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 JUNE 30, 2010.
 
 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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  oNo o
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large
      accelerated filer o
                Accelerated
      filer oNon-accelerated
      filer o
                Smaller
      reporting company x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes  o No x
 
 APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
 DURING
THE PRECEDING FIVE YEARS
 
 Indicate
by check mark whether the registrant filed all documents and reports required to
be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution
of securities under a plan confirmed by a court. Yes  o No  o
 
 APPLICABLE
ONLY TO CORPORATE ISSUERS
 
 State the
number of shares outstanding of each of the issuer's classes of common equity,
as of the latest practicable date: As of August 19, 2010, there were 22,639,551
outstanding shares of the Registrant's Common Stock, $.01 par
value.
 
 
 
 LATTICE
INCORPORATED
 JUNE
30, 2010 QUARTERLY REPORT ON FORM 10-Q
 
 TABLE
OF CONTENTS
 
 PagePART
      I - FINANCIAL INFORMATIONItem
      1. Financial Statements
                3Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                11Item
      3. Quantitative and Qualitative Disclosure About Market
    Risks
                17Item
      4T. Controls and Procedures
                17PART
      II - OTHER INFORMATIONItem
      1. Legal Proceedings
                18Item
      1A. Risk Factors
                18Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                18Item
      3. Defaults Upon Senior Securities
                18Item
      4. Reserved
                18Item
      5. Other Information
                18Item
      6. Exhibits
                18SIGNATURES
                19
  
 2
  ITEM 1. FINANCIAL STATEMENTS
 
 LATTICE
      INCORPORATED AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF OPERATIONSThree
      Months Ended June 30,
                  
                  
                  Six
      Months Ended June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenue
                  
                  $
                  3,373,737
                  
                  
                  $
                  4,166,700
                  
                  
                  $
                  7,114,794
                  
                  
                  $
                  7,974,583Cost
      of Revenue
                  
                  
                  1,981,885
                  
                  
                  
                  2,884,506
                  
                  
                  
                  4,549,436
                  
                  
                  
                  5,441,009Gross
      Profit
                  
                  
                  1,391,852
                  
                  
                  
                  1,282,194
                  
                  
                  
                  2,565,358
                  
                  
                  
                  2,533,574Operating  expenses:Selling,
      general and administrative
                  
                  
                  1,090,745
                  
                  
                  
                  1,239,801
                  
                  
                  
                  2,288,822
                  
                  
                  
                  2,361,793Research
      and development
                  
                  
                  144,799
                  
                  
                  
                  143,182
                  
                  
                  
                  300,330
                  
                  
                  
                  295,677Amortization
      expense and depreciation expense
                  
                  
                  172,136
                  
                  
                  
                  299,248
                  
                  
                  
                  281,272
                  
                  
                  
                  598,496Total
      operating expenses
                  
                  
                  1,407,680
                  
                  
                  
                  1,682,231
                  
                  
                  
                  2,870,424
                  
                  
                  
                  3,255,966Loss
      from operations
                  
                  
                  (15,828
                  )
                  
                  
                  (400,037
                  )
                  
                  
                  (305,066
                  )
                  
                  
                  (722,392
                  )Other
      income (expense):Derivative
      expense
                  
                  
                  (13,726
                  )
                  
                  
                  108,373
                  
                  
                  
                  (109,673
                  )
                  
                  
                  (64,070
                  )Extinguishment
      ( loss)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (130,055
                  )
                  
                  
                  -Other
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Interest
      expense
                  
                  
                  (94,069
                  )
                  
                  
                  (48,897
                  )
                  
                  
                  (175,840
                  )
                  
                  
                  (126,114
                  )Total
      other income
                  
                  
                  (107,795
                  )
                  
                  
                  59,476
                  
                  
                  
                  (415,568
                  )
                  
                  
                  (190,184
                  )Minority
      Interest
                  
                  
                  3,147
                  
                  
                  
                  5,052
                  
                  
                  
                  6,294
                  
                  
                  
                  10,447Income
      before taxes
                  
                  
                  (120,476
                  )
                  
                  
                  (335,509
                  )
                  
                  
                  (714,340
                  )
                  
                  
                  (902,129
                  )Income
      taxes (benefit)
                  
                  
                  (61,440
                  )
                  
                  
                  (163,355
                  )
                  
                  
                  (122,880
                  )
                  
                  
                  (326,710
                  )Net
      loss
                  
                  
                  (59,036
                  )
                  
                  
                  (172,154
                  )
                  
                  
                  (591,460
                  )
                  
                  
                  (575,419
                  )Reconciliation
      of net loss toLoss
      applicable to common shareholders:Net
      loss
                  
                  
                  (59,036
                  )
                  
                  
                  (172,154
                  )
                  
                  
                  (591,460
                  )
                  
                  
                  (575,419
                  )Preferred
      stock dividends
                  
                  
                  (6,277
                  )
                  
                  
                  (6,277
                  )
                  
                  
                  (12,554
                  )
                  
                  
                  (12,554
                  )Loss
      applicable to common stockholders
                  
                  
                  (65,313
                  )
                  
                  
                  (178,431
                  )
                  
                  
                  (604,014
                  )
                  
                  
                  (587,973
                  )Loss
      per common shareBasic
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.04
                  )Diluted
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.04
                  )Weighted
      average shares:Basic
                  
                  
                  22,639,450
                  
                  
                  
                  16,739,444
                  
                  
                  
                  21,631,755
                  
                  
                  
                  16,720,555Diluted
                  
                  
                  22,639,450
                  
                  
                  
                  16,739,444
                  
                  
                  
                  21,631,755
                  
                  
                  
                  16,720,555See
      accompanying notes to the consolidated financial
    statements.
  3
  LATTICE
      INCORPORATED AND SUBSIDIARIESCONSOLIDATED
      BALANCE SHEETSJune
      30,
                  
                  
                  December
      31,2010
                  
                  
                  2009unaudited
                  
                  
                  auditedASSETS:Current
      assets:Cash
      and cash equivalents
                  
                  $
                  835,737
                  
                  
                  $
                  212,616Accounts
      receivable
                  
                  
                  3,090,778
                  
                  
                  
                  3,560,293Inventories
                  
                  
                  29,402
                  
                  
                  
                  29,402Other
      current assets
                  
                  
                  297,822
                  
                  
                  
                  133,405Total
      current assets
                  
                  
                  4,253,739
                  
                  
                  
                  3,935,716Property
      and equipmen, net
                  
                  
                  265,691
                  
                  
                  
                  264,753Goodwill
                  
                  
                  3,599,386
                  
                  
                  
                  3,599,386Other
      intangibles, net
                  
                  
                  1,933,184
                  
                  
                  
                  977,455Other
      assetes
                  
                  
                  47,262
                  
                  
                  
                  54,259Total
      assets
                  
                  $
                  10,099,262
                  
                  
                  $
                  8,831,569LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                  
                  $
                  2,032,352
                  
                  
                  $
                  1,780,143Accrued
      expenses
                  
                  
                  1,426,323
                  
                  
                  
                  1,719,831Customer
      deposits
                  
                  
                  249,179
                  
                  
                  
                  94,954Notes
      payable - current
                  
                  
                  1,503,742
                  
                  
                  
                  1,503,742Derivative
      liability
                  
                  
                  183,458
                  
                  
                  
                  161,570Total
      current liabilities
                  
                  
                  5,395,054
                  
                  
                  
                  5,260,240Long
      term liabilities:Notes
      Payable - long term
                  
                  
                  1,324,143
                  
                  
                  
