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, 2012.

 

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. Employer
incorporation 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  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 filer o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

  

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS

DURING THE PRECEDING FIVE YEARS

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of November 16, 2012, there were 31,813,625 outstanding shares of the Registrant's Common Stock, $.01 par value.

  

LATTICE INCORPORATED

SEPTEMBER 30, 2012 QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

 

 

	Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3. Quantitative and Qualitative Disclosure About Market Risks	20
Item 4T. Controls and Procedures	20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings	21
Item 1A. Risk Factors	21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3. Defaults Upon Senior Securities	21
Item 4. Reserved	21
Item 5. Other Information	21
Item 6. Exhibits	21
SIGNATURES	24

 

 

  

LATTICE INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATION

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2012				2011				2012				2011
Revenue		$	2,731,599			$	2,545,429			$	8,615,139			$	9,006,867
Cost of Revenue			1,652,778				1,677,232				5,191,893				5,773,103
Gross Profit			1,078,821				868,197				3,423,246				3,233,764
Operating  expenses:
Selling, general and administrative			860,923				1,565,445				2,683,680				4,255,532
Research and development			160,876				192,930				514,067				513,160
Impairment loss			–				–				–				1,575,000
Amortization expense			80,448				104,727				241,344				314,181
Total operating expenses			1,102,247				1,863,102				3,439,091				6,657,873
Income (loss) from operations			(23,426	)			(994,905	)			(15,845	)			(3,424,109	)
Other income (expense):
Derivative income (loss)			8,483				82,359				38,733				64,150
Other income (expense)							–				255,613				–
Interest expense			(124,773	)			(105,274	)			(354,710	)			(342,397	)
Total other income			(116,290	)			(22,915	)			(60,364	)			(278,247	)
Noncontrolling interest			–				3,147				–				9,441
Income (Loss) before taxes			(139,716	)			(1,014,673	)			(76,209	)			(3,692,915	)
Income taxes (benefit)			(32,399	)			(85,504	)			(97,191	)			(256,512	)
Net income (loss)			(107,317	)			(929,169	)			20,982				(3,436,403	)
Reconciliation of net income (loss) to income applicable to common shareholders:
Net income (loss)			(107,317	)			(929,169	)			20,982				(3,436,403	)
Preferred stock dividends			(6,277	)			(6,277	)			(18,831	)			(18,831	)
Income (loss) applicable to common stockholders			(113,594	)			(935,446	)			2,151				(3,455,234	)
Income (loss) per common share
Basic		$	(0.00	)		$	(0.03	)		$	0.00			$	(0.13	)
Diluted		$	(0.00	)		$	(0.03	)		$	0.00			$	(0.13	)
Weighted average shares:
Basic			30,917,270				29,364,488				30,209,356				25,976,950
Diluted			30,917,270				29,364,488				73,208,384				25,976,950

 

See accompanying notes to the condensed consolidated financial statements.

  

 

LATTICE INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 30,				December 31,
		2012				2011
		(unaudited)
ASSETS:
Current assets:
Cash and cash equivalents		$	81,105			$	192,286
Accounts receivable			2,666,825				2,700,859
Inventories			7,350				7,350
Other current assets			110,249				142,500
Total current assets			2,865,529				3,042,995
Property and equipment, net			554,412				612,710
Goodwill			690,871				690,871
Other intangibles, net			1,255,465				1,594,306
Other assets			2,812				2,813
Total assets		$	5,369,089			$	5,943,695
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	1,817,378			$	1,769,896
Accrued expenses			1,326,914				1,698,617
Deferred revenues			12,500				50,000
Customer advances			360,239				124,266
Notes payable - current			2,152,823				1,869,043
Contingent Consideration			77,700				77,700
Derivative liability			57,634				96,366
Total current liabilities			5,805,188				5,685,888
Long term liabilities:
Notes Payable - long term			603,155				1,206,283
Deferred tax liabilities			126,581				223,771
Total long term liabilities			729,736				1,430,054
Total liabilities			6,534,924				7,115,942
Shareholders' equity
Preferred Stock - .01 par value
Series A 9,000,000 shares authorized 7,530,681 issued and 7,159,678 outstanding			71,597				75,307
Series B 1,000,000 shares authorized 1,000,000 issued and 502,160 outstanding			10,000				10,000
Series C 520,000 shares authorized  520,000 issued and outstanding			5,200				5,200
Series D 636,400 shares authorized  520,000 issued and outstanding			5,909				5,909
Common stock - .01 par value, 200,000,000 authorized, 31,176,509 and 22,942,437 issued and outstanding respectively			311,766				298,516
Additional paid-in capital			43,308,690				43,313,969
Accumulated deficit			(44,441,034	)			(44,443,185	)
			(727,872	)			(734,284	)
Stock held in treasury, at cost			(558,096	)			(558,096	)
Equity Attributable to shareowners of Lattice Incorporated			(1,285,968	)			(1,292,380	)
Equity Attributable to noncontrolling interest			120,133				120,133
Total liabilities and shareholders' equity		$	5,369,089			$	5,943,695

  

See accompanying notes to the condensed consolidated financial statements.

