**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


WASHINGTON,
      D.C. 20549




**FORM
      10-Q**




(Mark
      One)




**x** **QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE**


**ACT
      OF 1934**





**FOR
      THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008.**




*COMMISSION
      FILE NUMBER 000-10690*




**LATTICE
      INCORPORATED**


(Exact
      Name of Registrant as Specified in its Charter)





Delaware
            
            22-2011859(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            Identification
                No.)





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 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 filero
            Accelerated
                fileroNon-accelerated
                filero
            Smaller
                reporting companyx




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 November 14, 2008, there were
      16,829,950 outstanding shares of the Registrant's Common Stock, $.01 par
      value.
















**LATTICE
      INCORPORATED**


**SEPTEMBER
      30, 2008 QUARTERLY REPORT ON FORM 10-Q**




**TABLE
      OF CONTENTS**




**Page****PART
                I - FINANCIAL INFORMATION**Item
                1. Financial Statements
            3Item
                2. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations
            14Item
                3. Quantitative and Qualitative Disclosure About Market
                Risks
            20Item
                4T. Controls and Procedures
            20**PART
                II - OTHER INFORMATION**Item
                1. Legal Proceedings
            21Item
                1A. Risk Factors
            21Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            22Item
                3. Defaults Upon Senior Securities
            22Item
                4. Submission of Matters to a Vote of Security Holders
            22Item
                5. Other Information
            22Item
                6. Exhibits
            22**SIGNATURES**
            23


2


**LATTICE
      INCORPORATED AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEETS**


**(UNAUDITED)**




**September 30,**
            
            **December 31,****2008**
            
            **2007****(Unaudited)**
            
            **(Audited)**ASSETS:Current
                assets:Cash
                and cash equivalents
            
            $
            732,265
            
            $
            769,915Accounts
                receivable, net
            
            
            3,275,266
            
            
            3,839,744Inventories
            
            
            46,407
            
            
            65,846Other
                current assets
            
            
            286,448
            
            
            127,801Total
                current assets
            
            
            4,340,386
            
            
            4,803,306Property
                and equipment, net
            
            
            39,295
            
            
            27,530Goodwill
            
            
            7,629,632
            
            
            7,629,632Other
                intangibles, net
            
            
            4,237,900
            
            
            5,354,071Other
                assetes
            
            
            52,889
            
            
            118,623Total
                assets
            
            $
            16,300,102
            
            $
            17,933,162LIABILITIES
                AND SHAREHOLDERS' EQUITYCurrent
                liabilities:Accounts
                payable
            
            $
            2,182,292
            
            $
            2,716,411Accrued
                expenses
            
            
            1,109,505
            
            
            1,252,916Contingent
                Consideration - due former RTI owners
            
            
            —
            
            
            1,500,000Customer
                deposits
            
            
            15,000
            
            
            15,000Notes
                payable
            
            
            1,606,972
            
            
            1,050,254Derivative
                liability
            
            
            598,365
            
            
            7,217,099Total
                current liabilities
            
            
            5,512,134
            
            
            13,751,680Long
                term liabilities:Long
                Term Debt
            
            
            750,000Deferred
                tax liabilities
            
            
            2,139,330
            
            
            2,661,954Total
                long term liabilities
            
            
            2,889,330
            
            
            2,661,954Total
                liabilities
            
            
            8,401,464
            
            
            16,413,634Minority
                interest
            
            
            135,480
            
            
            214,599Shareholders'
                equityPreferred
                Stock - .01 par value
            
            
            78,387
            
            
            78,387Preferred
                Stock series A 9,000,000 shares authorized, 7,838,686
                issuedPreferred
                Stock series B 1,000,000 shares authorized 502160 and 1,000 000 issuedrespectively
            
            
            5,022
            
            
            10,000Preferred
                Stock series C 575,000 shares authorized 520,000 issued
            
            
            5,200
            
            
            —Common
                stock - .01 par value, 200,000,000 authorized,
            
            
            165,520
            
            
            168,42516,552,021
                and 16,842,428 issued, and 16,639,441 and 16,829,428
                outstandingAdditional
                paid-in capital
            
            
            38,158,180
            
            
            36,854,901Accumulated
                deficit
            
            
            (30,251,318
            )
            
            (35,408,951
            )8,160,991
            
            
            1,702,762Common
                stock held in treasury, at cost
            
            
            (397,833
            )
            
            (397,833
            )Shareholders'
                equity
            
            
            7,763,158
            
            
            1,304,929Total
                liabilities and shareholders' equity
            
            $
            16,300,102
            
            $
            17,933,162





See
      accompanying notes to the consolidated financial statements.


3


**LATTICE
      INCORPORATED AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(UNAUDITED)**





**Nine Months Ended**
              **September 30,**
            
            **Three Months Ended**
              **September 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Revenue
                - Technology Services
            
            $
            10,656,897
            
            $
            10,242,162
            
            $
            3,775,213
            
            $
            3,976,275Revenue
                - Technology Products
            
            
            866,245
            
            
            970,354
            
            
            428,934
            
            
            339,867Total
                Revenue
            
            
            11,523,142
            
            
            11,212,516
            
            
            4,204,147
            
            
            4,316,142Cost
                of Revenue - Technology Services
            
            
            7,916,610
            
            
            5,048,465
            
            
            2,924,049
            
            
            2,103,352Cost
                of Revenue - Technology Products
            
            
            335,386
            
            
            337,991
            
            
            167,370
            
            
            125,821Total
                cost of revenue
            
            
            8,251,996
            
            
            5,386,456
            
            
            3,091,419
            
            
            2,229,173Gross
                Profit
            
            
            3,271,146
            
            
            5,826,060
            
            
            1,112,728
            
            
            2,086,969Operating
                expenses:Selling,
                general and administrative
            
            
            3,359,768
            
            
            4,094,165
            
            
            1,024,628
            
            
            1,527,018Research
                and development
            
            
            384,692
            
            
            314,339
            
            
            123,720
            
            
            109,041Amortization
                expense
            
            
            1,116,171
            
            
            1,561,284
            
            
            372,057
            
            
            520,428Total
                operating expenses
            
            
            4,860,631
            
            
            5,969,788
            
            
            1,520,405
            
            
            2,156,487Loss
                from operations
            
            
            (1,589,485
            )
            
            (143,728
            )
            
            (407,677
            )
            
            (69,518
            )Other
                income (expense):Derivative
                income (expense)
            
            
            2,750,199
            
            
            3,889,788
            
            
            195,609
            
            
            2,828,906Extinguishment
                loss
            
            
            2,607,525
            
            
            (157,130
            )
            
            —
            
            
            —Other
                income
            
            
            970,150
            
            
            
            
            
            370,150Interest
                expense
            
            
            (140,910
            )
            
            (530,135
            )
            
            (32,703
            )
            
            (51,133
            )Finance
                expense
            
            
            (2,636
            )
            
            (21,520
            )
            
            (1,170
            )
            
            (7,202
            )Total
                other income (expense)
            
            
            6,184,328
            
            
            3,181,003
            
            
            531,886
            
            
            2,770,571Minority
                Interest
            
            
            79,119
            
            
            (188,781
            )
            
            23,700
            
            
            (87,602
            )Income
                before taxes
            
            
            4,673,962
            
            
            2,848,494
            
            
            147,909
            
            
            2,613,451Income
                taxes (benefit)
            
            
            (521,171
            )
            
            —
            
            
            (172,755
            )
            
            —Net
                income
            
            $
            5,195,133
            
            $
            2,848,494
            
            $
            320,664
            
            $
            2,613,451Reconciliation
                of net income lossIncome
                applicable to common shareholders:Net
                income
            
            $
            5,195,133
            
            $
            2,848,494
            
            $
            320,664
            
            $
            2,613,451Series
                B Preferred stock dividend
            
            
            (37,500
            )
            
            (37,500
            )
            
            (12,500
            )
            
            (12,500
            )Income
                applicable to common stockholders
            
            $
            5,157,633
            
            $
            2,810,994
            
            $
            308,164
            
            $
            2,600,951Income
                per common shareBasic
            
            $
            0.31
            
            $
            0.17
            
            $
            0.02
            
            $
            0.16Diluted
            
            $
            0.04
            
            $
            (0.02
            )
            $
            —
            
            $
            —Weighted
                average shares:Basic
            
            
            16,829,428
            
            
            16,642,428
            
            
            16,829,428
            
            
            16,642,428Diluted
            
            
            56,172,092
            
            
            64,230,056
            
            
            53,592,883
            
            
            64,230,056





See
      accompanying notes to the consolidated financial statements.


