NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
JUNE 30, 2016
(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 owned
100% of the shares of CLR Group Limited. (“CLR”), a government contractor. Together, the SMEI, RTI and CLR acquisitions
formed our federal government services business unit, Lattice Government Services (“LGS”). Through 2012 we operated
in two segments, our federal government services unit and our telecommunication services business.
As part of the Company’s strategy to
focus on its higher growth potential communications business, the Company decided during the first quarter of 2013 to exit the
Government services segment, which derived its revenues mainly from contracts with federal government Department of Defense agencies
either as a prime contractor or as a subcontractor to another prime contractor. On April 2, 2013, we entered an Asset Purchase
Agreement (“Purchase Agreement”) with Blackwatch International, Inc. (“Blackwatch”), a Virginia corporation,
pursuant to which we sold the assets of LGS for approximately $1.2 million. These assets essentially comprised our federal government
services segment operations.
On November 1, 2013, the Company purchased
certain assets of Innovisit, LLC. The acquired assets mainly included: awarded contracts, customer lists, and its intellectual
property rights to video visitation software assets. Under the agreement, the workforce and operating infrastructure supporting
Innovisit’s business operations have been transferred to Lattice, including but not limited to certain employees, and leases.
This acquisition complemented the product offering of our telecom services business.
In 2013, the Company established a wholly owned
subsidiary, Lattice Communications Inc., to enable us to operate in Canada. During 2014, we started operating a call center and
collecting fee income for processing prepaid deposits for a large Canadian telecom provider which operates Lattice technology systems
to provide call provisioning services to correctional facilities located in Canada.
b) Basis of Presentation / Going Concern
As disclosed in Note 3 to the condensed consolidated
financial statements, the Company adopted Accounting Standards Update (“ASU”) 2015-03, Interest-Imputation of Interest
(Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,” during the first quarter of 2016. In accordance
with the guidance, $115,000 of unamortized debt issuance costs, associated with the Company’s convertible notes payable,
were reclassified from other current assets, as previously reported on the consolidated balance sheet as of December 31, 2015,
to convertible notes payable, net of debt discount.
At June 30, 2016, our working capital
deficiency was approximately $7,114,000 compared to a working capital deficiency of approximately $7,059,000 at December 31, 2015.
Cash from operations and available capacity on current credit facilities are insufficient to cover liabilities currently due and
the liabilities which will mature over the next twelve months. Additionally, we are extended on payables with trade creditors.
We have several payment arrangements in place but face continuing pressures with trade creditors regarding overdue payables. These
conditions raise substantial doubt regarding our ability to continue as a going concern. Our ability to continue as a going concern
is highly dependent upon our ability to improve our operating cash flow, maintain our credit lines and secure additional capital.
Management is currently seeking financing. To address this objective and to address short term liquidity needs, Lattice raised
$600,000 during the quarter ended June 30, 2016 through the private placement of restricted common stock and is currently seeking
additional funding. There is no assurance, however, that we will succeed in raising the financing needed to provide for all of
our liquidity needs. In the event we fail to obtain the additional capital needed and/or restructure our existing debts with current
creditors, we may be required to curtail our operations significantly.
The condensed consolidated financial statements
have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”)
and the requirements of the Securities and Exchange Commission (“SEC”). The condensed consolidated balance sheet at
December 31, 2015 was derived from audited financial statements but does not include all disclosures required by accounting principles
generally accepted in the United States of America.
c) Interim Condensed Consolidated Financial Statements
The condensed consolidated financial statements
for the three and six months ended June 30, 2016 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, 2015 appearing in
Form 10-K filed on April 14, 2016.
d) Principles of Consolidation
The condensed consolidated 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.
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 consolidated 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) Fair Value Disclosures
Management believes that the carrying values
of financial instruments, including, cash, accounts receivable, accounts payable, and accrued liabilities approximate fair value
as a result of the short-term maturities of these instruments. As discussed in Note 1(m), derivative financial instruments are
carried at fair value.