 

 

LATTICE INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine  Months Ended  September 30,
		2012				2011
Cash flow from operating activities:
Net income (loss)		$	20,982			$	(3,436,403	)
Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities:
Derivative income			(38,733	)			(64,150	)
Impairment Loss			–				1,575,000
Amortization of intangible assets			338,844				411,681
Deferred income taxes			(97,191	)			(256,512	)
Minority interest			–				9,441
Share-based compensation			4,263				194,750
Depreciation			172,685				119,091
Changes in operating assets and liabilities:							–
(Increase) decrease in:							–
Accounts receivable			34,034				282,492
Other current assets			55,251				1,037
Increase (decrease) in:							–
Accounts payable and accrued liabilities			(343,052	)			(262,979	)
Deferred revenues			(37,500	)			(17,879	)
Customer advances			235,973				(78,786	)
Total adjustments			324,574				1,913,186
Net cash provided by (used in) operating activities			345,556				(1,523,217	)
Cash Used in investing activities:
Purchase of equipment			(114,387	)			(488,933	)
Acquired cash - CLR			–				59,518
Net cash used for investing activities			(114,387	)			(429,415	)
Cash flows from financing activities:
Revolving credit facility (payments) borrowings, net			(206,139	)			427,411
Payments on capital equipment lease			(16,718	)			13,718
Payments on Notes Payable			(264,055	)			(416,432	)
Proceeds from the issuance of Securities			175,000				1,937,461
Payments on Director Loans			(30,438	)			(24,436	)
Net cash provided by (used in) financing activities			(342,350	)			1,937,722
Net increase (decrease) in cash and cash equivalents			(111,181	)			(14,910	)
Cash and cash equivalents - beginning of period			192,286				324,149
Cash and cash equivalents - end  of period		$	81,105			$	309,239
Supplemental cash flow information
Interest paid in cash		$	396,051			$	342,397
Common Stock			–				1,231
Derivative liabilities			–				(31,999	)
Additional paid in Capital			–				30,768

 

See accompanying notes to the condensed consolidated financial statements.

 

 

Lattice Incorporated and Subsidiaries

Notes to Condensed Consolidated Financial Statements

September 30, 2012

 (Unaudited)

  

Note 1 - Organization and summary of significant accounting policies

 

a) Organization

 

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

 

b) Basis of Presentation going concern

 

At September 30, 2012 the Company had a working capital deficiency of $2,940,000. This compared to a working capital deficiency of $2,643,000 at December 31. 2011. The Company’s working capital deficiency and constrained liquidity raises substantial doubt regarding the Company’s ability to continue as a going concern. The Company’s ability to continue as a going concern is highly dependent upon (i) management’s ability to achieve its planned operating cashflows (ii), maintain continued availability on its line of credit and the ability to obtain alternative financing to fund capital requirements and/or debt obligations coming due. The accompanying financial statements do not include any adjustments that may result from the outcome of this uncertainty. 

 

c) Interim Condensed Consolidated Financial Statements

 

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

 

 

d) Principles of consolidation

 

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

 

e) Use of estimates

 

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

 

f) Share-based payments

 

On January 1, 2006, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board Accounting Standards Codification 718-10, Accounting for Share-based payment , to account for compensation costs under its stock option plans and other share-based arrangements.  ASC 718 requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. For purposes of estimating fair value of stock options, we use the Black-Scholes-Merton valuation technique. At September 30, 2012, there is $11,669 of unrecognized compensation cost related to unvested share-based compensation awards granted. For the nine months ended September 30, 2012 share-based compensation was $4,263 compared to $194,750 in the prior year period.

 

g) Revenue Recognition

 

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

 

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

 

 

h) Segment Reporting

 

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

   

i) Depreciation, amortization and long-lived assets:

 

Long-lived assets include:

 

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

 

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

 

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

 

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

 

j) Recent accounting pronouncements

 

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

 

 

Note 2 - Segment reporting

 

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

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2012				2011				2012				2011
Revenues:
Government Services		$	609,092			$	1,367,065			$	2,569,967			$	5,620,297
Communication Services			2,122,507				1,178,364				6,045,172				3,386,570
Total Consolidated Revenues		$	2,731,599			$	2,545,429			$	8,615,139			$	9,006,867
Gross Profit:
Government Services		$	257,345			$	570,247			$	1,076,205			$	2,121,297
Communication Services			821,476				297,950				2,347,041				1,112,467
Total Consolidated		$	1,078,821			$	868,197			$	3,423,246			$	3,233,764

 

  

		September 30,  2012				December 31, 2011
Total Assets:
Government Services		$	3,064,231			$	3,845,776
Communication Services			2,304,858				2,097,919
Total Consolidated Assets		$	5,369,089			$	5,943,695

 

Note 3 - Notes payable

 

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

  

		September 30,  2012				December 31, 2011
Bank line-of-credit (a)		$	206,631			$	412,770
Notes payable to Stockholder/director (b)			261,113				291,551
Capital lease payable (c)			30,961				47,679
Notes Payable (d)			1,918,460				1,815,460
Notes payable Cummings Creek/CLR  (e)			338,813				507,868
							–
Total notes payable			2,755,978				3,075,326
Less current maturities			(2,152,823	)			(1,869,043	)
Long-term debt		$	603,155			$	1,206,283

 

 

Interest expense including amortization of deferred finance fees associated with the above notes for the three months ended September 30, 2012 and 2011 was $125,000 and $105,000 respectively and interest for the nine months ended September 30, 2012 and 2011 was $355,000 and $342,000, respectively.

