Cyalume
Cyalume Technologies Holdings, Inc. (Form: 10-Q, Received: 11/01/2010 16:07:10)
 


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, 2010

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                             to                              

Commission File Number 000-52247


Cyalume Technologies Holdings, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
20-3200738
(State or other jurisdiction of
 incorporation or organization)
 
(I.R.S. Employer
 Identification No.)

96 Windsor Street, West Springfield, Massachusetts
 
01089
(Address of principal executive offices)
 
(Zip Code)

(413) 858-2500
(Registrant's telephone number, including area code)

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    ¨

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  ¨     No  ¨     

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 definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:

Large accelerated filer  ¨
 
Accelerated filer  ¨
 
Non-accelerated filer  ¨
 (Do not check if a smaller
reporting company)
 
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  ¨     No  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of October 26, 2010, there were outstanding 15,749,070 shares of the registrant’s Common Stock, par value $.001 per share.



 

 

Cyalume Technologies Holdings, Inc.

FORM 10-Q

INDEX

PART I—FINANCIAL INFORMATION
   
     
Item 1.
 
Financial Statements
   
         
   
Condensed Consolidated Statements of Operations (unaudited) for the three months ended September 30, 2010 and 2009
 
4
         
   
Condensed Consolidated Statements of Operations (unaudited) for the nine months ended September 30, 2010 and 2009
 
5
         
   
Condensed Consolidated Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009
 
6
         
   
Condensed Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the nine months ended September 30, 2010 (unaudited)
 
7
         
   
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2010 and 2009
 
8
         
   
Notes to Condensed Consolidated Financial Statements (unaudited)
 
9
         
Item 2.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
16
         
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
19
         
Item 4.
 
Controls and Procedures
 
19
         
PART II—OTHER INFORMATION
   
     
Item 1.
 
Legal Proceedings
 
20
         
Item 1A.
 
Risk Factors
 
20
         
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
20
         
Item 3.
 
Defaults Upon Senior Securities
 
20
         
Item 4.
 
[Removed and Reserved]
 
20
         
Item 5.
 
Other Information
 
20
         
Item 6.
 
Exhibits
 
21
         
Signatures
 
22

 
2

 

PART I—FINANCIAL INFORMATION

The statements contained in this quarterly report on Form 10-Q, including under the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other sections of this quarterly report, include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, without limitation, statements regarding our or our management's expectations, hopes, beliefs, intentions or strategies regarding the future. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," "plan" and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. The forward-looking statements contained in this quarterly report are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. Unless the content otherwise requires, all references to "we", "us", the “Company" or “Cyalume" in this quarterly report on Form 10-Q refers to Cyalume Technologies Holdings, Inc.

 
3

 

ITEM 1.
Financial Statements

Cyalume Technologies Holdings, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except shares and per share information)
(Unaudited)

   
For the Three
   
For the Three
 
   
Months Ended
   
Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
 
Revenues
  $ 11,570     $ 9,860  
Cost of goods sold
    5,483       5,938  
Gross profit
    6,087       3,922  
                 
Other expenses:
               
Sales and marketing
    917       791  
General and administrative
    1,343       887  
Research and development
    402       487  
Interest, net
    631       673  
Interest – related party
    17       16  
Amortization of intangible assets
    441       878  
Other, net
    91       16  
Total other expenses
    3,842       3,748  
                 
Income before income taxes
    2,245       174  
Provision for (benefit from) income taxes
    916       (151 )
Net income
  $ 1,329     $ 325  
                 
Income available to common stockholders for diluted net income per common share
  $ 1,034     $ 325  
                 
Net income per common share:
               
Basic
  $ .09     $ .02  
Diluted
  $ .06     $ .02  
                 
Weighted average shares used to compute net income per common share:
               
Basic
    15,511,183       15,352,478  
Diluted
    17,524,995       15,418,949  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
4

 
 
Cyalume Technologies Holdings, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except shares and per share information)
(Unaudited)

   
For the Nine
   
For the Nine
 
   
Months Ended
   
Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
 
Revenues
  $ 29,859     $ 24,443  
Cost of goods sold
    14,695       14,374  
Gross profit
    15,164       10,069  
                 
Other expenses:
               
Sales and marketing
    2,481       2,322  
General and administrative
    4,109       3,489  
Research and development
    1,135       1,295  
Interest, net
    1,931       1,925  
Interest – related party
    49       45  
Amortization of intangible assets
    1,353       2,612  
Other, net
          79  
Total other expenses
    11,058       11,767  
                 
Income (loss) before income taxes
    4,106       (1,698 )
Provision for (benefit from) income taxes
    1,585       (755 )
Net income (loss)
  $ 2,521     $ (943 )
                 
Income available to common stockholders for diluted net income per common share
  $ 2,242     $ (943 )
                 
Net income (loss) per common share:
               
Basic
  $ .16     $ (.06 )
Diluted
  $ .14     $ (.06 )
                 
Weighted average shares used to compute net income (loss) per common share:
               
Basic
    15,466,133       15,089,909  
Diluted
    16,240,932       15,089,909  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
5

 

Cyalume Technologies Holdings, Inc.
Condensed   Consolidated Balance Sheets
(in thousands, except shares and per share information)

   
September 30,
       
   
2010
(unaudited)
   
December 31,
2009
 
Assets
           
Current assets:
           
Cash
  $ 2,472     $ 2,003  
Accounts receivable, net of allowance for doubtful accounts of $26 and $239 at September 30, 2010 and December 31, 2009, respectively
    4,202       3,319  
Inventories, net
    8,876       9,320  
Income taxes refundable
          294  
Deferred income taxes
    810       682  
Prepaid expenses and other current assets
    453       382  
Total current assets
    16,813       16,000  
                 
Property, plant and equipment, net
    8,507       8,384  
Goodwill
    51,244       51,244  
Other intangible assets, net
    21,286       22,548  
Other noncurrent assets
    301       67  
Total assets
  $ 98,151     $ 98,243  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Lines of credit
  $     $ 3,200  
Current portion of notes payable
    1,012       6,940  
Accounts payable
    2,546       3,222  
Accrued expenses and other current liabilities
    2,413       2,069  
Advance due to related parties
    9       9  
Income taxes payable
    522        
Total current liabilities
    6,502       15,440  
                 