                  188,466Deferred
      tax liabilities
                  
                  
                  317,952
                  
                  
                  
                  440,832Total
      long term liabilities
                  
                  
                  1,642,095
                  
                  
                  
                  629,298Total
      liabilities
                  
                  
                  7,037,149
                  
                  
                  
                  5,889,538Shareholders'
      equityPreferred
      Stock - .01 par valueSeries
      A 9,000,000 shares authorized 7,530,681 and 7,567,685 issued
      respectively
                  
                  
                  75,307
                  
                  
                  
                  75,677Series
      B 1,000,000 shares authorized 1,000,000 issued and 502,160
      outstanding
                  
                  
                  10,000
                  
                  
                  
                  10,000Series
      C 520,000 shares authorized  520,000 issued
                  
                  
                  5,200
                  
                  
                  
                  5,200Common
      stock - .01 par value, 200,000,000 authorized,
                  
                  
                  229,425
                  
                  
                  
                  178,10422,942,437
      and 17,810,281 issued, 22,639,450 and 17,507,294 outstanding
      respectivelyAdditional
      paid-in capital
                  
                  
                  39,605,182
                  
                  
                  
                  38,925,743Accumulated
      deficit
                  
                  
                  (36,455,906
                  )
                  
                  
                  (35,851,892
                  )3,469,208
                  
                  
                  
                  3,342,832Stock
      held in treasury, at cost
                  
                  
                  (558,096
                  )
                  
                  
                  (558,096
                  )Equity
      Attributable to shareowners of Lattice Incorporated
                  
                  
                  2,911,112
                  
                  
                  
                  2,784,736Equity
      Attributable to noncontrolling interest
                  
                  
                  151,001
                  
                  
                  
                  157,295Total
      liabilities and shareholders' equity
                  
                  $
                  10,099,262
                  
                  
                  $
                  8,831,569See
      accompanying notes to the consolidated financial
    statements.
  4
  LATTICE
      INCORPORATED AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWSSix
      Month's ended June 30,2010
                  
                  
                  2009Cash
      flow from operating activities:Net
      loss
                  
                  $
                  (591,459
                  )
                  
                  $
                  (575,419
                  )Adjustments to reconcile net income to net cash provided by (used in)
      operating activities:Derivative
      income
                  
                  
                  109,673
                  
                  
                  
                  64,070Amortization
      of intangible assets
                  
                  
                  344,272
                  
                  
                  
                  598,496Deferred
      income taxes
                  
                  
                  (122,880
                  )
                  
                  
                  (326,710
                  )Extinguishment
      loss
                  
                  
                  130,055
                  
                  
                  
                  -Minority
      interest
                  
                  
                  (6,294
                  )
                  
                  
                  (10,447
                  )Share-based
      compensation
                  
                  
                  262,550
                  
                  
                  
                  251,266Depreciation
                  
                  
                  29,489
                  
                  
                  
                  -Changes
      in operating assets and liabilities:
                  
                  
                  -(Increase)
      decrease in:Accounts
      receivable
                  
                  
                  469,515
                  
                  
                  
                  (1,184,897
                  )Other
      current assets
                  
                  
                  16,582
                  
                  
                  
                  (155,601
                  )Other
      assets
                  
                  
                  6,997
                  
                  
                  
                  (1,275
                  )Increase
      (decrease) in:
                  
                  
                  
                  
                  
                  
                  -Accounts
      payable and accrued liabilities
                  
                  
                  (53,854
                  )
                  
                  
                  971,355Customer
      advances
                  
                  
                  154,225
                  
                  
                  
                  -Total
      adjustments
                  
                  
                  1,340,330
                  
                  
                  
                  206,257Net
      cash provided by (used for) operating activities
                  
                  
                  748,871
                  
                  
                  
                  (369,162
                  )Cash
      Used in investing activities:Purchase
      of intangibles
                  
                  
                  (1,300,000
                  )
                  
                  
                  -Purchase
      of equipment
                  
                  
                  (30,427
                  )
                  
                  
                  (32,773
                  )Net
      cash used for investing activities
                  
                  
                  (1,330,427
                  )
                  
                  
                  (32,773
                  )Cash
      flows from financing activities:Revolving
      credit facility (payments) borrowings, net
                  
                  
                  (45,714
                  )
                  
                  
                  (775,950
                  )Payments
      on captial equipment lease
                  
                  
                  (19,169
                  )
                  
                  
                  -Proceeds
      from the issuance of Note
                  
                  
                  1,100,000Proceeds
      from issuance of Series A preferred stock
                  
                  
                  250,000
                  
                  
                  
                  -Loans
      paid director
                  
                  
                  (80,441
                  )
                  
                  
                  (14,000
                  )Net
      cash provided by (used in) financing activities
                  
                  
                  1,204,676
                  
                  
                  
                  (789,950
                  )Net
      increase (decrease) in cash and cash equivalents
                  
                  
                  623,120
                  
                  
                  
                  (1,191,885
                  )Cash
      and cash equivalents - beginning of period
                  
                  
                  212,616
                  
                  
                  
                  1,363,130Cash
      and cash equivalents - end  of period
                  
                  $
                  835,736
                  
                  
                  $
                  171,245Supplemental
      cash flow informationInterest
      paid in cash
                  
                  $
                  172,168
                  
                  
                  $
                  100,769Taxes
      paid
                  
                  
                  2,850
                  
                  
                  
                  4,805Supplemental
      disclosures of Non-Cash Investing & Financing
    ActivitiesSale
      of accts receivable by factor proceeds paid directly to Private
      Bank
                  
                  
                  
                  
                  
                  
                  682,232Proceeds
      from Factoring agreement paid directly to Private Bank
      Facility
                  
                  
                  
                  
                  
                  
                  6,277Preferred
      stock dividends
                  
                  
                  
                  
                  
                  
                  -Conversion
      of preferred shares into common
                  
                  
                  (14,370
                  )
                  
                  
                  (280
                  )Conversion
      of preferred shares into  common
                  
                  
                  51,322
                  
                  
                  
                  1,000Additonal
      paid in capital
                  
                  
                  (36,951
                  )
                  
                  
                  (720
                  )Exchange
      of warrants for preferred series ADerivative
      liabilities
                  
                  
                  87,785Additional
      paid in Capital
                  
                  
                  453,840Deferred
      financing fees
                  
                  
                  150,000See
      accompanying notes to the consolidated financial
    statements.
  5
 
 Lattice
Incorporated and Subsidiaries
 Notes
to Condensed Consolidated Financial Statements
 June
30, 2010 (Unaudited)
 
 Note
1 - Organization and summary of significant accounting policies:
 
 a)
Organization
 
 Lattice
Incorporated (the "Company") was incorporated in the State of Delaware May 1973
and commenced operations in July 1977. The Company began as a provider of
specialized solutions to the telecom industry. Throughout its history Lattice
has adapted to the changes in this industry by reinventing itself to be more
responsive and open to the dynamic pace of change experienced in the broader
converged communications industry of today. Currently Lattice provides advanced
solutions for several vertical markets. The greatest change in operations is in
the shift from being a component manufacturer to a solution provider focused on
developing applications through software on its core platform technology. To
further its strategy of becoming a solutions provider, the Company acquired a
majority interest in “SMEI” in February 2005. In September 2006 the Company
purchased all of the issued and outstanding shares of the common stock of
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 through 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 76% of the
Company’s revenues are derived from solution services.  In December
2009 we changed RTI’s name to Lattice Government Services Inc.  In
January 2007, we changed our name from Science Dynamics Corporation to Lattice
Incorporated.
 
