly SFAS No. 123(R)), using the
prospective approach. As a result, we recognize stock-based compensation expense
for only those awards that are granted subsequent to December 31, 2005 and any
previously existing awards thatare 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 toamortize on a straight-line
basis.
 
 Intangible
Assets and Impairment of long Lived Assets
 
 In accordance with ASC 350 (formerly
SFAS No. 142), intangible assets are carried at cost less accumulated
amortization and impairment charges. Intangible assets areamortized on a straight-line basis over
the expected useful lives of the assets, between three and ten years. Other
intangible assets are reviewed for impairment in accordance with ASC 360,
Property, Plant, and Equipment,”(formerly SFAS No. 144),
annually, or whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be
recoverable. Measurement of any impairment loss for long-lived assets and
identifiable intangible assets that management expects to hold and use
isbased on the amount of the carrying
value that exceeds the fair value of the asset.


Impact
of Accounting Pronouncements




In April 2009, the FASB issued
guidance,which is now part of ASC
825, “Interim Disclosures about Fair Value of
Financial Instruments”(“ASC 825”),(formerly Financial Staff Position SFAS
107-1 and Accounting Principles Board (APB) Opinion No.
28-1).. ASC 825
amends FASB Statement No. 107, Disclosures about Fair Value of Financial
Instruments, to require disclosures about fair value of financial instruments for interim
reporting periods of publicly traded companies as well as in annual financial
statements. This FSP also amends APB Opinion No. 28, Interim Financial
Reporting, to require those disclosures in summarized financial information at interim reporting periods.
ASC 825 is effective for interim and annual reporting periods ending after June
15, 2009. The adoption of ASC 825did not have an impact on the
Company’s consolidated financial
statements.
 
 In May 2009, the FASB issuednew guidance for accounting for
subsequent events.  The new guidance, which is now part of ASC
855-10, “Subsequent Events”(“ASC 855-10”)(formerly, SFAS No. 165) is consistent
with existing auditing standards in defining subsequent events as events or
transactions that occur
after the balance sheet date but before the financial statements are issued or
are available to be issued, but it also requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for
thatdate. The new guidance defines two types
of subsequent events: “recognized subsequent
events”and “non-recognized subsequent
events.”Recognized
subsequent events provide additional evidence about conditions that existed at
the balance sheet date and mustbe reflected in the company’s financial statements. 
Non-recognized subsequent events provide evidence about conditions that arose
after the balance sheet date and are not reflected in the financial statements
of a company.  Certain non-recognized subsequent events may require disclosure to
prevent the financial statements from being misleading.  The new guidance
was effective on a prospective basis for interim or annual periods ending after
June 15, 2009.  We adopted the provisions of ASC 855-10 as
required.


27





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





Item
3. Quantitative and Qualitative Disclosure About Market Risks





Not
applicable.





Item
4T. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures


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





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





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




28




Changes
in Internal Control over Financial Reporting





There
have not been any changes in the Corporation’s internal control over financial
reporting during the quarter ended September 30, 2009 that have materially
affected, or are reasonably likely to materially affect, the
Company’s  internal control over financial reporting.





PART
II - OTHER INFORMATION


Item
1. Legal Proceedings





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


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





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





(b)
Russelle Choi Litigation





On or
about September 12, 2008, an action was commenced against the Company by
Russelle Choi ("Choi"), our former CEO and director, in the California Superior
Court, Orange County, in a matter entitled Choi v.


Elephant
Talk Communications, Inc., Case No. 30-2008-00111874.  The complaint
alleges that we breached a termination agreement and a consultancy agreement
entered into between the Company and Choi.  On August 19th, 2009,
the Company had settled both the dispute on the termination agreement as well as
the complaint regarding the alleged breach of the consulting
agreement.


The
entire action was dismissed by Choi with prejudice.





(c)
Manu Ohri Litigation


On March
26, 2009, an action was commenced against the Company in the state of California
by Manu Ohri (“Ohri”), our former Chief Financial Officer, alleging a breach of
written contract, a breach of oral contract, and a common count for services
rendered. The suit claims, among other things, $427,816 in unpaid severance
payments, $56,951 owed under an oral consulting agreement, and stock options
payable under the oral consulting agreement with a net value of
$622,000.  We deny all material allegations of Ohri's complaint and
assert various affirmative defenses. We also filed and served a cross-complaint
against Ohri, who then filed and served an answer, denying the material
allegations of our cross-complaint.





Additional
information regarding legal proceedings to which the Company was involved in may
be found in the Company’s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2009.





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, 2008 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. Submission of Matters to a Vote of Security Holders





None.


29





Item
5. Other Information





None.





Item 6. Exhibits





(a)
Exhibits


31.1
              
              Certification
      of the CEO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) on page
      X-1.31.2
              
              Certification
      of the CFO pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) on page
      X-2.32.1
              
              Certification
      pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002 on page X-3.32.2
              
              Certification
      pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002 on page
X-4.





SIGNATURES


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





ELEPHANT
      TALK COMMUNICATIONS, INC.November
      16, 2009
                  By:
                  /s/ Steven
      van der VeldenSteven
      van der VeldenPresident
      and Chief Executive Officer
                    (Principal
      Executive Officer)November
      16, 2009
                  By:
                  /s/ Mark
      NijeMark
      NijeChief
      Financial Officer
                    (Principal
      Financial and Accounting
Officer)





Index to
Exhibits




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


30