UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON,
D.C. 20549



FORM 10-Q



(Mark One)



xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934



FOR THE QUARTERLY PERIOD ENDED JUNE 30,
2012.



COMMISSION FILE NUMBER 000-10690











|LATTICE
INCORPORATED                                  
|------------------------------------------------------
|(Exact Name of Registrant as Specified in
its Charter)
|                                                      
|Delaware                                              
|(State or other jurisdiction of                       
|incorporation or organization)                        
|                                                      

|7150 N. Park Drive, Pennsauken, New Jersey |  | 08109     
|------------------------------------------ |  | ----------
|(Address of principal executive offices)   |  | (Zip code)
|                                           |  |           

Issuer's telephone number: (856) 910-1166



Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.  Yes x No o



Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant
to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  Yes  o No o



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.



|Large accelerated filer o | Accelerated filer o        
|------------------------- | ---------------------------
|                          |                            
|Non-accelerated filer o   | 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  o No x





APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS

DURING THE PRECEDING FIVE YEARS



Indicate by check mark whether the registrant filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan
confirmed by a court. Yes  o No  o



APPLICABLE ONLY TO CORPORATE ISSUERS



State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date: As of August 13, 2012, there were 31,164,033outstanding shares of the Registrant's Common Stock, $.01 par value.


























LATTICE INCORPORATED

JUNE 30, 2012 QUARTERLY REPORT ON FORM
10-Q



TABLE OF CONTENTS







|                                                                                              | Page
|--------------------------------------------------------------------------------------------- | ----
|PART I - FINANCIAL INFORMATION                                                               
|                                                                                              |     
|Item 1. Financial Statements                                                                  | 3   
|Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 14  
|Item 3. Quantitative and Qualitative Disclosure About Market Risks                            | 19  
|Item 4T. Controls and Procedures                                                              | 19  
|                                                                                              |     
|PART II - OTHER INFORMATION                                                                  
|                                                                                              |     
|Item 1. Legal Proceedings                                                                     | 20  
|Item 1A. Risk Factors                                                                         | 20  
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                           | 20  
|Item 3. Defaults Upon Senior Securities                                                       | 20  
|Item 4. Reserved                                                                              | 20  
|Item 5. Other Information                                                                     | 20  
|Item 6. Exhibits                                                                              | 20  
|SIGNATURES                                                                                    | 21  











2







PART I - FINANCIAL INFORMATION

Item 1. Financial Statements





LATTICE INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATION

(Unaudited)





|                                                                                 |  | Three Months EndedJune 30, |            |   | Six  Months EndedJune 30, |  
|-------------------------------------------------------------------------------- |  | -------------------------- | ---------- | - | ------------------------- | -
|                                                                                 |  | 2012                       |            |   | 2011                      |  
|                                                                                 |  |                            |            |   |                           |  
|Revenue                                                                          |  | $                          | 2,488,203  |   |                           | $
|                                                                                 |  |                            |            |   |                           |  
|Cost of Revenue                                                                  |  |                            | 1,503,618  |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Gross Profit                                                                     |  |                            | 984,585    |   |                           |  
|                                                                                 |  |                            | 39.6       | % |                           |  
|Operating expenses:                                                              |  |                            |            |   |                           |  
|Selling, general and administrative                                              |  |                            | 810,516    |   |                           |  
|Research and development                                                         |  |                            | 178,608    |   |                           |  
|Impairment loss                                                                  |  |                            | –          |   |                           |  
|Amortization expense                                                             |  |                            | 80,448     |   |                           |  
|Total operating expenses                                                         |  |                            | 1,069,572  |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Income (loss) from operations                                                    |  |                            | (84,987    | ) |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Other income (expense):                                                          |  |                            |            |   |                           |  
|Derivative income (loss)                                                         |  |                            | 18,467     |   |                           |  
|Other income (expense)                                                           |  |                            | 255,613    |   |                           |  
|Interest expense                                                                 |  |                            | (121,949   | ) |                           |  
|Total other income                                                               |  |                            | 152,131    |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Noncontrolling interest                                                          |  |                            | –          |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Income (Loss) before taxes                                                       |  |                            | 67,144     |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Income taxes (benefit)                                                           |  |                            | (32,397    | ) |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Net income (loss)                                                                |  |                            | 99,541     |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Reconciliation of net income (loss) to income applicable to common shareholders: |  |                            |            |   |                           |  
|Net income (loss)                                                                |  |                            | 99,541     |   |                           |  
|Preferred stock dividends                                                        |  |                            | (6,277     | ) |                           |  
|Income (loss) applicable to common stockholders                                  |  |                            | 93,264     |   |                           |  
|                                                                                 |  |                            |            |   |                           |  
|Income (loss) per common share                                                   |  |                            |            |   |                           |  
|Basic                                                                            |  | $                          | 0.00       |   |                           | $
|Diluted                                                                          |  | $                          | 0.00       |   |                           | $
|Weighted average shares:                                                         |  |                            |            |   |                           |  
|Basic                                                                            |  |                            | 29,548,522 |   |                           |  
|Diluted                                                                          |  |                            | 74,708,287 |   |                           |  







See accompanying notes to the condensed consolidated financial statements.





3







LATTICE INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS







|                                                                                                                    |  | June 30,2012(unaudited) |             |   | December 31,2011 |  
|------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ----------- | - | ---------------- | -
|ASSETS:                                                                                                             |  |                         |             |   |                  |  
|Current assets:                                                                                                     |  |                         |             |   |                  |  
|Cash and cash equivalents                                                                                           |  | $                       | 165,117     |   |                  | $
|Accounts receivable                                                                                                 |  |                         | 2,509,196   |   |                  |  
|Inventories                                                                                                         |  |                         | 7,350       |   |                  |  
|Other current assets                                                                                                |  |                         | 165,850     |   |                  |  
|Total current assets                                                                                                |  |                         | 2,847,513   |   |                  |  
|                                                                                                                    |  |                         |             |   |                  |  
|Property and equipment, net                                                                                         |  |                         | 605,756     |   |                  |  
|Goodwill                                                                                                            |  |                         | 690,871     |   |                  |  
|Other intangibles, net                                                                                              |  |                         | 1,368,412   |   |                  |  
|Other assets                                                                                                        |  |                         | 2,812       |   |                  |  
|Total assets                                                                                                        |  | $                       | 5,515,364   |   |                  | $
|                                                                                                                    |  |                         |             |   |                  |  
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                |  |                         |             |   |                  |  
|Current liabilities:                                                                                                |  |                         |             |   |                  |  
|Accounts payable                                                                                                    |  | $                       | 1,854,605   |   |                  | $
|Accrued expenses                                                                                                    |  |                         | 1,194,550   |   |                  |  
|Deferred revenues                                                                                                   |  |                         | 25,000      |   |                  |  
|Customer advances                                                                                                   |  |                         | 209,785     |   |                  |  
|Notes payable - current                                                                                             |  |                         | 2,043,162   |   |                  |  
|Contingent Consideration                                                                                            |  |                         | 77,700      |   |                  |  
|Derivative liability                                                                                                |  |                         | 66,117      |   |                  |  
|Total current liabilities                                                                                           |  |                         | 5,470,919   |   |                  |  
|Long term liabilities:                                                                                              |  |                         |             |   |                  |  
|Notes Payable - long term                                                                                           |  |                         | 939,125     |   |                  |  
|Deferred tax liabilities                                                                                            |  |                         | 158,978     |   |                  |  
|Total long term liabilities                                                                                         |  |                         | 1,098,103   |   |                  |  
|Total liabilities                                                                                                   |  |                         | 6,569,022   |   |                  |  
|                                                                                                                    |  |                         |             |   |                  |  
|Shareholders' equity                                                                                                |  |                         |             |   |                  |  
|Preferred Stock - .01 par value                                                                                     |  |                         |             |   |                  |  
|Series A 9,000,000 shares authorized 7,530,681 issued and outstanding                                               |  |                         | 75,307      |   |                  |  
|Series B 1,000,000 shares authorized 1,000,000 issued and 502,160 outstanding                                       |  |                         | 10,000      |   |                  |  
|Series C 520,000 shares authorized  520,000 issued and outstanding                                                  |  |                         | 5,200       |   |                  |  
|Series D 636,400 shares authorized  520,000 issued and outstanding                                                  |  |                         | 5,909       |   |                  |  
|Common stock - .01 par value, 200,000,000 authorized, 29,851,509 and 22,942,437 issued and outstanding respectively |  |                         | 298,516     |   |                  |  
|Additional paid-in capital                                                                                          |  |                         | 43,316,811  |   |                  |  
|Accumulated deficit                                                                                                 |  |                         | (44,327,438 | ) |                  |  
|                                                                                                                    |  |                         | (615,695    | ) |                  |  
|Stock held in treasury, at cost                                                                                     |  |                         | (558,096    | ) |                  |  
|Equity Attributable to shareowners of Lattice Incorporated                                                          |  |                         | (1,173,791  | ) |                  |  
|Equity Attributable to noncontrolling interest                                                                      |  |                         | 120,133     |   |                  |  
|Total liabilities and shareholders' equity                                                                          |  | $                       | 5,515,364   |   |                  | $







