Cyalume
Cyalume Technologies Holdings, Inc. (Form: 10-Q, Received: 11/14/2011 16:07:31)



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, 2011

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  o     No  o     

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:

Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  o
 (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  o     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 November 7, 2011, there were outstanding 18,177,644 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 Income for the three months ended September 30, 2011 and 2010 (unaudited)
 
4
       
 
Condensed Consolidated Statements of Income for the nine months ended September  30, 2011 and 2010 (unaudited)
 
5
       
   
Condensed Consolidated Balance Sheets as of September  30, 2011 (unaudited) and December 31, 2010
 
6
       
   
Condensed Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the nine months ended September  30, 2011 (unaudited)
 
7
       
   
Condensed Consolidated Statements of Cash Flows for the nine months ended September  30, 2011 and 2010 (unaudited)
 
8
       
   
Notes to Condensed Consolidated Financial Statements (unaudited)
 
9
       
Item 2.  
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
18
       
Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
 
22
       
Item 4.  
Controls and Procedures
 
22
       
PART II—OTHER INFORMATION    
   
       
Item 1.  
Legal Proceedings
 
22
       
Item 1A.  
Risk Factors
 
23
       
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
 
23
       
Item 3.  
Defaults Upon Senior Securities
 
23
       
Item 4.  
[Removed and Reserved]
 
23
       
Item 5.  
Other Information
 
23
       
Item 6.  
Exhibits
 
24
       
Signatures  
   
25

 
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 Income
(in thousands, except shares and per share information)
(Unaudited)

   
For the Three
   
For the Three
 
   
Months Ended
   
Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
 
Revenues
  $ 8,601     $ 11,570  
Cost of goods sold
    4,629       5,483  
Gross profit
    3,972       6,087  
                 
Other expenses (income):
               
Sales and marketing
    1,060       917  
General and administrative
    1,503       1,343  
Research and development
    489       402  
Interest, net
    563       631  
Interest – related party
    1       17  
Amortization of intangible assets
    451       441  
Other, net
    (232 )     91  
Total other expenses, net
    3,835       3,842  
                 
Income before income taxes
    137       2,245  
Provision for (benefit from) income taxes
    (107 )     916  
Net income
  $ 244     $ 1,329  
                 
Net income per common share:
               
Basic
  $ .01     $ .09  
Diluted
  $ .01     $ .06  
                 
Weighted average shares used to compute net income per common share:
               
Basic
    17,381,750       15,511,183  
Diluted
    18,202,764       17,524,995  

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

 
4

 

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

   
For the Nine
   
For the Nine
 
   
Months Ended
   
Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
 
Revenues
  $ 26,355     $ 29,859  
Cost of goods sold
    13,613       14,695  
Gross profit
    12,742       15,164  
                 
Other expenses (income):
               
Sales and marketing
    3,258       2,481  
General and administrative
    4,557       4,109  
Research and development
    1,427       1,135  
Interest, net
    1,771       1,931  
Interest – related party
    35       49  
Amortization of intangible assets
    1.256       1,353  
Other, net
    (448 )      
Total other expenses, net
    11,856       11,058  
                 
Income before income taxes
    886       4,106  
Provision for (benefit from) income taxes
    (574 )     1,585  
Net income
  $ 1,460     $ 2,521  
                 
Net income per common share:
               
Basic
  $ .09     $ .16  
Diluted
  $ .08     $ .14  
                 
Weighted average shares used to compute net income per common share:
               
Basic
    16,549,504       15,466,133  
Diluted
    18,279,284       16,240,932  

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,
       
   
2011
(unaudited)
   
December 31,
2010
 
Assets
           
Current assets:
           
Cash
  $ 3,361     $ 4,086  
Accounts receivable, net of allowance for doubtful accounts of $76 and $62 at September   30, 2011 and December 31, 2010, respectively
    3,972       1,925  
Inventories, net
    12,223       9,920  
Deferred income taxes
    348       931  
Prepaid expenses and other current assets
    559       429  
Total current assets
    20,463       17,291  
                 
Property, plant and equipment, net
    9,651       8,509  
Goodwill
    54,222       51,244  
Other intangible assets, net
    21,049       20,912  
Restricted cash
    750        
Due from related party
    3,676        
Other noncurrent assets
    186       286  
Total assets
  $ 109,997     $ 98,242  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Current portion of notes payable
  $ 1,594     $ 1,453  
Accounts payable
    3,000       2,185  
Accrued expenses and other current liabilities
    2,383       2,362  
Notes payable due to related parties
          1,131  
Income taxes payable
          700  
Total current liabilities
    6,977       7,831  
                 
Notes payable, net of current portion
    19,371       22,715  
Line of credit due to related party
    751        
Deferred income taxes
    6,376       8,147  
Contingent consideration due to business combination
    1,573        
Other noncurrent liabilities
    4,085       531  
Total liabilities
    39,133       39,224  
                 
Commitments and contingencies (Note 10)
           
                 
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; 18,177,719 and 15,748,570 shares issued and outstanding at   September   30, 2011 and December 31, 2010, respectively
    18       16  
Additional paid-in capital
    99,597       89,452  
Accumulated deficit
    (28,320 )     (29,780 )
Accumulated other comprehensive loss
    (431 )     (670 )
Total stockholders’ equity
    70,864       59,018  
Total liabilities and stockholders' equity
  $ 109,997     $ 98,242  

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
 
Balance at December 31, 2010
    15,748,570     $ 16     $ 89,452     $ (29,780 )   $ (670 )   $ 59,018     $  
Shares issued – private placement
    871,823       1       3,431                   3,432        
Shares issued – cashless option exercise
    450                                      
Shares issued – cashless warrant exercise
    6,060                                      
Shares issued – extinguishment of notes payable
    483,046             2,212                   2,212        
Shares issued – extinguishment of notes payable to related party
    253,288             1,160                   1,160        
Shares issued – business combination
    712,771       1       2,499                   2,500        
Repurchase and retirement of common stock
    (28,039 )           (134 )                 (134 )      
Share-based compensation expense
    129,750             970                   970        
Adjustment to the accounting for warrants issued in July 2010 in conjunction with issuance of subordinated term loan
                7                   7        
Foreign currency translation adjustments
                            234       234       234  
Unrealized gain on cash flow hedges, net of taxes of $(2)
                            5       5       5  
Net income
                      1,460             1,460       1,460  
Comprehensive income
                                      $ 1,699  
Balance at September   30, 2011
    18,177,719     $ 18     $ 99,597     $ (28,320 )   $ (431 )   $ 70,864          