The carrying values of the Company’s
long-term debts approximates their fair values based upon a comparison of the interest rates and terms of such debt to the rates
and terms of debt currently available to the Company.
g) Cash and Cash Equivalents
The Company maintains its cash balances with
various financial institutions. Balance at various times during the year may exceed Federal Deposit Insurance Corporation limits.
h) Inventories
Inventories are stated at the lower of cost
or market, with cost determined on a first-in, first-out basis.
i) Revenue Recognition
Revenue is recognized when all significant
contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. Revenue from product
sales is recognized when the goods are shipped and title passes to the customer.
Direct Call Provisioning Services:
Revenues related to collect and prepaid calling
services generated by communication services 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.
Wholesaled Technology:
We sell telephony systems with embedded proprietary
software to other service providers. We recognize revenue when the equipment is shipped to the customer.
Breakage:
In compliance with regulatory tariffs, we recognize
as income prepaid deposits which have aged beyond six to nine months and the customer has not requested a refund of the unused
deposit.
Prepaid Cards:
We also sell prepaid phone cards to end user
facilities on a wholesale basis. We recognize revenue on prepaid phone cards when they are either shipped or emailed to customer
end user facilities.
Software Maintenance:
We offer software maintenance and support contracts
to customers who purchase our technology systems. These are unbundled and invoiced separately and revenue is recognized ratably
over the life of the contract.
Revenue Recognition for Construction Projects:
Revenues from construction contracts are included
in contract revenue in the condensed consolidated statements of operations and are recognized under the percentage-of-completion
accounting method. The percent complete is measured by the cost incurred to date compared to the estimated total cost of each project.
This method is used as management considers expended cost to be the best available measure of progress on these contracts, the
majority of which are completed within one year, but may occasionally extend beyond one year. Inherent uncertainties in estimating
costs make it at least reasonably possible that the estimates used will change within the near term and over the life of the contracts.
Contract costs include all direct material
and labor costs and those indirect costs related to contract performance and completion. Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are determined. General and administrative costs are charged to expense as
incurred.
Changes in job performance, job conditions
and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result
in revisions to costs and income. Such revisions are recognized in the period in which they are determined. An amount equal to
contract costs incurred that are attributable to claims is included in revenue when realization is probable and the amount can
be reliably estimated.
Costs and estimated earnings in excess of billings
are comprised principally of revenue recognized on contracts (on the percentage-of-completion method) for which billings had not
been presented to customers because the amount were not billable under the contract terms at the balance sheet date. Amounts are
billed based on contractual terms. Billings in excess of costs and estimated earnings represent billings in excess of revenues
recognized.
Software and Software License Sales
The Company recognizes revenue when a fixed
fee order has been received and delivery has occurred to the customer. The Company assesses whether the fee is fixed or determinable
and free of contingencies based upon signed agreements received from the customer confirming terms of the transaction. Software
and licenses are delivered electronically to the customer. Revenue attributable to software licenses sold with extended payment
terms in excess of twelve months are recognized ratably over the payment term.
j) 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 consolidated
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, 2016, there was $104,471 of total unrecognized compensation
cost related to unvested share-based compensation awards granted under the equity compensation plans which do not include the effect
of future grants of equity compensation, if any. This amount will be amortized over the remaining vesting periods of the grants.
k) Depreciation, Amortization and Long-Lived
Assets:
Long-lived assets include:
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|
·
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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.
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·
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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.
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At least annually, The Company reviews all
long-lived assets for impairment. When necessary, charges are recorded for impairments of long-lived assets for the amount by which
the fair value is less than the carrying value of these assets.
l) Fair Value of Financial Instruments
In accordance with FASB ASC 820, fair value
is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”)
in an orderly transaction between market participants at the measurement date.
In determining fair value, the Company uses
various valuation approaches. In accordance with GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes
the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used
when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market
data. Unobservable inputs reflect assumptions about the inputs market participants would use in pricing the asset or liability
developed based on the best information available in the circumstances. The fair value hierarchy is categorized into three levels
based on the inputs as follows:
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·
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Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
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·
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Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
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·
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Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value.