4


**LATTICE
      INCORPORATED AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(UNAUDITED)**





**Nine Months ended**
              **September 30,****2008**
            
            **2007**Cash
                flow from operating activities:Net
                income before preferred dividends
            
            $
            5,195,133
            
            $
            2,848,494Adjustments
                to reconcile net loss to net used for operating
                activities:Derivative
                income
            
            
            (2,750,199
            )
            
            (3,772,263
            )Amortization
                of intangible assets
            
            
            1,116,171
            
            
            1,561,284Amortization
                of debt discount (effective method)
            
            
            —
            
            
            205,809Amortization
                of deferred financing
            
            
            —
            
            
            21,520Settlement
                of Contingent Liability - former RTI shareholders
            
            
            (1,057,650
            )Extinguishment
                (gain) loss
            
            
            (2,607,525
            )
            
            157,130Deferred
                income taxes
            
            
            (521,171
            )
            
            —Minority
                interest
            
            
            (79,119
            )
            
            188,781Share-based
                compensation
            
            
            156,635
            
            
            184,320Depreciation
            
            
            21,079
            
            
            12,375Changes
                in operating assets and liabilities:
            
            
            —(Increase)
                decrease in:
            
            
            —Accounts
                receivable
            
            
            564,478
            
            
            (1,773,718
            )Inventories
            
            
            19,439
            
            
            10,643Other
                current assets
            
            
            (6,998
            )
            
            (16,311
            )Other
                assets
            
            
            65,734
            
            
            (16,818
            )Increase
                (decrease) in:
            
            
            —Accounts
                payable and accrued liabilities
            
            
            (677,530
            )
            
            986,837Deferred
                revenue
            
            
            —
            
            
            (62,495
            )Total
                adjustments
            
            
            (5,756,656
            )
            
            (2,312,906
            )Net
                cash provided by ( used in) operating activities
            
            
            (561,523
            )
            
            535,588Cash
                Used in investing activities:Purchase
                of equipment
            
            
            (32,844
            )
            
            (832
            )Net
                cash used for investing activities
            
            
            (32,844
            )
            
            (832
            )Cash
                flows from financing activities:Payments
                on notes payable
            
            
            (131,000
            )
            
            (842,000
            )Bank
                line-of-credit borrowings (payments), net
            
            
            687,717
            
            
            25,315Net
                cash provided by (used for) by financing activities
            
            
            556,717
            
            
            (816,685
            )Net
                decrease in cash and cash equivalents
            
            
            (37,650
            )
            
            (281,929
            )Cash
                and cash equivalents - beginning of period
            
            
            769,915
            
            
            392,275Cash
                and cash equivalents - end of period
            
            $
            732,265
            
            $
            110,346—Supplemental
                cash flow informationInterest
                paid in cash
            
            $
            81,397
            
            $
            215,685Supplemental
                disclosures of Non-Cash Investing & Financing
                ActivitiesPreferred
                stock Series B
            
            
            (4,978
            )
            
            —Preferred
                Stock Series C
            
            
            5,200
            
            
            —Common
                Stock
            
            
            (2,905
            )
            
            —Additional
                paid in capital
            
            
            1,257,883
            
            
            —Derivative
                liability
            
            
            (1,261,010
            )
            
            —


See
                  accompanying notes to the consolidated financial
                  statements.


5


**LATTICE
      INCORPORATED AND SUBSIDIARIES**


**NOTES
      TO THE CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1- Organization and summary of significant accounting
      policies:**





**a)
      Organization:**





Lattice
      Incorporated (the "Company") was incorporated in the State of Delaware in 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 service provider which
      includes developing software applications for clients based on its core platform
      technology. To further its strategy of becoming a service provider, the Company
      acquired a majority interest in Systems Management Engineering, Inc, (“SMEI”) in
      February 2005 and purchased all of the issued and outstanding common shares
      of
      Ricciardi Technologies Inc. “(RTI”) in September 2006. RTI 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 though prime
      contractors of such governmental agencies. RTI’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. With the SMEI and the RTI acquisitions,
      approximately 93% of the Company’s revenues are derived from from
      services we provided to various departments and agencies of the Federal
      Government, both directly and through other prime contractors, rendered
      to the Department of Defenese . In January 2007, we changed our name from
      Science Dynamics Corporation to Lattice Incorporated.





**b)
      Basis of Presentation:**





The
      accompanying unaudited condensed consolidated financial statements have been
      prepared in accordance with generally accepted accounting principles for interim
      financial information and with the instructions contained in Article 3 of
      Regulation S-X. Accordingly, they do not include all of the information and
      footnotes required by generally accepted accounting principles for complete
      financial statements. For further information, refer to the financial statements
      and footnotes thereto included in the Company's annual report for Form 10-KSB
      for the year ended December 31, 2007. In the opinion of management, all
      adjustments (consisting of normal recurring accruals) considered necessary
      for a
      fair presentation have been included. Operating results for the nine month
      period ended September 30, 2008 are not necessarily indicative of the results
      that may be expected for the year ended December 31, 2008.





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 Company has a working capital deficiency
      of $1,171,748 including non-cash derivative liabilities of $598,365. The
      Company’s ability to continue as a going concern is dependent upon its ability
      to obtain adequate alternative financing to support its operations and satisfy
      any obligations coming due.





**c)
      Principles of consolidation** :





The
      consolidated financial statements included 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 minority
      interests. Investments in affiliates over which the Company has significant
      influence, but not a controlling interest are carried on the equity
      basis.





**d)
      Use of estimates** :





The
      preparation of these financial statements in accordance with accounting
      principles generally accepted in the United States of America (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 of 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.


6


**e)**  **Revenue**  **Recognition** :





Revenue
      is recognized when all significant contractual obligations have been satisfied
      and collection of the resulting receivable is reasonably assured. Revenue from
      product sales is recognized when the goods are shipped and title passes to
      the
      customer.





The
      company applies the guidance of SOP-97-2 with regards to its software products
      sold under its Technology Products segment. Under this guidance, the Company
      determined that its product sales do not contain multiple deliverables for
      an
      extended period beyond delivery where bifurcation of multiple elements is
      necessary. The software is embedded in the products sold and shipped. Revenue
      is
      recognized upon delivery, installation and acceptance by the customer. PCS
      (post-contract support) and upgrades are billed separately and when rendered
      or
      delivered and not contained in the original arrangement with the customer.
      Installation services are included with the original customer arrangement but
      are rendered at the time of delivery of the product and invoicing.




In
      our
      Technology Services segment, our revenues are derived from IT and business
      process outsourcing services under cost-plus, time-and-material, and fixed-price
      contracts, which may extend up to 5 years. For fixed-price contracts, revenues
      are generally recorded as delivery is made. For time-and-material contracts,
      revenues are computed by multiplying the number of direct labor-hours expended
      in the performance of the contract by the contract billing rates and adding
      other billable direct costs. Under cost-plus contracts, revenues are recognized
      as costs are incurred and include an estimate of applicable fees earned.
      Services provided over the term of these arrangements may include, network
      engineering, architectural guidance, database management, expert programming
      and
      functional area expert analysis   Revenue is generally recognized when the
      service is provided and the amount earned is not contingent upon any further
      event.




Our
      fixed
      price contracts are primarily based on unit pricing (labor hours) or level
      of
      effort As such, the Company recognizes revenue for the number of units delivered
      in any given fiscal period. Accordingly, these contracts do not fall within
      the
      scope of SOP 81-1, *Accounting
      for Performance of Construction-Type and Certain Production-Type
      Contracts* ,
      where
      revenue is recognized on the percentage-of-completion method using costs
      incurred in relation to total estimated costs.