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,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net income
  $ 1,460     $ 2,521  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation of property, plant and equipment
    819       577  
Amortization
    1,578       1,593  
Provision for deferred income taxes
    (1,265 )     1,068  
Stock-based compensation expense
    970       875  
Other non-cash expenses
    88       186  
Changes in operating assets and liabilities:
               
Accounts receivable
    (1,708 )     (920 )
Inventories
    (1,283 )     377  
Prepaid expenses and other current assets
    (76 )     (28 )
Accounts payable and accrued liabilities
    483       (169 )
Income taxes payable
    (765 )     777  
Net cash provided by operating activities
    301       6,857  
                 
Cash flows from investing activities:
               
Payment relating to a business combination, net of $200 cash acquired
    (2,300 )      
Proceeds from disposal of long-lived assets
          207  
Purchases of long-lived assets
    (959 )     (1,219 )
Net cash used in investing activities
    (3,259 )     (1,012 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock
    3,432        
Net repayment of line of credit
          (3,200 )
Repayment of notes payable
    (1,278 )     (9,859 )
Proceeds from convertible notes payable
          7,942  
Payments to reacquire and retire common stock
    (134 )      
Payment of debt issuance costs
          (250 )
Net cash provided by (used in) financing activities
    2,020       (5,367 )
                 
Effect of exchange rate changes on cash
    213       (9 )
Net increase (decrease) in cash
    (725 )     469  
Cash, beginning of period
    4,086       2,003  
Cash, end of period
  $ 3,361     $ 2,472  

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 8-03 of Regulation S-X. Accordingly, these interim condensed consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements.
 
The preparation of financial statements in conformity with U.S. GAAP 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, 2011, including the estimates inherent in the process of preparing financial statements. Additionally, all significant intercompany accounts and transactions have been eliminated in consolidation.

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, 2010 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, 2010.

2.
DESCRIPTION OF BUSINESS

These condensed consolidated financial statements and footnotes include the financial position and results of operations of Cyalume Technologies Holdings, Inc. (“Cyalume”), a holding company that is the sole shareholder of Cyalume Technologies, Inc. (“CTI”) and Cyalume Specialty Products, Inc. (“CSP”). CTI is the sole shareholder of Cyalume Technologies, SAS (“CTSAS”).

CTI and CTSAS manufacture and sell chemiluminescent products and reflective and photoluminescent materials to military, commercial and public safety markets. CTSAS is located in Aix-en-Provence, France and represents us in certain international markets, primarily Europe and the Middle East. CTI, which is located in West Springfield, Massachusetts, sells to customers in all other geographic markets.

CSP manufactures and sells high-performance specialty polymers and pharmaceutical products to customers predominantly in the pharmaceutical and military polymer markets. CSP’s operations are located in Bound Brook, New Jersey.

Our headquarters are located in West Springfield, MA. Our products are manufactured at all of our locations.

3.
NEW ACCOUNTING PRONOUNCEMENT

In September 2011, the Financial Accounting Standards Board (”FASB”) issued Accounting Standards Update No. 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”), which amends ASC 350 Intangibles—Goodwill and Other . ASU 2011-08 allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under ASU 2011-08, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances, such as financial performance, economic conditions and loss of key personnel, for an entity to consider in conducting the qualitative assessment. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early application is permitted. We have adopted ASU 2011-08 early for our annual goodwill impairment test performed as of August 31, 2011; our qualitative assessment pursuant to ASU 2011-08 indicated that it is more likely than not that our goodwill’s fair value is greater than its carrying amount and therefore the two-step quantitative goodwill impairment test was not performed.

 
9

 

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

4.
BUSINESS COMBINATION

In 2011, Cyalume created a new, wholly owned subsidiary (Cyalume Specialty Products, Inc., or “CSP”) that, on August 31, 2011, entered into an Asset Purchase Agreement (“APA”) with JFC Technologies, LLC (“JFC”) and the stockholders of JFC. Pursuant to the APA, effective September 1, 2011, CSP acquired from JFC substantially all of its business assets and a portion of its liabilities for cash and 712,771 shares of Cyalume common stock plus other consideration that is contingent on future financial performance of CSP.

JFC was a leading researcher, developer and manufacturer of specialty chemicals with operations in Bound Brook, New Jersey. CSP’s acquisition of JFC’s business assets and liabilities is expected to augment our research, development and production capabilities. These operations offer a wide range of services that will accelerate the development and deployment of new chemical-light products by CTI and CTSAS and provide additional sources of revenues and business opportunities. We also believe that vertically integrating the chemical manufacturing process at a United States-based facility will allow us to more effectively manage our supply chain.