 

(a) Bank Line-of-Credit

 

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

 

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

 

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

 

The outstanding balance owed on the line at September 30, 2012 and December 31, 2011 was $206,633 and $412,770 respectively.  At September 30, 2012 our interest rate was approximately 13.25%.

 

(b) Notes Payable Stockholders/Director

 

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

 

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

 

(c) Capital Lease Payable

 

On June 16, 2009 Lattice entered an equipment lease financing agreement with Royal Bank America Leasing to purchase approximately $130,000 in equipment for our communication services. The terms of which included monthly payments of $5,196 per month over 32 months and a  $1.00 buy-out at end of the lease term. On July 15, 2011 we signed an addendum to this lease and received additional equipment financing for $58,122 payable over 30 months at $2,211 per month. As of September 30, 2012 and December 31, 2011, the outstanding balance was $30,961 and $47,679, respectively.

 

  

(d) Note Payable

 

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

 

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

 

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

 

On December 13, 2011, we converted outstanding invoices that we owed a vendor by converting the liability to a promissory note in the amount of $416,533. The note is payable quarterly over a two year term with principal payments due as follows: December 31, 2011 of $10,000, January 15, 2012 of $50,000, March 31, 2012 of $20,000, June 30, 2012 of $30,000, September 30, 2012 of $30,000, December 31, 2012 of $45,000, March 31, 2013 of $45,000, June 30, 2013 of $55,000, September 30, 2013 of $55,000 and December 31, 2013 of $76,533. The note carries a 12% annual interest rate calculated on the outstanding principal balance payable monthly. As of September 30, 2012, the outstanding balance of the note is $311,533.

 

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

 

(e)  Notes payable Cummings Creek / CLR

 

In conjunction with the Cumming Creek Capital / CLR acquisition, Lattice assumed notes totaling $676,925 comprised of three notes each with the former principles of CLR Group.   The notes bear interest on the unpaid principal amount until paid in full, at a rate of four percent (4.0%) per annum payable quarterly. The Company will pay the unpaid principal amount as follows: beginning on May 31, 2011, the Company will make equal payments of principal on the first day of each calendar quarter  totaling $58,275 (i.e., February 28, May 31, August 30 and November 30), until February 15, 2014. The unpaid balance of the notes totaled $338,813 at September 30, 2012. 

 

 

Note 4 - Derivative financial instruments

 

The balance sheet caption derivative liabilities consist of Warrants, issued in connection with the 2005 Laurus Financing Arrangement, and the 2006 Omnibus Amendment and Waiver Agreement with Laurus. These derivative financial instruments are indexed to an aggregate of 1,658,333 shares of the Company’s common stock as of March 31, 2012 and December 31, 2011 and are carried at fair value. The balance at September 30, 2012 and December 31, 2011 was $57,634 and $96,367 respectively.

 

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

     

Note 5 - Litigation

 

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

 

Note 6 - Goodwill and other intangible assets

 

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

 

A summary of the changes in the carrying amount of goodwill for the period ended September 30, 2012 and December 31, 2011, is shown below:

 

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

 

 

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

 

		Gross Carry amount				Accumulated Amortization				Net Carry amount				Weighted Average Remaining Amortization Period
Purchase intangible associated with CLR purchase		$	759,000			$	446,042			$	312,958				1.79 years
IP Rights Agreement			1,300,000				357,494				942,506				4.88 years
		$	2,059,000			$	803,536			$	1255,464

 

 

2012		$	112,952
2013			320,525
2014			171,987
2015			130,000
2016			130,000
Thereafter			390,000
Total		$	1,255,464

 

Note 7 - Net income (loss) per share

 

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

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2012				2011				2012				2011
Basic net income (loss)		$	(107,317	)		$	(929,169	)		$	20,982			$	(3,436,403	)
Preferred Stock Dividends			(6,277	)			(6,277	)			(18,831	)			(18,831	)
Numerator for diluted net income (loss) per share			(113,594	)			(935,446	)			2,151				(3,455,234	)
Weighted average common shares outstanding:			30,917,270				29,364,488				30,209,356				25,976,950
Dilutive securities
Preferred Stock A, B, C, D			0				0				41,588,524				0
Options			0				0				1,410,505				0
Warrants			0				0				0				0
Diluted weighted average common shares outstanding and assumed conversion			30,917,270				29,364,488				73,208,384				25,976,950
Basic net income (loss) per share		$	0.00			$	(0.03	)		$	0.00			$	(0.13	)
Diluted net income (loss) per share		$	0.00			$	(0.03	)		$	0.00			$	(0.13	)

 

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

 

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2012		2011		2012		2011
Warrant		5,378,233		0		5,378,233		0

 

 

Note 8 – Common Stock

 

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

 

 

Note 9 - Subsequent Events

 

On October 15, 2012, Barron Partners L.P. converted 262,202 shares of Series A Preferred Stock into 940,000 Common Shares. Subsequent to this conversion event, Barron Partners owned 5,443,866 shares of Series A Preferred Stock and 1,569,147 Common Shares.