**f)
      Share-based payments:**





On
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      Financial Accounting Standards Board Statement of Financial Accounting Standards
      (“SFAS”) No. 123(R), *Accounting
      for Share-based payments* , to
      account for compensation costs under its stock option plans and other
      share-based arrangements. Prior to January 1, 2006, the Company utilized the
      intrinsic value method under Accounting Principles Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* .
      Statement 123R 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. For the nine months ended
      September 30, 2008 and 2007, share-based payment expense was $156,635 and
      $184,320, respectively. As of September 30, 2008, there was approximately
      $1,582,474 of total unrecognized compensation cost related to unvested
      share-based compensation awards granted under the equity compensation plans
      which does not include the effect of future grants of equity compensation,
      if
      any. The $1,582,474 will be amortized over the weighted average remaining
      service period.




**g)
      Derivative financial instruments and registration payment
      arrangements:**





Derivative
      financial instruments, as defined in Financial Accounting Standard No. 133, *Accounting
      for Derivative Financial Instruments and Hedging Activities* (“FAS
      133”), consist of financial instruments or other contracts that contain a
      notional amount and one or more underlying (e.g. interest rate, security price
      or other variable), require no initial net investment and permit net settlement.
      Derivative financial instruments may be free-standing or embedded in other
      financial instruments. Further, derivative financial instruments are initially,
      and subsequently, measured at fair value and recorded as liabilities or, in
      rare
      instances, assets. The Company generally does not use derivative financial
      Company’s own stock. These contracts require careful evaluation to determine
      whether derivative features embedded in host contracts require bifurcation
      and
      fair value measurement or, in the case of freestanding derivatives (principally
      warrants) whether certain conditions for equity  classification has been
      achieved. In instances where derivative financial instruments require liability
      classification, the Company is required to initially and subsequently measure
      such instruments at fair value. Accordingly, the Company adjusts the fair value
      of these derivative components at each reporting period through a charge to
      income until such time as the instruments acquire classification in
      stockholders’ equity. See Note 5 for additional information.


7


As
      previously stated, derivative financial instruments are initially recorded
      at
      fair value and subsequently adjusted to fair value at the close of each
      reporting period. The Company estimates fair values of derivative financial
      instruments using various techniques (and combinations thereof) that are
      considered to be consistent with the objective measuring fair values. In
      selecting the appropriate technique, management considers, among other factors,
      the nature of the instrument, the market risks that it embodies and the expected
      means of settlement. For less complex derivative instruments, such as
      free-standing warrants, the Company generally uses the Black-Scholes-Merton
      option valuation technique because it embodies all of the requisite assumptions
      (including trading volatility, dividend yield, estimated terms and risk free
      rates) necessary to fair value these instruments. For complex derivative
      instruments, such as embedded conversion options, the Company generally uses
      the
      Flexible Monte Carlo valuation technique because it embodies all of the
      requisite assumptions (including credit risk, interest-rate risk and
      exercise/conversion behaviors) that are necessary to fair value these more
      complex instruments. For forward contracts that contingently require net-cash
      settlement as the principal means of settlement, the Company projects and
      discounts future cash flows applying probability-weightage to multiple possible
      outcomes. Estimating fair values of derivative financial instruments requires
      the development of significant and subjective estimates that may, and are likely
      to, change over the duration of the instrument with related changes in internal
      and external market factors. In addition, option-based techniques are highly
      volatile and sensitive to changes in the trading market price of our common
      stock, which has a high-historical volatility. Since derivative financial
      instruments are initially and subsequently carried at fair values, our income
      (loss) will reflect the volatility in these estimate and assumption
      changes.





h)   Fair
      Value of Financial Instruments





On
      January 1, 2008, the Company adopted SFAS No. 157. SFAS No. 157, Fair Value
      Measurements, defines fair value, establishes a three-level valuation hierarchy
      for disclosures of fair value measurement and enhances disclosures requirements
      for fair value measures. The carrying amounts reported in the balance sheets
      for
      current assets and current liabilities qualified as financial instruments are
      a
      reasonable estimate of fair value because of the short period of time between
      the origination of such instruments and their expected realization and their
      current market rate of interest. The three levels are defined as
      follow:





·
            Level
                1 — inputs to the valuation methodology are quoted prices (unadjusted)
                for
                identical assets or liabilities in active
                markets.





·
            Level
                2 — inputs to the valuation methodology include quoted prices for similar
                assets and liabilities in active markets, and inputs that are observable
                for the assets or liability, either directly or indirectly, for
                substantially the full term of the financial
                instruments.





·
            Level
                3 — inputs to the valuation methodology are unobservable and significant
                to the fair value.





As
      of
      September 30, 2008 and December 31, 2007, the derivative liabilities amounted
      to
      $598,365 and $7,217,099, respectively. In accordance with SFAS 157, the Company
      determined that the carrying value of these derivatives approximated the fair
      value using the level 1 inputs.





**Note
      2- Settlement with former RTI Shareholders:**





In
      June
      2008, the Company filed suit in New Jersey Superior Court against Michael
      Ricciardi and Marie Ricciardi, former shareholders of Ricciardi Technologies,
      Inc. (“RTI”), along with the Domenix Corporation, a company owned by Marie
      Ricciardi and operated by her and Michael Riccardi. The defendants removed
      the
      case to the United States District Court for the district of New Jersey, where
      it was pending under the caption, *Lattice,
      Inc. v.Marie Ricciardi, et al.,* Civil
      Action No. 08 cv 3208 (the “New Jersey Action”). The New Jersey Action sought to
      enforce the restrictive covenant contained in the September 12, 2006 Stock
      Purchase Agreement (the “SPA”), pursuant to which the Company purchased RTI
      from, *inter
      alia,* the
      Ricciardis. The restrictive covenant prohibited the former owners of RTI from
      (a) competing, directly or indirectly against Lattice and RTI and/or (b)
      soliciting employees or others engaged by RTI for a period of three years from
      the date of the SPA. The Company sought a preliminary injunction to prevent
      Marie Ricciardi, acting in concert with her husband and through Domenix, from
      continuing to breach the restrictive covenant and damages in an as yet
      undetermined amount for damages resulting from the breach. A hearing on
      Lattice’s motion for preliminary injunction occurred on August 7, 2008.





Michael
      Ricciardi also filed a suit against the Company in June, 2008, in the United
      States District Court for the Eastern District of Virginia under the
      caption *Michael
      Ricciardi v. Lattice, Inc.,* Civil
      Action No. 1:08-cv-519 (the “Virginia Action”) In the Virginia Action, Michael
      Ricciardi (a) disputes the Company’s claim (the “Indemnity Claim”) that it is
      entitled to be paid approximately $308,000, plus fees and costs, from the escrow
      created pursuant to the SPA to cover its indemnifiable losses (a defined term
      under the SPA), claiming instead that the entire escrow should be dispersed
      to
      him as the representative of the RTI shareholders, as provided for in the SPA,
      and (b) asserts that a contingent $1.5 million Earn Out Payment (as such term
      is
      defined in the SPA) provided for in the SPA is due and payable by the Company
      to
      the former shareholders of RTI.





In
      September 2008, the Company and former RTI shareholders signed a settlement
      agreement (the “Settlement Agreement”) whereby $150,000 of the amount held in
      escrow pursuant to the SPA will be returned to the Company. As of September
      30,
      2008, we recorded a receivable for such amount in other current assets. In
      October 2008 we received the funds. In addition, pursuant to the Settlement
      Agreement, Michael Ricciardi and Marie Ricciardi agreed to return 497,840 shares
      of the Company’s preferred stock and 290,407 shares of the Company’s common
      stock. Pursuant to the Settlement Agreement, the Company agreed to pay the
      former shareholders of RTI the aggregate sum of $750,000 as settlement of the
      Earn Out Payment, which amount shall be paid over the next twenty-four months,
      consisting of interest only for the first twelve months and then twelve monthly
      installments of $62,500 plus interest. Accordingly, the Company has reduced
      its
      recorded reserve from $1.5 million and recognized $750,000 as other income.
      In
      addition, the Company recorded income for the nine months ended September 30,
      2008 from the settlement in the amount of $970,000, net of $150,000 in legal
      fees.