The purchase price consisted of (in thousands):

   
Consideration
   
Cash Acquired
   
Cash Paid, Net of
Cash Acquired
 
Cash
  $ 2,500     $ 200     $ 2,300  
712,771 shares of Cyalume common stock, at fair value
    2,500                  
Contingent consideration, at fair value
    1,573                  
Total consideration
  $ 6,573                  

The contingent consideration ranges from $0 to $7 million and is based on the financial performance of the acquired business during the combined calendar years 2012 and 2013, to be paid after calendar year 2013 when CSP’s financial performance is known. These payments, if any, will consist of a minimum of 30% cash and the remainder paid in Cyalume common stock. The cash-portion of the payment can be greater than 30% at our discretion. Up to $5 million of the contingent payment is based on CSP achieving the following average earnings before interest, taxes, depreciation and amortization (“EBITDA”) thresholds for the calendar years ending December 31, 2012 and 2013:

Average 2012 and 2013 EBITDA Thresholds
 
Contingent Payment
$1,300,000 +
 
$5,000,000
$1,100,000 - $1,299,999
 
$3,000,000 - $4,900,000
$1,000,000 - $1,099,999
 
$2,200,000 - $2,920,000
$900,000 - $999,999
 
$1,500,000 - $2,130,000
$800,000 - $899,999
 
$800,000 - $1,430,000
$700,000 – 799,999
 
$400,000 - $790,000

An additional payment of $2,000,000 is contingent upon CSP achieving average EBITDA of $1,800,000 for calendar years ending December 31, 2012 and 2013.

 
10

 

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

The preliminary allocation of the fair value of the assets acquired and liabilities assumed are as follows (all amounts in thousands):

Cash
  $ 200  
Restricted cash     (1)
    750  
Accounts receivable, net
    359  
Inventories, net
    1,015  
Other current assets
    1  
Property, plant and equipment
    1,062  
Patents
    50  
Customer backlog
    140  
Customer relationships
    920  
Non-compete agreements
    160  
Goodwill    (2)
    2,978  
Total assets
    7,635  
         
Accounts payable
    130  
Accrued expenses
    122  
Customer prepayments
    4  
Line of credit          (1)
    750  
Deferred tax liability
    56  
Total liabilities
    1,062  
Net assets
  $ 6,573  

 
(1)
The $750,000 line of credit, which is payable to one of the sellers, is secured by the $750,000 of restricted cash. The line of credit accrues interest at an annual rate of 2%, calculated quarterly, and this interest is added to the principal amount outstanding on the line of credit. If CSP’s net working capital, as defined in the APA, does not exceed certain amounts and other restrictions are not met, CSP may use all or a portion of the restricted cash for its general business purposes. The amount of restricted cash that CSP may use is determined as of the last day of every calendar-year quarter. On any such quarter end, the line of credit must be repaid by the amount CSP’s working capital, as defined in the APA, is greater than $1.5 million. Additionally, any remaining restricted cash balance in excess of $375,000 as of December 31, 2012 must be used to repay the line of credit. As of December 31, 2013, any remaining restricted cash balance must be repaid to the seller and the line of credit and accrued interest thereon must be repaid.

 
(2)
Goodwill of $3.1 million is expected to be deductible for tax purposes. The amount of goodwill recorded under U.S. GAAP has not changed from the acquisition date through September 30, 2011.

The following unaudited pro forma financial summary is presented as if this acquisition was completed as of January 1, 2010. The pro forma combined results are not necessarily indicative of the actual results that would have occurred had the acquisition been consummated on that date, or of the future operations of the combined entities. The pro forma results for net income include adjustments for depreciation, intangible asset amortization, inventory step-up amortization and rent expense. The pro forma weighted average shares used to compute net income per common share (basic and diluted) differ from the weighted average shares used in these condensed consolidated statements of income in order to reflect the 712,771 shares of Cyalume common stock issued for the business combination as being issued on January 1, 2010.

   
Nine Months Ended September 30,
 
   
2011
   
2010
 
Revenues (in thousands)
  $ 31,261     $ 34,029  
Net income (in thousands)
  $ 2,561     $ 2,542  
Net income per common share:
               
Basic
  $ .15     $ .16  
Diluted
  $ .14     $ .15  
Weighted average shares used to compute net income per common share:
               
Basic
    17,181,338       16,178,904  
Diluted
    18,279,284       16,953,703  

 
11

 

Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
 
CSP’s revenues and net income are included in our condensed consolidated statements of income and total $446,000 and $16,000 since we acquired CSP.
 
5.
INVENTORIES

Inventories consist of the following (all amounts in thousands):

   
September   30,
2011
   
December 31,
2010
 
Raw materials
  $ 6,961     $ 5,539  
Work-in-process
    3,655       3,356  
Finished goods
    1,682       1,227  
      12,298       10,122  
Less: Reserve for obsolescence
    (75 )     (202 )
    $ 12,223     $ 9,920  

6.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The derivative liabilities as of September 30, 2011 in our condensed consolidated balance sheet consist of the following (all amounts in thousands):

Derivative Instrument
   
Balance Sheet Location
   
Fair Value
 
Interest rate swaps
   
Other noncurrent liabilities
   
$
(330
)
Currency forward contracts
   
Prepaid expenses and other current assets
     
25
 

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, which ends upon maturity of the notes payable, 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 swaps’ 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. For such transactions of $50,000 or more, 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 in our condensed consolidated statements of income. 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, 2011, we held three such currency forward contracts.

 
12

 

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 income for the three months ended September 30, 2011 was as follows (all amounts in thousands):

   
Gain (Loss)
   
Gain (Loss)
   
Gain (Loss)
 
   
In AOCL  (1)
   
Reclassified  (2)
   
in Earnings  (3)
 
Derivatives designated as cash flow hedging relationships:
                 
Interest rate swaps, net of taxes of $0
  $ 1     $     $  
Derivatives not designated as hedging instruments:
                       
Forward currency contracts
  $     $     $ 25  

 
(1)
Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the three months ended September 30, 2011.
 
(2)
Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the three months ended September 30, 2011.
 
(3)
Amount of gain (loss) recognized in earnings on the derivative (ineffective portion and amount excluded from effectiveness testing) reported in other, net in the condensed consolidated statement of income for the three months ended September 30, 2011.

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of income for the nine months ended September 30, 2011 was as follows (all amounts in thousands):

   
Gain (Loss)
   
Gain (Loss)
   
Gain (Loss)
 
   
In AOCL  (1)
   
Reclassified  (2)
   
in Earnings  (3)
 
Derivatives designated as cash flow hedging relationships:
                 
Interest rate swaps, net of taxes of $(2)
  $ 5     $     $  
Derivatives not designated as hedging instruments:
                       
Forward currency contracts
  $     $     $ 53  

 
(1)
Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the nine months ended September 30, 2011.
 