 

The note dated June 2011 originally for $1,250,000 with a current balance of $981,655 with a maturity date of October 31, 2012 is currently in default. The Company is in the process of amending the note which includes extending the maturity date to January 31, 2013. Other terms of the amendment include; converting the timing of interest payments from quarterly to monthly and the Company agreeing that 40% of the proceeds from any new financing, other than advances made by Action Capital Corporation under its existing line of credit facility shall first be used to reduce the Company’s indebtedness under the note until the Note is paid in full.

 

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

 

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

 

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

 

GENERAL OVERVIEW

 

Revenues for the quarter ended September 30, 2012 were $2,731,000 compared to $2,545,000 in the prior year quarter.  Our operating income for the quarter ended September 30, 2012 adjusts to $148,000 positive compared to $810,000 negative in the prior year period, after adding back non-cash expenses for depreciation, amortization and share based compensation.

 

Revenues from Communications Services accounted for $2,123,000 or 78% of our overall revenues compared to 46% in the prior year quarter.  Consistent with our expectations, the percentage of revenue generated from Communications Services continued to increase. We anticipate revenues from Communications Service will further increase including as a share of total revenues based on further anticipated growth in this segment of our business. 

 

For the three months ended September 30, 2012, revenues from our Government Services segment decreased to $609,000 versus the prior year of $1,367,000.  The decrease in Government Services revenue is primarily attributable to contracts ending in 2011 and 2012 and the stagnation of contract funding in the Federal DoD market.  

 

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

 

Communication Services :

 

Our recurring revenue from both direct and wholesale customers have continued to grow. Revenue in our Communications Services segment increased 80.1% to $2,123,000 from the same period a year ago. Communication Services recurring revenue during the third quarter 2012 increased 27.3% to $1,436,000 from $1,128,000 in the same period a year ago. The increase is mainly the result of higher call volumes from correctional facilities and the increased number of facilities on our network. Our sales pipeline remains strong. With the completion of the election cycle, we anticipate realizing a higher sales closure rate in the coming quarters. Revenue from our technology sales increased by $636,000 from the prior year quarter and we continue to see an increase in our sales pipeline. We anticipate year over year sales growth in technology sales to continue to be robust while we also anticipate technology sales to fluctuate from quarter to quarter. However, we anticipate the overall trend of technology sale volume as positive for the year and consistent with full year revenue forecast in the range of $2.0 to $2.5 million based on our sales pipeline.

 

We are marketing our technology internationally, including through current negotiations for sales for our technology and services with correctional facilities, service providers, and telecommunications companies in the corrections industry in Europe, Canada, and Asia. We are also currently responding to a number of requests for proposals in Europe and Canada. We have been notified that two of our proposals in the Canadian market have been successful and anticipate receipt of corresponding orders. Based on these results, we anticipate recognizing revenue from these sales in the current year. In addition, we continue to provide service in two U.K. facilities and anticipate hearing the outcome of a number of proposals we have submitted this year.

 

The new direct services model will continue to require the company to make upfront capital investments in equipment at the inception of each new contract. To date, we have secured equipment financing and raised alternative financing to support our new contracts. Our change to a direct service based model should not require significant R&D investments to further developing our call platform technology. Our call control technology has been deployed and is currently operating in this market from our legacy wholesaling business. As we continue to expand and accelerate our growth, we will require additional capital to support an acceleration in the pace with our installations. We are currently negotiating for additional financing to support intensifying capital which may be required to support accelerating growth in our communications revenue.

  

Government Services :

 

We have implemented cost cutting measures and continue to reduce our costs in line with the decline in revenues mainly due to loss of the large SPAWAR contracts in May 2011 and the continued stagnation in funding of government contracts. All cost cutting has been realized in the current quarter. We continue to manage our cost structure closely so that the Government segment generates positive operating income. These steps aided the company in its ability to improve from a net loss of $3,436.000 in the year ago nine months to net income of $21,000. We anticipate revenue to increase later in the year from Q3 levels. This is based on the following factors:

 

	1.	Awarded a SBIR contract with the Air Force effective May 2012. We originally anticipated revenues to ramp in August of this year  but do to staffing and subcontract delays now expect to see the increase in revenue to begin in November with a total contract value of $750,000.
	2.	We have been notified as a subcontractor to the winning prime contractor on 3 contracts; C4I Systems Engineering IDIQ contract with Accenture, C4I Software Applications and Database IDIQ contract with FGM, and SPAWAR Center – Atlantic NCR Security Engineering Contract with Mantech. To date we have not received tasks orders against these contracts but we anticipate receiving them as the year progresses.
	3.	All the contracts we anticipated expiring or being recompeted this year have been as of the end of the second quarter. This includes a contract with AMC which was not renewed and had a large subcontractor component. Although there was a top line impact of approximately $500,000 per quarter the contract was primarily pass through subcontractor revenue that carried a low gross margin.