8





**Note
      3- Segment reporting**





Management
      views its business as one reportable segment: Government services. The Company
      evaluates performance based on profit or loss before intercompany
      charges.







**Nine Months Ended**
              **September 30,**
            
            **Three Months Ended**
              **September 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Revenues:Goverment
                Services
            
            $
            10,656,897
            
            $
            10,242,162
            
            $
            3,775,213
            
            $
            3,976,275Other
            
            
            866,245
            
            
            970,354
            
            
            428,934
            
            
            339,867Total
                Consolidated Revenues
            
            
            11,523,142
            
            
            11,212,516
            
            
            4,204,147
            
            
            4,316,142Gross
                Profit:Government
                Services
            
            
            2,740,287
            
            
            5,193,697
            
            
            851,164
            
            
            1,872,923Corporate
                and other
            
            
            530,859
            
            
            632,363
            
            
            261,564
            
            
            214,046Total
                Consolidated
            
            
            3,271,146
            
            
            5,5826,060
            
            
            1,112,728
            
            
            2,086,969Total
                Assets:Goverment
                Services
            
            
            15,683,314Corporate
                and Other
            
            
            616,788Total
                Consolidated Assets
            
            
            16,300,102




9


**Note 4
      - Notes payable**





Notes
      payable consists of the following as of September 30, 2008 and December 31,
      2007:





September 30,
              2008
            
            December 31,
              2007Bank
                line-of-credit**(a)**
            
            $
            1,427,972
            
            $
            740,254Note
                Payble – former RTI owners (b)
            
            
            750,000Notes
                payable to Stockholders/Officers**(c))**
            
            
            179,000
            
            
            310,000Total
                notes payable
            
            
            2,356,972
            
            
            1,050,254Less
                current maturities
            
            
            (1,606,972
            )
            
            (1,050,254
            )Long-term
                debt
            
            $
            750,000
            
            $
            —





**(a)
      Bank line-of-credit:**




On
      March
      7, 2008, Lattice Incorporated (the “Company”) entered into a Loan and Security
      Agreement (the “Loan Agreement”) with the Private Bank of Peninsula (“Private
      Bank”) pursuant to which Private Bank agreed to extend a line of credit of up to
      $4.0 million to the Company. Pursuant to the Loan Agreement, the Company can
      request advances on the line-of-credit, which in the aggregate cannot exceed
      85%
      of the Company’s eligible accounts receivable. The line-of-credit bears interest
      at 3% above the Prime Rate (8.25% at September 30, 2008). The outstanding
      balance at September 30, 2008 was $1,427,972. Pursuant to the Loan Agreement,
      the Company is required to maintain certain financial covenants including a
      minimum current ration of 0.75:1.00 and a minimum EBITDA of $200,000. As of
      September 30, 2008, the Company was not in compliance with the minimum EBITDA
      requirement which constitutes a default on the line of credit. As a result
      of
      the default and in accordance with the Loan Agreement, the interest rate on
      the
      line of credit shall be increased by 5%. In addition, Private Bank is entitled
      to declare all amounts due under the Loan Agreement to be immediately due and
      payable, which as of September 30, 2008 amount to $1,472,972. Private Bank
      is
      also entitled to cease advancing money or extending credit to the Company.
      Private Bank also has a right of set-off for any and all balances and deposits
      of the Company held by Private Bank. Further, Private Bank has the right to
      foreclose on the collateral, which includes all personal property of the
      Company.





**(b)
      Note payable - former RTI owners:**





In
      accordance with the Settlement Agreement with Michael Ricciard as owner
      representative of the former RTI shareholders (as described in Note 2), the
      Company issued a 24 month promissory note to the former RTI shareholders payable
      at 10% interest only in the initial 12 months starting October 2008 and paying
      principal of $62,500 plus interest per month starting with the 13th month.





**(c)
      Notes payable stockholders/officers:**




At
      September 30, 2008 the Company has a short-term loan payable to a former officer
      and stockholder of the Company totaling $9,000. This note bears interest of
      8.0%
      per annum. The note is an unsecured demand note and payable in full by December
      31, 2008.





At
      September 30, 2008 the Company has a term note payable of $170,000 with a
      director of the Company. The note bears interest at 20% per annum and is payable
      monthly at $ 9,368 with any residual balance maturing September
      2009.





**Note
      5 - Derivative financial instruments:**





The
      balance sheet caption derivative liabilities consist of Warrants, issued in
      connection with the 2005 Laurus Financing Arrangement, the 2006 Omnibus
      Amendment and Waiver Agreement with Laurus, and the 2006 Barron Financing
      Arrangement. These derivative financial instruments are indexed to an aggregate
      of 17,438,465 and 40,483,333 shares of the Company’s common stock as of
      September 30, 2008 and December 31, 2007, respectively, and are carried at
      fair
      value. The following tabular presentations set forth information about the
      derivative instruments as of and for the periods September 30, 2008 and
      September 30, 2007:





Nine months
              ended
              June30,
              2008
            
            Nine months
              ended
              September30,
              2007
            
            Three months
              ended
              September30,
              2008
            
            Three months
              ended
              September30,
              2007Derivative
                income(expense):Conversion
                features
            
            
            —
            
            $
            (467,120
            )
            
            —
            
            
            —Warrant
                derivative
            
            $
            2,750,199
            
            $
            4,356,908
            
            $
            195,609
            
            $
            2,828,906




10





September 30,
              2008
            
            December 31
              2007Derivative
                liabilities:Warrant
                derivative
            
            $
            (
                598,365
            )
            $
            (7,217,099
            )




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 and Barron 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
      September 30, 2008 included conversion or strike prices ranging from $0.10
      -
      $1.10; historical volatility factors ranging from 104.26% - 106.49% based upon
      forward terms of instruments; terms-remaining term for all instruments; and
      a
      risk free rate ranging from 2.91% - 4.29%.





Embedded
      derivative instruments consist of multiple individual features that were
      embedded in the convertible debt instruments. The Company evaluated all
      significant features of the hybrid instruments and, where required under current
      accounting standards, bifurcated features for separate report classification.
      These features were, as attributable to each convertible note, aggregated into
      one compound derivative financial instrument for financial reporting purposes.
      The compound embedded derivative instruments were valued using the Flexible
      Monte Carlo methodology because that model embodies certain relevant assumptions
      (including, but not limited to, interest rate risk, credit risk, and
      Company-controlled redemption privileges) that are necessary to value these
      complex derivatives.  Since the conversion feature no longer required
      bifurcation as of February 2, 2007, there was no compound derivative recorded
      as
      of September 30, 2008. The expense recorded in the nine months ended September
      30, 2007 related to the fair value adjustments on the embedded derivative
      instrument from the period from January 1, 2007 through February 2,
      2007.





**Note
      6 -Exchange of**  **Warrants
      for shares of Series C Preferred Stock**





On
      June
      30, 2008, the Company entered into an agreement with Barron Partners L.P.,
      pursuant to which Barron Partners agreed to return their unregistered warrants
      to the Company for cancellation in exchange for 520,000 shares of newly issued
      Series C Convertible Preferred Stock (the “Exchange Agreement”). The following
      warrants were returned for cancellation pursuant to the Exchange
      Agreement:




-
            Series
                A Warrants indexed to 10,544,868 shares of common stock which were
                originally issued in conjunction with the September 19, 2006 Barron
                financing-
            Series
                B Warrants indexed to 12,500,000 shares of common stock which were
                originally issued in conjunction with the September 19, 2006 Barron
                financing-
            Additional
                Warrants indexed to 1,900,000 shares of common stock which were originally
                issued in February 2007 as consideration for a waiver on overdue
                payments
                due to Barron Partners, L.P.