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As of June 30, 2016 and December 31, 2015,
the derivative liability amounted to $37,511 and $30,154. In accordance with the accounting standards the Company determined that
the carrying value of these derivatives approximated the fair value using the level 3 inputs.
m)
Derivative
Financial Instruments and Registration Payment Arrangements
Derivative financial instruments,
as defined in Financial Accounting Standards, consist of financial instruments or other contracts that contain a notional amount
and one or more underlying variables (e.g. interest rate, security price or other variable), require no initial net investment
and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further,
derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare
instances, assets. The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market
or foreign-currency risks. However, the Company has entered into various types of financing arrangements to fund its business capital
requirements, including convertible debt and other financial instruments indexed to the Company's own stock. These contracts require
careful evaluation to determine whether derivative features embedded in host contracts require bifurcation and fair value measurement
or, in the case of freestanding derivatives (principally warrants) whether certain conditions for equity classification have been
achieved. In instances where derivative financial instruments require liability classification, the Company is required to initially
and subsequently measure such instruments at fair value. Accordingly, the Company adjusts the fair value of these derivative components
at each reporting period through a charge to income until such time as the instruments require classification in stockholders'
equity (deficit). See Note 4 for additional information.
As previously stated, derivative
financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting
period. The Company estimates fair values of derivative financial instruments using various techniques (and combinations thereof)
that are considered to be consistent with the objective measuring fair values. In selecting the appropriate technique, management
considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement.
For less complex derivative instruments, such as free-standing warrants, the Company generally uses the Black-Scholes-Merton option
valuation technique because it embodies all of the requisite assumptions (including trading volatility, dividend yield, estimated
terms and risk free rates) necessary to fair value these instruments. For complex derivative instruments, such as embedded conversion
options, the Company generally uses the Flexible Monte Carlo valuation technique because it embodies all of the requisite assumptions
(including credit risk, interest-rate risk and exercise/conversion behaviors) that are necessary to fair value these more complex
instruments. Estimating fair values of derivative financial instruments requires the development of significant and subjective
estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external
market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading market price of
our common stock, which has a high-historical volatility. Since derivative financial instruments are initially and subsequently
carried at fair values, our income (loss) will reflect the volatility in these estimate and assumption changes.
n) 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 exited its
government services business in April 2013 and is reporting the operating results of that unit as discontinued operations in the
consolidated financial reports. Accordingly, the Company operated in one segment during the three months ended June 30, 2016 and
2015 (Telecom services).
o) Basic and Diluted Income (Loss) Per Common
Share
The Company calculates income (loss) per common
share in accordance with ASC Topic 260, “Earnings Per Share”. Basic and diluted income (loss) per common share is computed
based on the weighted average number of common shares outstanding. Common share equivalents (which consist of convertible preferred
stock, options and warrants) are excluded from the computation of diluted loss per share since the effect would be anti-dilutive.
Common share equivalents which could potentially dilute basic earnings per share in the future, and which were excluded from the
computation of diluted loss per share, totaled approximately 39 million shares at June 30, 2016.
p) Recent Accounting Pronouncements
In July 2015, the FASB issued ASU No. 2015-11, “Simplifying
the Measurement of Inventory” (“ASU 2015-11“). ASU 2015-11 requires that inventory within the scope of the guidance
be measured at the lower of cost and net realizable value. Inventory measured using last-in, first-out and retail inventory
method are excluded from this new guidance. This ASU replaces the concept of market with the single measurement of net realizable
value and is intended to create efficiencies for preparers and more closely aligns U.S. GAAP with IFRS. This ASU is effective for
public business entities in fiscal years beginning after December 15, 2016, including interim periods within those years. Prospective
application is required and early adoption is permitted as of the beginning of an interim or annual reporting period. The Company
is currently evaluating the impact of the new standards.
In April 2015, the FASB issued ASU 2015-03,
“Interest – Imputation of Interest” (“ASU 2015-03”), which requires that debt issuance costs related
to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability,
consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments
in this ASU. ASU 2015-03 is effective for annual and interim periods beginning on or after December 15, 2015. See Note 3 for
the impact of this adoption.