Senior notes payable, net of current portion
    15,142       18,874  
Convertible notes payable, net of discount
    7,917        
Notes payable due to related parties
    1,114       1,065  
Deferred income taxes
    8,125       7,105  
Derivatives
    442       69  
Asset retirement obligation, net of current portion
    164       158  
Total liabilities
    39,406       42,711  
  
               
Commitments and contingencies (Note 9)
           
                 
Stockholders' equity:
               
Preferred stock, $0.001 par value; 1,000,000 shares authorized, no shares issued or outstanding
           
Common stock, $0.001 par value; 50,000,000 shares authorized; 15,749,070 and 15,405,570 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively
    16       15  
Additional paid-in capital
    89,151       87,926  
Accumulated deficit
    (29,872 )     (32,393 )
Accumulated other comprehensive loss
    (550 )     (16 )
Total stockholders’ equity
    58,745       55,532  
Total liabilities and stockholders' equity
  $ 98,151     $ 98,243  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
6

 
 
Cyalume Technologies Holdings, Inc.
Condensed Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income
(in thousands, except shares)
(Unaudited)
 
   
Common Stock
   
Additional
         
Accumulated 
Other
   
Total
       
   
Number 
of Shares
   
Amount
   
Paid-In
Capital
   
Accumulated
Deficit
   
Comprehensive 
Loss
   
Stockholders’ 
Equity
   
Comprehensive
Income (Loss)
 
Balance at December 31, 2009
    15,405,570     $ 15     $ 87,926     $ (32,393 )   $ (16 )   $ 55,532     $  
Stock issued
    343,500       1       145                   146        
Stock-based compensation expense
                875                   875        
Warrants issued in conjunction with issuance of convertible debt
                205                   205        
Foreign currency translation adjustments
                            (301 )     (301 )     (301 )
Unrealized loss on cash flow hedges, net of taxes of $140
                            (233 )     (233 )     (233 )
Net income
                      2,521             2,521       2,521  
Comprehensive income
                                      $ 1,987  
Balance at September 30, 2010
    15,749,070     $ 16     $ 89,151     $ (29,872 )   $ (550 )   $ 58,745          

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
7

 

Cyalume Technologies Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)

   
For the Nine
   
For the Nine
 
   
Months Ended
   
Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Net income (loss)
  $ 2,521     $ (943 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation of property, plant and equipment
    577       479  
Amortization
    1,593       3,446  
Provision for deferred income taxes
    1,068       (1,009 )
Stock-based compensation expense
    875       271  
Other non-cash expenses
    186       357  
Changes in operating assets and liabilities:
               
Accounts receivable
    (920 )     (1,024 )
Inventories
    377       953  
Prepaid expenses and other current assets
    (28 )     (9 )
Accounts payable and accrued liabilities
    (169 )     (22 )
Income taxes payable
    777       329  
Net cash provided by operating activities
    6,857       2,828  
                 
Cash flows from investing activities:
               
Proceeds from disposal of long-lived assets
    207        
Purchases of long-lived assets
    (1,219 )     (449 )
Net cash used in investing activities
    (1,012 )     (449 )
                 
Cash flows from financing activities:
               
Payments for common stock subject to redemption
          (1,123 )
Net repayment of line of credit
    (3,200 )     (200 )
Repayment of long-term notes payable
    (9,859 )     (2,633 )
Proceeds from convertible notes payable
    7,942        
Payments to reacquire and retire common stock
          (263 )
Payment of stock registration costs
          (279 )
Payment of debt issuance costs
    (250 )     (65 )
Proceeds from exercises of warrants
          27  
Net cash used in financing activities
    (5,367 )     (4,536 )
                 
Effect of exchange rate changes on cash
    (9 )     36  
Net increase (decrease) in cash
    469       (2,121 )
Cash, beginning of period
    2,003       3,952  
Cash, end of period
  $ 2,472     $ 1,831  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
8

 
 
Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

1.
BASIS OF PRESENTATION

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these interim condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period.
 
These accompanying unaudited interim condensed consolidated financial statements recognize the effects of all subsequent events that provide additional evidence about conditions that existed at September 30, 2010, including the estimates inherent in the process of preparing financial statements. Additionally, all significant intercompany accounts and transactions have been eliminated in consolidation.
 
Certain amounts in prior periods have been reclassified to conform to the 2010 presentation. These reclassifications had no effect on operating results as previously reported.

We believe all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation have been included in these interim condensed consolidated financial statements. Operating results for the three and nine-month periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the full year. The consolidated balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date. We suggest that these unaudited interim condensed consolidated financial statements be read in conjunction with the consolidated financial statements and footnotes thereto in our Annual Report on Form 10-K for the year ended December 31, 2009.

2.
DESCRIPTION OF BUSINESS

We have one subsidiary: Cyalume Technologies, Inc. (“CTI”), whose headquarters are also located in West Springfield, MA. CTI has one subsidiary, Cyalume Technologies, SAS (“CTSAS”), located in Aix-en-Provence, France. Our products are manufactured at both the West Springfield and Aix-en-Provence locations.

We primarily produce products based on technologies whereby light is generated through a chemical reaction known as chemiluminescence. CTI manufactures and sells such chemiluminescent products, in addition to reflective and photoluminescent products, to military, commercial and public safety markets.  Our base product is known as a ‘‘light stick’’ and is typically 6 inches in length. A light stick is a translucent flexible plastic tube that is partly filled with one chemical ingredient and also with a glass container (‘‘ampoule’’) that contains a complementary reactive chemical. When the tube is bent enough to break the glass ampoule, the chemicals contained within the plastic tube and ampoule mix and light is generated. Additionally, we manufacture and sell a component of 40mm training ammunition that utilizes our light-stick technology; sales of these components have been an increasing source of our revenues in recent years.  Also, we produce reflective (patches) and reflective plus photoluminescent (fire tape) products. Based on our customers’ specifications, our products are manufactured in varying shapes, sizes and functions, and provide light in different colors, intensity and durations.