 b)
Basis of Presentation going concern
 
 At June
30, 2010 the Company has a working capital deficiency of $1,141,315 including
non-cash derivative liabilities of approximately $183,000.  For the
three months ended June 30, 2010, the Company had a loss from operations
of  $15,828 of which $318,155 was from non-cash items. For the six months
ended June 30, 2010, the reported loss from operations was
$305,066.  For the six months, non-cash expenses included in the
reported loss of $305,066 totaled $636,311 consisted
of   $373,761 in amortization of intangibles and depreciation and
$262,550 from non-cash share based compensation.   During the past
quarter, the Company obtained long-term financing to repay shorter-term
obligations when due. These conditions taken in conjunction with the Company’s
history of operating losses raises doubt regarding the Company’s ability to
continue as a going concern. The Company’s ability to continue as a going
concern is highly dependent upon management’s ability to increase operating cash
flows, continued availability on its line of credit and the ability to obtain
alternative financing to fund capital requirements and/or debt repayments coming
due in the next twelve months. The accompanying financial statements do not
include any adjustments that may result from the outcome of this
uncertainty.
 
 c) Interim Condensed Consolidated
Financial Statements
 
 The
condensed consolidated financial statements as of June 30, 2010 and for
the three and six months ended June 30, 2010 are
unaudited.   In the opinion of management, such condensed
consolidated financial statements include all adjustments (consisting of normal
recurring accruals) necessary for the fair representation of the consolidated
financial position and the consolidated results of
operations.   The consolidated results of operations for the
periods presented are not necessarily indicative of the results to be expected
for the full year.  The interim condensed consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements for the year end December 31, 2009 appearing in Form 10K filed on
April 15, 2010.
 
 d) 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.
 
 e) Use of
estimates:
 
 The
preparation of these financial statements in accordance with accounting
principles generally accepted in the United States (US GAAP) requires management
to make estimates and assumptions that affect the reported amounts in the
financial statements and accompanying notes. These estimates form the basis for
judgments made about the carrying values of assets and liabilities that are not
readily apparent from other sources. Estimates and judgments are based on
historical experience and on various other assumptions that the Company believes
are reasonable under the circumstances. However, future events are subject to
change and the best estimates and judgments routinely require adjustment. US
GAAP requires estimates and judgments in several areas, including those related
to impairment of goodwill and equity investments, revenue recognition,
recoverability of inventory and receivables, the useful lives long lived assets
such as property and equipment, the future realization of deferred income tax
benefits and the recording of various accruals. The ultimate outcome and actual
results could differ from the estimates and assumptions used.
 
 6
 
 f)
Share-based payments
 
 On
January 1, 2006, the Company adopted the fair value recognition provisions of
Financial Accounting Standards Board  Accounting Standards
Condification 718-10, Accounting for Share-based
payments , to account for compensation costs under its stock option plans
and other share-based arrangements.  ASC 718 requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the financial statements based on their fair values. For
purposes of estimating fair value of stock options, we use the
Black-Scholes-Merton valuation technique. At June 30, 2010, there was
approximately $437,158 of total unrecognized compensation cost related to
unvested share-based compensation awards granted. The $437,158 will be charged
to operations over the weighted average remaining service period. For the three
months and six months ended June 30, 2010 share-based compensation was $131,275
and $262,500 respectively. This compared to $125,631 and $251,266 in the prior
year periods.
 
 g)
Reclassifications
 
 Certain
items have been reclassified in the accompanying consolidated Financial
Statements and Notes for prior periods to be comparable with the classification
for the period ended March 31, 2010. The reclassification had no effect on
previously reported Net income.
 
 Certain
prior period amounts have been reclassified to conform to the current
presentation. Such reclassifications were limited to the statement of Operations
presentation and did not impact the Net Income (Loss). Specially, the Company
reclassified revenues from “Revenue – Technology Services and Revenue –
Technology Products to “Revenue”, with prior periods updated to conform to this
presentation.
 
 h)
Revenue Recognition
 
 Revenues
related to collect and prepaid calling services generated by the communication
services  segment are recognized during the period in which the calls
are made. In addition, during the same period, the Company records the related
telecommunication costs for validating, transmitting, billing and collection,
and line and long distance charges, along with commissions payable to the
facilities and allowances for uncollectible calls, based on historical
experience.
 
 Government
claims: Unapproved claims relate to contracts where costs have exceeded the
customer’s funded value of the task ordered on our cost reimbursement type
contract vehicles. The unapproved claims are considered to be probable of
collection and have been recognized as revenue. Unapproved claims included as a
component of our Accounts Receivable totaled approximately $1,525,000 and
$1,245,000 as of June 30, 2010 and December 31, 2009, respectively. Consistent
with industry practice, we classify assets and liabilities related to these
claims as current, even though some of these amounts are not expected to be
realized within one year.
  Additional
revenue recognition policies are stated in our 10K filed April 15,
2010.
 
 i)
Segment Reporting
 
 FASB ASC
280-10-50, “Disclosure about Segments of an Enterprise and Related Information”
requires use of the “management approach” model for segment
reporting.  The management approach model is based on the way a
company’s management organizes segments within the company for making operating
decisions and assessing performance.  Reportable segments are based on
products and services, geography, legal structure, management structure, or any
other manner in which management disaggregates a company.  The Company
operates in two segments for the six months ended June 30, 2010. Prior to 2010
the company operated in one segment.
 
 j)
Recent accounting pronouncements
 
 The FASB
issued guidance on revenue recognition that will become effective for us
beginning July 1, 2010, with earlier adoption permitted. Under the new
guidance on arrangements that include software elements, tangible products that
have software components that are essential to the functionality of the tangible
product will no longer be within the scope of the software revenue recognition
guidance, and software-enabled products will now be subject to other relevant
revenue recognition guidance. Additionally, the FASB issued guidance on revenue
arrangements with multiple deliverables that are outside the scope of the
software revenue recognition guidance. Under the new guidance, when vendor
specific objective evidence or third party evidence for deliverables in an
arrangement cannot be determined, a best estimate of the selling price is
required to separate deliverables and allocate arrangement consideration using
the relative selling price method. The new guidance includes new disclosure
requirements on how the application of the relative selling price method affects
the timing and amount of revenue recognition. We believe adoption of this new
guidance will not have a material impact on our financial
statements.
  
 7
  Note
2- Segment reporting
 
 Management
views its business as two reportable segments: Government Services and
Communication Services. The Company evaluates performance based on profit or
loss before intercompany charges.
 