In May 2014, the FASB issued ASU No. 2014-09,
“Revenue from Contracts with Customers” (“ASU 2014-09”), which requires entities to recognize revenue in
a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which
the entity expects to be entitled to in exchange for those goods or services. The new guidance also requires additional disclosure
about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant
judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In July 2015, the
FASB voted to delay the effective date of ASU 2014-09 by one year to the first quarter of 2018 to provide companies sufficient
time to implement the standards. Early adoption will be permitted, but not before the first quarter of 2017. Adoption
can occur using one of two prescribed transition methods. In March and April 2016, the FASB issued ASU 2016-08, “Revenue
from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” and ASU 2016-10,
“Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing” which provide supplemental
adoption guidance and clarification to ASC 2014-09. ASU 2016-08 and ASU 2016-10 must be adopted concurrently with the adoption
of ASU 2014-09. The Company is currently evaluating the impact of these new standards.
In August 2014, the FASB issued ASU No. 2014-15,
“Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”),
which provides guidance on management’s responsibility in evaluating whether there is substantial doubt about an entity’s
ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for the annual period
ending after December 15, 2016, and for annual and interim periods thereafter. The adoption of ASU 2014-15 is not expected
to have a material impact on our financial position, results of operations or cash flows.
During January 2016, the FASB issued ASU No.
2016-01, “Financial Instruments — Overall: Recognition and Measurement of Financial Assets and Financial Liabilities
(“ASU 2016-01”). The standard addresses certain aspects of recognition, measurement, presentation, and disclosure of
financial instruments. This ASU is effective for fiscal years, and interim periods within those years, beginning after December
15, 2017. Early adoption is not permitted with the exception of certain provisions related to the presentation of other comprehensive
income. The adoption of ASU 2016-01 is not expected to have a material impact on our financial position, results of operations
or cash flows.
During February 2016, the FASB issued ASU No.
2016-02, “Leases” (“ASU 2016-02”). The standard requires lessees to recognize a lease liability and a lease
asset for all leases, including operating leases, with a term greater than 12 months on its balance sheet. The update also expands
the required quantitative and qualitative disclosures surrounding leases. ASU 2016-02 is effective for fiscal years beginning after
December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of the new
standard.
In March 2016, the FASB issued ASU No. 2016-06,
“Contingent Put and Call Option in Debt Instruments” (“ASU 2016-06”). ASU 2016-06 is intended to
simplify the analysis of embedded derivatives for debt instruments that contain contingent put or call options. The amendments
in ASU 2016-06 clarify that an entity is required to assess the embedded call or put options solely in accordance with the four-step
decision sequence. Consequently, when a call (put) option is contingently exercisable, an entity does not have to initially assess
whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. The amendments
in ASU 2016-06 take effect for public business entities for financial statements issued for fiscal years beginning after December
15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period.
The Company does not expect the adoption of ASU 2016–01 to have a significant impact on its financial statements.
In March 2016, FASB issued ASU No. 2016-09,
“Improvements to Employee Share-based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 simplifies
several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including
the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement
of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2017, and interim periods within annual
periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the standard and the
impact on its consolidated financial statements and footnote disclosures.
Management does not believe there would have
been a material effect on the accompanying financial statements had any other recently issued, but not yet effective, accounting
standards been adopted in the current period.
Note 2 – Notes Payable
Notes payable consists of the following as
of June 30, 2016 and December 31, 2015:
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June 30,
2016
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December 31,
2015
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Bank line of credit (a)
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$
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–
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$
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–
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Notes payable to shareholder/former director (b)
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192,048
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192,048
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Notes payable (c)
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4,131,368
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|
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1,656,996
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Note payable, Innovisit (d)
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12,734
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27,734
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Total notes payable
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4,336,150
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1,876,778
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Less current maturities
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(2,792,781
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)
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(1,806,981
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)
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Long term debt
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$
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1,543,369
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$
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69,797
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(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 is obligated to pay Action Capital interest on the advances outstanding under
the Action Agreement equal to the prime rate in effect on the last business day of the prior month plus 1%. In addition, the Company
is obligated to pay a monthly fee to Action Capital equal to 0.75% of the total outstanding balance at the end of each month.