(2)
Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the nine months ended September 30, 2011.
 
(3)
Amount of gain (loss) recognized in earnings on the derivative (ineffective portion and amount excluded from effectiveness testing) reported in other, net in the condensed consolidated statement of income for the nine months ended September 30, 2011.

7.
INCOME TAXES

For the three months ended September 30, 2011, the effective tax rate of (78)% differed from the statutory rate of 34% primarily due to the following: (i) a reduction in the valuation allowance against foreign tax credits which is based on changes to our anticipated future use of those credits in the near-term to offset future current U.S. federal income taxes; and (ii) changes in repatriated earnings from CTSAS as a result of current year-to-date earnings of CTSAS. For the three months ended September 30, 2010, the effective tax rate of 41% differed from the statutory rate of 34% due to true-ups including changes in repatriated earnings from CTSAS and valuation allowances against foreign tax credits.

For the nine months ended September 30, 2011, the effective tax rate of (65)% differed from the statutory rate of 34% primarily due to the following: (i) foreign tax credits created during 2011 as a result of a declared dividend from CTSAS, (ii) a reduction in the valuation allowance against foreign tax credits which is based on changes to our anticipated future use of those credits in the near-term to offset future current U.S. federal income taxes; and (iii) changes in repatriated earnings from CTSAS as a result of current year-to-date earnings of CTSAS. 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 against deferred tax assets.

 
13

 

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

8.
DEBT TRANSACTIONS

As described in more detail in Note 11 of our Annual Report on Form 10-K for the year ended December 31, 2010, we had a note payable that was entered into in December 2008 with Rodman & Renshaw, LLC (“Rodman”). Principal and accrued interest payable on this note payable totaled approximately $2.2 million as of June 30, 2011. On June 30, 2011, we entered into a securities exchange agreement with Rodman in which Rodman agreed to accept, subject to certain conditions being met, 483,046 shares of our common stock as payment in full of all principal and accrued interest on this note. The transaction closed in July 2011.

As described in more detail in Note 12 of our Annual Report on Form 10-K for the year ended December 31, 2010, we had notes payable to three stockholders. Principal and accrued interest payable on these notes payable totaled approximately $1.2 million as of June 30, 2011. On July 7, 2011, these stockholders each entered into a securities exchange agreement in which they agreed to accept, subject to certain conditions being met, an aggregate of 253,288 shares of our common stock as payment in full of all principal and accrued interest on these notes. These transactions closed in July 2011.

We incurred a $750,000 line of credit in conjunction with a business combination.  See Note 4 for more information regarding this line of credit.

9.
NET INCOME PER COMMON SHARE

Basic net income per common share is computed by dividing net income 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 share equivalents 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 convertible notes using the “if-converted” method.

   
Three Months Ended  September  30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Basic:
                       
Net income (in thousands)
  $ 244     $ 1,329     $ 1,460     $ 2,521  
Weighted average shares
    17,381,750       15,511,183       16,549,504       15,466,133  
Basic income per common share
  $ .01     $ .09     $ .09     $ .16  
Diluted:
                               
Net income (in thousands)
  $ 244     $ 1,329     $ 1,460     $ 2,521  
Adjustments to net income assuming convertible notes payable are converted to common stock:
                               
Reversal of interest expense on convertible notes payable (in thousands)
    (1)     167       (1)     167  
Write off of unamortized costs of issuing convertible notes payable (in thousands)
          (889 )           (889 )
Adjustment’s 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)
  $ 244     $ 1,034     $ 1,460     $ 2,242  
Weighted average shares
    17,381,750       15,511,183       16,549,504       15,466,133  
Effect of dilutive securities
    821,014       2,013,812       1,729,780       774,799  
Weighted average shares, as adjusted
    18,202,764       17,524,995       18,279,284       16,240,932  
Diluted net income per common share
  $ .01     $ .06     $ .08     $ .14  

 
(1)
Assumes convertible notes payable are not converted to common stock because the effect would be antidilutive.
 
(2)
Assumes an effective tax rate of 40.8%.
 
(3)
Assumes an effective tax rate of 38.6%.

 
14

 
 
Cyalume Technologies Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
 
The following common shares issuable upon exercise of convertible securities were excluded from the calculation of diluted net income per common share because their effect was antidilutive for each of the periods presented:

 
Three Months Ended  September  30,
 
Nine Months Ended September 30,
 
 
2011
 
2010
 
2011
 
2010
 
Options and warrants
    5,372,588       6,388,256       5,090,088       6,495,756  
Convertible notes payable
    2,666,667             2,666,667        

10.
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.  These proceedings are known as Civil Action No. 06-706 in Superior Court of the Commonwealth of Massachusetts.

On December 19, 2008, while Civil Action 06-706 was still unresolved, we acquired CTI (the “Acquisition”). According to the 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 No. 06-706.

On July 18, 2011, CTI received an Order for Entry of Final Judgment in Civil Action No. 06-706 in which the Court awarded approximately $2.6 million in damages to Omniglow, LLC. Prejudgment interest at the rate of twelve (12%) percent per annum since the filing of the complaint in 2006 will accrue on approximately $1.3 million of the damages. The Court also awarded Omniglow, LLC reimbursement of attorney fees and costs of approximately $235,000, on which interest at the rate of twelve (12%) percent per annum will accrue beginning with the date of the final ruling.

Although we will appeal the final judgment and do not believe the awards in the final judgment will stand upon appeal, we have recorded a litigation award payable in the amount of approximately $3.6 million on our condensed consolidated balance sheet (included in “other noncurrent liabilities”) as of September 30, 2011. Since the Former Owners (i) retained the responsibility for paying the costs and liabilities associated with Civil Action No. 06-706 and (ii) are related parties under U.S. GAAP due to their ownership interest in us and their membership on our board of directors, we have recorded approximately $3.7 million, which includes the $3.5 million litigation award payable and other costs we have incurred while litigating Civil Action No. 06-706, as due from related party on our condensed consolidated balance sheet as of September 30, 2011. We believe that the related party receivable is collectible. CTI has filed motions for reconsideration and amendment of findings. In addition, CTI has prepared and will file an appeal of the final decision with the Massachusetts appellate court.