 Three Months Ended
                  
                  
                  Six Months EndedJune
      30,
                  
                  
                  June
      30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenues:Goverment
      Services
                  
                  $
                  2,519,118
                  
                  
                  $
                  3,860,923
                  
                  
                  $
                  5,430,953
                  
                  
                  $
                  7,367,448Communication
      Serivices
                  
                  
                  854,620
                  
                  
                  
                  305,777
                  
                  
                  
                  1,683,842
                  
                  
                  
                  607,135Total
      Consolidated Revenues
                  
                  $
                  3,373,738
                  
                  
                  $
                  4,166,700
                  
                  
                  $
                  7,114,795
                  
                  
                  $
                  7,974,583Gross
      Profit:Government
      Services
                  
                  $
                  1,137,065
                  
                  
                  $
                  1,084,064
                  
                  
                  $
                  2,104,242
                  
                  
                  $
                  2,149,493Communication
      Serivices
                  
                  
                  301,030
                  
                  
                  
                  198,130
                  
                  
                  
                  553,604
                  
                  
                  
                  384,081Total
      Consolidated
                  
                  $
                  1,438,095
                  
                  
                  $
                  1,282,194
                  
                  
                  $
                  2,657,846
                  
                  
                  $
                  2,533,574
   June
      30,
                    2010
                  
                  
                  December
      31,
                    2009Total
      Assets:Government
      Services
                  
                  $
                  7,821,000
                  
                  
                  $
                  8,270,589Communication
      Services
                  
                  
                  2,278,000
                  
                  
                  
                  560,980Total
      Consolidated Assets
                  
                  $
                  10,099,000
                  
                  
                  $
                  8,831,569
  Note 3
- Notes payable
 
 Notes
payable consists of the following as of June 30, 2010 and December 31,
2009:
 
 June
      30,
                    2010
                  
                  
                  December 31,
                    2009Bank
      line-of-credit (a)
                  
                  $
                  792,517
                  
                  
                  $
                  838,231Note
      Payable –  (b)
                  
                  
                  531,000
                  
                  
                  
                  562,500Notes
      payable to Stockholders/director (c )
                  
                  
                  179,239
                  
                  
                  
                  197,180Capital
      lease payable (d)
                  
                  
                  75,129
                  
                  
                  
                  94,297Note
      Payable – I Wistar Morris (e)
                  
                  
                  1,250,000
                  
                  
                  
                  -Total
      notes payable
                  
                  
                  2,827,885
                  
                  
                  
                  1,692,208Less
      current maturities
                  
                  
                  (1,503,742
                  )
                  
                  
                  (1,503,742
                  )Long-term
      debt
                  
                  $
                  1,324,143
                  
                  
                  $
                  188,466
  8
 
 (a)
Bank line-of-credit:
 
 On July
17, 2009, the Company and its wholly-owned subsidiary, Lattice Government
Services (formally “RTI”), entered into a Financing and Security Agreement (the
“Action Agreement”) with Action Capital Corporation (“Action
Capital”).
 
 Pursuant
to the terms of the Action Agreement, Action Capital agreed to provide the
Company with advances of up to 90% of the net amount of certain acceptable
account receivables of the Company (the “Acceptable Accounts”).  The
maximum amount eligible to be advanced to the Company by Action Capital under
the Action Agreement is $3,000,000.  The Company will pay Action
Capital interest on the advances outstanding under the Action Agreement equal to
the prime rate of Wachovia Bank, N.A. in effect on the last business day of the
prior month plus 1%.  In addition, the Company will pay a monthly fee
to Action Capital equal to 0.75% of the total outstanding balance at the end of
each month.
 
 In
addition, pursuant to the Action Agreement, the Company granted Action Capital a
security interest in certain assets of the Company including all, accounts
receivable, contract rights, rebates and books and records pertaining to the
foregoing (the “Action Lien”). On June 11, 2010, Action Capital and I. Wistar
Morris entered into an agreement under which $1,250,000 of the collateral
otherwise securing advances covered by the Action Agreement are subordinated to
a new security interest securing an additional load from Morris.
 
 The
outstanding balance owed on the line at June 30, 2010 and December 31, 2009 was
$792,517 and $838,231 respectively.
 
 (b)
Note payable
 
 In  February
2010 (“effective date”)the former RTI shareholders   assigned their
interest in the note to a third party, at which time the Company
amended  the terms of the note  to pay interest only and
extend the maturity for 18 months with a balloon payment August 19, 2012. The
holder has a call option on the principal balance of $531,000 which includes
$31,000 in deferred financing fees after twelve months from the effective date
upon written notification 45 days in advance. The balance at June 30, 2010 and
December 31, 2009 was $531,000 and  $562,500
respectively.
 
 (c)
Notes payable Director:
 
 The
Company has a term note payable with a director of the Company totaling $179,239
and $197,180 at June 30, 2010 and  December 31, 2009, respectively.
The note bears interest at 21.5% per annum   In February 2010 the Company
renegotiated the terms of the note as follows:
 
 Monthly
principal payments:
 
 $6,000
from February 1, 2010 to July 1, 2010
 $9,869
from August 1, 2010 to December 1, 2010
 $10,368
from January 1, 2011 to July 1, 2011
 Balance
due of $85,011 August 1, 2011
 
 (d)
Capital Lease Payable:
 
 On June
16, 2009 Lattice entered an equipment lease financing agreement with Royal Bank
America Leasing  to purchase approximately $130,000 in equipment for
our communication services. The terms of which included monthly payments of
$5,196 per month over 32 months and a  $1.00 buy-out at end of the
lease term. As of June 30, 2010 and December 31, 2009, the outstanding balance
was $75,129 and $94,297 respectively.
 
 (e)
Note Payable – I. Wistar Morris
 
 On June
11, 2010 Lattice closed on a Note Payable with I. Wistar Morris for
$1,250,000.  The proceeds to the Company were $1,100,000. The note
matures June 30, 2012 and payment of principal will be due at that time in the
lump sum value of $1,250,000 including interest. Until maturity, Lattice is
required to make quarterly interest payments (calculated in
arrears)  at 12% stated interest with the first quarter interest
payment of $37,500 due September 30, 2010 and $37,500 due each quarter end
thereafter until the final payment comes due June 30, 2012 totaling $1,287,500
including the final interest payment. The note is secured by certain receivables
totaling $1,250,000. Concurrent with the note, an intercreditor agreement was
signed between Action Capital and I. Wistar Morris where Action has
agreed to subordinate the ACTION Lien on certain government contracts, task
orders and accounts receivable totaling $1,250,000.
 
 Note
4 - Derivative financial instruments:
 
 The
balance sheet caption derivative liabilities consist of Warrants, issued in
connection with the 2005 Laurus Financing Arrangement, and the 2006 Omnibus
Amendment and Waiver Agreement with Laurus. These derivative financial
instruments are indexed to an aggregate of 2,358,333 and 4,313,465 shares
of the Company’s common stock as of June 30, 2010 and December 31, 2009 and are
carried at fair value. The balance at June 30, 2010 and December 31, 2009 was
$183,458 and $161,570, respectively.
 
 9
  Note 5 - Major Customers and
Concentrations
 
 Our
government service segment’s primary  "end-user" customer is the U.S.
Department of Defense (DoD) which accounted for approximately 76% and 93%
 of our total revenues for six months ended June 30, 2010 and June 30, 2009
respectively. For the three months ended June 30, 2010 and 2009 they
accounted for 75% and 92% of our total revenue. Accounts
receivable for these contracts at June 30, 2010 and December 31, 2009 was
$2,898,000 and $3,335,667 respectively.
 
 Included
in the government segment are two contract vehicles with the Navy Space and
Navel Warfare Command (SPAWAR) in San Diego that account for 
58%  and  74% of its revenues in the six months ended June
30, 2010 and 2009 respectively and 61% and 70% of its revenues in the three
months ended June 30, 2010 and 2009 respectively. Accounts receivable for these
contracts at June 30, 2010 and 2009 was $1,968,000 and
$2,926,000 respectively.
  Note
6 – Commitments and Contingencies
 
 From time
to time, lawsuits are threatened or filed against us in the ordinary course of
business. Such lawsuits typically involve claims from customers, former or
current employees, and vendors related to issues common to our industry. A
number of such claims may exist at any given time. Although there can be no
assurance as to the ultimate disposition of these matters, it is our
management's opinion, based upon the information available at this time, that
the expected outcome of these matters, individually and in the aggregate, will
not have a material adverse effect on the results of operations, liquidity or
financial condition of our company.
 