The outstanding balance owed on the line at
June 30, 2016 and December 31, 2015 was $0 and $0 respectively. If the credit facility is drawn upon, the interest rate would be
13.25%.
(b) Notes Payable to Shareholder/Former
Director
There are two notes outstanding with a former
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 principal was to be paid. This note had an outstanding principal balance of $24,048 as of June
30, 2016 and December 31, 2015, respectively. The Company is in arrears on interest payments that were due but has accrued the
interest on the note. The holder has not as of the date of this filing invoked his rights under the default provisions of the note
related to the past due principal and interest payments.
The second note is dated October 14, 2011
and 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 was 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 was due at maturity on October 14, 2014. This
note had an outstanding principal balance of $168,000 as of June 30, 2016 and December 31, 2015, respectively. The Company is
in arrears on interest payments that were due but has accrued the interest on the note. The holder has not as of the date of this
filing invoked his rights under the default provisions of the note related to the past due principal and interest payments.
(c) Notes 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 difference between the face amount of the
note and proceeds received was 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
and 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 December 31, 2013. During 2014 the Company paid $100,000 each in April and July reducing the principal on this note to $781,655
as of December 31, 2014. As of June 30, 2016 and December 31, 2015, there was $781,655 of unpaid principal remaining on this note.
As of the date of this filing, the Company is currently in violation under terms of the note agreement requiring principal due
at the October 31, 2012 maturity date. The Company is current with quarterly interest payments. The holder has not as of the date
of this filing invoked his rights under the default provisions of the note.
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 was 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 became due along with any unpaid and accrued interest. The
Company is not in compliance with the terms of the note. As of June 30, 2016 and December 31, 2015, there was $200,000 of unpaid
principal remaining on this note. The holder has not as of the date of this filing invoked his rights under the default provisions
of the note.
On January 23, 2012, we issued several promissory
notes to private investors with face values totaling $198,000. The proceeds from the notes totaled $175,000. 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 June 30, 2012.
During the quarter ended June 30, 2014, the Company paid in cash the principal owed on two of the notes totaling $113,636 leaving
a remaining principal balance owed of $84,364 as of June 30, 2016 and December 31, 2015. On January 23, 2014 the maturity date,
the principal amounts of the notes were due along with any unpaid and accrued interest. As a result, Company is not in compliance
with the terms of the note. The holder has not as of the date of this filing invoked his rights under the default provisions of
the note.
During November 2015,
the Company issued a secured bridge note to an investor for $580,000, with an original due date of May 2, 2016, for which $355,174
of net proceeds were received. Of the $580,000; $58,000 was an original issue discount, $29,000 was used for placement fees and
legal expenses and $137,826 was used to pay the remaining principal and accrued interest outstanding on the March 2015 note. In
addition, the Company issued 1,862,500 shares of common stock ($55,875 based on the closing price of the stock on the date of
closing) to the Lender. The original issue discount, the value of the 1,862,500 shares and the placement and legal fees were recorded
as a debt discount. The debt discount associated with the origination of the note was amortized in full as of May 2, 2016 using
the effective interest method. The carrying balance of this note at May 2, 2016 was $600,000. On April 27, 2016, the maturity
date of this note was extended from May 2, 2016 to July 2, 2016. As consideration, the Company agreed to increase the original
issue discount of the note by $20,000, thereby increasing the principal balance to $600,000, and to issue 1,000,000 common shares
at a fair value of $80,000 to the investor. The original issue discount and the value of the 1,000,000 shares were recorded as
a debt discount. On June 30, 2016, the maturity date of this note was extended from July 2, 2016 to November 2, 2016. As consideration,
the Company agreed to increase the original issue discount of the note by $20,000, thereby increasing the principal balance to
$620,000, and to issue 2,000,000 common shares at a fair value of $120,000 to the investor. The original issue discount and the
value of the 2,000,000 shares were recorded as a debt discount. The unamortized debt discount at June 30, 2016 was $140,000. The
carrying value of this note at June 30, 2016 was $480,000.