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 to our chief executive officer on a regular basis as per his reasonable requests;
 
·
Identifying strategic partners with companies with which Selway has relationships and access. In this connection, Selway will focus on 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.

 
15

 

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

The management agreement stipulates that these services would be performed by Yaron Eitan, an employee of Selway and a member of our Board of Directors, with assistance, as needed, from other employees of Selway.  The management agreement 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. Under the management agreement, we indemnified Selway and Selway indemnified us against certain losses that could have been incurred while carrying out its obligations under the management agreement. Per the management agreement and subsequent amendments thereto, Selway’s compensation for these services is $11,667 per month. We also reimburse Selway for costs incurred specifically on our behalf for these services.

Lease with Related Party

In conjunction with the business combination discussed in Note 4, CSP entered into a market-based operating lease with an entity controlled by one of our stockholders for industrial-use property located in Bound Brook, New Jersey, U.S.A. As a result of that business combination, that seller also became a shareholder of Cyalume, CSP’s parent, therefore we consider this lease to be with a party related to us. The lease ends on August 31, 2016, with extension options available, and requires lease payments of $24,000 per month from September 1, 2011 through August 31, 2013; thereafter the monthly lease payments will be adjusted to reflect the changes of average cost per square foot as reported by Newmark Knight and Frank in their 2nd Quarter New Jersey Industrial Market Report, Average Asking Rate for Somerset County.

11.
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:

 
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, 2011, 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, which are measured at fair value using level 2 inputs, and the contingent consideration liability described in Note 4, which is measured at fair value using level 3 inputs. The contingent consideration liability’s fair value of $1.6 million has not changed since the liability was incurred. The contingent consideration liability’s fair value is determined by calculating the present value of the estimated liability that is expected to be paid in 2014.

We have other non-derivative financial instruments, such as cash, accounts receivable, due from related party, accounts payable, accrued expenses, notes payable and line of credit whose carrying amounts approximate fair value.

12.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash Paid for Interest and Income Taxes (all amounts in thousands):

 
Nine Months Ended September   30,
 
 
2011
 
2010
 
Interest
$ 1,405   $ 1,686  
Income taxes
  1,461     192  

 
16

 

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

Non-Cash Investing and Financing Activities (all amounts in thousands):

   
Nine Months Ended September   30,
 
   
2011
   
2010
 
Adjustment to the accounting for warrants issued in July 2010 in conjunction with issuance of subordinated term loan
  $ 7     $  
Issued 712,771 shares of our common stock to effect a business combination
    2,500        
Issued 483,046 shares of our common stock to repay note payable and accrued interest thereon
    2,212        
Issued 253,288 shares of our common stock to repay notes payable to three stockholders and accrued interest thereon
    1,160        
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  
 
 
17

 

ITEM 2.
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 maintain principal executive offices at 96 Windsor Street, West Springfield, Massachusetts 01089. We have two direct subsidiaries: Cyalume Technologies, Inc. (“CTI”) and Cyalume Specialty Products, Inc. (“CSP”). CTI is a Delaware corporation formed on March 27, 1997 with headquarters also located in West Springfield, Massachusetts. CSP is a Delaware corporation formed on June 16, 2011 with operations located in Bound Brook, New Jersey. CTI has one subsidiary, Cyalume Technologies, SAS (“CTSAS”), located in Aix-en-Provence, France.

CTI and CTSAS primarily produce products based on technologies whereby light is generated through a chemical reaction known as chemiluminescence. 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. In addition, we also produce reflective (patches) and reflective plus photoluminescent (fire tape) products. Chemiluminescent products come in varying shapes, sizes and functions, and provide light in different colors, intensity and durations.

CSP manufactures and sells high-performance specialty polymers and pharmaceutical products to customers predominantly in the pharmaceutical and military polymer markets. In 2011, we created CSP in order to acquire substantially all of JFC Technologies, LLC’s (“JFC”) business assets and liabilities. CSP’s acquisition of JFC’s business assets and liabilities is expected to augment our research, development and production capabilities. These operations offer a wide range of services that will accelerate the development and deployment of new chemical-light products by CTI and CTSAS and provide additional sources of revenues and business opportunities. We also believe that vertically integrating the chemical manufacturing process at a United States-based facility will also allow us to more effectively manage our supply chain and enable us to manufacture all of our active chemical components within the United States.

We manufacture products at all of our locations.

Material Changes in Results of Operations – Three Months Ended September 30, 2011 versus the Three Months Ended September 30, 2010

Revenues in 2011 were lower than for the comparable period in 2010 due to a decrease in units sold, partially offset by price increases. The decrease in units sold caused a decrease in revenue of approximately $3.7 million, while price increases provided approximately $300,000 of additional revenue. $446,000 in new revenues were generated by the CSP operations acquired September 1, 2011. Many products are sold under indefinite quantity type contracts whereby we fulfill orders as they are placed by customers. We do not have insight into why military customers order at the times or in the quantities that they do. However, we see no indication that the underlying usage of our products has diminished. We believe that the global recession and constraints on budgets worldwide negatively affected revenues in both 2011 and 2010.
 
Cost of goods sold in 2011 was lower than the comparable period in 2010. That decrease is due primarily to the decrease in units sold as discussed above.  Changes in product mix sold and reduced recovery of fixed overhead costs due to lower sales volume and, to a lesser extent, cost increases accounted for the change in gross margin from 52.6% in 2010 to 46.1% in 2011.

Sales and marketing expenses increased primarily due to increases in payroll costs caused by the hiring of additional sales personnel.

General and administrative expenses increased primarily due to increases in professional fees related to the acquisition of JFC Technologies, partially offset by a decrease in payroll costs. Payroll costs decreased due to the accrual of cash bonuses in 2010 but none in 2011.