 Note
7 -Exchange of Series
A Preferred Stock for cancellation of Series A Warrants
 
 On
February 1, 2010, we received cash proceeds of $250,000 from Barron Partners
L.P. in exchange for the issuance of 1,400,011 shares of Series A Convertible
Preferred Stock (“Series A Preferred”) and the return and cancellation of
1,955,132 shares of Series A warrants which were originally issued in
conjunction with the September 19, 2006 Barron financing.  The
exchange was effective February 19, 2010.
 
 The
Series A warrants did not meet all the conditions of Accounting Standards
Codification (“ASC”) 815 Derivatives and
Hedging for equity classification so they had been recorded as derivative
liabilities since inception. The fair value of the Series A warrants on the
transaction date was determined to be $87,785 using the Black-Scholes option
pricing model. Significant assumptions used in the Black Scholes model as of the
date of the exchange included a strike price of $0.283; a historical volatility
factor of 181% based upon forward terms of instruments; a remaining term of 1.58
years; and a risk free rate of 0.95%.
 
 The
Series A Preferred was designated on August 28, 2006. The Series A Preferred has
a par value of $0.01 and as of the date of the exchange, each share of preferred
stock is convertible into 3.5714 shares of the Company’s common stock and would
be automatically converted into common stock upon a change in control
liquidation, at an amount equal to $.575 per share.  The conversion
price is 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 A Preferred are not entitled to dividends and the Holder has no
voting rights.
 
 In
considering the application of ASC 815, 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 were required to determine whether the host contract
(the Series A Preferred) was 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 ASC 815 we concluded, based upon the preponderance and
weight of all terms, conditions and features of the host contracts, that the
Series A 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 fair
value of the Series A Preferred on the date of the exchange was determined to be
$467,840 by considering both (i) the fair value based upon the common stock
equivalent value, plus the fair value of enhancements, such as the anti-dilution
protection and (ii) the liquidation value. Since the fair value of the Series A
Preferred was greater than the carrying value of the warrants and the cash paid,
we are required to record a loss on extinguishment in accordance with ASC 470
Modifications and
Extinguishments for the difference.  This exchange resulted in
a loss on extinguishment of $130,055.
 
 Note
8 - Purchase of intellectual property
 
 On
January 4, 2010 the Company entered into a Patent Licensing agreement supporting
its communication services products.  In conjunction with the
agreement the Company agreed to pay  $1,300,000 as
follows;  $50,000 on the first of each month starting on January 1,
2010 and ending June 1, 2010 and a lump sum payment due of
$1,000,000  on June 30, 2010. The $1,300,000 was paid in full pursuant
to the licensing agreement as of June 30, 2010. The 1,300,000 was accounted for
as intangible property and is being amortized over 120 months. Accordingly
$32,500 amortization expense was included as a component of the communication
segment cost of sales for the three months ended June 30, 2010.
 
 Note
9 - Subsequent Events
 
 Pursuant
to Financial Accounting Standards Board Accounting Standards Codification
855-10, we have evaluated all events or transactions that occurred from July 1,
2010 through the filing with the SEC.  We did not have any material
recognizable subsequent events during this period.
 
 10
  ITEM 2. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
 The
information in this report contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. This Act
provides a "safe harbor" for forward-looking statements to encourage companies
to provide prospective information about themselves so long as they identify
these statements as forward looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from the
projected results. All statements other than statements of historical fact made
in this report are forward looking. In particular, the statements herein
regarding industry prospects and future results of operations or financial
position are forward-looking statements. Forward-looking statements reflect
management's current expectations and are inherently uncertain. Our actual
results may differ significantly from management's expectations.
 
 The
following discussion and analysis should be read in conjunction with the
financial statements and notes thereto included elsewhere in this report and
with our annual report on Form 10-K for the fiscal year ended December 31, 2009.
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
 
 We derive
a substantial portion of our revenues from government contracts under which we
act as both a prime contractor and indirectly as a subcontractor to Federal DoD
agencies.  Revenues in the quarter ended June 30, 2010 from government
contracts accounted for $2,519,118 or 75% of our overall revenues. Of our total
government services revenues for the three months ended June 30, 2010,
approximately 62% were from two Prime contract vehicles under SPAWAR
(JPMIS).  Although we should continue to see government contracts
accounting for the largest portion of our revenue we expect to start to see the
percentage of overall revenues from our communications group increase based on
anticipated growth in our communications services revenues. For the three months
ended June 30, 2010, revenues from our communication segment increased to 25% of
total revenues from 7% in the prior year same period.  For the six
months ended June 30, 2010, revenues from our communication segment increased to
24% of total revenues from 8% in the prior year same period.
  Our total
revenues for the three months ended June 30, 2010 were $3,373,738 which was a
decrease of 792,963 or 19% compared to the prior year same
period.  This consisted of a decrease of $1,341,805 or 34.8% in our
Government services segment partially offset by an increase of $548,843 or 179%
in our Communications segment.  The decrease in our Government segment
consisted of, primarily a decline in lower margin subcontractor revenues
attributable to certain task orders on certain programs ending in 2009 combined
with a funding delays on certain other programs during the current quarter under
our Seaport (SPAWAR) contract vehicles. We anticipate that the
new  task orders will be awarded and the delayed funding to resume
under our Seaport contract as contract ceilings have not yet been fully
absorbed. Based on our bid pipeline and teaming arrangements, we continue to
anticipate wins in new agencies and expansion on existing contracts in the
2nd half
of the year.   Our current legacy contracts that have extensions
have all been renewed for 2010 and we expect our higher margin in-house or
direct labor revenues to be consistent with 2009 levels on these legacy
contracts.  The majority of the bids we currently have and are
awaiting on are awards are with new agencies or new contracts that add to our
current contract base.  In addition, we have entered into a number of
teaming agreements with other government contractors enabling us to provide
services on current contracts that they have been awarded.  We
anticipate these awards to begin in the second half of this year.  The
addition of new contracts will also decrease the concentration risk of revenues
attributable to our SPAWAR contracts.
  11
  Historically,
our revenue from the Communications Group has been derived from wholesaling
product and services to service providers providing telecom services to inmate
facilities.  In the second  half of 2009 we expanded
our offering to include direct services to end-user inmate facilities either
providing directly to inmate facilities or via a partnering arrangement with
other service providers.  This decision was made based on our insight
to the growth opportunities with the company’s current customer base and within
the inmate telecommunications market.  The transition to the new
services model was completed late in 2009 and enabled us to move into a market
that has an addressable market of over $1.2 billion per year.  This is
based on the size of the inmate population in the United States and the
telecommunications traffic derived by this population and does not take into
account any additional products we may offer or foreign markets we may be able
to pursue.  With the transition to the direct service based model
$487,602 or 57% of our total communications segment revenues for the three
months ended June 30, 2010 was attributable to our new direct services product
offering.  For the six months ended June 30, 2010 approximately
$1,045,000 or 62% of our communication segment revenues was attributable to
direct services launched late in 2009. This resulted in an overall increase in
out communication segment revenues of of 179% and 177% for the three and six
months ended June 30, 2010  compared to the prior year periods. There
are risk factors such as contracts being cancelled or a drop in network usage
that could cause a decline in our communication group revenue however based on
our current operations we do not foresee any factors that would cause a
disruption.
 