See accompanying notes to the condensed consolidated financial statements.



4





LATTICE
INCORPORATED AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)









|                                                                                                       |  | Six Months EndedJune 30, |         
|------------------------------------------------------------------------------------------------------ |  | ------------------------ | --------
|                                                                                                       |  | 2012                     |         
|Cash flow from operating activities:                                                                   |  |                          |         
|Net income (loss)                                                                                      |  | $                        | 128,301 
|Adjustments to reconcile net (loss) income to net cash provided by (used in)
    operating activities: |  |                          |         
|Derivative income                                                                                      |  |                          | (30,250 
|Impairment Loss                                                                                        |  |                          | –       
|Amortization of intangible assets                                                                      |  |                          | 225,896 
|Deferred income taxes                                                                                  |  |                          | (64,786 
|Minority interest                                                                                      |  |                          | –       
|Share-based compensation                                                                               |  |                          | 2,842   
|Depreciation                                                                                           |  |                          | 116,004 
|Changes in operating assets and liabilities:                                                           |  |                          | –       
|(Increase) decrease in:                                                                                |  |                          | –       
|Accounts receivable                                                                                    |  |                          | 191,664 
|Other current assets                                                                                   |  |                          | (23,350 
|Increase (decrease) in:                                                                                |  |                          | –       
|Accounts payable and accrued liabilities                                                               |  |                          | (408,919
|Deferred revenues                                                                                      |  |                          | (25,000 
|Customer advances                                                                                      |  |                          | 85,519  
|Total adjustments                                                                                      |  |                          | 69,619  
|Net cash provided by (used for) operating activities                                                   |  |                          | 197,920 
|Cash Used in investing activities:                                                                     |  |                          |         
|Purchase of equipment                                                                                  |  |                          | (109,049
|Acquired cash - CLR                                                                                    |  |                          | –       
|Net cash used for investing activities                                                                 |  |                          | (109,049
|Cash flows from financing activities:                                                                  |  |                          |         
|Revolving credit facility (payments) borrowings, net                                                   |  |                          | (67,721 
|Payments on capital lease                                                                              |  |                          | (10,998 
|Payments on notes payable                                                                              |  |                          | (192,707
|Proceeds from the issuance of notes payable                                                            |  |                          | 175,000 
|Payments on Director Loans                                                                             |  |                          | (19,614 
|Net cash provided by (used in) financing activities                                                    |  |                          | (116,040
|Net increase (decrease) in cash and cash equivalents                                                   |  |                          | (27,169 
|Cash and cash equivalents - beginning of period                                                        |  |                          | 192,286 
|Cash and cash equivalents - end  of period                                                             |  | $                        | 165,117 
|Supplemental cash flow information                                                                     |  |                          |         
|Interest paid in cash                                                                                  |  | $                        | 220,959 
|Common Stock                                                                                           |  |                          | –       
|Derivative liabilities                                                                                 |  |                          | –       
|Additional paid-in Capital                                                                             |  |                          | –       







See accompanying notes to the condensed consolidated financial statements.







5









Lattice Incorporated and Subsidiaries

Notes to Condensed Consolidated Financial
Statements

June 30, 2012

(Unaudited)





Note 1 - Organization and summary of significant accounting
policies



a) Organization



Lattice Incorporated (the “Company”)
was incorporated in the State of Delaware May 1973 and commenced operations in July 1977. The Company began as a provider of specialized
solutions to the telecom industry. Throughout its history Lattice has adapted to the changes in this industry by reinventing itself
to be more responsive and open to the dynamic pace of change experienced in the broader converged communications industry of today.
Currently Lattice provides advanced solutions for several vertical markets. The greatest change in operations is in the shift from
being a component manufacturer to a solution provider focused on developing applications through software on its core platform
technology. To further its strategy of becoming a solutions provider, the Company acquired a majority interest in “SMEI”
in February 2005. In September 2006 the Company purchased all of the issued and outstanding shares of the common stock of Lattice
Government Services, Inc., (“LGS”) (formerly Ricciardi Technologies Inc. (“RTI”)). LGS was founded
in 1992 and provides software consulting and development services for the command and control of biological sensors and other Department
of Defense requirements to United States federal governmental agencies either directly or through prime contractors of such governmental
agencies. LGS’s proprietary products include SensorView, which provides clients with the capability to command, control and
monitor multiple distributed chemical, biological, nuclear, explosive and hazardous material sensors. In December 2009 we changed
RTI’s name to Lattice Government Services Inc. In January 2007, we changed our name from Science Dynamics Corporation
to Lattice Incorporated. On May 16, 2011 we acquired 100% of the shares of Cummings Creek Capital, a holding Company which itself
owns 100% of the shares of CLR Group Limited. (“CLR”). CLR a government contractor compliments our Government
Services business by expanding markets and service offerings.



b) Basis of Presentation going concern



At June 30, 2012 the Company had a working
capital deficiency of $2,623,000. This compared to a working capital deficiency of $2,643,000 at December 31. 2011. The Company’s
working capital deficiency and constrained liquidity raises doubt regarding the Company’s ability to continue as a going
concern. The Company’s ability to continue as a going concern is highly dependent upon (i) management’s ability to
achieve its planned operating cashflows (ii), maintain continued availability on its line of credit and the ability to obtain alternative
financing to fund capital requirements and/or debt obligations coming due. The accompanying financial statements do not include
any adjustments that may result from the outcome of this uncertainty.



c) Interim Condensed Consolidated Financial Statements



The condensed consolidated financial
statements as of June 30, 2012 and for the three and six months ended June 30, 2012 and 2011 are
unaudited. In the opinion of management, such condensed consolidated financial statements include all
adjustments (consisting of normal recurring accruals) necessary for the fair representation of the consolidated financial
position and the consolidated results of operations. The consolidated results of operations for the periods
presented are not necessarily indicative of the results to be expected for the full year.  The interim condensed
consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the
year end December 31, 2011 appearing in Form 10-K filed on April 2, 2012.