Research and development expenses increased primarily due to an increase in consultant expenses related to increased R&D efforts.

 
18

 

Provision for (benefit from) income taxes decreased in 2011 primarily due to (i) the creation of foreign tax credits through our France-based subsidiary CTSAS, (ii) a reduction in the valuation allowance against accumulated foreign tax credits and (iii) changes in repatriated earnings from CTSAS. The reduction in the valuation allowance against foreign tax credits is due to changes in our anticipated future use of those credits in the near term to offset future income taxes.

Other, net increased in 2011 due to our earning reimbursement of product development costs for certain new products that we are working on. Such transactions did not occur in 2010. This income was augmented by the effects of changes in foreign exchange rates.

Material Changes in Results of Operations – Nine Months Ended September 30, 2011 versus the Nine Months Ended September 30, 2010

Revenues in 2011 were lower than for the comparable period in 2010 due to a decrease in units sold, offset by price increases. The decrease in units sold caused a decrease in revenue of approximately $4.3 million, while price increases provided approximately $400,000 of additional revenue. $446,000 in new revenues were generated by the CSP operations acquired September 1, 2011. Many products are sold under indefinite quantity type contracts whereby we fulfill orders as they are placed by customers. We do not have insight into why military customers order at the times or in the quantities that they do. However, we see no indication that the underlying usage of our products has diminished. We believe that the global recession and constraints on budgets worldwide negatively affected revenues in both 2011 and 2010.

Cost of goods sold in 2011 was lower than the comparable period in 2010. That decrease is due primarily to the decrease in units sold as discussed above.  Price increases and changes in product mix sold offset each other, resulting in minimal change in gross margin from 50.8% in 2010 to 48.3% in 2011.

Sales and marketing expenses increased primarily due to increases in payroll costs, share-based compensation awards, trade show expenses and share-based consultant costs. Payroll costs have increased mainly due to the hiring of additional sales personnel. Expense relating to share-based compensation awards to employees increased in part due to awards to these new employees, and also due to other share-based awards in the first quarter of 2011. We also incurred consulting costs related to the selling of new and existing products to military customers.

General and administrative expenses increased primarily due to increases in depreciation expense and professional fees, partially offset by a decrease in payroll costs. Depreciation expense has increased since 2010 primarily due to the implementation of a new information system in July 2010. Professional fees increased due to costs incurred related to the acquisition of JFC Technologies. Payroll costs decreased due to the accrual of cash bonuses in 2010 but none in 2011.

Research and development expenses increased primarily due to increases in payroll and consultant costs due to increased R&D efforts.

A benefit from income taxes was recorded in 2011 primarily due to (i) the creation of foreign tax credits through our France-based subsidiary CTSAS, (ii) a reduction in the valuation allowance against accumulated foreign tax credits and (iii) changes in repatriated earnings from CTSAS. The reduction in the valuation allowance against foreign tax credits is due to changes in our anticipated future use of those credits in the near term to offset future income taxes.

Other, net increased in 2011 due to our earning reimbursement of product development costs for certain new products that we are working on. Such transactions did not occur in 2010. This income was partially offset by the effects of changes in foreign exchange rates.

Material Changes in Financial Condition – September 30, 2011 versus December 31, 2010

Our accounts receivable increased due to higher sales in the month of September 2011 versus the month of December 2010 and due to the addition of accounts receivable associated with CSP.  We have no significant collection problems. Our inventory balance is typically higher in September than in December due to lower levels of production in the fourth quarter. Additionally, CSP holds inventory that was not on the consolidated balance sheet at December 31, 2010.

We have recorded an approximately $3.6 million litigation award payable and a related approximately $3.7 million receivable from a related party. This payable and receivable are based on a July 2011 ruling against CTI under Civil Action No. 06-706. See Part II. Item 1 “Legal Proceedings” for additional information.

Property, plant and equipment, goodwill, other intangible assets, restricted cash and accounts payable all increased due to the addition of balances associated with CSP at September 30, 2011 that were not present at December 31, 2010.

 
19

 

Our deferred tax asset decreased primarily due to the anticipated use of net operating losses in 2011 and changes in repatriated earnings from our France-based subsidiary, CTSAS.  Our deferred tax liability decreased since December 31, 2010 primarily due to the following items: (i) non-deductible amortization of intangible assets, (ii) additional temporarily non-deductible stock-based compensation, (iii) a net decrease in repatriated earnings from CTSAS primarily resulting from the recently declared dividend and offset by the increase in current year-to-date earnings of CTSAS and (iv) changes in the carrying balance of foreign tax credits which increased as a result of foreign tax credits being created during 2011, anticipated usage during 2011 and further reduced by the reduction in the valuation allowance against foreign tax credits which is based on changes to our anticipated future use of those credits in the near-term to offset future current U.S. federal income taxes.
 
Income taxes payable decreased due to payments to federal and state tax authorities during 2011.

Liquidity and Capital Resources

As of September 30, 2011 and December 31, 2010, we had $3.4 million and $4.1 million, respectively, of cash on hand. The major sources and uses of cash during the nine months ended September 30, 2011 were all in the normal course of business, except for the securities exchange agreements and asset purchases as discussed below.

In June 2011 we entered into securities exchange agreements with several note holders in which they agreed to accept an aggregate of 736,344 shares of our common stock as payment in full of all principal and accrued interest on $3.4 million of notes payable and accrued interest. These transactions closed in July 2011. Settling these notes payable and accrued interest using our common stock, rather than cash, avoids a significant cash outlay in 2014.

At September 1, 2011, we invested $2.3 million, net of cash received, in purchasing certain assets and liabilities from JFC Technologies.

Forecasted principal and interest payments on debt for the next 12 months are $3.7 million. All operating and capital expenditures are expected to be funded completely from operating cash flows.