3.
NEW ACCOUNTING PRONOUNCEMENTS

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-06, Improving Disclosures about Fair Value Measurements , to amend existing guidance in FASB Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures , to expand and clarify existing disclosures regarding recurring and nonrecurring fair value measurements. The amendments in this ASU were effective on January 1, 2010 for our interim and annual reporting. The adoption of this ASU did not have an impact on these unaudited interim condensed consolidated financial statements.

 
9

 

Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements. The amendments in this ASU remove the requirement for an SEC filer (such as us) to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. GAAP. All of the amendments in this ASU were effective for us upon the FASB’s issuance of ASU No. 2010-09.  The only effect of our adoption of this ASU on these unaudited interim condensed consolidated financial statements was to not disclose the date through which subsequent events have been evaluated in preparing these consolidated financial statements; for SEC filers, that evaluation date must be the date of issuance of the financial statements.

4.
INVENTORIES

Inventories consist of the following (all amounts in thousands):
   
September 30,
2010
   
December 31,
2009
 
Raw materials
  $ 4,903     $ 4,887  
Work-in-process
    3,305       3,439  
Finished goods
    1,059       1,903  
      9,267       10,229  
Less: Reserve for obsolescence
    (391 )     (909 )
    $ 8,876     $ 9,320  

5.
NOTES PAYABLE

On July 29, 2010 we issued $8.5 million in convertible notes due in 2014. The convertible notes require monthly interest payments starting on September 1, 2010 at a rate of 11% per annum and mature on March 19, 2014, unless earlier repurchased or converted. No principal payments are required on these convertible notes until maturity. We have the right to prepay the notes in whole or in part at any time without penalty. The convertible notes are senior secured obligations and rank junior to all senior debt held by TD Bank, N.A. but senior to all other remaining long-term debt including existing and future subordinated debt. The notes are convertible at any time into 2,666,667 shares of our common stock at a conversion price of approximately $3.19 per share. Under certain circumstances, such a conversion feature could be considered to be a “beneficial” conversion feature, as defined by U.S. GAAP, requiring separate measurement and accounting. We determined that the convertible notes’ conversion feature was not “beneficial” under U.S. GAAP. 

Simultaneous with the issuance of the convertible notes, we issued warrants to repay certain costs of obtaining the convertible notes. These warrants allow the holder to purchase 160,000 shares of our common stock at $2 per share through July 29, 2015. The warrants have a five-year term. In accordance with U.S. GAAP, we allocated the $8.5 million proceeds from the issuance of the convertible notes and the warrants based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at time of issuance. The portion of the proceeds so allocated to the warrants ($205,000) was recorded as a debt discount (a decrease to convertible notes payable, net of discount) and an increase to additional paid-in capital on our condensed consolidated balance sheet. The $205,000 debt discount will be amortized to interest expense over the life of the convertible notes.

On July 29, 2010, the carrying value of the convertible notes was $7.9 million, computed as follows (all amounts in thousands):

Principal amount of convertible notes
  $ 8,500  
Less: Debt issuance costs
    (399 )
Less: Warrants issued to convertible note lenders
    (205 )
    $ 7,896  

The convertible note principal of $8.5 million was used in the following manner (all amounts in thousands):

Principal amount of convertible notes
  $ 8,500  
Less: Debt issuance costs
    (558 )
Proceeds from convertible notes payable
    7,942  
Less amounts paid from proceeds from convertible notes:
       
Principal payment on senior debt held by TD Bank, N.A.
    (7,200 )
Principal payment on line of credit held by TD Bank, N.A.
    (500 )
Debt issuance costs
    (50 )
Cash retained by Cyalume Technologies Holdings, Inc.
  $ 192  

 
10

 

Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

As part of this transaction, the remaining unpaid TD Bank, N.A. senior debt was modified to have reduced principal payments and lower interest rates.  However, because the convertible notes and the modified TD Bank, N.A. senior debt, on a combined basis, have a higher weighted-average interest rate than the pre-modified TD Bank, N.A. senior debt, we expect that our interest expense will be higher than it would have been had we not partially repaid and modified the TD Bank, N.A. senior debt. Because the convertible notes and the modified TD Bank, N.A. senior debt require lower monthly principal payments than the pre-modified TD Bank, N.A. senior debt, we expect our future debt levels to be higher than they would have been had we not partially repaid and modified the TD Bank, N.A. senior debt. We do expect the lower monthly principal payments to significantly improve our short-term cash flows.

Simultaneous with the repayment of a portion of the TD Bank, N.A. senior debt, our interest rate swaps (see Note 6) were modified to incorporate this repayment since it was not anticipated in the original swap agreement. This allows us to continue to assume that these hedges meet the criteria for the shortcut method for assessing hedge effectiveness; therefore, the hedge is assumed to still be 100% effective.

Simultaneous with the issuance of the convertible notes, we amended our management agreement with Selway Capital, LLC (see Note 9).

6.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The derivative liabilities as of September 30, 2010 in our condensed consolidated balance sheet consist of the following (all amounts in thousands):
 
           
Derivative Instrument
 
Balance Sheet Location
 
Fair Value
 
Interest rate swaps
 
Derivatives (non-current liabilities)
 
$
(442
)

Interest Rate Swaps

In December 2008, we entered into two pay-fixed, receive-variable, interest rate swaps to reduce exposure to changes in cash payments caused by changes in interest rates on our notes payable with TD Bank, N.A. Both relationships are designated as cash flow hedges and meet the criteria for the shortcut method for assessing hedge effectiveness; therefore, the hedge is assumed to be 100% effective and all changes in the fair value of the interest rate swaps are recorded in comprehensive income. These unrealized gains and losses must be reclassified in whole or in part into earnings if, and when, a comparison of the swaps and the related hedged cash flows demonstrates that the shortcut method is no longer applicable. We expect these hedges to meet the criteria of the shortcut method for the duration of the hedging relationship and therefore we do not expect to reclassify any portion of these unrealized losses from comprehensive income to earnings in the future. The fair values of the swaps are determined by discounting the estimated cash flows to be received and paid due to the swaps over the swap’s contractual lives using an estimated risk-free interest rate for each swap settlement date.