The
      Series A and B warrants did not meet all the conditions of EITF 00-19 for equity
      classification so they had been recorded as derivative liabilities since
      inception. The fair value of the Series A and B warrants on the transaction
      date
      was determined to be $3,868,535 using the Black-Scholes option pricing model.
      Significant assumptions used in the Black Scholes model as of the date of the
      exchange included strike prices ranging from $0.275 to $0.25; a historical
      volatility factor of 106.49% based upon forward terms of instruments; a
      remaining term of 3.25 years; and a risk free rate of 2.91%





The
      Additional Warrants had achieved equity classification and they had been
      recorded in equity since inception. Their fair value at their inception (and
      thus their carrying value at the time of the exchange) was
      $1,031,130.




11




In
      accordance with the Share Exchange Agreement, on June 30, 2008, we designated
      575,000 shares of our preferred stock as Series C Convertible Preferred Stock
      (“Series C Preferred”). The Series C Preferred has a par value of $0.01 and each
      share of preferred stock is convertible into 10 shares of common stock at any
      time, at the option of the holder. The conversion prices are subject to
      anti-dilution protection for (i) traditional capital restructurings, such as
      splits, stock dividends and reorganizations and (ii) sales or issuances of
      common shares or contracts to which common shares are indexed at less than
      the
      stated conversion prices. Holders of the Company’s Series C Preferred are not
      entitled to dividends and the Holder has no redemption privileges. In
      considering the application of Statement 133, we identified those specific
      terms
      and features embedded in the contract that possess the characteristics of
      derivative financial instruments. Those features included the conversion option
      and buy-in and non-delivery puts. In evaluating the respective classification
      of
      these embedded derivatives, we are required to determine whether the host
      contract (the Series C Preferred) is more akin to a debt or equity instrument
      in
      regards to the risks. This determination is subjective. However, in complying
      with the guidance provided in EITF D-109 Determining the Nature of a Host
      Contract Related to a Hybrid Financial Instrument Issued in the Form of a Share
      under Statement No. 133 we concluded, based upon the preponderance and weight
      of
      all terms, conditions and features of the host contracts, that the Series C
      Preferred was more akin to an equity instrument for purposes of considering
      the
      clear and close relation of the embedded feature to the host contract. Based
      upon this conclusion, we further concluded that (i) embedded features did not
      require derivative liability classification and (ii) certain Non-delivery and
      Buy-in puts which require the Company to make-whole the investor for market
      fluctuation losses in the event of non-delivery of conversion shares meet the
      requisite criteria of a derivative financial instrument and should be
      bifurcated. Since share delivery is in the Company’s option and they have enough
      authorized shares to settle their share-settleable debt, it was determined
      that
      the value of these puts was deminimus.





The
      following table sets forth the computation of basic and diluted earnings per
      share:




**Note
      7 -Earnings per share**





Nine months
              ended
              September 30,
              2008
            
            Nine months
              ended
              September 30,
              2007
            
            Three months
              ended
              September 30,
              2008
            
            Three months
              ended
              September 30,
              2007Income
                (loss) applicable to common stockholders, as reported
            
            $
            5,157,633
            
            $
            2,810,994
            
            $
            308,164
            
            $
            2,600,951Reconciliation
                to numerator for diluted earnings per share:Income
                on derivative warrants
            
            
            (2,750,199
            )
            
            (3,889,788
            )
            
            (195,609
            )
            
            (2,828,906
            )Preferred
                stock dividends
            
            
            37,500
            
            
            37,500
            
            
            12,500
            
            
            12,500Numerator
                for diluted earnings per share
            
            $
            2,444,934
            
            $
            (1,041,294
            )
            $
            125,055
            
            $
            (227,955
            )Weighted
                average shares
            
            
            16,829,428
            
            
            16,642,428
            
            
            16,829,428
            
            
            16,642,428Reconciliation
                to denominator for diluted earnings per shareDilutive
                derivative warrants
            
            
            5,379,707
            
            
            27,011,111
            
            
            5,739,670
            
            
            27,011,111Shares
                indexed to convertible preferred stock
            
            
            34,110,568
            
            
            20,398,517
            
            
            34,110,568
            
            
            20,398,517Dilutive
                employee options
            
            
            (147,615
            )
            
            178,000
            
            
            (3,086,784
            )
            
            178,000Denominator
                for diluted earnings per share
            
            
            56,172,088
            
            
            64,230,056
            
            
            53,232,288
            
            
            64,230,056Earnings
                per common share:Basic
            
            
            0.31
            
            
            0.17
            
            
            0.02
            
            
            0.16Diluted
            
            
            0.04
            
            
            (0.02
            )
            
            0.00
            
            
            (0.00
            )





The
      above
      table includes only dilutive instruments and their effects on earnings per
      common share.


12


**Note
      8 Stock Based Compensation:**





On
      May
      15, 2008 the Company’s board of directors approved the adoption of the Company’s
      2008 Incentive Stock Option Plan.. The maximum number of shares available for
      issuance under the Plan is 10,000,000. The options may be granted to officers,
      directors, employees or consultants of the Company and its subsidiaries at
      not
      less than 100% of the fair market value of the date on which options are
      granted. The term of each Option granted under the Plan shall be contained
      in a
      stock option agreement between the optionee and the Company.





In
      May
      2008 and August 2008 the board issued options to purchase an aggregate of
      6,309,000 shares of the Company’s common stock to various officers and directors
      of the company. The company recorded $146,807 in connection with the issuance
      of
      options plus $9,833 from prior grants, for a total stock base compensation
      expense of $156,640.





The
      weighted-average fair value per share of the options granted during 2008 was
      estimated on the date of grant using the Black-Scholes-Merton option pricing
      model; the following assumptions were used to estimate the fair value of the
      options at grant date based on the following:





2008
            
            2007Risk-Free
                interest rate
            
            
            4.91
            %
            
            4.27
            %Expected
                dividend yield
            
            
            —
            
            
            —Expected
                stock price volatility
            
            
            106.49
            %
            
            131
            %Expected
                option Life
            
            
            5.5
                years
            
            
            10
                years





Number of
            
            Number of
            
            Weighted-Options
            
            Options
            
            AverageAvailable
            
            Outstanding
            
            Exercise PriceBalance
                December 31, 2007
            
            
            467,000
            
            
            1,371,000
            
            $
            1.002008
                Plan
            
            
            10,000,000Options
                granted under Plan in 2008
            
            
            (6,309,000
            )
            
            6,309,000
            
            
            .33Balance
                September 30, 2008
            
            
            4,158,000
            
            
            7,680,000
            
            $
            .45




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-KSB for the fiscal year ended December 31,
      2007. 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**





Lattice
      Incorporated was incorporated in the State of Delaware in May 1973 and commenced
      operations in July 1977. We have been developing and delivering secure
      technologically advanced communication solutions for over twenty-five years
      and
      recently expanded our product offering to include IT solutions with the
      acquisition of 86% of Systems Management Engineering, Inc. ("SMEI") on February
      14, 2005. In September 2006, pursuant to a Stock Purchase Agreement, dated
      as of
      September 12, 2006 (the "RTI Agreement"), the Company purchased all of the
      issued and outstanding shares of the common stock of Ricciardi Technologies
      Inc.
      ("RTI"). RTI 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 though prime contractors of such governmental
      agencies RTI'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. RTI
      is
      headquartered in Manassas, Virginia. The purchase of RTI's common stock was
      completed on September 19, 2006.




We
      intend
      to continue the expansion of our sales efforts both within the federal
      government secure software solutions space and commercial accounts. We continue
      to build upon our recent success in these markets by expanding our marketing
      efforts through our direct sales strategy. Our strong contract backlog has
      given
      us an opportunity to expand our existing revenue base. With regards to our
      acquisition strategy, we will continue to pursue profitable companies with
      proprietary products and services we can sell to our existing customers and
      which have synergies with our existing business.





We
      derive
      substantially all of our revenues from governmental contracts under which we
      act
      as both a prime contractor and indirectly as a subcontractor. Revenues from
      government contracts accounted for approximately $10,657,000 or 93% of our
      overall revenues for the nine months ended September 30, 2008. Of our total
      government contract revenues, 89% were from Prime contract
      vehicles.