6









d) Principles of consolidation



The condensed financial statements include
the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. All significant inter-company
accounts and transactions have been eliminated in consolidation. For those consolidated subsidiaries where Company ownership is
less than 100%, the outside stockholders’ interests are shown as non-controlling interest. Investments in affiliates over
which the Company has significant influence but not a controlling interest are carried on the equity basis.



e) Use of estimates



The preparation of these financial statements
in accordance with accounting principles generally accepted in the United States (US GAAP) requires management to make estimates
and assumptions that affect the reported amounts in the financial statements and accompanying notes. These estimates form the basis
for judgments made about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates
and judgments are based on historical experience and on various other assumptions that the Company believes are reasonable under
the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment.
US GAAP requires estimates and judgments in several areas, including those related to impairment of goodwill and equity investments,
revenue recognition, recoverability of inventory and receivables, the useful lives long lived assets such as property and equipment,
the future realization of deferred income tax benefits and the recording of various accruals. The ultimate outcome and actual results
could differ from the estimates and assumptions used.



f) Share-based payments



On January 1, 2006, the Company adopted
the fair value recognition provisions of Financial Accounting Standards Board Accounting Standards Codification 718-10, Accounting
for Share-based payment, to account for compensation costs under its stock option plans and other share-based arrangements.  ASC
718 requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial
statements based on their fair values. For purposes of estimating fair value of stock options, we use the Black-Scholes-Merton
valuation technique. At June 30, 2012, there is $13,090 of unrecognized compensation cost related to unvested share-based compensation
awards granted. For the six months ended June 30, 2012 share-based compensation was $2,842 compared to $194,750 in the prior year
period.



g) Revenue Recognition



Revenues related to collect and prepaid calling services generated
by the communication services segment are recognized during the period in which the calls are made. In addition, during
the same period, the Company records the related telecommunication costs for validating, transmitting, billing and collection,
and line and long distance charges, along with commissions payable to the facilities and allowances for uncollectible calls, based
on historical experience.



Government claims: Unapproved claims relate to contracts where
costs have exceeded the customer’s funded value of the task ordered on our cost reimbursement type contract vehicles. The
unapproved claims are considered to be probable of collection and have been recognized as revenue. Unapproved claims included as
a component of our Accounts Receivable totaled approximately $1,555,000 as of June 30, 2012. Consistent with industry practice,
we classify assets and liabilities related to these claims as current, even though some of these amounts are not expected to be
realized within one year.





7









h) Segment Reporting



FASB ASC 280-10-50, “Disclosure
about Segments of an Enterprise and Related Information” requires use of the “management approach” model
for segment reporting. The management approach model is based on the way a company’s management organizes
segments within the company for making operating decisions and assessing performance. Reportable segments are
based on products and services, geography, legal structure, management structure, or any other manner in which management
disaggregates a company. The Company operates in two segments for the six months ended June 30, 2012 and 2011 (see
Note 2 for details).



i) Depreciation, amortization
and long-lived assets:



Long-lived assets include:



Property, plant and equipment - These assets
are recorded at original cost. The Company depreciates the cost evenly over the assets’ estimated useful lives. For tax purposes,
accelerated depreciation methods are used as allowed by tax laws.



Goodwill - Goodwill represents the difference
between the purchase price of an acquired business and the fair value of the net assets acquired and the liabilities assumed at
the date of acquisition. Goodwill is not amortized. The Company tests goodwill for impairment annually (or in interim periods if
events or changes in circumstances indicate that its carrying amount may not be recoverable) by comparing the fair value of each
reporting unit, as measured by discounted cash flows, to the carrying value to determine if there is an indication that potential
impairment may exist. Absent an indication of fair value from a potential buyer or similar specific transactions, the Company believes
that the use of this income approach method provides reasonable estimates of the reporting unit’s fair value. Fair value
computed by this method is arrived at using a number of factors, including projected future operating results, economic projections
and anticipated future cash flows. The Company reviews its assumptions each time goodwill is tested for impairment and makes appropriate
adjustments, if any, based on facts and circumstances available at that time. There are inherent uncertainties, however, related
to these factors and to management’s judgment in applying them to this analysis. Nonetheless, management believes that this
method provides a reasonable approach to estimate the fair value of the Company’s reporting units.



The income approach, which is used for
the goodwill impairment testing, is based on projected future debt-free cash flow that is discounted to present value using factors
that consider the timing and risk of the future cash flows. Management believes that this approach is appropriate because it provides
a fair value estimate based upon the reporting unit’s expected long-term operating and cash flow performance. This approach
also mitigates most of the impact of cyclical downturns that occur in the reporting unit’s industry. The income approach
is based on a reporting unit’s five year projection of operating results and cash flows that is discounted using a build
up approach. The projection is based upon management’s best estimates of projected economic and market conditions over the
related period including growth rates, estimates of future expected changes in operating margins and cash expenditures. Other significant
estimates and assumptions include terminal value growth rates, future capital expenditures and changes in future working capital
requirements based on management projections.



Identifiable intangible assets - The Company
amortizes the cost of other intangibles over their useful lives unless such lives are deemed indefinite. Amortizable intangible
assets are tested for impairment based on undiscounted cash flows and, if impaired, written down to fair value based on either
discounted cash flows or appraised values. Intangible assets with indefinite lives are not amortized; however, they are tested
annually for impairment and written down to fair value as required.



j) Recent accounting pronouncements



No new accounting pronouncements issued
or effective during the period has had or is expected to have a material impact on the financial statements.





8









Note 2- Segment reporting



Management views its business as two reportable segments: Government
services and Telecommunications. The Company evaluates performance based on profit or loss before intercompany charges.



|                            |  | Three Months Ended June
    30, |           |  | Six Months Ended June
    30, |  
|--------------------------- |  | ------------------------------- | --------- |  | ----------------------------- | -
|                            |  | 2012                            |           |  | 2011                          |  
|Revenues:                   |  |                                 |           |  |                               |  
|Government Services         |  | $                               | 648,971   |  |                               | $
|Communication Services      |  |                                 | 1,839,232 |  |                               |  
|Total Consolidated Revenues |  | $                               | 2,488,203 |  |                               | $
|                            |  |                                 |           |  |                               |  
|Gross Profit:               |  |                                 |           |  |                               |  
|Government Services         |  | $                               | 302,381   |  |                               | $
|Communication Services      |  |                                 | 682,204   |  |                               |  
|Total Consolidated          |  | $                               | 984,585   |  |                               | $





|                          |  | June 30,  2012 |           |  | December 31, 2011 |  
|------------------------- |  | -------------- | --------- |  | ----------------- | -
|Total Assets:             |  |                |           |  |                   |  
|Government Services       |  | $              | 3,421,053 |  |                   | $
|Communication Services    |  |                | 2,094,311 |  |                   |  
|Total Consolidated Assets |  | $              | 5,515,364 |  |                   | $





Note 3 - Notes payable



Notes payable consists of the following
as of June 30, 2012 and December 31, 2011:



|                                          |  | June 30,  2012 |            |   | December 31, 2011 |  
|----------------------------------------- |  | -------------- | ---------- | - | ----------------- | -
|                                          |  |                |            |   |                   |  
|Bank line-of-credit (a)                   |  | $              | 345,049    |   |                   | $
|Notes payable to Stockholder/director (b) |  |                | 271,937    |   |                   |  
|Capital lease payable (c)                 |  |                | 36,681     |   |                   |  
|Notes Payable (d)                         |  |                | 1,933,460  |   |                   |  
|Notes payable Cummings Creek/CLR  (e)     |  |                | 395,161    |   |                   |  
|                                          |  |                |            |   |                   |  
|Total notes payable                       |  |                | 2,982,287  |   |                   |  
|Less current maturities                   |  |                | (2,043,162 | ) |                   |  
|Long-term debt                            |  | $              | 939,125    |   |                   | $









9







Interest expense including amortization
of deferred finance fees associated with the above notes for the three months ended June 30, 2012 and 2011 was $122,000 and $99,000
respectively and interest for the six months ended June 30, 2012 and 2011 was $230,000 and $237,000, respectively.