Currency Forward Contracts

CTSAS’ functional currency is the Euro. Periodically, CTSAS purchases inventory from CTI, which requires payment in U.S. dollars. Beginning in 2009 and only under certain circumstances, we use currency forward contracts to mitigate CTSAS’ exposure to changes in the Euro-to-U.S.-dollar exchange rate upon CTSAS’ payment to CTI for these inventory purchases.  Such currency forward contracts typically have durations of less than six months. We report these currency forward contracts at their fair value. This relationship has not been designated as a hedge and therefore all changes in these currency forward contracts’ fair value are recorded in other, net on our condensed consolidated statement of operations. The fair value of these contracts are determined by taking the difference between (a) the U.S. dollar amount due on the contract at maturity and (b) the present value of estimated cash flows developed using, among other data, expectations of future currency exchange rates over the remaining term of the contract discounted at an estimated risk-free interest rate. At September 30, 2010, we held no such currency forward contracts.

 
11

 

Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

Effect of Derivatives on Statement of Operations

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of operations for the three months ended September 30, 2010 was as follows (all amounts in thousands):
 
   
Gain (Loss)
   
Gain (Loss)
   
Gain (Loss)
 
   
in AOCL (1)
   
Reclassified (2)
   
in Earnings (3)
 
Derivatives in cash flow hedging relationships:
                 
Interest rate swaps
  $ (82 )   $     $  
Derivatives not designated as hedging instruments:
                       
Forward currency contracts
  $     $     $  

 
(1)
Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the three months ended September 30, 2010.
 
(2)
Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the three months ended September 30, 2010.
 
(3)
Amount of gain (loss) recognized in earnings on the derivative (ineffective portion and amount excluded from effectiveness testing) reported in other, net on the condensed consolidated statement of operations for the three months ended September 30, 2010.

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of operations for the nine months ended September 30, 2010 was as follows (all amounts in thousands):
 
   
Gain (Loss)
   
Gain (Loss)
   
Gain (Loss)
 
   
in AOCL  (1)
   
Reclassified  (2)
   
in Earnings  (3)
 
Derivatives in cash flow hedging relationships:
                 
Interest rate swaps
  $ (233 )   $     $  
Derivatives not designated as hedging instruments:
                       
Forward currency contracts
  $     $     $ (22 )

 
(1)
Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the nine months ended September 30, 2010.
 
(2)
Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the nine months ended September 30, 2010.
 
(3)
Amount of gain (loss) recognized in earnings on the derivative (ineffective portion and amount excluded from effectiveness testing) reported in other, net on the condensed consolidated statement of operations for the nine months ended September 30, 2010.

7.
INCOME TAXES

For the three months ended September 30, 2010, the effective tax rate of 41% differed from the statutory rate of 34% due to state taxes and prior year true-ups. For the three months ended September 30, 2009, the effective tax rate of (87)% differed from the statutory rate of 34% due to state and foreign taxes.

For the nine months ended September 30, 2010, the effective tax rate of 39% differed from the statutory rate of 34% primarily due to state and foreign taxes and prior year true-ups including changes in the valuation allowance. For the nine months ended September 30, 2009, the effective tax rate of 44% differed from the statutory rate of 34% due to state and foreign taxes.

8.
NET INCOME (LOSS) PER COMMON SHARE

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. Potential common shares consist of (i) shares issuable upon the exercise of warrants and options (using the “treasury stock” method), (ii) unvested restricted stock awards (using the “treasury stock” method) and (iii) shares issuable upon conversion of our convertible notes (see Note 5) using the “if-converted” method.

 
12

 

Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

   
Three Months Ended
September 30,
   
Nine   Months   Ended
September   30,
 
   
2010
   
2009
   
2010
   
2009
 
Basic:
                       
Net income (loss) (in thousands)
  $ 1,329     $ 325     $ 2,521     $ (943 )
Weighted average shares
    15,511,183       15,352,478       15,466,133       15,089,909  
Basic income (loss) per common share
  $ 0.09     $ 0.02     $ 0.16     $ (0.06 )
Diluted:
                               
Net income (loss) (in thousands)
  $ 1,329     $ 325     $ 2,521     $ (943 )
Adjustments to net income assuming convertible notes payable are converted to common stock:
                               
Reversal of interest expense on convertible notes payable (in thousands)
  $ 167     $     $ 167     $  
Write off of unamortized costs of issuing convertible notes payable (in thousands)
  $ (889 )   $     $ (889 )   $  
Adjustments’ estimated effect on provision for income taxes (in thousands)
  $ 427 (2)   $     $ 443 (3)   $  
Income available to common stockholders for diluted net income per common share (in thousands)
  $ 1,034     $ 325     $ 2,242     $ (943 )
Weighted average shares
    15,511,183       15,352,478       15,466,133       15,089,909  
Effect of dilutive securities
    2,013,812       66,471       774,799       (1)
Weighted average shares, as adjusted
    17,524,995       15,418,949       16,240,932       15,089,909  
Diluted income (loss) per common share
  $ 0.06     $ 0.02     $ 0.14     $ (0.06 )

 
(1)
Since we experienced a loss during this period, common shares issuable upon exercise of convertible securities were excluded from the loss per share calculation because the effect would be antidilutive.
 
(2)
Assumes an effective tax rate of 40.8%.
 
(3)
Assumes an effective tax rate of 38.6%.

The following common shares issuable upon exercise of convertible securities were excluded from the calculation of diluted net income (loss) per common share because their effect was antidilutive for each of the periods presented:

   
Three Months Ended
September 30,
 
Nine   Months   Ended
September   30,
 
   
2010
 
2009
 
2010
 
2009
 
Options and warrants
 
6,388,256
   
6,225,256
 
6,495,756
   
6,225,256
 

9.
COMMITMENTS AND CONTINGENCIES

Civil Action No. 06-706 in Superior Court of the Commonwealth of Massachusetts

On January 23, 2006, before we owned CTI, the former owners of CTI (from whom we purchased CTI) (the “Former Owners”) acquired all of the outstanding capital stock of Omniglow Corporation (the “Transaction”) and changed the name of the company to Cyalume Technologies, Inc. Prior to, or substantially simultaneously with, the Transaction, CTI sold certain assets and liabilities related to Omniglow Corporation’s novelty and retail business to certain former Omniglow Corporation stockholders and management (“the Omniglow Buyers”).  This was done because CTI sought to retain only the Omniglow Corporation assets and current liabilities associated with its government, military and safety business. During 2006, CTI and the Omniglow Buyers commenced litigation and arbitration proceedings against one another. Claims include breaches of a lease and breaches of various other agreements between CTI and the Omniglow Buyers.  The Omniglow Buyers sought compensatory damages of $1.4 million, to be trebled, and recovery of costs and legal fees. CTI filed for damages of $368,000 against the Omniglow Buyers.  These proceedings are known as Civil Action No. 06-706 in Superior Court of the Commonwealth of Massachusetts.


Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

On December 19, 2008, while Civil Action 06-706 was still unresolved, we acquired CTI (the “Acquisition”). According to the Acquisition’s Stock Purchase Agreement between the Former Owners and us, the Former Owners retained the responsibility for paying for all costs and liabilities associated with Civil Action 06-706.

On June 11, 2010, CTI received preliminary Findings of Fact, Rulings of Law and Order for Judgment (the “Findings”) regarding Civil Action No. 06-706.  Pursuant to the Findings, the court found in favor of the Omniglow Buyers and ruled that the Omniglow Buyers were entitled to calculable damages of approximately $828,000 from CTI, in addition to damages for certain lost profits that have not been calculated, costs and attorney’s fees. These additional damages, costs and fees have not yet been calculated or determined by the court. On August 17, 2010, the court vacated this judgment. The court will enter a final judgment once the court issues an order on these additional damages, costs and fees.

CTI is considering its alternatives relating to the suit in light of the Findings. No amounts have been reported in these interim condensed consolidated financial statements since payment of damages or loss is not yet deemed to be probable since all of our legal remedies have not been exhausted.

Management Agreement with Board Member

On October 1, 2009, we entered into a management agreement with Selway Capital, LLC (“Selway”) that provides for (but is not limited to) the following services to be performed by Selway on our behalf:

 
·
Strategic development and implementation as well as consultation with our chief executive officer on a regular basis as per his reasonable requests;
 
·
Identifying strategic partnerships with companies with which Selway has relationships and access, including building partnerships with companies in Israel, Singapore, India and Europe. The focus will be on the expansion of our munitions business;
 
·
Advise and support us on our investor relations strategy;
 
·
Advise and support our future fund raising, including identifying sources of capital in the United States; and
 
·
Support our mergers and acquisitions strategy and play an active role in our due diligence and analysis.

The management agreement stipulates that these services will be performed by Yaron Eitan, a member of our Board of Directors and an employee of Selway, with the assistance as needed from other employees of Selway.  The management agreement is retroactive to August 1, 2009, expires on October 1, 2012 and can be terminated by either us or Selway upon 30-days’ written notice or upon our default in payment or Selway’s failure to perform services under the management agreement. Through July 2010, Selway’s compensation for these services was $41,667 per month. However, we were only required to pay $16,000 per month, with the balance of $25,667 per month remaining unpaid until our senior lender consented to such payment. We will also reimburse Selway for costs incurred specifically on our behalf for these services. Under the management agreement, we indemnify Selway and Selway indemnifies us against certain losses that may be incurred while carrying out its obligations under the management agreement.

On July 29, 2010 we amended our management agreement (the “Amended Management Agreement”) with Selway. Pursuant to the Amended Management Agreement, (i) the monthly compensation payable to Selway was reduced to $11,667 and (ii) we were required to issue to Selway 45,000 shares of our common stock in full satisfaction of all accrued and unpaid liabilities (including all management fees) we owed to Selway pursuant to this management agreement through July 2010. Those 45,000 shares were issued in July 2010.

10.
FAIR VALUE

Under U.S. GAAP, we are required to record certain financial assets and liabilities at fair value and may choose to record other financial assets and financial liabilities at fair value as well. Also under U.S. GAAP, we are required to record nonfinancial assets and liabilities at fair value due to events that may or may not recur in the future, such as an impairment event. When we are required to record such assets and liabilities at fair value, that fair value is estimated using an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. That fair value is determined based on significant inputs contained in a fair value hierarchy as follows:

 
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Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements

Level 1
Quoted prices for identical assets or liabilities in active markets to which we have access at the measurement date.
Level 2
Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3
Unobservable inputs for the asset or liability.

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

As of September 30, 2010, our only assets and liabilities required to be reported at fair value on a recurring basis were the interest rate swaps and currency forward contracts described in Note 6, both of which are measured at fair value using level 2 inputs.

We have other non-derivative financial instruments, such as cash, accounts receivable, accounts payable, accrued expenses and long-term debt whose carrying amounts approximate fair value.

11.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash Paid for Interest and Income Taxes (all amounts in thousands):
 
 
Nine   Months   Ended   September   30,
 
 
2010
 
2009
 
Interest
  $ 1,686     $ 1,495  
Income taxes
    192       608  

Non-Cash Investing and Financing Activities (all amounts in thousands):
 
   
Nine   Months   Ended   September   30,
 
   
2010
   
2009
 
Warrants issued in conjunction with issuance of convertible notes
  $ 205     $  
Stock issued as payment for accounts payable
    146        
Debt issuance costs withheld from convertible note proceeds
    558        
Increase in the Acquisition date fair value of intangible assets (a reduction of goodwill)
          2,024  
Increase in the Acquisition date fair value of property, plant & equipment (a reduction of goodwill)
          372  
Accrual of costs directly related to the Acquisition (an increase to goodwill)
          435  
Reduction of goodwill resulting from subsequent recognition of deferred taxes
          549  
Remeasurement of asset retirement obligation
          26  
Extinguishment of notes payable due to related parties by issuing common stock
          82  

 
15

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with our interim condensed consolidated financial statements and the accompanying notes to those financial statements included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Unless the content otherwise requires, all references to "we", "us", the “Company" or “Cyalume" in this Quarterly Report on Form 10-Q refers to Cyalume Technologies Holdings, Inc.