During June 2015, we closed on an equipment
loan of $67,275 with Royal Bank America Leasing, L.P. The loan is payable monthly at $2,136 per month over a 36 month term with
the last payment due in May 2018. The principal balance on this loan as of June 30, 2016 and December 31, 2015 was $44,715 and
$53,454 respectively.
During October 2015, we closed on an equipment
loan of $61,783 with Royal Bank America Leasing, L.P. The loan is payable monthly at $1,941 per month over a 36 month term with
the last payment due in September 2018. The principal balance on this loan as of June 30, 2016 and December 31, 2015 was $45,009
and $56,831 respectively.
On February 25, 2016, the Company issued to
an investor a promissory note in the aggregate principal amount $375,000 and received $353,000 in gross proceeds (equivalent to
a 5% original issue discount of $18,750 and other closing fees of $3,065) (the "Loan"). Additionally, the Company issued
600,000 shares of its common stock to the investor at a fair value of $24,000. The Loan was secured by a first priority security
interest in certain of the Company's components and work-in progress. The loan was re-paid in full during May 2016.
On April 29, 2016, Lattice entered into a
settlement agreement with Global Tel*Link Corporation (“GTL”) for $2,745,625 related to past due general unsecured
(on-demand) liabilities. Per the settlement agreement, Lattice converted the on-demand liability to a promissory note for $2,745,625
carrying an 8% annual interest rate with principal payments due as follows: $250,000 within five business days of the date of
the settlement agreement leaving a remaining principal balance owed of $2,495,625, of which, $250,000 will be payable in (7) quarterly
principal payments starting July 31, 2016 with any remaining principal balance due under the note by April 30, 2018. The obligations
under the promissory note are secured by all of the Company’s assets pursuant to the terms of a Security Agreement (subject
to pre-existing liens). The principal balance outstanding on this loan as of June 30, 2016 was $2,495,615. Lattice did not make
the $299,913 payment due on July 31, 2016, and agreed with GTL to extend the payment due date to August 31, 2016. Lattice made
the payment on August 31, 2016.
(d) Note Payable – Innovisit
In conjunction with the purchase of intellectual
property and certain other assets of Innovisit on November 1, 2013, Lattice issued a promissory note for $590,000 to Icotech LLC,
the owner of Innovisit. Lattice agreed to pay to Icotech; (a) $250,000 on November 30, 2013, (b) four payments of $60,000 on each
of January 1, 2014, April 30, 2014, July 31, 2014, and October 31, 2014, and (c) final payment of $100,000 on January 31, 2015.
The note bears no interest on the unpaid principal amount and is secured with the intellectual property acquired. In 2016, the
Company made cash payments on this note totaling $15,000 leaving $12,734 outstanding as of June 30, 2016, compared to an outstanding
balance of $27,734 at December 31, 2015.
Note 3 – Convertible Notes
On May 30, 2014, the Company entered into a
Note Purchase and Security Agreement with Lattice Funding, LLC (“Lender”), a Pennsylvania limited liability company
affiliated with Cantone Asset Management, LLC. The Company delivered a secured promissory note (the “LF1 Note”) in
the principal sum of $1,500,000, bearing interest at 8% per annum and maturing on May 15, 2017. Interest on the LF1 Note is payable
quarterly. The outstanding principal may be converted into restricted common stock. The Company also executed UCC financing statements,
securing the LF1 Note with proceeds of certain agreements.
Each $10,000 of LF1 Note principal is convertible
into 75,000 common shares at an exercise price of $0.133333 per share any time after November 30, 2014, to be adjusted for splits,
reorganizations, stock dividends and similar corporate events (anti-dilution provisions). If the market price of Lattice
common stock equals or exceeds twice the exercise price and certain other conditions are met, the Company may call the Note at
face value for the purpose of forcing conversion of the balance of the LF1 Note into common stock.