 

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

  

RESULTS OF OPERATIONS

 

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

  

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

 

		For the Three Months Ending  September 30,
		2012				2011
REVENUE		$	2,731,599			$	2,545,429
Net (loss)		$	(107,317	)		$	(929,169	)
Net (loss) per common share – Basic & Diluted		$	(0.00	)		$	(0.03	)

 

		OPERATING EXPENSES								PERCENT OF SALES
		THREE MONTHS ENDED SEPTEMBER 30, 2012				THREE MONTHS ENDED SEPTEMBER 30, 2011				THREE MONTHS ENDED SEPTEMBER 30, 2012				THREE MONTHS ENDED SEPTEMBER 30, 2011
Research & Development			160,876				192,930				5.9%				7.6%
Selling, General & Administrative			860,923				1,565,445				31.5%				61.5%

  

REVENUES:

 

Total revenues for the three months ended September 30, 2012 increased by $186,000 or 7.3% to $2,732,000 compared to $2,545,000 for the three months ended September 30, 2011. A decrease in our government segment revenues of $758,000 or 55.5% from prior year quarter was offset by an increase in our telecom segment of $944,000 or 80.1% from prior year. Our Telecom segment accounted for 78% of total revenues compared to 43% in the year ago quarter.

 

 

Our Government services revenues which represents revenues from professional engineering services to Federal government Dept of Defense (DoD) agencies decreased by $758,000 or 55.4% to $609,000 from $1,367,000 in the year ago quarter. The decrease was mainly attributable to several contracts ending late 2011 and during 2012 combined with lower funding levels on existing task orders.

 

Our communications segment revenues increased by $944,000 or 80.1% to $2,123,000 from $1,178,000 in the prior year. The increase was comprised of an increase in recurring service revenues of $308,000 or 27.3% and an increase of $636,000 in technology equipment sales. The recurring services increase is attributable to volume growth from the continuing addition to the number of customer contracts where we provide direct telecom service provisioning to end-user correctional facilities.

 

GROSS MARGIN:

 

Gross profit for the three months ended September 30, 2012 was $1,079,000, an increase of $211,000 or 24.3% compared to the $868,000 for three months ended September 30, 2011. Gross margin, as a percentage of revenues, increased to 39.5% from 34.1% for the same period in 2011. The increase in gross margin was primarily due to an increase in margin in our telecom from a shifting mix of product sales in higher margin wholesale technology equipment sales relative to recurring telecom service revenues. The technology equipment margins range approximately 70% and services margins range between 20 to 30% of revenues. Additionally, gross margin as a percent of sales increased in our Government segment due to the loss of contracts that included a high component of lower margin pass-thru or subcontracted work,

 

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, 2012, research and development expenses decreased to $161,000 as compared to $193,000 for the three months ended September 30, 2011. The decrease was due to the prior year including one-time fringe expenses and not to a reduction in labor or effort. 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 September 30, 2012, SG&A expenses decreased to $861,000 from $1,565,000 in the comparable period prior year. As a percentage of revenues, SG&A was 31.5% for the three months ended September 30, 2012 versus 61.5% in the comparable period a year ago. The decrease was mainly attributable to cost cutting measures in line with the decline in revenues and billable FTE’s in our Government segment combined with lower corporate expenses.

 

AMORTIZATION EXPENSES:

 

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

 

INTEREST EXPENSE:

 

Interest Expense increased to $125,000 for the three months ended September 30, 2012 compared to $105,000 for the three months ended September 30, 2011 due to a net increase in the level of borrowings.

 

NET INCOME (LOSS):

 

The Company’s net loss for the three months ended September 30, 2012 was $107,000 compared to a net loss of $929,000 for the three months ended September 30, 2011. The increase was mainly due to higher gross profit generated in our Telecom segment and lowered operating expenses as a result of restructuring the Government segment in line with declined revenues.

 

 

NINE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2011

 

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

 

		For the Nine Months Ending  September 30,
		2012				2011
REVENUE		$	8,615,139			$	9,006,867
Net income (loss)		$	20,981			$	(3,436,402	)
Net (loss) per common share – Basic & Diluted		$	0.00			$	(0.13	)

 

		OPERATING EXPENSES								PERCENT OF SALES
		NINE MONTHS ENDED SEPTEMBER 30, 2012				NINE MONTHS ENDED SEPTEMBER 30, 2011				NINE MONTHS ENDED SEPTEMBER 30, 2012				NINE MONTHS ENDED SEPTEMBER 30, 2011
Research & Development			514,067				513,160				5.9%				5.7%
Selling, General & Administrative			2,863,680				4,255,532				31.2%				47.2%

  

REVENUES:

 

Total revenues for the nine months ended September 30, 2012 decreased by $392,000 or 4.3% to $8,615,000 compared to $9,007,000 for the nine months ended September 30, 2011.  A decrease in our government segment revenues of $3,050,000 or 54.3% was partially offset by an increase in our telecom segment of  $2,659,000 or 78.5%.  Our Government Services segment which represents revenues from professional engineering services to Federal government Dept of Defense (DoD) agencies accounted for 30% of total revenues compared to 62% in the year ago period.