 The new
business model will continue to require the company to make upfront capital
investments in equipment with each new contract win.  To
date,  we have secured equipment financing to support our contract
wins.  In addition, in the quarter ended June 30, 2010 we have made a
$1,300,000 investment in licensing technology.  We were able to
finance this payment with the $1,250,000 debt financing closed in the current
quarter.   The change in strategy to a direct service based model
in our communication group business should not require significant R&D
investments in developing our call platform technology since our call control
technology has been deployed and is currently operating in this market from our
legacy wholesaling business.
 
 RESULTS OF
OPERATIONS
 
 THREE
MONTHS ENDED JUNE 30, 2010 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2009
  The
following tables set forth income and certain expense items as a percentage of
total revenue:
 
 For the Three
      Months EndingJune
      30,2010
                  
                  
                  2009REVENUE
                  
                  $
                  3,373,737
                  
                  
                  $
                  4,166,700Net
      (loss)
                  
                  $
                  (59,035
                  )
                  
                  $
                  (172,154
                  )Net
      (loss) per common share – Basic & Diluted
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.01
                  )
 
 OPERATING
      EXPENSES
                  
                  PERCENT
      OF SALESTHREE
                    MONTHS
                    ENDED
                    JUNE
      30, 2010
                  
                  THREE
                    MONTHS
                    ENDED
                    JUNE
      30, 2009
                  
                  THREE
                    MONTHS
                    ENDED
                    JUNE
      30, 2010
                  
                  THREE
                    MONTHS
                    ENDED
                    JUNE
      30, 2009Research
      & Development
                  
                  144,799
                  
                  143,182
                  
                  4.3
                  %
                  3.4
                  %Selling,
      General & Administrative
                  
                  1,090,745
                  
                  1,239,801
                  
                  32.3
                  %
                  29.78
                  %
  12
 
 REVENUES:
 
 Total
revenues for the three months ended June 30, 2010 decreased by $792,963 or 19%
to $3,373,737 compared to $4,166.700 for the three months ended June 30, 2009.
Our Government Services segment which represents revenues from professional
engineering services to Federal government Dept of Defense (DoD) agencies
accounted for 74% of total revenues compared to 93% in the year ago
quarter.
 
 Our
Government services revenues decreased by $1,341,805 or 34.8% to $2,519,118 from
$3,860,923 in the year ago quarter. The decrease was mainly attributable to
certain task orders ending in 2009 combined with funding delays during the
current quarter on other programs under our Seaport (SPAWAR) contract vehicle.
The decrease was mainly attributable to a decline in lower margin subcontracted
revenues as opposed to revenues supported by higher margin in-house or direct
labor. We anticipate the funding will resume on some of the programs and the
addition of new programs will be added in the 2nd half
of this year to absorb unutilized contract ceilings on both our Seaport
SPAWAR-JPMIS and SSA contract vehicles.
 
 Our
communications segment revenues increased by $548,843 or 179.5% to $854,620 from
$305,777 in the prior year.  The revenue increase was mainly
attributable to the direct service model launched late in 2009 which accounted
for approximately $487,602 or 160% of the increase.
 
 GROSS
MARGIN:
 
 Gross
margin for the three months ended June 30, 2010 was $1,391,852, an increase of
$109,658 or 8.6% compared to the $1,282,194 for three months ended June 30,
2009. Gross margin, as a percentage of revenues, increased to 41.3% from 30.7%
for the same period in 2009. The increase in percentage was primarily due to an
increase in our Government service margin percent partially offset by a decrease
in our communication segment margin. The increase in our Government segment
margin from 28.1% to 45.1% was mainly due to a decline in lower margin
subcontracted revenues relative to in-house or direct labor revenues compared to
the prior year period.  Our communication margin percent decreased
from 64.8% to 35.2% as a result of the launch of the direct service product line
late in 2009. Historically, the margin percentage in our communication segment
from wholesaling telecom equipment systems and services ran in the low 60%
range.  The direct service gross margin percentage runs in the 20 to
30 percent range.
 
 RESEARCH
AND DEVELOPMENT EXPENSES:
 
 Research
and development expenses consist primarily of salaries and related personnel
costs, and consulting fees associated with product development in our Technology
Products segment.   For the three months ended June 30, 2010,
research and development expenses increased slightly to $144,799 as compared to
$143,182 for the three months ended June 30, 2009.  Management
believes that continual enhancements of the Company's existing products are
required to enable the Company to maintain its current competitive
position.
 
 SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES:
 
 Selling,
General and administrative ("SG&A") expenses consist primarily of expenses
for management, fringe benefits, indirect overhead, labor costs of billable
technical staff not charged to a project or contract, finance, administrative
personnel, legal, accounting, consulting fees, sales commissions, marketing,
facilities costs, corporate overhead and depreciation expense.  For
the three months ended June 30, 2010, SG&A expenses decreased to $1,090,745
from $1,239,801 in the comparable period prior year.  As a percentage
of revenues, SG&A was 32.3% for the three months ended June 30, 2010 versus
29.8% in the comparable period a year ago. The decrease in expense was mainly
attributable to a decrease in corporate expense due to cost cutting measures, a
decrease in variable government fringe and indirect overhead expenses which
declined in line with a decrease in billable staff in our Government segment.
These decreases were partially offset by an increase in selling costs supporting
our new direct services product launched late 2009 in our communications
segment.
 
 AMORTIZATION
EXPENSES:
 
 Non-cash
amortization expenses related mainly 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 June 30, 2010 was
$172,136 compared to $299,248 for the three months ended June 30, 2009. The
decrease is attributed to certain intangibles being fully amortized in 2009 and
an impairment charge to the carrying value of intangibles taken in the 4th
quarter of 2009.
 
 INTEREST
EXPENSE:
 
 Interest
Expense increased to $94,069 for the three months ended June 30, 2010 compared
to $48,897 for the three months ended June 30, 2009.  The increase in
interest expense was mainly due to increased average outstanding balance on our
revolving line-of-credit, an increase in net borrowings and an increase in
interest rate on the amended note with fomer RTI shareholders.. Interest expense
in the quarter ended June 30, 2010 was comprised primarily of interest charges
on its revolving line-of-credit and short term notes.
 
 13
 NET
LOSS:
 
 The
Company’s net loss for the three months ended June 30, 2010 was $59,035 compared
to a net loss of $172,154 for the three months ended June 30, 2009.
 
 SIX
MONTHS ENDED JUNE 30, 2010 COMPARED TO THE SIX MONTHS ENDED JUNE 30,
2009
  The
following tables set forth income and certain expense items as a percentage of
total revenue:
 
 For the Six
      Months Ending  June 30,2010
                  
                  
                  2009REVENUE
                  
                  $
                  7,114,794
                  
                  
                  $
                  7,974,583Net
      (loss)
                  
                  $
                  (591,460
                  )
                  
                  $
                  (575,419
                  )Net
      (loss) per common share – Basic & Diluted
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.04
                  )
 
 OPERATING
      EXPENSES
                  
                  PERCENT
      OF SALESSIX
                    MONTHS
                    ENDED
                    JUNE
      30, 2010
                  
                  SIX
                    MONTHS
                    ENDED
                    JUNE
      30, 2009
                  
                  SIX
                    MONTHS
                    ENDED
                    JUNE
      30, 2010
                  
                  SIX
                    MONTHS
                    ENDED
                    JUNE
      30, 2009Research
      & Development
                  
                  300,330
                  
                  295,677
                  
                  4.2
                  %
                  3.7
                  %Selling,
      General & Administrative
                  
                  2,288,822
                  
                  2,361,793
                  
                  32.2
                  %
                  29.6
                  %
  REVENUES:
 
 Total
revenues for the six months ended June 30, 2010 decreased by $859,789 or 10.8%
to $7,114,794 compared to $7,974,583 for the six months ended June 30, 2009. Our
Government Services segment which represents revenues from professional
engineering services to Federal government Dept of Defense (DoD) agencies
accounted for 76% of total revenues compared to 92% in the year ago
period.
 