The LF1 Note contained a provision whereby
the conversion price is adjustable upon the occurrence of certain events, including the issuance of common stock or common stock
equivalents at a price which is lower than the current conversion price. Under FASB ASC 815-40-15-5, the embedded conversion feature
is not considered indexed to the Company’s own stock and, therefore does not meet the scope exception in FASB ASC 815-10-15
and thus needed to be accounted for as a derivative liability. The initial fair value at May 30, 2014 of the embedded conversion
feature was estimated at $1,223,923 and recorded as a derivative liability, resulting in a net carrying value of the note at May
30, 2014 of $276,077 ($1,500,000 face value less $1,223,923 debt discount). On November 2, 2015 the derivative was valued at $218,819.
The debt discount was amortized using the effective interest method and was $956,090 at November 2, 2015. The fair value of the
embedded conversion feature was estimated at the end of each quarterly reporting period using the Monte Carlo model.
On November 2, 2015, the Company issued
5,000,000 shares of its common stock to Lender to amend the promissory note issued to it in May 2015 to eliminate certain anti-dilution
provisions. Based on management’s review, the accounting for debt extinguishment applied. In accordance with the accounting
for debt extinguishment, the Company wrote-off the unamortized debt discount of $929,177 and unamortized deferred finance fees
relating to this note of $172,222. These charges were offset by the difference of the carrying value of the associated embedded
derivative liability of $218,819 and the fair value of $150,000 for the 5,000,000 shares issued resulting in a net gain of $68,819.
The net of these three items resulted in a loss on extinguishment of debt of $1,032,580 in 2015.
On May 13, 2015, the Company entered into
a Note Purchase and Security Agreement with the Lender. The Company delivered a secured promissory note (the “LF2 Note”)
in the principal sum of $908,000, bearing interest at 8% per annum and maturing on April 30, 2020. Interest on the LF2 Note is
payable quarterly. The Lender has the right to convert the principal amount of the note into conversion shares at any time before
maturity at a price of $0.15, to be adjusted for splits, reorganizations, stock dividends and similar corporate events (anti-dilution
provisions). The Company cannot prepay the amount due. The Company also executed UCC financing statements, securing the LF2 Note
with proceeds of certain agreements.
Each $1,000 of LF2 Note principal is convertible
into common shares at a conversion price of $0.15, to be adjusted for splits, reorganizations, stock dividends and similar corporate
events (anti-dilutive provisions). If the market price of Lattice common stock equals or exceeds twice the exercise price and certain
other conditions are met, the Company may call the note at face value for the purpose of forcing conversion of the balance of the
note in common stock.
The LF2 Note Purchase and Security Agreement
contains a provision that for every $1,000 borrowed, the Company would need to issue 2,500 common shares to holder. The Company
borrowed $908,000 on the note and issued 2,875,333 shares valued at $0.07 per share based on the closing price the day of the borrowings.
This resulted in a debt discount of $355,633, which is being amortized over the life of the loan using the effective interest method.
Amortization expense of the debt discount was $15,146 in the current period.
The LF2 convertible note consists of the following at June 30, 2016:
|
|
|
June 30, 2016
|
|
|
Principal
|
|
$
|
908,000
|
|
|
Discount
|
|
|
(355,633
|
)
|
|
Accumulated amortization of discount
|
|
|
68,295
|
|
|
Total
|
|
$
|
620,662
|
|
During the first quarter of 2016, the Company
adopted ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,”
In accordance with the guidance, $115,000 of unamortized debt issuance costs, associated with the Company’s convertible notes
payable, were reclassified from other current assets, as previously reported on the consolidated balance sheet as of December 31,
2015, to convertible notes payable, net of debt discount.
Note 4 – Fair Value of Derivative
Financial Instruments
The condensed consolidated balance sheet caption
derivative liability includes warrants. The warrants were 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 758,333 shares of the Company’s common stock as of June 30, 2016 and December 31, 2015, and are carried at fair value.
The balance at June 30, 2016 was $37,511 compared to $30,154 at December 31, 2015.