(a) Bank Line-of-Credit



On July 17, 2009, the Company and its wholly-owned
subsidiary, Lattice Government Services (formally “RTI”), entered into a Financing and Security Agreement (the “Action
Agreement”) with Action Capital Corporation (“Action Capital”).



Pursuant to the terms of the Action Agreement,
Action Capital agreed to provide the Company with advances of up to 90% of the net amount of certain acceptable account receivables
of the Company (the “Acceptable Accounts”).  The maximum amount eligible to be advanced to the Company by
Action Capital under the Action Agreement is $3,000,000.  The Company will pay Action Capital interest on the advances
outstanding under the Action Agreement equal to the prime rate of Wachovia Bank, N.A. in effect on the last business day of the
prior month plus 1%.  In addition, the Company will pay a monthly fee to Action Capital equal to 0.75% of the total outstanding
balance at the end of each month.



In addition, pursuant to the Action Agreement,
the Company granted Action Capital a security interest in certain assets of the Company including all, accounts receivable, contract
rights, rebates and books and records pertaining to the foregoing (the “Action Lien”). On June 11, 2010, Action Capital
and an accredited investor entered into an agreement under which $1,250,000 of the collateral otherwise securing advances
covered by the Action Agreement are subordinated to a new security interest securing an additional loan from the accredited investor.
During November 2011, $268,345 of the collateral was collected by Action, escrowed and paid directly to the accredited investor reducing
the collateral and outstanding balance on the loan to $981,655 at June 30, 2012 and December 31, 2011.



The outstanding balance owed on the line at June 30,
2012 and December 31, 2011 was $345,049 and $412,770 respectively.  At June 30, 2012 our interest rate was
approximately 13.25%.



(b) Notes Payable Stockholders/Director



The first note bears interest at 21.5%
per annum. During December 2010, the note was amended to flat monthly payments of $6,000 until maturity, December
31, 2013, at which time any remaining interest and or principal will be paid. This note has an outstanding balance of $99,113 and
$123,551 as of June 30, 2012 and  December 31, 2011, respectively.



The second note dated October 14, 2011
has a face value of $168,000 of which the Company received $151,200 in net proceeds during October 2011. The discount of $16,800
is being amortized to interest expense over the term of the note. The note carries an annual interest rate of 10% payable quarterly
at the rate of $4,200 per quarter. The entire principal on the note of $168,000 is due at maturity on October 14, 2014.



(c) Capital Lease Payable



On June 16, 2009 Lattice entered an
equipment lease financing agreement with Royal Bank America Leasing to purchase approximately $130,000 in equipment for our
communication services. The terms of which included monthly payments of $5,196 per month over 32 months and
a  $1.00 buy-out at end of the lease term. On July 15, 2011 we signed an addendum to this lease and received
additional equipment financing for $58,122 payable over 30 months at $2,211 per month. As of June 30, 2012 and December 31,
2011, the outstanding balance was $36,681 and $47,679, respectively.





10









(d) Note Payable



On June 11, 2010, Lattice closed on a Note
Payable for $1,250,000.  The net proceeds to the Company were $1,100,000. The $150,000 is being amortized over the
life of the note as additional interest expense. The note matured June 30, 2012 and payment of principal was due at that time in
the lump sum value of $981,655 including any unpaid interest. On June 30, 2012 the holder of the note agreed to an extension
for payment in full of the note to October 31, 2012. In addition to the maturity extension the Company agreed to increase the collateral
by $250,000 the note was secured by certain receivables totaling $981,655, the new secured total is approximately $1,232,000. Until
maturity, Lattice is required to make quarterly interest payments (calculated in arrears)  at 12% stated interest with
the first quarter interest payment of $37,500 due September 30, 2010 and $37,500 due each quarter end thereafter until the final
payment comes due June 30, 2012 totaling $1,019,155 including the final interest payment. On Concurrent with the note, an intercreditor
agreement was signed between Action Capital and Holder where Action Capital has agreed to subordinate the Action Lien on certain
government contracts, task orders and accounts receivable totaling $981,655. During November 2011, $268,345 of the original $1,250,000
accounts receivable securing the note was collected, escrowed and paid directly to the note holder by Action Capital thereby reducing
the outstanding balance on the note and the collateral to $981,655 at June 30, 2012. As of the date of this filing, the Company
is current with all interest payments.



During the quarter ended June 30, 2011,
we issued a two year promissory note payable for $200,000 to a shareholder of the Company.  The Note bears interest
of 12% per year. The Company is required to pay interest quarterly on a calendar basis starting with a pro-rata
interest payment on June 30, 2011. On May 15, 2013 the maturity date, the principal amount of $200,000 will be due along with
any unpaid and accrued interest.



During the quarter ended September 30,
2011, we issued a two year promissory note payable for $227,272 to an investor.  The Note bears interest of 12%
per year. The Company is required to pay interest quarterly on a calendar basis starting with a pro-rata interest
payment on September 30, 2011. On August 3, 2013 the maturity date, the principal amount of the note will be due along with
any unpaid and accrued interest.



On December 13, 2011, we converted outstanding
invoices that we owed a vendor by converting the liability to a promissory note in the amount of $416,533. The note is payable
quarterly over a two year term with principal payments due as follows: December 31, 2011 of $10,000, January 15, 2012 of $50,000,
March 31, 2012 of $20,000, June 30, 2012 of $30,000, September 30, 2012 of $30,000, December 31, 2012 of $45,000, March 31, 2012
of $45,000, June 30, 2012 of $55,000, September 30, 2012 of $55,000 and December 31, 2013 of $76,533. The note carries a 12% annual
interest rate calculated on the outstanding principal balance payable monthly. As of June 30, 2012, the outstanding balance of
the note is $326,533.



On January 23, 2012, we issued
a several promissory notes to private investors with face values totaling $198,000. The proceeds from the notes
totaled $175,000 used for working capital. The discount of $23,000 has been recorded as a deferred financing fee and
amortized over the life of the note. The Notes bear interest of 12% per year. The Company is required to pay
interest quarterly on a calendar basis starting with a pro-rata interest payment on March 31, 2012. On January 23,
2014 the maturity date, the principal amount of the notes will be due along with any unpaid and accrued interest.



(e)  Notes payable Cummings Creek / CLR



In conjunction with the Cumming Creek
Capital / CLR acquisition, Lattice assumed notes totaling $676,925 comprised of three notes each with the
former principles of CLR Group.   The notes bear interest on the unpaid principal amount until paid in full, at a
rate of four percent (4.0%) per annum payable quarterly. The Company will pay the unpaid principal amount as
follows: beginning on May 31, 2011, the Company will make equal payments of principal on the first day of each
calendar quarter  totaling $58,275 (i.e., February 28, May 31, August 30 and November 30), until February 15, 2014.
The unpaid balance of the notes totaled $395,161 at June 30, 2012.