**RESULTS
      OF OPERATIONS**





THREE
      MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER
      30,
      2007




REVENUES:





Total
      revenues for the three months ended September 30, 2008 decreased slightly by
      $112,000 or 2.6% to $4,204,000 compared to $4,316,000 for the three months
      ended
      September 30, 2007. Our Technology Services segment which represents revenues
      from professional engineering services to Federal government Dept of Defense
      (DoD) agencies accounted for 90% of total revenues.





GROSS
      MARGIN:





Gross
      margin for the three months ended September 30, 2008 was $1,113,000, a decrease
      of 974,000 or 46.7% compared to the $2,087,000 for three months ended September
      30, 2007. Gross margin, as a percentage of revenues, decreased to 26.5% from
      48.4% for the same period in 2007. The decrease in percentage was mainly due
      to
      a higher component of our costs of sales attributable to an increased use of
      subcontractors in support of our government contracts, primarily the JPM-IS
      Seaport-e contract, a material contract which was won in July 2007.


14





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 September 30, 2008, research and
      development expenses increased to $124,000 as compared to $109,000 for the
      three
      months ended September 30, 2007. 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, finance, administrative
      personnel, legal, accounting, consulting fees, sales commissions, marketing,
      facilities costs, corporate overhead and depreciation expense. For the three
      months ended September 30, 2008, SG&A expenses decreased to $1,025,000 from
      $1,527,000 in the comparable period prior year. As a percentage of revenues,
      SG&A was 24.4% for the current quarter ended September 30, 2008 versus 35.4%
      in the comparable period a year ago. The decrease in expense was mainly
      attributable to cost savings initiatives and lower fringe and indirect overhead
      costs, which decreased in line with the decline in our direct labor costs.
      Also,
      in the prior year quarter, the company incurred non-recurring corporate expenses
      related to executive hiring efforts.





AMORTIZATION
      EXPENSES:





Non-cash
      amortization expenses related to intangible assets acquired in the acquisitions
      of RTI and SMEI are stated separately in our statement of operations.
      Amortization expense for the three months ended September 30, 2008 was $372,000
      compared to $520,000 for the three months ended September 30, 2007. The decrease
      is attributed to intangibles being fully amortized in 2007.




INTEREST
      EXPENSE:





Interest
      Expense decreased to $33,000 for the three months ended September 30, 2008
      compared to $51,000 for the three months ended September 30, 2007. Interest
      expense in 2008 was comprised primarily of interest charges on its revolving
      line-of-credit and short term notes. The decrease is attributed to lower
      interest rate we pay on our line of credit versus prior year level. We have
      also
      reduced our short term borrowing. We expect interest to increase in the future
      due to our loan agreement with the former RTI Shareholders.





DERIVATIVE
      INCOME (EXPENSE):





The
      following table is derived from Note 5 in the accompanying financial
      statements.





Three months
              ended
              September 30, 2008
            
            Three months
              ended
              September 30, 2007Derivative
                income (expense)Conversion
                features
            
            $
            
            
            $Warrant
                derivative
            
            $
            195,609
            
            $
            2,828,906





NET
      INCOME:





The
      Company's net income for the three months ended September 30, 2008 was $320,000
      compared to net income of $2,613,000 for the three months ended September 30,
      2007. Net income is influenced by the matters discussed in the other sections
      of
      this MD&A. However, it should be noted that the net income in the current
      quarter included; (i) other income of $370,000 related to the Company’s
      settlement with the former RTI shareholders, (ii) non-cash derivative income
      of
      $196,000 and (iii) an income tax benefit of $173,000 related to the carrying
      value of deferred tax liabilities.





NINE
      MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
      30,
      2007




REVENUES:





Total
      revenues for the nine months ended September 30, 2008 increased by $311,000
      or
      2.8% to $11,523,000 compared to $11,213,000 for the nine months ended September
      30, 2007. Our Technology Services segment, which represents revenues from
      professional engineering services to Federal government Dept of Defense (DoD)
      agencies, accounted for 93% of total revenues.


15





GROSS
      MARGIN:





Gross
      margin for the nine months ended September 30, 2008 was $3,271,000, a decrease
      of $2,555,000 or 43.9% compared to the $5,826,000 for the nine months ended
      September, 2007. Gross margin as a percentage of revenues decreased to 28.4%
      from 52% for the same period in 2007. The decrease in percentage was mainly
      due
      to a higher component of our costs of sales attributable to an increased use
      of
      subcontractors in support of our government contracts, primarily the JPM-IS
      Seaport-e contract.





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 nine months ended September 30, 2008, research and
      development expenses increased to $385,000 as compared to $314,000 for the
      nine
      months ended September 30, 2007. 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, finance, administrative
      personnel, legal, accounting, consulting fees, sales commissions, marketing,
      facilities costs, corporate overhead and depreciation expense. For the nine
      months ended September 30, 2008, SG&A expenses decreased to $3,360,000 from
      $4,094,000 in the comparable period prior year. As a percentage of revenues,
      SG&A was 29.2% for the current quarter ended September 30, 2008 versus 36.5%
      in the comparable period a year ago. The decrease in SG&A was a result of:
      lower fringe and indirect overhead costs which moved in line with the decrease
      in our direct labor costs, non-recurring expenses in the prior year period
      and
      cost saving initiatives.





AMORTIZATION
      EXPENSES:





Non-cash
      amortization expenses related to intangible assets acquired in the acquisitions
      of RTI and SMEI are stated separately in our statement of operations..
      Amortization expense for the nine months ended September 30, 2008 was $1,116,000
      compared to $1,561,000 for the nine months ended September 30, 2008. The
      decrease is attributed to intangibles fully amortized in 2007.




INTEREST
      EXPENSE:





Interest
      Expense decreased to $141,000 the nine months ended September 30, 2008 compared
      to $530,000 for the nine months ended September 30, 2007. Interest expense
      in
      2008 was comprised primarily of interest charges on its revolving line-of-credit
      and short term notes. Interest expense in 2007 included $206,000 in amortized
      debt discount from the convertible debenture with Barron. The decrease is also
      due to the lower interest rate we pay on our line of credit versus year ago
      levels.





DERIVATIVE
      INCOME (EXPENSE):





The
      following table is derived from Note 5 in the accompanying financial
      statements.





Nine months
              ended
              September 30, 2008
            
            Nine months
              ended
              September 30, 2007Derivative
                income (expense)
            
            
            
            
            
            (467,120
            )Conversion
                features
            
            $
            
            
            $Warrant
                derivative
            
            $
            2,750,199
            
            $
            4,356,908





NET
      INCOME:





The
      Company's net income for the nine months ended September 30, 2008 was $5,195,000
      compared to net income of $2,848,000 for the nine months ended September 30,
      2007. Net income (loss) is influenced by the matters discussed in the other
      sections of this MD&A. However, it should be noted that the net income in
      the current period included; (i) a non-cash derivative gain of $2,750,000,
      (ii)
      an extinguishment gain of $2,608,000, (iii) other income related to the
      settlement with the former RTI shareholders of $970,000 and an income tax
      benefit of $521,000 related to the carrying value of deferred tax
      liabilities.