The valuation of the derivative warrant liability
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 June 30, 2016 included the June 30, 2016 publicly traded stock price of the Company of $0.05, the conversion or strike
price of $0.10 per the agreement, a historical volatility factor of 212.94%, a risk free rate of 1.15% and remaining life 6.22
years.
Note 5 – Litigation
On June 26, 2015, Global Tel*Link Corporation (“GTL”)
filed an arbitration claim against us with JAMS pursuant to a Master Services Agreement between, dated December 31, 2008 (the “MSA”).
GTL alleged that we breached the MSA by failing to pay them commissions pursuant to the MSA and that we owed them approximately
$2.9 million, including interest. We filed a reply to the claim on July 24, 2015. On April 29, 2016, we and GTL entered into a
settlement agreement pursuant to which:
|
|
·
|
we agreed to pay GTL $250,000 within five business days of the date of the settlement agreement;
|
|
|
·
|
we issued a confession of judgment promissory note in the aggregate principal amount of $2,495,625 (see Note 2); and
|
|
|
·
|
we entered into a Teaming Agreement with GTL.
|
The obligations under the promissory note
are secured by all of the Company’s assets pursuant to the terms of a Security Agreement (subject to pre-existing liens).
Except as disclosed above, 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.
Note 6 – Commitments
(a) Operating Leases
The Company leases its office, sales and manufacturing
facilities under non-cancelable operating leases with varying terms expiring through 2016. The leases generally provide that the
Company pay the taxes, maintenance and insurance expenses related to the leased assets. The lease expired in May 2016. The Company
is currently on a month to month lease basis on the same terms until an extension is finalized.
There are no future minimum lease commitments
at June 30, 2016.
Total rent expense was $23,901 for the six months ended June
30, 2016 compared to $22,249 in the prior year period.
(b) Capital lease
During May 2015, we entered into a capital
lease financing obligation with Marlin Leasing Corporation in the amount of $14,585 which bears interest at 13% and is payable
monthly over a 3 year term at $497 per month. The lease includes an end of term purchase option of $1.00. The outstanding
principal balance on this lease at June 30, 2016 was $9,572.
Note 7 – Common Stock
On April 22, 2016, Lattice
sold an aggregate of 10,633,336 subscriptions for shares of its common stock to accredited investors for aggregate gross proceeds
of $382,800. In connection with the sale of the shares, the Company paid a placement agent fee of $19,140 and issued 319,000 warrants
at a fair value of $21,666. The warrants were valued using the Black Scholes Merton model. Significant assumptions used included
the publicly traded stock price at the date of the agreement, the conversion or strike price of $0.06 per the agreement, a historical
volatility factor of 246.45%, a risk-free rate of 1.37% and a term of 3 years per the agreement.
On April 27, 2016, the
maturity date of the $580,000 bridge note was extended from May 2, 2016 to July 2, 2016. As consideration, the Company agreed to
increase the original issue discount of the note by $20,000 thereby increasing the principal balance to $600,000 and issued 1,000,000
common shares to the investor at a fair value of $80,000.
On May 23, 2016, Lattice
sold an aggregate of 6,033,333 shares of its common stock to accredited investors for aggregate gross proceeds of $382,800. In
connection with the sale of the shares, the Company paid a placement agent fee of $10,860 and issued 181,000 warrants at a fair
value of $10,501. The warrants were valued using the Black Scholes Merton model. Significant assumptions used included the publicly
traded stock price at the date of the agreement, the conversion or strike price of $0.06 per the agreement, a historical volatility
factor of 245.18%, a risk-free rate of 1.38% and a term of 3 years per the agreement.
On June 30, 2016, the maturity date of
the $580,000 bridge note (which was increased to $600,000 pursuant to the April 27, 2016 extension) was extended from July 2,
2016 to November 2, 2016. As consideration, the Company agreed to increase the original issue discount of the note by $20,000
thereby increasing the principal balance to $620,000 and to issue 2,000,000 common shares to the investor at a fair value of
$120,000.