 

Our Government services revenues decreased by $3,050,000 or 54.3% to $2,570,000 from $5,620,000 in the year ago period. The decrease was mainly attributable to several contracts ending during 2011 and 2012 mainly the SPAWAR contract vehicles which ended May 15, 2011. The decrease in revenues from the loss of contracts was partially offset by the full year effect of revenues attributable to the CLR acquisition which closed in May 2011.

 

Our communications segment revenues increased by $2,659,000 or 78.5% to $6,045,000 from $3,387,000 in the prior year.  The increase was comprised of an increase in recurring service revenues of $1,521,000 or 55% and an increase of $1,138,000 in technology equipment sales. The recurring services increase is attributable to volume growth from the continuing addition to the number of customer contracts where we provide direct telecom service provisioning to end-user correctional facilities.

 

GROSS MARGIN:

 

Gross profit for the nine months ended September 30, 2012 was $3,423,000, an increase of $189,000 or 5.9% compared to the $3,234,000 for the nine months ended September 30, 2011. Gross margin as a percentage of revenues increased to 39.7% from 35.9% for the same period in 2011. The increase in gross margin was primarily due to an increase in both the government services and communications segments. The increase in margin from 33% to 39% in our communications segment was due an increase in revenues attributable to higher margin wholesale technology equipment sales relative to recurring telecom service revenues. The technology equipment margins range approximately 70% and services margins range between 20 to 30% of revenues. The increase in government services margin from 37.7% to 41.5% was mainly attributable to the decrease of lower margin subcontracted revenues relative to higher margin in-house labor resulting from the termination of contracts with heavy subcontracted components.

 

RESEARCH AND DEVELOPMENT EXPENSES:

 

Research and Development expenses consist primarily of salaries and related personnel costs, and consulting fees associated with product development in our Technology Products segment.   For the nine months ended September 30, 2012, research and development expenses increased slightly to $514,067 as compared to $513,160 for the nine months ended September 30, 2011. Management believes that continual enhancements of the Company's existing products are required to enable the Company to maintain its current competitive position. 

 

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:

 

Selling, General and administrative ("SG&A") expenses consist primarily of expenses for management, fringe benefits, indirect overhead, labor costs of billable technical staff not charged to a project or contract, finance, administrative personnel, legal, accounting, consulting fees, sales commissions, marketing, facilities costs, corporate overhead and depreciation expense.  For the nine months ended September 30, 2012, SG&A expenses decreased to $2,684,000 from $4,256,000 in the comparable period prior year.  As a percentage of revenues, SG&A was 31.7% for the nine months ended September 30, 2012 versus 47.2% in the comparable period a year ago. The decrease in SG&A was comprised of an increase in sales and marketing costs supporting our Telecom services growth and a decrease in share based compensation and a decrease in SG&A supporting our Government services segment.  The decrease in Government segment SG&A was driven cost cutting in response to the contraction in revenues and billable FTE’s and the integration of CLR which was acquired May 2011.

 

AMORTIZATION EXPENSES:

 

Non-cash amortization expenses related mainly to intangible assets acquired in the acquisitions of Cummings Creek/CLR, LGS (formerly RTI) and SMEI are stated separately in our statement of operations. Amortization expense for the nine months ended September 30, 2012 was $241,000 compared to $314,000 for the nine months ended September 30, 2011. The decrease is attributed to certain intangibles attributable to the RTI and SMEI purchases being fully amortized in prior periods.

 

INTEREST EXPENSE:

 

Interest expense increased to 355,000 for the nine months ended September 30, 2012 compared to $342,000 for the nine months ended September 30, 2011.

 

NET INCOME (LOSS):

 

The Company’s net income for the nine months ended September 30, 2012 was $21,000 compared to a net loss of $3,436,000 for the nine months ended September 30, 2011. The prior year net loss included an impairment charge of $1,575,000 to the carrying value of intangible assets associated with the Government services segment. The remaining improvement was driven by lower expenses from restructuring the Government Services segment costs in line with the decrease in revenues . Additionally, non-cash share based compensation decreased from $194,487 to $4,253.

 

LIQUIDITY AND CAPITAL RESOURCES:

 

Cash and cash equivalents at September 30, 2012 was $81,000, which compared to $192,000 at December 31, 2011. Net cash provided by operating activities was $346,000 for the nine months ended September 30, 2012 compared to net cash used in operating activities of $1,523,000 in the corresponding nine months ended September 30, 2011. The increase in the current period is mainly due to an increase in adjusted operating income to $500,000 from a year ago loss of $1,124,000. The adjustments to reported operating income included adding back non cash; amortization, share based compensation, impairment charges and depreciation expenses.