16





LIQUIDITY
      AND CAPITAL RESOURCES





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. For the nine
      months ended September 30, 2008 we had negative operating cash of $562,000.
      and
      the Company’s working capital deficiency at September 30, 2008 of $1,242,000
      including non-cash derivative liabilities of $598,000. These conditions raise
      doubt regarding the Company’s ability to continue as a going concern. The
      Company’s ability to continue as a going concern is dependent upon its ability
      to improve near term operating performance; maintain its line of credit
      availability and to obtain adequate alternative financing sufficient enough
      to
      support operations until the necessary operating improvements are made. Pursuant
      to the Loan Agreement, the Company is required to maintain certain financial
      covenants including a minimum current ration of 0.75:1.00 and a minimum EBITDA
      of $200,000. As of September 30, 2008, the Company was not in compliance with
      the minimum EBITDA requirement which constitutes a default on the line of
      credit. As a result of the default and in accordance with the Loan Agreement,
      the interest rate on the line of credit shall be increased by 5%. In addition,
      Private Bank is entitled to declare all amounts due under the Loan Agreement
      to
      be immediately due and payable, which as of November 14, 2008 amount to
      approximately $1,442,000. Private Bank is also entitled to cease advancing
      money
      or extending credit to the Company. Private Bank also has a right of set-off
      for
      any and all balances and deposits of the Company held by Private Bank. Further,
      Private Bank has the right to foreclose on the collateral, which includes all
      personal property of the Company. As of November 14, 2008, Private Bank has
      not
      taken any of the aforementioned actions against the Company as a result of
      the
      default. However, we can provide no assurance that they will not take such
      actions at a future date. We can not guarantee that we be successful in either
      improving our operating performance or obtaining alternative financing. We
      are
      highly dependent upon the line of credit to support our ongoing operations,
      however, at the time of this filing, we can provide no assurance that future
      advances on the line of credit will be available to us, nor that we will be
      able
      to secure alternative financing on terms acceptable to us.





Working
      capital and other activities:




The
      Company’s working capital deficiency as of September 30, 2008 amounts to
      $1,242,000 compared to a deficiency of $8,948,000 as of December 31, 2007.
      Included in the deficiency was $598,000 and $7,217,000 of non-cash derivative
      liabilities respectively. Excluding derivative liabilities, at September 30,
      2008 our current assets of $4,340,000 compared to current liabilities of
      $4,984,000.





For
      the
      nine month period ended September 30, 2008, cash and cash equivalents decreased
      slightly to $732,000 from $770,000 at December 31, 2007.





Net
      cash
      used by operating activities was $562,000 for the nine months ended September
      30, 2008 compared to net cash provided by operating activities of $536,000
      in
      the corresponding nine month period ended September 30, 2007.





Net
      cash
      provided by financing activities was $557,000 for the nine months ended
      September 30, 2008 compared to net cash used in financing of $817,000 in the
      corresponding nine months ended September 30, 2007.





Short-term
      notes at September 30, 2008 totaled $1,607,000 compared to $1,050,000 at
      December 31, 2007. Included in short term notes was an outstanding balance
      on
      our $4,000,000 line of credit facility of $1,428,000. (See Note 4 to the
      Financial Statements for a discussion of these liabilities)





The
      Company’s negative cash flow from operations of $562,000 for the nine months
      ended September 30, 2008 has been mainly financed by borrowings on its line
      of
      credit facility and the Company’s cash and cash equivalents. The outstanding
      balance on its line of credit at September 30, 2008 was $1,428,000 compared
      to
      $740,000 at December 31, 2007. As a result of the default on our line of credit
      described above, we may not be able to obtain future advances under the line
      of
      credit.


17




**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, revenues, and results
      of
      operations, liquidity or capital expenditures. The Company does not have
      adequate liquidity for the next twelve month’s to neither service its short term
      debt, satisfy a potential contingent liability of $750,000 nor fund its
      near-term negative operating cash flows until the necessary operating
      improvements are made. Accordingly, the Company is actively engaged in seeking
      alternative financing to provide adequate capital to allow it sufficient time
      to
      improve operations and service debt payments coming due in the next twelve
      months. As of this filing, the Company has not secured the financing
      required.




**CRITICAL
      ACCOUNTING POLICIES AND SENSITIVE ESTIMATES:**





**SENSITIVE
      ESTIMATES:**





The
      Company’ financial statements have been prepared in accordance with accounting
      principles generally accepted in the United States (US GAAP). The preparation
      of
      these financial statements 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.


18


**Derivative
      Financial Instruments:**





Derivative
      financial instruments are initially recorded at fair value and subsequently
      adjusted to fair value at the close of each reporting period. The Company
      estimates fair values of derivative financial instruments using various
      techniques (and combinations thereof) that are considered to be consistent
      with
      the objective measuring of fair values. In selecting the appropriate technique,
      management considers, among other factors, the nature of the instrument, the
      market risks that it embodies and the expected means of settlement. For less
      complex derivative instruments, such as free-standing warrants, the Company
      generally uses the Black-Scholes-Merton option valuation technique because
      it
      embodies all of the assumptions (including trading volatility, estimated terms
      and risk free rates) necessary to fair value these instruments. For complex
      derivative instruments, such as embedded conversion options, the Company
      generally uses the Flexible Monte Carlo valuation technique because it embodies
      all of the requisite assumptions (including credit risk, interest rate risk
      and
      exercise/conversion behaviors) that are necessary to fair value these more
      complex instruments. For forward contracts that contingently require net-cash
      settlement as the principal means of settlement, the Company projects and
      discounts future cash flows applying probability-weightage to multiple possible
      outcomes. Estimating fair values of derivative financial instruments, requires
      the development of significant and subjective estimates that may, and are likely
      to, change over the duration of the instrument with related changes in internal
      and external market factors. In addition, option-based techniques are highly
      volatile and sensitive to changes in the trading market price of our common
      stock, which has a high-historical volatility. Since derivative financial
      instruments are initially and subsequently carried at fair values, our income
      (loss) will reflect the volatility in these estimate and assumption
      changes.





**Revenue
      Recognition:**





Revenue
      is recognized when all significant contractual obligations have been satisfied
      and collection of the resulting receivable is reasonably assured. Revenue from
      product sales is recognized when the goods are shipped and title passes to
      the
      customer.





The
      company applies the guidance of SOP-97.2, "Interim Guidance for Conducting
      Aggregate Exposure and Risk Assessments," with regards to its software products.
      Under this guidance, the Company determined that its product sales do not
      contain multiple deliverables for an extended period beyond delivery where
      bifurcation of multiple elements is necessary. The software is embedded in
      the
      products sold and shipped. Revenue is recognized upon delivery, installation
      and
      acceptance by the customer. PCS (post contract customer support) and upgrades
      are billed separately and when rendered or delivered and not contained in the
      original arrangement with the customer. Installation services are included
      with
      the original customer arrangement but are rendered at the time of delivery
      of
      the product and invoicing.





The
      Company provides IT and business process outsourcing services under
      time-and-material, fixed-price contracts, which may extend up to 5 years.
      Services provided over the term of these arrangements may include, network
      engineering, architectural guidance, database management, expert programming
      and
      functional area expert analysis   Revenue is generally recognized when the
      product or service is provided and the amount earned is not contingent upon
      any
      further event.





**Impairments
      of long-lived assets:**





At
      least
      annually, the Company reviews all long-lived assets with determinate lives
      for
      impairment. Long-lives assets subject to this evaluation include property and
      equipment and intangible assets that amount to $11,906,827 (or 75%) of total
      assets at September 30, 2008. The Company considers the possibility that
      impairments may exist when indicators of impairment are present. In the event
      that indicators are identified or, if within management’s normal evaluation
      cycle, the Company establishes the presence of possible impairment by comparing
      asset carrying values to undiscounted projected cash flows. The preparation
      of
      cash flow projections requires management to develop many estimates about the
      Company’s performance. These estimates include consideration of revenue streams
      from existing customer bases, the potential increase and decrease in customer
      sales activity and potential changes in the Company’s direct and indirect costs.
      In addition, if the carry values of long-lived assets exceed undiscounted cash
      flow, the Company would estimate the impairment based upon discounted cash
      flow.
      The development of discount rates necessary to develop this cash flow
      information requires additional assumptions, including the development of market
      and risk adjusted rates for discounting cash flows. While management utilizes
      all available information in developing these estimates, actual results are
      likely to be different from those estimates.





Goodwill
      represents the difference between the purchase price of an acquired business
      and
      the fair value of the net assets of businesses the Company has acquired.
      Goodwill is not amortized. Rather, 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
      of the reporting unit to determine if there is an indication that potential
      impairment may exist. One of the most significant assumptions underlying this
      process is the projection of future sales. The Company reviews its assumptions
      when goodwill is tested for impairment and makes appropriate adjustments, if
      any, based on facts and circumstances available at that time. While management
      utilizes all available information in developing these estimates, actual results
      are likely to be different than those estimates.


19


**ITEM
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK.**




N/A.