11











Note 4 - Derivative financial instruments





The balance sheet caption derivative
liabilities consist of Warrants, issued in connection with the 2005 Laurus Financing Arrangement, and the 2006 Omnibus
Amendment and Waiver Agreement with Laurus. These derivative financial instruments are indexed to an aggregate of 1,658,333
shares of the Company’s common stock as of March 31, 2012 and December 31, 2011 and are carried at fair value. The
balance at June 30, 2012 and December 31, 2011 was $66,117 and $96,367 respectively.



The valuation of the derivative warrant
liabilities is determined using a Black Scholes Merton Model. Freestanding derivative instruments, consisting of warrants and options
that arose from the Laurus financing are valued using the Black-Scholes-Merton valuation methodology because that model embodies
all of the relevant assumptions that address the features underlying these instruments. Significant assumptions used in the Black
Scholes models as of December 31, 2011 and 2010 included conversion or strike prices ranging from $0.10 - $1.10; historical volatility
factors ranging from 123.01% - 183.73% based upon forward terms of instruments; and a risk free rate ranging from 0.27% -
3.36%.



Note 5 - Litigation



From time to time, lawsuits are threatened
or filed against us in the ordinary course of business. Such lawsuits typically involve claims from customers, former or current
employees, and vendors related to issues common to our industry. Such threatened or pending litigation also can involve claims
by third-parties, either against customers or ourselves, involving intellectual property, including patents. A number of such claims
may exist at any given time. In certain cases, derivative claims may be asserted against us for indemnification or contribution
in lawsuits alleging use of our intellectual property, as licensed to customers, infringes upon intellectual property of a third-party.
Although there can be no assurance as to the ultimate disposition of these matters, it is our management’s opinion, based
upon the information available at this time, that the expected outcome of these matters, individually and in the aggregate, will
not have a material adverse effect on the results of operations, liquidity or financial condition of our company. There were no
liabilities of this type at June 30, 2012.



Note 6 - Goodwill and other intangible assets



In accordance with the Goodwill and
Other Intangibles Topic of the ASC, goodwill and indefinite-lived intangible assets are tested for impairment annually, and
interim impairment tests are performed whenever an event occurs or circumstances change that indicate that it is more likely
than not that an impairment has occurred. Goodwill is tested for impairment at the reporting unit level. As
of June 30, 2012 and December 31, 2011, all goodwill was allocated to the Government Services Sector which was
considered one reporting unit. As of June 30, 2012 there were no significant events that would indicate that
there was an impairment to our goodwill.



A summary of the changes in the carrying amount of goodwill
for the years in the period ended December 31, 2011, is shown below:



|Balance as of January 1, 2011              |  | $ | 3,599,386  |  
|------------------------------------------ |  | - | ---------- | -
|Addition due to Cummings Creek acquisition |  |   | 402,795    |  
|Goodwill impairment charges                |  |   | (3,396,310 | )
|Balance as of December 31, 2011            |  | $ | 690,871    |  
|Goodwill impairment charges                |  |   | –          |  
|Balance as of June 30, 2012                |  | $ | 690,871    |  











12







The table below present amortizable assets as of June 30, 2012:



|                                                 |  | GrossCarry amount |           |  | AccumulatedAmortization |   |         | NetCarry amount |  |   |           | Weighted Average Remaining Amortization Period | 
|------------------------------------------------ |  | ----------------- | --------- |  | ----------------------- | - | ------- | --------------- |  | - | --------- | ---------------------------------------------- | 
|Purchase intangible associated with CLR purchase |  | $                 | 759,000   |  |                         | $ | 365,594 |                 |  | $ | 393,406   |                                                | 
|IP Rights Agreement                              |  |                   | 1,300,000 |  |                         |   | 324,994 |                 |  |   | 975,006   |                                                | 
|                                                 |  | $                 | 2,059,000 |  |                         | $ | 690,588 |                 |  | $ | 1,368,412 |                                                | 





|2012       |  | $ | 225,900   | 
|---------- |  | - | --------- | 
|2013       |  |   | 320,525   | 
|2014       |  |   | 171,987   | 
|2015       |  |   | 130,000   | 
|2016       |  |   | 130,000   | 
|Thereafter |  |   | 390,000   | 
|Total      |  | $ | 1,368,412 | 



Note 7 - Subsequent Event



On July 5, 2012, Barron Partners
L.P. converted 371,003 shares of Series A Preferred Stock into 1,325,000 Common Shares. Subsequent to this conversion event,
Barrons Partners owned 5,707,068 shares of Series A Preferred Stock and 1,478,753 Common Shares.









Note 8 - Net income per share



The following table sets forth the information
needed to compute basic and diluted earnings per share:



|                                                                          |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|------------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | -
|                                                                          |  | 2012                        |            |   | 2011                      |  
|                                                                          |  |                             |            |   |                           |  
|Basic net income                                                          |  | $                           | 99,541     |   |                           | $
|Preferred Stock Dividends                                                 |  |                             | (6,277     | ) |                           |  
|Numerator for diluted net income per share                                |  |                             | 93,264     |   |                           |  
|Weighted average common shares outstanding:                               |  |                             | 29,548,522 |   |                           |  
|Dilutive securities                                                       |  |                             |            |   |                           |  
|Preferred Stock A, B, C, D                                                |  |                             | 42,913,524 |   |                           |  
|Options                                                                   |  |                             | 2,246,241  |   |                           |  
|Warrants                                                                  |  |                             | 0          |   |                           |  
|Diluted weighted average common shares outstanding and assumed conversion |  |                             | 74,708,287 |   |                           |  
|Basic net income per share                                                |  | $                           | 0.00       |   |                           | $
|Diluted net income per share                                              |  | $                           | 0.00       |   |                           | $



For the three and six month periods ended June 30, 2012 certain
potential shares of common stock have been excluded from the calculation of diluted income per share because the exercise price
was greater than the average market price of our common stock, and therefore, the effect on diluted income per share would have
been anti-dilutive. The following table sets forth the number of potential shares of common stock that have been excluded from
diluted net income per share because their effect was anti-dilutive.



|        |  | Three Months Ended June 30, |  | Six Months Ended June 30, | 
|------- |  | --------------------------- |  | ------------------------- | 
|        |  | 2012                        |  | 2011                      | 
|Warrant |  | 5,378,233                   |  | 0                         | 







13







ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS





The information in this report contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe
harbor” for forward-looking statements to encourage companies to provide prospective information about themselves so long
as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors
that could cause actual results to differ from the projected results. All statements other than statements of historical fact made
in this report are forward looking. In particular, the statements herein regarding industry prospects and future results of operations
or financial position are forward-looking statements. Forward-looking statements reflect management’s current expectations
and are inherently uncertain. Our actual results may differ significantly from management’s expectations.



The following discussion and analysis should
be read in conjunction with the financial statements and notes thereto included elsewhere in this report and with our annual report
on Form 10-K for the fiscal year ended December 31, 2011. This discussion should not be construed to imply that the results discussed
herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual
operating results in the future. Such discussion represents only the best present assessment of our management.