 

 

Reconciliation of Reported Operating income (loss) to EBITDA:            

 

		Three Months Ended September 30,								Nine Months Ended    September 30,
		2012				2011				2012				2011
Operating income (loss) reported			(23,426	)			(994,905	)			(15,845	)			(3,424,109	)
Non-cash expenses:
Amortization of intangibles			112,948				137,227				338,844				411,681
Impairment charge			–				–				–				1,575,000
Share based compensation (stock options)			1,421				–				4,263				194,750
Depreciation			56,681				47,208				172,685				119,091
EBITDA		$	147,624			$	(810,470	)		$	499,947			$	(1,123,587	)

 

Net cash used in investment activities was $114,000 for the nine months ended September 30, 2012 compared to $429,000 in the corresponding period ended September 30, 2011. Purchase of property, plant and equipment primarily consists of central office hardware and premise equipment supporting our direct telecom services growth, totaled $114,000 related to our installs of equipment supporting our direct telecom services revenues for the nine months ended September 30, 2012, compared to $489,000 in the prior period. We expect to continue to have a requirement for capital on a project by project basis as we are awarded service contracts. To date, we have financed these equipment purchases with equipment based financing, alternative debt and equity financings. The capital requirement for our Government services business is minimal and mainly driven by the level of new hiring’s of billable staff, which requires the purchase of personal computers, in-house servers and network infrastructure.

 

Net cash used by financing activities was $342,000 for the nine months ended September 30, 2012 compared to net cash provided by financing activities of $1,879,000 in the corresponding nine months ended September 30, 2011. The $342,000 consisted of: principal repayments on outstanding indebtedness totaling $517,000 offset by proceeds on notes issued in January 2012 of $175,000.

 

Our current level of liquidity combined with projected operating cash flows is not adequate to support our working capital needs, service our debt obligations, or support the capital requirements for further expansion of our telecom segment. Accordingly, we remain highly dependent on (i) successfully executing our business plan, (ii) the ability to raise alternative financing in the near term and (iii) our ability to renegotiate terms with note holders and other creditors. It should be noted that the note for $982,000 maturing October 31, 2012 is currently in default and is in the process of being amended which includes extending the maturity date to January 31, 2013.

 

 

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 mainly due to the Company’s working capital deficiency at September 30, 2012 of $2,940,000. This condition raises substantial doubt regarding the Company’s ability to achieve its planned operating cashflows, maintain continued availability under its line of credit financing and the ability to obtain additional alternative financing.

 

Financing activities:

 

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

 

OFF BALANCE SHEET ARRANGEMENTS:

 

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

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

N/A.

 

ITEM 4T. CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

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

 

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

  

Changes in internal control

 

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

 

 

PART II

 

OTHER INFORMATION

 

ITEM. LEGAL PROCEEDINGS

 

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

 

ITEM 1A. RISK FACTORS

 

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

 

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

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. RESERVED

 

ITEM 5. OTHER INFORMATION

 

None.

 

Item 6. EXHIBITS

 

Exhibit Number	Description
2.2	Stock Purchase Agreement dated December 16, 2004 among Science Dynamics Corporation, Systems Management Engineering, Inc. and the shareholders of Systems Management Engineering, Inc. identified on the signature page thereto (Incorporated by reference to Form 8-K, filed with the Securities and Exchange Commission on December 22, 2004)
2.3	Amendment No. 1 to Stock Purchase Agreement dated February 2, 2005 among Science Dynamics Corporation, Systems Management Engineering, Inc. and the shareholders of Systems Management Engineering, Inc. identified on the signature page thereto (Incorporated by reference to Form 8-K, filed with the Securities and Exchange Commission on February 11, 2005)
2.4	Stock purchase agreement by Ricciardi Technologies, Inc., its Owners, including Michael Ricciardi as the Owner Representative and Science Dynamics Corporation, dated as of September 12, 2006.(1)
3.1	Certificate of Incorporation (Incorporated by reference to the Company’s registration statement on Form S-18 (File No. 33-20687), effective April 21, 1981)
3.2	Amendment to Certificate of Incorporation dated October 31, 1980 (Incorporated by reference to the Company’s registration statement on Form S-18 (File No. 33-20687), effective April 21, 1981)
3.3	Amendment to Certificate of Incorporation dated November 25, 1980 (Incorporated by reference to the Company’s registration statement on Form S-18 (File No. 33-20687), effective April 21, 1981)
3.4	Amendment to Certificate of Incorporation dated May 23, 1984 (Incorporated by reference to the Company’s registration statement on Form SB-2 (File No. 333-62226) filed with the Securities and Exchange Commission on June 4, 2001)
3.5	Amendment to Certificate of Incorporation dated July 13, 1987 (Incorporated by reference to the Company’s registration statement on Form SB-2 (File No. 333-62226) filed with the Securities and Exchange Commission on June 4, 2001)
3.6	Amendment to Certificate of Incorporation dated November 8, 1996 (Incorporated by reference to the Company’s registration statement on Form SB-2 (File No. 333-62226) filed with the Securities and Exchange Commission on June 4, 2001)
3.7	Amendment to Certificate of Incorporation dated December 15, 1998 (Incorporated by reference to the Company’s registration statement on Form SB-2 (File No. 333-62226) filed with the Securities and Exchange Commission on June 4, 2001)

 

 