As further described in Part II. Item 1 “Legal Proceedings”, we have recorded an approximately $3.6 million payable for ongoing litigation for which a related party has retained the responsibility of paying. Assuming (i) our appeal of these findings is not successful and (ii) our related party is unable to reimburse us for these findings (and the related legal costs we incur), our liquidity and capital resources could be adversely affected. We believe that the related party receivable is collectible.
 
Off-Balance Sheet Arrangements

In conjunction with CSP’s acquisition of JFC’s business assets and liabilities discussed in the “Company Overview” above, CSP entered into an operating lease with an entity controlled by one of our stockholders for industrial-use property located in Bound Brook, New Jersey, U.S.A. The lease ends on August 31, 2016, with extension options available, and requires lease payments of $24,000 per month from September 1, 2011 through August 31, 2013; thereafter the monthly lease payments will be adjusted to reflect the changes of average cost per square foot as reported by Newmark Knight and Frank in their 2nd Quarter New Jersey Industrial Market Report, Average Asking Rate for Somerset County.

Other than the lease discussed in the previous paragraph, we did not have any material off-balance sheet arrangements during 2010 or the through the nine months ended September 30, 2011.

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.

 
20

 

Revenue Recognition

Revenue from the sale of products and services is recognized when the earnings process is complete, the amount of revenue is determinable and the risks and rewards of ownership have transferred to the customer. Depending on the terms of the individual sales arrangement with our customer, sales are recognized at either the shipping point or upon receipt by the customer. Costs and related expenses to manufacture the products or provide services are recorded as costs of goods sold when the related revenue is recognized.

We have several contracts providing for the sale of indefinite quantities of items at fixed per unit prices, subject to adjustment for certain economic factors. 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.

CSP has a contract for the sale of a pharmaceutical ingredient to a customer who uses that ingredient to produce a prescription drug that they, in turn, sell to their customer. In addition to CSP’s sale of the ingredient, the contract requires the customer to pay CSP a formula-based royalty tied to sales and profitability of the prescription drug sales by the customer. Although CSP earns these royalty revenues as the customer sells their product, these revenues are not quantifiable until CSP is informed by the customer of its sales and profitability of their prescription drug. Because this creates a lag time between (i) when these revenues are earned by CSP and (ii) when these revenues can be properly recorded by CSP, royalty revenues under this contract may be earned in one accounting period but recorded in a subsequent accounting period. Specifically, at the end of each calendar-year quarter, the customer determines the sales and profitability of the drug that they sold in that quarter, calculates the royalty earned by CSP during that quarter and reports that earned royalty to CSP within one month of that quarter end. Because CSP does not know and cannot estimate the amount of royalty revenue earned up to a month after each quarter end, CSP’s revenue under this contract is not fixed or determinable until that time. Therefore these royalty revenues are not recorded until the dollar amount of these revenues is communicated to CSP by their customer.

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.

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, interim impairment reviews.  Impairment charges, if any, are recorded in the period in which the impairment is determined.

Intangible Assets

Intangible assets include developed technologies and patents, customer backlogs and customer relationships, 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 amortized intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that those carrying amounts may not be recoverable. Because it is not amortized, the carrying amount of trademarks is reviewed annually for impairment. Costs incurred to register new patents or defend existing patents are capitalized while costs to renew or extend the term of intangible assets are expensed when incurred.

 
21

 

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 their local currency (the euro) as the functional currency. For consolidation, revenues and expenses are converted to U.S. dollars using the average exchange rate for the monthly period being reported. Assets and liabilities are converted to U.S. dollars using the exchange rate in effect as of the balance sheet date. Equity transactions are converted to U.S. dollars using the exchange rate in effect as of the date of the transaction. 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 (expense) income in the statement of income 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.

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, 2011. 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, 2011.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the three  months ended September 30, 2011 that has materially affected, or is 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.

CTI is currently named a defendant in Civil Action No. 06-706 in Superior Court of the State of Massachusetts. Filing suit against CTI is Omniglow, LLC (the former novelty business of CTI which was sold on January 23, 2006). CTI sold certain assets and liabilities related to the novelty and retail business to certain former shareholders and management (the “Omniglow Buyers”).  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.

On July 18, 2011, CTI received an Order for Entry of Final Judgment in Civil Action No. 06-706 in which the Court awarded approximately $2.6 million in damages to Omniglow, LLC. Prejudgment interest at the rate of twelve (12%) percent per annum since the filing of the complaint in 2006 will accrue on approximately $1.3 million of the damages. The Court also awarded Omniglow, LLC reimbursement of attorney fees and costs of approximately $235,000, on which interest at the rate of twelve (12%) percent per annum will accrue beginning with the date of the final ruling.

 
22

 

CTI has filed motions for reconsideration and amendment of findings. In addition, CTI will file an appeal of the final decision with the Massachusetts appellate court. According to the stock purchase agreement with CTI’s former owners (from whom we purchased CTI in 2008 and who is also a party related to us), the former owners have indemnified CTI for all costs and liabilities associated with Civil Action No. 06-706, therefore we recorded the receivable from them for (i) damages awarded in the Order for Entry of Final Judgment and (ii) related costs that CTI has incurred through September 30, 2011.

Since CTI will be appealing these findings, we cannot estimate at this time the final amounts that will be paid and collected under Civil Action No. 06-706, but expect them to be significantly less than those in the July 2011 ruling.

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

Incorporated by reference to the Current Report on Form 8-K dated June 30, 2011 and filed with the Commission July 7, 2011 and by reference to the Current Report on Form 8-K dated August 31, 2011 and filed with the Commission September 6, 2011.

Purchases of Equity Securities by the Company and Affiliated Purchasers

Period
 
Total Number
of Shares
Purchased
   
Average
Price
Paid per
Share
   
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
   
Maximum
Number (or 
Approximate
Dollar Value) of
Shares that May
yet be Purchased
under the Plans
or Programs
 
                         
July 1 to July 30
    3,500
(1)
  $ 3.90           $  
August 1 to August 31
                       
September 1 to September 30
                       

 
(1)
3,500 shares of our common stock were repurchased from an employee of CTI. These shares were a portion of the shares that these employees received relating to stock awards that recently vested. These shares were purchased to provide these employees with cash to pay personal income taxes arising from the stock awards.