GENERAL OVERVIEW



Revenues for the quarter
ended June 30, 2012 were $2,488,000 compared to $3,195,000 in the prior year quarter.  Our operating income for the quarter
ended June 30, 2012 after adding back non-cash expenses for depreciation, amortization and share based compensation adjusts to
$89,000 positive compared to $369,000 negative, a net increase of $458,000.



Revenues from Communications
Services accounted for $1,839,000 or 74% of our overall revenues compared to 37% in the prior year quarter.  As expected
we will continue to see the percentage of revenue generated from Communications Services to continue to trend upward based on anticipated
growth in this segment. For the three months ended June 30, 2012, revenues from our Government Services segment decreased to $649,000
versus the prior year of $1,997,000.  The decrease in Government Services revenue is primarily attributable to contracts
ending in 2011 and 2012 mainly the SPAWAR contracts and the stagnation of contract funding in the Federal DoD market.  The
ending of the SPAWAR contracts accounted for approximately $747,000 of the decrease from prior year.



We operate in two principal
business segments: Communication Services and Government Services. We organize our business segments based on the nature of the
services offered and end-user markets served.



Communication Services:



We continue to see
growth in our recurring revenue generated from both direct and wholesale customers.  Revenue from our Communications
Services segment increased 54% from the same period a year ago to $1,839,000.  Revenue from our recurring services for
the second quarter 2012, increased to $1,554,000 from $817,000 in the same period a year ago.  The 90% increase in recurring
revenue is mainly the result of higher call volumes from correctional facilities and the increased number of facilities on our
network.  Although revenue from our technology sales decreased by $95,000 from the prior year quarter we continue to see an
increase in our sales pipeline and we anticipate year over year sales growth to be robust. We do anticipate the revenue from our
technology sales to fluctuate from quarter to quarter but we see the overall trend as positive for the year and we anticipate our
full year revenue to for technology sales to be in the range of $2.0 to $2.5M based on our sales pipeline.



Our technology is now
making inroads internationally and we are currently negotiating sales for both technology and services with correctional facilities,
service providers, and telecommunications companies in the corrections industry in Europe, Canada, and Asia.  We anticipate
recognizing revenue from these sales in the second half of this year.  This includes two agreements we have with two
separate Canadian service providers that we have begun configuring systems for. In addition, we have completed our first installation
in Bermuda and anticipate additional sales from the region in the coming months.



The new direct services
model will continue to require the company to make upfront capital investments in equipment with each new contract win.  To
date, we have secured equipment financing and raised alternative financings to support our contract wins.  The change
in strategy to a direct service based model should not require significant R&D investments in developing our call platform
technology since our call control technology has been deployed and is currently operating in this market from our legacy wholesaling
business. As we continue to expand and accelerate our growth, we will be required to source additional capital to keep pace with
our installation growth.



Government Services:



We have implemented
cost cutting measures and continue to reduce our costs in line with the decline in revenues mainly due to loss of the large
SPAWAR contracts in May 2011 and the continued stagnation in funding of government contracts. We continue to manage our cost structure
closely so that the Government segment generates positive operating income going forward. These steps aided the company in its
ability to turn in positive net income for the six months ended June 30, 2012 and we anticipate revenue to increase in the
second half of the year from Q2 levels. This is based on the following factors:





14









| | 1. | Awarded a SBIR contract with the Air Force effective May 2012. We anticipate revenues to ramp in
August of this year with a total contract value of $750,000.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | We have been notified as a subcontractor to the winning prime contractor on 3 contracts; C4I Systems
Engineering IDIQ contract with Accenture, C4I Software Applications and Database IDIQ contract with FGM, and SPAWAR Center –
Atlantic NCR Security Engineering Contract with Match. To date we have not received tasks orders against these contracts but we
anticipate receiving them as the year progresses.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | All the contracts we anticipated expiring or being recompeted this year have been as of the end of the
second quarter. This includes a contract with AMC which was not renewed and had a large subcontractor component. Although there
was a top line impact of approximately $500,000 per quarter the contract was primarily pass through subcontractor revenue that
carried a low gross margin.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We maintain a strong
sales pipeline in our Government business, however, we are cautious as budget pressures in the Federal Government continue to delay
contract awards and funding. However, our management of cost structure and our current contracts and new contract awards should
enable us to manage to positive operating income from our Government Services division.



RESULTS OF OPERATIONS



THREE MONTHS ENDED JUNE 30, 2012 COMPARED
TO THE THREE MONTHS ENDED JUNE 30, 2011



The following tables set forth income and certain expense items
as a percentage of total revenue:





|                                              |  | For the Three Months Ending June 30, |          
|--------------------------------------------- |  | ------------------------------------ | ---------
|                                              |  | 2012                                 |          
|REVENUE                                       |  | $                                    | 2,488,203
|                                              |  |                                      |          
|Net income  (loss)                            |  | $                                    | 99,541   
|                                              |  |                                      |          
|Net (loss) per common share – Basic & Diluted |  | $                                    | 0.00     





|                                  |  | OPERATING EXPENSES            |         |  | PERCENT OF SALES              | 
|--------------------------------- |  | ----------------------------- | ------- |  | ----------------------------- | 
|                                  |  | THREEMONTHSENDEDJUNE 30, 2012 |         |  | THREEMONTHSENDEDJUNE 30, 2011 | 
|                                  |  |                               |         |  |                               | 
|Research & Development            |  |                               | 178,608 |  |                               | 
|                                  |  |                               |         |  |                               | 
|Selling, General & Administrative |  |                               | 810,516 |  |                               | 



REVENUES:



Total revenues for the three months ended
June 30, 2012 decreased by $706,000 or 22.1% to $2,488,000 compared to $3,195,000 for the three months ended June 30, 2011. A decrease
in our government segment revenues of $1,348,000 or 67.5% from prior year quarter was offset by an increase in our telecom segment
of $642,000 or 53.6% from prior year. Our Government Services segment which represents revenues from professional engineering services
to Federal government Dept of Defense (DoD) agencies accounted for 26% of total revenues compared to 63% in the year ago quarter.





15







Our Government services revenues decreased
by $1,348,000 or 67.5% to $649,000 from $1,998,000 in the year ago quarter. The decrease was mainly attributable to several contracts
ending, mainly the SPAWAR contract vehicles which ended May 15, 2011. The decrease in revenues from the loss of contracts was partially
offset by revenues attributable to the CLR acquisition which closed in May 2011.



Our communications segment revenues increased by $642,000 or
52.3% to $1,839,000 from $1,197,000 in the prior year. The increase was comprised of an increase in recurring service revenues
of $737,000 or 90.3% offset by a decrease of $95,000 in wholesaled technology equipment sales. The recurring services increase
is attributable to volume growth from the continuing addition to the number of customer contracts where we provide direct
telecom service provisioning to end-user correctional facilities.



GROSS MARGIN:



Gross profit for the three months ended
June 30, 2012 was $985,000, a decrease of $216,000 or 18.0% compared to the $1,200,000 for three months ended June 30, 2011. Gross
margin, as a percentage of revenues, increased to 39.6% from 37.6% for the same period in 2011. The increase in gross margin was
primarily due to an increase in margin from government services to 46.6% from 37.5% in the year ago period. The increase was related
to the decrease of lower margin subcontracted revenues relative to higher margin in-house labor resulting from the termination
of contracts with heavy subcontracted components. The margin in our communications segment was 37.1% compared to 37.7% in the year
ago period.