3.8	Amendment to Certificate of Incorporation dated December 4, 2002 (Incorporated by reference to the Company’s information statement on Schedule 14C filed with the Securities and Exchange Commission on November 12, 2002)
3.9	By-laws (Incorporated by reference to the Company’s registration statement on Form S-18 (File No. 33-20687), effective April 21, 1981)
3.10	Restated Certificate of Incorporation (Incorporated by reference to the Registration Statement On Form SB-2. file with the Securities and Exchange Commission on February 12, 2007)
4.1	Form of warrant issued to Barron Partners LP.(1)
4.2	Promissory Note issued to Barron Partners LP.(1)
4.3	Form of warrant issued to Dragonfly Capital Partners LLC.(1)
10.1	Executive Employment Agreement Amendment made as of February 14, 2005 by and between Science Dynamics Corporation and Paul Burgess (Incorporated by reference to Form 8-K filed with the Securities and Exchange Commission on March 2, 2005).(1)
10.2	Stock Purchase Agreement by Ricciardi Technologies, Inc., its Owners, including Michael Ricciardi as Owner Representative and Lattice Incorporated, dated September 12, 2006.(1)
10.3	Omnibus Amendment and Waiver between Lattice Incorporated and Laurus Master Fund, LTD, dated September 18, 2006.(1)
10.4	Executive Employment of dated March 7, 2005 by and between Science Dynamics Corporation and Joe Noto (Incorporated by reference to the 10-KSB filed on April 17, 2006)

 

10.5	Microsoft Partner Program Agreement (Incorporated by reference to Form 8-K filed with the Securities and Exchange Commission on February 18, 2005)
10.6	AmberPoint Software Partnership Agreement (Incorporated by reference to Form 8-K filed with the Securities and Exchange Commission on February 18, 2005)
10.7	Securities Agreement between Science Dynamics Corporation and Barron Partners LP, dated September 15, 2006.(1)
10.8	Amendment to Employment Agreement - Paul Burgess.(1)
10.9	Amendment to Employment Agreement - Joe Noto.(1)
10.10	Registration Rights Agreement by and among Science Dynamics Corporation and Barron Partners LLP, dated As of September 19, 2006.(1)
10.11	Amendment to Securities Purchase Agreement and Registration Rights Agreement (Incorporated by Reference to the Registration Statement on Form SB-2 filed with the SEC on February 12, 2007).
10.12	Exchange Agreement between Lattice Incorporated and Barron Partners LP dated June 30, 2008.(2)
10.13	Certificate of Designations of Series C Preferred Stock.(2)
10.14	Accounts Receivable Purchase Agreement dated March 11, 2009.(3)
10.15	Securities Purchase Agreement dated February 1, 2010
10.16	Promissory Note issued to I. Wistar Morris. (4)
10.17	Security Agreement dated June 11, 2010 by and between Lattice, Incorporated, Lattice Government Services, Inc. and I. Wistar Morris.(4)
10.18	Certificate of Designation, Series D Convertible Preferred Stock, dated February 10, 2011.(5)

 

10.19	Securities Purchase Agreement, between the Company and Barron Partners LP, dated February 14, 2011.(5)
10.20	Securities Purchase Agreement between Company and Barron Partners LP, dated March 28, 2011
10.21	Amended Certificate of Designation, Series D Convertible Preferred Stock, dated April 17, 2011.(6)
10.22	Contribution and Exchange Agreement By and Among Lattice Incorporated and Cummings Creek Capital, Inc. and Ralph Alexander Dated as of May 16, 2011.(7)
10.23	Employment Agreement with Ralph Alexander.(7)
14.1	Code of Ethics (Incorporated by reference to the Company’s annual report on Form 10-KSB for the fiscal year ended December 31, 2003, filed with the Securities and Exchange Commission on April 9, 2004)
21.1	Subsidiaries of the Company (Incorporated by Reference to the Registration Statement on Form SB-2 filed with the SEC on February 12, 2007).
31.1	Certification by Chief Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act
31.2	Certification by Chief Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act
32.1	Certification by Chief Executive Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code
32.2	Certification by Chief Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code
99.3	Form of Lock Up Agreement, executed pursuant to the Securities Purchase Agreement between Science Dynamics Corporation and Barron Barron Partners, dated September 15, 2006.(1)
101.INS	XBRL Instance Document
101.SCH	XBRL Schema Documen
101.CAL	XBRL Calculation Linkbase Document
101.DEF	XBRL Definition Linkbase Document
101.LAB	XBRL Label Linkbase Document
101.PRE	XBRL Presentation Linkbase Document

 

__________

(1) Incorporated by reference to the 8-K filed by the Company with the SEC on September 25, 2006
(2) Incorporated by reference to the 8-K filed by the Company on July 8, 2008
(3) Incorporated by reference to the 8-K filed by the Company on March 27, 2009
(4) Incorporated by reference to the 10-Q for fiscal quarter ending June 30, 2010 and filed by the Company on August 20, 2010
(5) Incorporated by reference to the 8-K filed by the Company on February 22, 2011
(6) Incorporated by reference to the 8-K filed by the Company on March 13, 2011
(7) Incorporated by reference to the 8-K filed by the Company on May 27, 2011

 

 

 

 

 

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 19, 2012

 

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

 

DATE: November 19, 2012

 

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

 

 

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