**ITEM
      4T. CONTROLS AND PROCEDURES.**





**Evaluation
      of Disclosure Controls and Procedures**




Our
      management is responsible for establishing and maintaining a system of
      disclosure controls and procedures (as defined in Rule 13a-15(e)) under the
      Exchange Act) that is designed to ensure that information required to be
      disclosed by the Company in the reports that we file or submit under the
      Exchange Act is recorded, processed, summarized and reported, within the time
      specified in the Commission's rules and forms. Disclosure controls and
      procedures include, without limitation, controls and procedures designed to
      ensure that information required to be disclosed by an issuer in the reports
      that it files or submits under the Exchange Act is accumulated and communicated
      to the issuer's management, including its principal executive officer or
      officers and principal financial officer or officers, or persons performing
      similar functions, as appropriate to allow timely decisions regarding required
      disclosure.




Pursuant
      to Rule 13a-15(b) under the Exchange Act the Company carried out an evaluation
      with the participation of the Company’s management, including Paul Burgess, the
      Company’s Chief Executive Officer (“CEO”) and Joe Noto, the Company’s Chief
      Financial Officer (“CFO”), of the effectiveness of the Company’s disclosure
      controls and procedures (as defined under Rule 13a-15(e) under the Exchange
      Act)
      as of the nine months ended September 30, 2008. Based upon that evaluation,
      the
      Company’s CEO and CFO concluded that the Company’s disclosure controls and
      procedures were not effective to ensure that information required to be
      disclosed by the Company in the reports that the Company files or submits under
      the Exchange Act, is recorded, processed, summarized and reported, within the
      time periods specified in the SEC’s rules and forms, and that such information
      is accumulated and communicated to the Company’s management, including the
      Company’s CEO and CFO, as appropriate, to allow timely decisions regarding
      required disclosure. As disclosed in the Company’s 10-KSB for the year ended
      December 31, 2007, the Company’s CEO and CFO concluded that the limited
      financial backgrounds of certain members of the Company’s executive management
      team beyond its CFO are inhibiting its financial reporting process. The Company
      intends to hire additional personnel with more substantial financial backgrounds
      but has not done so to date.




**Changes
      in internal controls**




Our
      management, with the participation 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 2008
      Quarter ended September 30, 2008.  Based on that evaluation, our Chief
      Executive Officer and our Chief Financial Officer concluded that no change
      occurred in the Company's internal controls over financial reporting during
      the
      2008 Quarter ended September 30, 2008 that has materially affected, or is
      reasonably likely to materially affect, the Company's internal controls over
      financial reporting.


20


**PART
      II**




**OTHER
      INFORMATION**





**ITEM
      1 - LEGAL PROCEEDINGS**




In
      June
      2008, the Company filed suit in New Jersey Superior Court against Michael
      Ricciardi and Marie Ricciardi, former shareholders of Ricciardi Technologies,
      Inc. (“RTI”), along with the Domenix Corporation, a company owned by Marie
      Ricciardi and operated by her and Michael Riccardi. The defendants removed
      the
      case to the United States District Court for the district of New Jersey, where
      it was pending under the caption, *Lattice,
      Inc. v.Marie Ricciardi, et al.,* Civil
      Action No. 08 cv 3208 (the “New Jersey Action”). The New Jersey Action sought to
      enforce the restrictive covenant contained in the September 12, 2006 Stock
      Purchase Agreement (the “SPA”), pursuant to which the Company purchased RTI
      from, *inter
      alia,* the
      Ricciardis. The restrictive covenant prohibited the former owners of RTI from
      (a) competing, directly or indirectly against Lattice and RTI and/or (b)
      soliciting employees or others engaged by RTI for a period of three years from
      the date of the SPA. The Company sought a preliminary injunction to prevent
      Marie Ricciardi, acting in concert with her husband and through Domenix, from
      continuing to breach the restrictive covenant and damages in an as yet
      undetermined amount for damages resulting from the breach. A hearing on
      Lattice’s motion for preliminary injunction occurred on August 7, 2008.





Michael
      Ricciardi also filed a suit against the Company in June, 2008, in the United
      States District Court for the Eastern District of Virginia under the
      caption *Michael
      Ricciardi v. Lattice, Inc.,* Civil
      Action No. 1:08-cv-519 (the “Virginia Action”) In the Virginia Action, Michael
      Ricciardi (a) disputes the Company’s claim (the “Indemnity Claim”) that it is
      entitled to be paid approximately $308,000, plus fees and costs, from the escrow
      created pursuant to the SPA to cover its Indemnifiable Losses (a defined term
      under the SPA), claiming instead that the entire escrow should be dispersed
      to
      him as the representative of the RTI shareholders, as provided for in the SPA,
      and (b) asserts that a contingent $1.5 million Earn Out Payment (as such term
      is
      defined in the SPA) provided for in the SPA is due and payable by the Company
      to
      the former shareholders of RTI.





In
      September 2008, the Company and former RTI shareholders signed a settlement
      agreement (the “Settlement Agreement”) whereby $150,000 of the amount held in
      escrow pursuant to the SPA will be returned to the Company. As of September
      30,
      2008, we recorded a receivable for such amount in other current assets. In
      October 2008, we received the funds. In
      addition, pursuant to the Settlement Agreement, Michael Ricciardi and Marie
      Ricciardi agreed to return 497,840 shares of the Company’s preferred stock and
      290,407 shares of the Company’s common stock. Pursuant to the Settlement
      Agreement, the Company agreed to pay the former shareholders of RTI the
      aggregate sum of $750,000 as settlement of the Earn Out Payment, which amount
      shall be paid over the next twenty-four months, consisting of interest only
      for
      the first twelve months and then twelve monthly installments of $62,500 plus
      interest.





**ITEM
      1A. RISK FACTORS**




There
      have been no material changes from the Risk Factors described in our Annual
      Report on Form 10-KSB for the fiscal year ended December 31,
      2007.


21


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




None .





**ITEM
      3 - DEFAULTS UPON SENIOR SECURITIES**




On
      March
      7, 2008, the Company entered into a Loan and Security Agreement (the “Loan
      Agreement”) with the Private Bank of Peninsula (“Private Bank”), pursuant to
      which Private Bank agreed to extend a lien of credit of up to $4.0 million
      to
      the Company. Pursuant to the Loan Agreement, the Company is required to maintain
      certain financial covenants including a minimum current ration of 0.75:1.00
      and
      a minimum EBITDA of $200,000. As of September 30, 2008, the Company was not
      in
      compliance with the minimum EBITDA requirement which constitutes a default
      on
      the line of credit. As a result of the default and in accordance with the Loan
      Agreement, the interest rate on the line of credit shall be increased by 5%.
      In
      addition, Private Bank is entitled to declare all amounts due under the Loan
      Agreement to be immediately due and payable, which as of November 14, 2008
      amount to approximately $1,442,000. Private Bank is also entitled to cease
      advancing money or extending credit to the Company. Private Bank also has a
      right of set-off for any and all balances and deposits of the Company held
      by
      Private Bank. Further, Private Bank has the right to foreclose on the
      collateral, which includes all personal property of the Company. As of November
      14, 2008, Private Bank has not taken any of the aforementioned actions against
      the Company as a result of the default.





**ITEM
      4 - SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS**




None.





**ITEM
      5 - OTHER INFORMATION**




None.




There
      were no material changes to the procedures by which security holders may
      recommend nominees to the registrant’s board of directors.





**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 Act31.2
            
            Certification
                by Chief Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a)
                of the Exchange Act32.1
            
            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 Code32.2
            
            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




22


**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:
      November 17, 2008**




**LATTICE INCORPORATED***BY:*
            */s/ Paul Burgess**PAUL BURGESS**CHIEF EXECUTIVE OFFICER*
              *(PRINCIPAL EXECUTIVE**OFFICER),**SECRETARY AND**DIRECTOR*




*BY:*
            */s/ Joe Noto**JOE NOTO**CHIEF FINANCIAL OFFICER*
              *(PRINCIPAL ACCOUNTING**OFFICER) AND DIRECTOR*




23