RESEARCH AND DEVELOPMENT EXPENSES:



Research and development expenses consist
primarily of salaries and related personnel costs, and consulting fees associated with product development in our Technology Products
segment. For the three months ended June 30, 2012, research and development expenses is $179,000 as compared to $168,000 for the
three months ended June 30, 2011. Management believes that continual enhancements of the Company's existing products are required
to enable the Company to maintain its current competitive position.



SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:



Selling, General and Administrative ("SG&A")
expenses consist primarily of expenses for management, fringe benefits, indirect overhead, labor costs of billable technical staff
not charged to a project or contract, finance, administrative personnel, legal, accounting, consulting fees, sales commissions,
marketing, facilities costs, corporate overhead and depreciation expense. For the three months ended June 30, 2012, SG&A expenses
decreased to $811,000 from $1,563,000 in the comparable period prior year. As a percentage of revenues, SG&A was 32.6% for
the three months ended June 30, 2012 versus 48.9% in the comparable period a year ago. The decrease in SG&A was mainly comprised
of an increase in selling costs supporting our Telecom services growth offset by a decrease in share based compensation and a decrease
in SG&A supporting our Government services segment.  The decrease in Government segment’s SG&A was driven
by a decrease in indirect overhead and general and administrative expenses resulting from cost cutting measures taken in response
to the contraction in revenues and billable FTE’s and integration savings from combining CLR which was acquired May 2011.



AMORTIZATION EXPENSES:



Non-cash amortization expenses related
mainly to intangible assets acquired in the acquisitions of Cummings Creek/CLR, LGS (formerly RTI) and SMEI are stated separately
in our statement of operations. Amortization expense for the three months ended June 30, 2012 was $80,000 compared to $105,000
for the three months ended June 30, 2011. The decrease is attributed to certain intangibles attributable to the RTI and SMEI purchases
being fully amortized in prior periods.



INTEREST EXPENSE:



Interest Expense increased to $122,000
for the three months ended June 30, 2012 compared to $99,000 for the three months ended June 30, 2011 due to an increase in the
level of indebtedness.



NET INCOME (LOSS):



The Company’s net income for the
three months ended June 30, 2012 was $100,000 compared to a net loss of $1,966,000 for the three months ended June 30, 2011. Net
income of $100,000 included nonrecurring income of $256,000 related to the expiration of stale accounts payables that have exceeded
statute of limitations. The prior year net loss of $1,966,000 included a noncash impairment charge of $1,575,000 and derivative
income of $255,000. Excluding these items, the improvement in net income was mainly due to higher gross profit generated in our
Telecom segment and a decrease in SG&A expenses.





16







SIX MONTHS ENDED JUNE 30, 2012 COMPARED TO THE SIX MONTHS
ENDED JUNE 30, 2011



The following tables set forth income and certain expense items
as a percentage of total revenue:



|                                              |  | For the Six Months Ending June 30, |          
|--------------------------------------------- |  | ---------------------------------- | ---------
|                                              |  | 2012                               |          
|REVENUE                                       |  | $                                  | 5,883,684
|                                              |  |                                    |          
|Net income (loss)                             |  | $                                  | 128,301  
|                                              |  |                                    |          
|Net (loss) per common share – Basic & Diluted |  | $                                  | 0.00     





|                                  |  | OPERATING EXPENSES             |           |  | PERCENT OF SALES               | 
|--------------------------------- |  | ------------------------------ | --------- |  | ------------------------------ | 
|                                  |  | SIX MONTHS ENDED JUNE 30, 2012 |           |  | SIX MONTHS ENDED JUNE 30, 2011 | 
|                                  |  |                                |           |  |                                | 
|Research & Development            |  |                                | 353,190   |  |                                | 
|                                  |  |                                |           |  |                                | 
|Selling, General & Administrative |  |                                | 1,820,182 |  |                                | 



REVENUES:



Total revenues for the six months ended June 30, 2012 decreased
by $578,000 or 9.2% to $5,884,000 compared to $6,461,000 for the six months ended June 30, 2011.  A decrease in our government
segment revenues of $2,292,000 or 53.9% was partially offset by an increase in our telecom segment of $1,714,000 or 77.6%.  Our
Government Services segment which represents revenues from professional engineering services to Federal government Dept of Defense
(DoD) agencies accounted for 33% of total revenues compared to 66% in the year ago period.



Our Government services revenues decreased by $2,292,000
or 53.9% to $1,961,000 from $4,253,000 in the year ago period. The decrease was mainly attributable to several contracts
ending during 2011 and 2012 mainly the SPAWAR contract vehicles which ended May 15, 2011. The decrease in revenues from the
loss of contracts was partially offset by revenues attributable to the CLR acquisition which closed in May 2011.



Our communications segment revenues increased by $1,714,000
or 77% to $3,923,000 from $2,208,000 in the prior year.  The increase was comprised of an increase in recurring direct
service revenues of $1,168,000 or 70% and an increase of $547,000 in wholesaled technology equipment sales. The recurring services
increase is attributable to volume growth from the continuing addition to the number of customer contracts where we provide
direct telecom provisioning services to end-user correctional facilities.



GROSS MARGIN:



Gross profit for the six months ended June 30, 2012 was $2,342,000
which compared to the $2,366,000 for the six months ended June 30, 2011. Gross margin, as a percentage of revenues, increased to
39.8% from 36.6% for the same period in 2011. The increase in gross margin was primarily due to an increase in both the
government services and communications segments. The increase in margin from 36.9% to 38.9% in our communications segment was due
an increase in revenues attributable to n higher margin wholesale technology equipment sales relative to recurring telecom
service revenues. The technology equipment margins range approximately 70% and services margins range between 20 to 30% of revenues.
The increase in government services margin to 41.6% from 36.5% was mainly attributable to the decrease of lower margin subcontracted
revenues relative to higher margin in-house labor resulting from the termination of contracts with heavy subcontracted components.



RESEARCH AND DEVELOPMENT EXPENSES:



Research and Development expenses consist primarily of salaries
and related personnel costs, and consulting fees associated with product development in our Technology Products segment. For
the six months ended June 30, 2012, research and development expenses were $353,000 which compared to $320,000 for the six months
ended June 30, 2011.  The increase was due to the addition of engineering staff supporting the growth in our Telecom
segment. Management believes that continual enhancements of the Company's existing products are required to enable the Company
to maintain its current competitive position.





17





SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:



Selling, General and Administrative ("SG&A") expenses
consist primarily of expenses for management, fringe benefits, indirect overhead, labor costs of billable technical staff not charged
to a project or contract, finance, administrative personnel, legal, accounting, consulting fees, sales commissions, marketing,
facilities costs, corporate overhead and depreciation expense.  For the six months ended June 30, 2012, SG&A expenses
decreased to $1,820,000 from $2,690,000 in the comparable period prior year.  As a percentage of revenues, SG&A was
30.9% for the six months ended June 30, 2012 versus 41.6% in the comparable period a year ago. The decrease in SG&A was mainly
comprised of an increase in sales and marketing costs supporting our Telecom services growth offset by a decrease in share
based compensation and a decrease in SG&A supporting our Government services segment.  The decrease in Government
segment SG&A was driven by cost cutting in response to the contraction in revenues and billable FTE’s and the integration
of CLR which was acquired May 2011.



AMORTIZATION EXPENSES:



Non-cash amortization expenses related mainly to intangible
assets acquired in the acquisitions of Cummings Creek/CLR, LGS (formerly RTI) and SMEI are stated separately in our statement of
operations. Amortization expense for the six months ended June 30, 2012 was $161,000 compared to $209,000 for the six months ended
June 30, 2011. The decrease is attributed to certain intangibles attributable to the RTI and SMEI purchases being fully amortized
in prior periods.