 Our
Government services revenues decreased by $1,936,495 or 26.3% to $5,430,953 from
$7,367,448 in the year ago period. The decrease was mainly attributable to
certain task orders ending in 2009 combined with funding delays incurred in the
current quarter on certain programs under our Seaport (SPAWAR) contract
vehicles. The decrease was mainly attributable to lower margin subcontracted
revenues as opposed to in-house or direct labor revenues.
 
 Our
communications segment revenues increased by $1,076,707 or 177% to $1,683,842
from $607,135 in the prior year.  The revenue increase consisted of
revenue growth attributable to our new direct services product launched in the
latter part of 2009 accounting for $1,045,000 or 172% of the increase compared
to prior year.
 
 GROSS
MARGIN:
 
 Gross
margin for the six months ended June 30, 2010 was $2,565,358, an increase of
$31,784 or 1.3% compared to the $2,533,574 for the six months ended June 30,
2009. Gross margin, as a percentage of revenues, increased to 36.1% from 31.8%
for the same period in 2009. The increase in percentage was due to an increase
in our government service margin percentage from 29.2% to 38.7% partially offset
by a decrease in our communication services segment margin from 63.3% to 32.9%.
The increase in Government services margin percent was primarily mix related due
to the decline in lower margin subcontracted revenue relative to direct labor
revenue.  The decrease in our communication service gross margin
percentage was mainly the result of the introduction of direct service product
revenues launched in latter part of 2009.. The legacy margin in our
communications services segment from wholesaling telecom equipment systems and
services runs in the low 60% range.  The direct service gross margin
percentage runs in the 20 to 30 percent range.
 
 RESEARCH
AND DEVELOPMENT EXPENSES:
 
 Research
and development expenses consist primarily of salaries and related personnel
costs, and consulting fees associated with product development in our Technology
Products segment.   For the six months ended June 30, 2010,
research and development expenses increased slightly to $300,330 as compared to
$295,677 for the six months ended June 30, 2009.  Management believes
that continual enhancements of the Company's existing products are required to
enable the Company to maintain its current competitive
position.
  14
  SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES:
 
 Selling,
General and administrative ("SG&A") expenses consist primarily of expenses
for management, fringe benefits, indirect overhead, labor costs of billable
technical staff not charged to a project or contract, finance, administrative
personnel, legal, accounting, consulting fees, sales commissions, marketing,
facilities costs, corporate overhead and depreciation expense.  For
the six months ended June 30, 2010, SG&A expenses decreased to $2,288,822
from $2,361,793 in the comparable period prior year.  As a percentage
of revenues, SG&A was 32.2% for the six months ended June 30, 2010 versus
29.6% in the comparable period a year ago. The decrease in expense was mainly
attributable to a decrease in corporate expenses due to cost cutting measures, a
decrease in variable fringe and indirect overhead expenses which declined in
line with a decrease in billable staff in our Government segment. These
decreases were partially offset by an increase in selling costs supporting our
new direct services product launched late 2009 in our communications
segment.
 AMORTIZATION
EXPENSES:
 
 Non-cash
amortization expenses related mainly to intangible assets acquired in the
acquisitions of RTI and SMEI are stated separately in our statement of
operations.. Amortization expense for the six months ended June 30, 2010 was
$281,272 compared to $598,496 for the six months ended June 30, 2009. The
decrease is attributed to certain intangibles being fully amortized in 2009 and
an impairment charge to the carrying value of intangibles taken in the 4th
quarter of 2009.
 
 INTEREST
EXPENSE:
 
 Interest
Expense increased to $175,840 for the six months ended June 30, 2010 compared to
$126,114 for the six months ended June 30, 2009.  Interest expense in
2010 was comprised primarily of interest charges on its revolving line-of-credit
and short term notes. The increase was due to increase in (i) average
outstanding borrowings on our line of credit (ii) partial interest on the
$1,250,000 debt financing closed in June 2010, (iii) increased interest rate
from 10% to 15% per annum on the amended note with the former RTI
shareholders.
  NET
LOSS:
 
 The
Company’s net loss for the six months ended June 30, 2010 was $591,460 compared
to a net loss of $575,419 for the six months ended June 30, 2009.
 
 LIQUIDITY
AND CAPITAL RESOURCES
 
 Cash and
cash equivalents increased to $835,737 at June 30, 2010 from $212,616 at
December 31, 2009. Net cash provided by operating activities was $748,871 for
the six months ended June 30, 2010 compared to net cash used in operating
activities of $369,162 in the corresponding six months ended June 30,
2009.  The increase in operating cashflows in  the current
period  was mainly due to decrease in Government segment receivables
of $469,515from December 31, 2009 levels due to the decrease in revenues and an
increase in customer advances of $154,225 due to the increased revenues from our
direct services communications product.
 
 Net cash
used in investment activities was $1,330,427 for the six months ended June 30,
2010 compared to $32,773 in the corresponding period ended June 30, 2009.
Investing activities totaled $1,330,427 and was comprised of $1,300,000 for
patent licensing and $30,427 for network equipment supporting our direct telecom
services revenues for the six months ended June 30, 2010 compared to $32,773 in
the six months ended June 30, 2009. With the launch of our direct telecom
services product in the latter part of 2009, we expect to continue to have a
requirement for capital on a project by project basis as we are awarded service
contracts. To date, we have financed these equipment purchases with equipment
based financing and operating cashflows. The capital requirement for our
Government services business is nominal since it is mainly driven by the level
of and hiring’s of billable staff, which requires the purchase of personal
computers, in-house servers and network infrastructure.
 
 Net cash
provided by financing activities was $1,204,676 for the six months ended June
30, 2010 compared to net cash used by financing activities of $789,950 in the
corresponding six months ended June 30, 2009. The $1,204,676 consisted of
$1,350,000 in financing proceeds which included the $1,100,000 proceeds on the
$1,250,000 debt financing closed in June 2010 and the $250,000 proceeds from the
issuance of Series C Preferred Stock in the first quarter of 2010. These
proceeds were offset by payments totaling $145,324 on our revolving line of
credit and short term notes.
 
 Going
concern considerations:
 
 The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. The going concern basis was due to the
Company’s historical negative operating cash flow and losses. The Company’s
working capital deficiency at June 30, 2010 was $1,141,315 including non-cash
derivative liabilities of $183,458. This condition raises doubt regarding the
Company’s ability to continue as a going concern. The Company’s ability to
continue as a going concern is highly dependent upon its ability to improve its
operating cashflows over current levels and maintain continued availability
under its line of credit financing. Included in the working capital deficiency,
is a $1,503,742 of notes payable comprised of $792,517 outstanding on the
Company’s revolving line of credit, and $710,925 short term debt coming due
within the next twelve months, $531,000 of which could come due February 2011
upon 45 days notice at the option of the holder.   The Company
will need to increase its operating cashflows from current levels raise
alternative financing and/or restructure existing debt in a difficult credit
environment to continue as a going concern. There is no assurance that
management will be successful in raising the necessary alternative financing
required.
  15
 Financing
Activities:
 
 On
February 1, 2010, the Company received cash proceeds of $250,000 from Barron
Partners LP in exchange for the issuance of 1,400,011 shares of Series A
Preferred Stock and the return and cancellation of 1,955,000 “A” warrants. Each
share of Series A Preferred is convertible to 3.5714 shares of common stock. The
proceeds from the issuance were primarily used to fund the monthly payments
pursuant to the settlement agreement and patent license agreement entered into
January 4, 2010 (see below).
 