Company Overview

We primarily produce products based on technologies whereby light is generated through a chemical reaction known as chemiluminescence. CTI manufactures and sells such chemiluminescent products, in addition to reflective and photoluminescent products, to military, commercial and public safety markets.  Our base product is known as a ‘‘light stick’’ and is typically 6 inches in length. A light stick is a translucent flexible plastic tube that is partly filled with one chemical ingredient and also with a glass container (‘‘ampoule’’) that contains a complementary reactive chemical. When the tube is bent enough to break the glass ampoule, the chemicals contained within the plastic tube mix and light is generated. Additionally, we manufacture and sell a component of 40mm training ammunition that uses our light-stick technology; sales of these components have been an increasing source of our revenues in recent years.  Also, we produce reflective (patches) and reflective plus photoluminescent (fire tape) products. Based on our customers’ specifications, our products are manufactured in varying shapes, sizes and functions, and provide light in different colors, intensity and durations.

We have one subsidiary: Cyalume Technologies, Inc. (“CTI”), whose headquarters are also located in West Springfield, MA. CTI has one subsidiary, Cyalume Technologies, SAS (“CTSAS”), located in Aix-en-Provence, France. Our products are manufactured at both the West Springfield and Aix-en-Provence locations.

Material Changes in Results of Operations – Three Months Ended September 30, 2010 versus the Three Months Ended September 30, 2009
 
Revenues :   For the three-month period ended September 30, 2010, sales were higher than for the comparable period in 2009 due primarily to the volume of units sold. Price increases provided some of the additional revenues for the most recent 3-month period.
 
Cost of goods sold: For the three-months ended September 30, 2010, cost of goods sold was lower than for the comparable period in 2009 despite the increase in sales discussed in the previous paragraph.  Gross margin for the quarter was 52.6% compared to a 39.8% gross margin for the comparable prior-year period. 2010 margin improved primarily due to (i) a product mix resulting in improved sales levels of higher margin products, (ii) price increases and (iii) the impact of the amortization of inventory step-up to fair market value arising from our acquisition of CTI in December 2008, which depressed 2009 gross margin. .
 
Expenses: Selling expenses increased 15.9% primarily due to payroll costs of additional hires that was incurred in the three-month period ended September 30, 2010 but not incurred in the three-month period ended September 30, 2009. General and administrative expenses increased 51.4% primarily due to increases in expenses related to (i) share-based award accruals, (ii) depreciation expense and  (iii) employee bonus accruals.  The increase in the share-based expenses is primarily due to awards issued in 2010. The increase in depreciation expense is primarily due to our new enterprise resource planning (“ERP”) computer system, which began depreciating in 2010. Accruals for employee bonuses have increased in 2010 due to our increased profitability in 2010
 
Research and development expenses decreased primarily due to lower patent maintenance and defense costs.
 
Amortization of intangible assets: In December 2009, we recorded impairments on our trademark and customer relationship intangible assets that significantly reduced our intangible assets to be amortized in the three months ended September 30, 2010 compared to same period in the prior year.
 
Provision for (benefit from) income taxes increased significantly for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009 due to our generation of net income in 2010 and operating losses in 2009.

Other, net consists primarily of the effects of changes in foreign exchange rates.

Material Changes in Results of Operations – Nine Months Ended September 30, 2010 versus the Nine Months Ended September 30, 2009
 
Revenues :   For the nine-month period ended September 30, 2010, sales were higher than for the comparable period in 2009 due primarily to the volume of units sold. Price increases provided approximately 12% of the additional revenues for the 2010 period, with the higher number of units sold comprising the rest of the increase.

 
16

 
 
Cost of goods sold: For the nine-months ended September 30, 2010, cost of goods sold was 2.2% higher than the comparable period in 2009 due to the increase in units sold discussed above.  Gross margin for the period was 50.8% compared to a 41.1% gross margin for the comparable prior-year period. 2010 margin improved partially due to price increases as discussed in the previous paragraph. Gross margin in the nine months ended September 30, 2009 was depressed by the amortization of the inventory step-up to fair market value arising from our acquisition of CTI in December 2008.
 
Expenses: Selling expenses increased 6.8% primarily due to (i) 2010 payroll costs of additional hires, (ii) increased bonuses accrued for sales staff due to our increased profitability in 2010 and (iii) other expenses that typically increase when sales increase, such as commissions and freight on sales.  General and administrative expenses increased 17.8% primarily due to increases in expenses related to (i) share-based award accruals, (ii) depreciation expense, (iii) employee bonus accruals and (iv) consultants.  The increase in the share-based expenses is primarily due to awards issued in 2010. The increase in depreciation expense is primarily due to our new ERP computer system, which began depreciating in 2010. Accruals for employee bonuses have increased in 2010 due to our increased profitability in 2010.
 
Research and development expenses decreased primarily due to lower patent maintenance and defense costs.
 
Amortization of intangible assets: In December 2009, we recorded impairments on our trademark and customer relationship intangible assets that significantly reduced our intangible assets to be amortized in the nine months ended September 30, 2010 compared to same period in the prior year.
 
Provision for (benefit from) income taxes increased significantly for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009 due to our generation of net income in 2010 and operating losses in 2009.

Other, net consists primarily of the effects of changes in foreign exchange rates.

Material Changes in Financial Condition – September 30, 2010 versus December 31, 2009

Assets, other than cash : Assets, other than cash, were $95.7 million at September 30, 2010 compared to $96.2 million at December 31, 2009. The decrease is primarily due to intangible assets amortization, fixed asset depreciation and a decrease in inventories. Those decreases were partially offset by the purchase and installation of our new ERP computer system, an increase in accounts receivable resulting from increased sales activity during 2010 and an increase in capitalized debt issuance costs incurred when we incurred new convertible debt in July 2010. The remaining changes in asset values are the result of normal business activities.

Liabilities: Liabilities were $39.4 million at September 30, 2010, compared to $42.7 million at December 31, 2009. The decrease is due primarily to scheduled payments made on our notes payable and complete repayment of our line of credit. The December 31, 2009 line of credit balance of $3.2 million was repaid by $500,000 of the proceeds of our July 2010 convertible debt issuance and by $2.7 million of operating cash flows. Our derivatives liability increased since December 31, 2009 primarily due to a decrease in estimated future LIBOR rates used to estimate the fair value of our pay fixed/receive LIBOR interest rate swaps. Also, our income tax liability increased in 2010 due to our being profitable in 2010. The remaining changes are the result of normal business activities.