INTEREST EXPENSE:



Interest Expense for the six months ended June 30, 2012 was
$230,000 for the six months ended June 30, 2012 which compared to $237,000 for the six months ended June 30, 2011.



NET INCOME (LOSS):



The Company’s net income for the six months ended June
30, 2012 was $128,000 compared to a net loss of $2,507,000 for the six months ended June 30, 2011. Net income of $128,000 includes
$256,000 of other income related to the expiration of stale accounts payables that have exceeded statute of limitations. The prior
year net loss of $2,507,000 included a noncash impairment charge of $1,575,000. Excluding these items, the improvement in net income
was mainly due to higher gross profit generated in our Telecom segment and decreased SG&A expenses.



LIQUIDITY AND CAPITAL RESOURCES:



Cash and cash equivalents at June 30, 2012
was $165,017 which compared to $192,286 at December 31, 2011. Net cash provided by operating activities was $198,000 for the six
months ended June 30, 2012 compared to net cash used by operating activities of $930,000 in the corresponding six months ended
June 30, 2012.  The increase in the current period is mainly due to an increase in adjusted operating income to
$352,000 from a year ago loss of $312,000. The adjustments to reported operating income included adding back non cash; amortization,
share based compensation, impairment charges and depreciation expenses.



Net cash used in investment activities
was $109,000 for the six months ended June 30, 2012 compared to net cash used of $204,000 in the corresponding period ended June
30, 2011.  Purchase of property, plant and equipment, primarily consists of central office hardware and premise equipment
supporting our direct telecom services growth, totaled $109,000 related to our installs of equipment supporting our direct
telecom services revenues for the six months ended June 30, 2012 compared to $264,000 in the prior year same period. We expect
to continue to have a requirement for capital on a project by project basis as we are awarded service contracts. To date, we have
financed these equipment purchases with equipment based financing, alternative debt and equity financings. The capital requirement
for our Government services business is minimal and mainly driven by the level of new hiring’s of billable staff, which requires
the purchase of personal computers, in-house servers and network infrastructure.



Net cash used by financing activities was $116,000 for the six
months ended June 30, 2012 compared to net cash provided by financing activities of $1,205,000 in the corresponding year ago period.
The $116,000 consisted of:  proceeds of $175,000 from the issuance of notes issued in January 2012 to private investors
offset by payments on our line of credit and notes payable..



Our current level of liquidity combined with projected operating
cash flows is not adequate to support our working capital needs, service our debt obligations, or support the capital requirements
for further expansion of our telecom segment.  Accordingly, we remain highly dependent on (i) successfully executing
our business plan, (ii) the ability to raise alternative financing in the near term and (iii) our ability to renegotiate terms
with note holders and other creditors.  It should be noted that the note originally maturing June 2012 for $982,000 was
amended and extended to October 31, 2012.  If the Company is not successful in achieving these measures then the Company could
be required to reduce or curtail operations.



Going concern considerations:



The accompanying financial
statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. The going concern basis was due to the Company’s historical negative operating cash flow
and losses. The Company’s working capital deficiency at June 30, 2012 was $2,623,000.  This condition raises
doubt regarding the Company’s ability to continue as a going concern. The Company’s ability to continue as a going
concern is highly dependent upon its ability to achieve its planned operating cashflows, maintain continued availability under
its line of credit financing and the ability to obtain additional alternative financing.



18







Financing activities:



On January 23,
2012, we issued a several promissory notes to private investors with face values totaling $198,000. The proceeds from the
notes totaled $175,000 used for working capital. The discount of $23,000 has been recorded as a deferred financing fee and is
being amortized over the life of the note. The Notes bear interest of 12% per year. The Company is required to pay
interest quarterly on a calendar basis starting with a pro-rata interest payment on March 31, 2012. On January 23,
2014 the maturity date, the principal amount of the notes will be due along with any unpaid and accrued interest.



OFF BALANCE SHEET ARRANGEMENTS:



We do not have any off balance sheet arrangements
that are reasonably likely to have a current or future effect on our financial condition, revenue, results of operations, liquidity
or capital expenditures.





ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.



N/A.



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 Chief Financial, we evaluated the effectiveness
of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this Quarterly Report
on Form 10-Q. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures as of the end of the period covered by this report were not effective such that the information required
to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to
our management to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance, however, that
the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues
and instances of fraud if any, within a company have been detected.



Management has determined that there were
material weaknesses in our internal controls as of June 30, 2012. A material weakness in the Company’s internal controls
exists in that, beyond the Company’s Chief Financial Officer there is a limited financial background amongst other executive
officers or the board of directors.  This material weakness may affect management’s ability to effectively review
and analyze elements of the financial statement closing process and prepare financial statements in accordance with U.S. GAAP.  In
making this assessment, our management used the criteria established in Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  As a result of the material weaknesses
described above, our management concluded that as of June 30, 2012, we did not maintain effective internal control over financial
reporting based on the criteria established in Internal Control — Integrated Framework issued by the COSO.



Changes in internal control

Our management, with the participation
of our Chief Executive Officer and Chief Financial Officer, performed an evaluation as to whether any change in our internal controls
over financial reporting occurred during the 2012 Quarter ended June 30, 2012. Based on that evaluation, our Chief Executive Officer
and Chief Financial Officer concluded that no change occurred in the Company’s internal controls over financial reporting
during the 2012 Quarter ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s
internal  controls over financial reporting.





19







PART II



OTHER INFORMATION



ITEM 1 - LEGAL PROCEEDINGS



We are not a party to any pending legal proceeding, nor is our
property the subject of a pending legal proceeding, that is not in the ordinary course of business or otherwise material to the
financial condition of our business. Two pending proceedings involving our Government Service Division are Subcontractor suits
relating to payments on change orders. We expect to resolve these and any similar suits within the ordinary course of business.
None of our directors, officers or affiliates is involved in a proceeding adverse to our business or has a material interest adverse
to our business.



ITEM 1A. RISK FACTORS



There have been no material changes from
the Risk Factors described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.



ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE
OF PROCEEDS



None.



ITEM 3 - DEFAULTS UPON SENIOR SECURITIES



None.







ITEM 4 - RESERVED



ITEM 5 - OTHER INFORMATION



None.



Item 6 -  EXHIBITS



|Exhibit
        Number |  | Description                                                                                                                                                                    
|---------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                       |  |                                                                                                                                                                                
|                       |  |                                                                                                                                                                                
|                       |  |                                                                                                                                                                                
|31.1                   |  | Certification by Chief Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act                                                                     
|                       |  |                                                                                                                                                                                
|31.2                   |  | Certification by Chief Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act                                                                     
|                       |  |                                                                                                                                                                                
|32.1                   |  | Certification by Chief Executive Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code
|                       |  |                                                                                                                                                                                
|32.2                   |  | Certification by Chief Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code





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





* Pursuant to Rule 405(a)(2) of Regulation
S-T, the Company will furnish the XBRL Interactive Data Files with detailed footnote tagging as Exhibit 101 in an amendment to
this Form 10-Q within the permitted 30-day grace period granted for the first quarterly period in which detailed footnote tagging
is required.



Other exhibits are contained under Item
15 of the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2011 filed on April 2, 2012.





20







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.





DATE: August 14, 2012





| | LATTICE INCORPORATED
| | --------------------
| |                     
| | By:                 
| |                     





DATE: August 14, 2012





| |    
| | ---
| | By:
| |    









21


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