 On
January 4, 2010 the Company entered into a settlement and patent licensing
agreement supporting its communication services products.  In
conjunction with the agreements the Company agreed to pay  $1,300,000
as follows;  $50,000 on the first of each month starting on January 1,
2010 and ending June 1, 2010 and a lump sum payment due of
$1,000,000  on June 30, 2010.  As of the date of this
filing, the Company has paid the $1,300,000 in full.
 On
February 19, 2010, we amended the terms on the $750,000 note ($562,500 remaining
balance as of December 31, 2009) as follows: (i) the interest rate was increased
to 15% from 10%, (ii) the maturity date of the note was extended to August 19,
2012 from October 15, 2010., (iii) the principal amortization of the note was
changed from monthly payments of $62,500 to a lump sum payment of 531,000 due
August 19, 2012.  A call option was added on the principle balance of
$531,000 after twelve months from the effective date upon 45 days prior written
notice.
 
 On June
11, 2010 Lattice closed on a Note Payable with I. Wistar Morris for
$1,250,000.  The proceeds to the Company were $1,100,000. The note
matures June 30, 2012 and payment of principal will be due at that time in the
lump sum value of $1,250,000 including interest. Until maturity, Lattice is
required to make quarterly interest payments (calculated in
arrears)  at 12% stated interest with the first quarter interest
payment of $37,500 due September 30, 2010 and $37,500 due each quarter end
thereafter until the final payment comes due June 30, 2012 totaling $1,287,500
which includes the final interest payment. The note is secured by certain
receivables totaling $1,250,000. Concurrent with the  note, an
intercreditor agreement was signed between Action Capital and I. Wistar Morris
where Action has agreed to
subordinate the Action Lien in certain government contracts, task orders and
accounts receivable totaling $1,250,000. The note, security agreement and
intercreditor agreement were amended on July 21, 2010 to correct references to
accounts and invoices.
 
 Our
current cash position, availability on our line of credit and current level of
operating cashflows are not adequate to support payments on indebtedness coming
due over the next twelve months. In this regard, we are highly dependent on
increasing our operating cashflows, maintaining continued availability on our
line of credit facility and raising alternative financing in order for us to
service our current indebtedness coming due over the next twelve
months.  We have initiated cost reduction activities early 2010 which
we estimate to have annualized cost savings of approximately $300,000 –
$400,000. Additionally, we have secured new customer accounts related to our new
telecom services product which added approximately $2,000,000 in annualized
revenues to our communication group business. Despite these measures though,
there can be no assurances that the Company’s businesses will generate
sufficient forward cash flows from operations or that future borrowings under
our line of credit facility will be available in an amount sufficient to service
our current indebtedness or to fund other liquidity needs.Additionally, we are highly dependent on
our ability to maintain contract funding and increase funding under our SPAWAR
contract vehicles which comprised 46% of our overall revenues.  Any
interruption in task order funding or continued funding delays on these vehicles
will have a material adverse effect on operations and our ability to continue
business as a going concern. As of the date of filing we are in good standing on
these contracts and we anticipate follow-on funding to continue for the
remaining multi-year contract term which expires on March 31, 2012.
  
 OFF
BALANCE SHEET ARRANGEMENTS:
 
 We do not
have any off balance sheet arrangements that are reasonably likely to have a
current or future effect on our financial condition,  revenue, results
of operations, liquidity or capital expenditures.
 
 16
 
 ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
 N/A.
 
 ITEM
4T. CONTROLS AND PROCEDURES.
 
 Evaluation
of Disclosure Controls and Procedures
  Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial, we evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934 (the “Exchange Act”) as of the end of the period covered by
this  Quarterly Report on Form 10-Q. Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures as of the end of the period covered by this
report were not effective such that the information required to be disclosed by
us in reports filed under the Securities Exchange Act of 1934 is
(i) recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms and (ii) accumulated and
communicated to our management to allow timely decisions regarding disclosure. A
controls system cannot provide absolute assurance, however, that the objectives
of the controls system are met, and no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud if any, within
a company have been detected.
 
 Management
has determined that, as of June 30, 2010, there were material weaknesses in our
internal controls as of June 30, 2010.  A material weakness in the
Company’s internal controls exists in that, beyond the Company’s Chief Financial
Officer there is a limited financial background amongst other executive officers
or the board of directors.  This material weakness may affect
management’s ability to effectively review and analyze elements of the financial
statement closing process and prepare financial statements in accordance with
U.S. GAAP.  In making this assessment, our management used the
criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  As a result of the material weaknesses
described above, our management concluded that as of June 30, 2010, we did not
maintain effective internal control over financial reporting based on the
criteria established in Internal Control — Integrated
Framework issued by the COSO.
 .
 Changes
in internal control
 
 Our
management, with the participation 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 2010 Quarter
ended June 30, 2010. Based on that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that no change occurred in the Company’s
internal controls over financial reporting during the 2010 Quarter ended June
30, 2010 that has materially affected, or is reasonably likely to materially
affect, the Company’s internal  controls over financial
reporting.
 
 17
 PART
II
 
 OTHER INFORMATION
 
 ITEM
1 - LEGAL PROCEEDINGS
 
 We are not a party to any
pending legal proceeding, nor is our property the subject of a pending legal
proceeding, that is not in the ordinary course of business or otherwise material
to the financial condition of our business. None of our directors, officers or
affiliates is involved in a proceeding adverse to our business or has a material
interest adverse to our business.
 
 ITEM
1A. RISK FACTORS
 
 There
have been no material changes from the Risk Factors described in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2009.
 
 ITEM
2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 None.
 
 ITEM
3 - DEFAULTS UPON SENIOR SECURITIES
 
 None.
 
 ITEM
4 - RESERVED
 
 ITEM
5 - OTHER INFORMATION
  None.
 
 Item
6. Exhibits
 
 Exhibit
                    Number
                  
                  Description10.25
                  
                  Promissory
      Note issued to I. Wistar Morris10.26
                  
                  Security
      Agreement dated June 11, 2010 by and between Lattice, Incorporated,
      Lattice Government Services, Inc. and I. Wistar Morris10.27
                  
                  Inter-Creditor
      Agreement dated June 11, 2010 among Action Capital Corporation and I.
      Wistar Morris10.28
                  
                  Amendment
      Number One to Promissory Note issued to I. Wistar Morris dated July 21,
      201010.29
                  
                  Amendment
      Number One to Security Agreement by and between Lattice, Incorporated,
      Lattice Government Services, Inc. and I. Wistar Morris dated July 21,
      201010.30
                  
                  First
      Amendment to Intercreditor Agreement between Action Capital Corporation
      and I. Wistar Morris31.1
                  
                  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
  18
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 DATE: August 20,
2010
 
 LATTICE
      INCORPORATEDBY:
                  /s/
      Paul BurgessPAUL
      BURGESSCHIEF
      EXECUTIVE OFFICER
                    (PRINCIPAL
      EXECUTIVE
                    OFFICER), SECRETARY
      AND
                    DIRECTOR
 
 
 DATE:
August 20, 2010
 
 BY:
                  /s/ Joe
  NotoJOE
    NOTOCHIEF
      FINANCIAL OFFICER
                    (PRINCIPAL
      ACCOUNTING
                    OFFICER)