Liquidity and Capital Resources

Cash on hand was $2.5 million at September 30, 2010 and $2.0 million at December 31, 2009. The increase since December 31, 2009 resulted primarily improved sales levels offset by payments on debt and related debt issuance costs and payments for property, plant and equipment.

During the nine months ended September 30, 2010, we did not sell any shares of our common stock. However 298,500 common shares were issued for stock-based compensation awards and 45,000 common shares were issued to Selway Capital, LLC in full satisfaction of all accrued and unpaid liabilities (including all management fees) we owed to Selway pursuant to this management agreement through July 2010.

On July 29, 2010 we issued $8.5 million in convertible notes due in 2014. The convertible notes require monthly interest payments that started on September 1, 2010 at a rate of 11% per annum and will mature on March 19, 2014, unless earlier repurchased or converted. No principal payments are required on these convertible notes until maturity. We have the right to prepay the notes in whole or in part at any time without penalty. The notes are convertible at any time into 2,666,667 shares of our common stock at a conversion price of approximately $3.19 per share.  In addition, the lenders received 160,000 warrants for our common stock, exercisable at the lenders’ option for $2.00 per share. The warrants have a five-year term. The convertible notes are senior secured obligations and rank junior to all senior debt held by TD Bank, N.A. but senior to all other remaining long-term debt including existing and future subordinated debt.

 
17

 

We used $7.2 million of the net proceeds of the convertible notes to reduce, but not eliminate, the outstanding principal balance on our senior debt held by TD Bank, N.A. Also, we used $500,000 of the net proceeds of the convertible notes to reduce the outstanding principal balance on our line of credit with TD Bank, N.A. As part of this transaction, the remaining unpaid TD Bank, N.A. senior debt was modified to have reduced principal payments and lower interest rates.  However, because the convertible notes and the modified TD Bank, N.A. senior debt, on a combined basis, have a higher weighted-average interest rate than the pre-modified TD Bank, N.A. senior debt, we expect that our interest expense will be higher than it would have been had we not partially repaid and modified the TD Bank, N.A. senior debt. Because the convertible notes and the modified TD Bank, N.A. senior debt require lower monthly principal payments than the pre-modified TD Bank, N.A. senior debt, we expect our future debt levels to be higher than they would have been had we not partially repaid and modified the TD Bank, N.A. senior debt. We do expect the lower monthly principal payments to significantly improve our short-term cash flows.

In addition to the $500,000 reduction of our line of credit described in the preceding paragraph, the December 31, 2009 line of credit balance of $3.2 million was reduced to $0 by $2.7 million in cash payments obtained from operating cash flows. We have the ability to access this line of credit for up to a maximum of $5 million (not including a $1million reserve for pending legal issues).

We own interest rate swaps on a majority of our senior debt with TD Bank, N.A. in order to minimize the effect of variable interest rates charged on that TD Bank, N.A. debt.

Forecasted principal and interest payments on debt for the next 12 months are $3.2 million and are expected to be funded from operating cash flows. All other operating and capital expenditures are also expected to be funded completely from operating cash flows.

Off-Balance Sheet Arrangements

Other than immaterial operating leases, we did not have any off-balance sheet arrangements during 2010 or 2009.

Critical Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.  Estimates are used when accounting for certain items such as reserves for inventory, accounts receivable and deferred tax assets; assessing the carrying value of intangible assets including goodwill; determining the useful lives of property, plant and equipment and intangible assets; and in determining asset retirement obligations.  Estimates are based on historical experience, where applicable, and assumptions that we believe are reasonable under the circumstances.  Due to the inherent uncertainty involved with estimates, actual results may differ.

Revenue Recognition

Revenue from the sale of products is recognized when the earnings process is complete and the risks and rewards of ownership have transferred to the customer. Costs and related expenses to manufacture the products are recorded as costs of goods sold when the related revenue is recognized.

We have several significant contracts providing for the sale of indefinite quantities of items at fixed per unit prices, subject to adjustment for certain economic factors. Revenue under these contracts is recognized when goods ordered under the contracts are received by the customer. Whenever costs change, we review the pricing under these contracts to determine whether they require the sale of products at a loss. To date, we have no loss contracts which would require the accrual of future losses in the current financial statements.

Income Taxes

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse.  Deferred tax assets are recognized when, based upon available evidence, realization of the assets is more likely than not.

 
18

 

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefit associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

We classify interest on tax deficiencies as interest expense and income tax penalties as other miscellaneous expenses.  
  
Goodwill

Goodwill is deemed to have an indefinite life and accordingly, is not subject to amortization.  Goodwill is subject to an annual impairment review, and, if conditions warrant, an interim impairment review.  Impairment charges, if any, are recorded in the period in which the impairment is determined. Our annual impairment review was performed as of August 31, 2010 and we determined that no impairment of goodwill has occurred.

Intangible Assets

Intangible assets include developed technologies and patents, customer relationships and non-compete agreements, which are amortized over their estimated useful lives, and trademarks and trade names, which are considered to have indefinite useful lives and therefore are not amortized. The carrying amounts of intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that those carrying amounts may not be recoverable.

Costs incurred to renew or extend the term of our intangible assets are expensed when incurred. Costs to third parties that are related to internally developing or successfully defending an intangible asset are capitalized as part of the intangible asset developed or defended and amortized over that asset’s remaining useful life. Such costs to third parties that are related to patent applications that are ultimately rejected by the relevant government authority are expensed upon rejection.

Inventories

Inventories are stated at the lower of cost (on a first-in first-out (“FIFO”) method) or net realizable value.  We periodically review the realizability of our inventory. Provisions are recorded and reserves are established for potential obsolescence. Determining adequate reserves for inventory obsolescence requires management’s judgment. Conditions impacting the realizability of our inventory could cause actual write-offs to be materially different than reported inventory reserve balances.

Foreign Operations and Currency

Accounts of our foreign subsidiary are recorded using its local currency (the euro) as the functional currency. For consolidation purposes, our foreign subsidiary’s (i) income statement accounts are converted to U.S. dollars using the average exchange rate for the monthly period being reported, (ii) assets and liabilities are converted to U.S. dollars using the exchange rate in effect as of the balance sheet date and (iii) equity transactions are converted to U.S. dollars using the exchange rate in effect as of the date of the transaction. The resulting translation gains and losses are reported as a component of accumulated other comprehensive income or loss. Gains and losses resulting from transactions which are denominated in other than the functional currencies are reported as other, net in the statement of operations in the period the gain or loss occurred.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, we are not required to provide information typically disclosed under this item.

ITEM 4.
CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls include, without limitation, controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to management, including principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

 
19

 

Our management carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of September 30, 2010. Based upon that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that the design and operation of our disclosure controls and procedures were effective as of September 30, 2010.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2010 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS

Cyalume is not currently a named party in any legal proceedings.

There have been no material developments in the proceedings known as Civil Action No. 06-706 in Superior Court of the Commonwealth of Massachusetts since the developments described in our Form 10-Q filed August 11, 2010. For full details in this matter, see Note 8 of the condensed consolidated financial statements in Part 1, Item 1 of this Form 10-Q

ITEM 1A. 
RISK FACTORS

As a smaller reporting company, we are not required to provide information typically disclosed under this item.

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

Recent Sales of Unregistered Securities and Use of Proceeds from Registered Securities

None.

Purchases of Equity Securities by the Company and Affiliated Purchasers

None.

DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.
[REMOVED AND RESERVED]

ITEM 5.
OTHER INFORMATION

There were no changes to the procedures by which security holders may recommend nominees to our Board of Directors during the three months ended September 30, 2010.

There is no information to report under this Item in lieu of reporting that information on Form 8-K.

 
20

 

ITEM 6. 
EXHIBITS

Exhibit
Number
 
Description
10.1
 
Extension of deadline contained in the Second Amendment to the Credit Agreement and Limited Waiver with TD Bank, N.A. (1)
10.2
 
Subordinated Loan Agreement dated as of July 29, 2010 among Cyalume Technologies, Inc., Cyalume Technologies Holdings, Inc., the Lenders and other financial institutions or other entities from time to time parties thereto and Granite Creek Partners Agent, LLC as Agent. (2)
10.3
 
Subordinated Security and Pledge Agreement dated as of July 29, 2010 between Cyalume Technologies, Inc. and Granite Creek Partners Agent, LLC. (2)
10.4
 
Subordinated Guaranty Agreement dated as of July 29, 2010 entered into by Cyalume Technologies Holdings, Inc. for the benefit of Granite Creek Partners Agent, LLC. (2)
10.5
 
Subordinated Stock Pledge Agreement dated as of July 29, 2010 entered into by Cyalume Technologies Holdings, Inc.  (2)
10.6
 
Amended and Restated Revolving Credit and Term Loan Agreement dated as of July 29, 2010 among Cyalume Technologies, Inc., Cyalume Technologies Holdings, Inc., the Lenders and the other financial institutions or other entities from time to time parties thereto and TD Bank, N.A., a national banking association, as Agent and as Lender. (2)
10.7
 
Form of Warrant issued to Granite Creek FlexCap I, L.P. (2)
10.8
 
Form of Warrant issued to Patriot Capital II, LP. (2)
10.9
 
Registration Rights Agreement between CTHI and Granite Creek FlexCap I, L.P. (2)
10.10
 
Registration Rights Agreement between CTHI and Patriot Capital II, LP. (2)
10.11
 
Amended Management Agreement with Selway Capital, LLC. (2)
11.1
 
Statement Regarding Computation of Per Share Earnings. (3)
31.1
*
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
*
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
*
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*
Filed herewith.
(1)
Incorporated by reference to the Current Report on Form 8-K dated June 30, 2010 and filed with the Commission July 8, 2010.
(2)
Incorporated by reference to the Current Report on Form 8-K dated July 29, 2010 and filed with the Commission August 3, 2010.
(3)
Incorporated by reference to Note 8 of the condensed consolidated financial statements in Part 1, Item 1 of this Form 10-Q.
 
 
21

 

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.

 
Cyalume Technologies Holdings, Inc.
     
Date: November 1, 2010
By:
/s/  DEREK DUNAWAY
   
Derek Dunaway, Chief Executive Officer
   
(Principal Executive Officer)
     
Date: November 1, 2010
By:
/s/  MICHAEL BIELONKO
   
Michael Bielonko, Chief Financial Officer
   
(Principal Financial Officer and Principal Accounting
Officer)

 
22

 

Exhibit 31.1

CERTIFICATION

I, Derek Dunaway, certify that:

1.
I have reviewed this Quarterly Report on Form 10-Q of Cyalume Technologies Holdings, Inc.;

2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: November 1, 2010
/s/  DEREK DUNAWAY
 
Derek Dunaway, Chief Executive Officer

 
 

 
 

Exhibit 31.2

CERTIFICATION

I, Michael Bielonko, certify that:

1.
I have reviewed this Quarterly Report on Form 10-Q of Cyalume Technologies Holdings, Inc.;

2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.
The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 
Date: November 1, 2010
/s/  MICHAEL BIELONKO
 
Michael Bielonko, Chief Financial Officer

 
 

 

Exhibit 32.1

CERTIFICATION

Each of the undersigned officers of Cyalume Technologies Holdings, Inc. (the "Company") hereby certifies that, to his knowledge, the Company's Quarterly Report on Form 10-Q to which this certification is attached (the "Report"), as filed with the Securities and Exchange Commission on the date hereof, fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
Date: November 1, 2010
/s/  DEREK DUNAWAY
 
Derek Dunaway, Chief Executive Officer
(the Principal Executive Officer)
 
Date: November 1, 2010
/s/  MICHAEL BIELONKO
 
Michael Bielonko, Chief Financial Officer
(the Principal Financial Officer and Principal Accounting
Officer)
 
This certification is being furnished and not filed, and shall not be incorporated into any document for any purpose, under the Securities Exchange Act of 1934 or the Securities Act of 1933.