ITEM 3.
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, 2011.

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

 
23

 

ITEM 6.    EXHIBITS

Exhibit
Number
 
Description
10.1
 
Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Winston Churchill dated July 7, 2011. (1) (10.2)
10.2
 
Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Thomas Rebar dated July 7, 2011. (1) (10.3)
10.3
 
Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Wayne Weisman dated July 7, 2011. (1) (10.4)
10.4
 
Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Rodman Principal Investments, LLC dated June 30, 2011. (1) (10.1)
10.5
*
Amendment No. 2 to the Employee Agreement of Derek Dunaway.
10.6
*
Amendment No. 1 to the Employee Agreement of Michael Bielonko.
10.7
*
Amendment No. 2 to the Employee Agreement of Edgar E. Cranor.
10.8
*
Asset Purchase Agreement dated August 31, 2011 among Cyalume Technologies Holdings, Inc., Cyalume Specialty Products, Inc., JFC Technologies, LLC and Selling Members of Seller.
10.9
*
Registration Rights Agreement between Cyalume Technologies Holdings, Inc., James G. Schleck, James R. Schleck, Jame Fine Chemical, Inc., and JFC Technologies, LLC dated as of August 31, 2011.
10.10
*
Lease Agreement between Brook Industrial Park, LLC and Cyalume Specialty Products, Inc.
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, 2011 and filed with the Commission July 7, 2011. The number given in parenthesis indicates the corresponding exhibit number in such Form 8-K.

 
24

 

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 14, 2011
By:
/s/  DEREK DUNAWAY
     
   
Derek Dunaway, Chief Executive Officer
   
(Principal Executive Officer)
     
Date: November 14, 2011
By:
/s/  MICHAEL BIELONKO
     
   
Michael Bielonko, Chief Financial Officer
   
(Principal Financial Officer)
 
 
25

 

Amendment No. 2 to the
Employee Agreement of Derek Dunaway
 
This Amendment No. 2 (this “Amendment”) dated September 1, 2011, to the Employment Agreement (as defined below) is made by and among Cyalume Technologies, Inc., a Delaware corporation (the “ Company ”) and Derek Dunaway (the “ Employee ”).  Any capitalized term not defined herein shall have the meaning for such term specified in the Employment Agreement.
 
WHEREAS , the Company and the Employee entered into an Employment Agreement dated June 2, 2009, (the “ Employment Agreement ”), as amended May 9, 2011 pursuant to which the Employee shall earn a certain base salary and may earn a certain equity bonus; and
 
WHEREAS , the Company and the Employee desire to reduce the base salary and amend the terms of the equity bonus in the Employment Agreement to permit the award of restricted stock or stock options; and
 
WHEREAS , the Compensation Committee of the Board of Directors of the Company has authorized the Company’s Chief Financial Officer to enter into this Amendment.
 
NOW THEREFORE, in consideration of the foregoing and the representations, warranties, covenants and agreements herein contained and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows:
 
1.           The Employment Agreement is hereby amended as follows:
 
(a) Base Salary as set forth on Section 1 of Schedule 1 shall be reduced to $297,500.00; and
 
(b) Each use of the term “restricted stock” under the heading “Equity Bonus” in Section 2 of Schedule 1 shall be deleted in its entirety and replaced with the term “restricted stock and/or stock options”; and
 
(c)  The following sentence is added to the end of Section 2 of Schedule 1: “The Board of Directors, in its sole discretion, may determine whether to award options and/or restricted stock in satisfaction of the Company’s obligations under this Section 2.”
 
2.           The amendments set forth herein are limited precisely as written and shall not be deemed to be an amendment of any other term or condition of the Employment Agreement or any of the documents referred to therein.
 
 
 

 
 
3.           Whenever the Employment Agreement is referred to in any agreement, document or instrument, such reference shall be to the Employment Agreement as amended hereby.  Except as expressly amended hereby, the terms and conditions of the Employment Agreement shall continue in full force and effect.
 
4.           This Amendment may be signed in any number of counterparts, each of which shall be an original and all of which shall be deemed to be one and the same instrument, with the same effect as if the signatures thereto and hereto were upon the same instrument.  A facsimile signature shall be deemed to be an original signature for purposes of this Amendment.
 
[ Signature page follows ]
 
 
 

 
 
IN WITNESS WHEREOF , the parties hereto have duly executed this Amendment No. 2 to the Employment Agreement as of the day and year first above written.
 
CYALUME TECHNOLOGIES, INC.
 
EMPLOYEE
     
/s/ Michael Bielonko
 
/s/ Derek Dunaway
     
[Michael Bielonko, CFO]
   
 
 
 

 
 

Amendment No. 1 to the
Employee Agreement of Michael Bielonko
 
This Amendment No. 1 (this “Amendment”) dated September 1, 2011, to the Employment Agreement (as defined below) is made by and among Cyalume Technologies, Inc., a Delaware corporation (the “ Company ”) and Michael Bielonko (the “ Employee ”).  Any capitalized term not defined herein shall have the meaning for such term specified in the Employment Agreement.
 
WHEREAS , the Company and the Employee entered into an Employment Agreement dated May 15, 2009, (the “ Employment Agreement ”),  pursuant to which the Employee shall earn a certain base salary and may earn a certain equity bonus; and
 
WHEREAS , the Company and the Employee desire to reduce the base salary and amend the terms of the equity bonus in the Employment Agreement to permit the award of restricted stock or stock options; and
 
WHEREAS , the Compensation Committee of the Board of Directors of the Company has authorized the Company’s Chief Financial Officer to enter into this Amendment.
 
NOW THEREFORE, in consideration of the foregoing and the representations, warranties, covenants and agreements herein contained and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows:
 
1.           The Employment Agreement is hereby amended as follows:
 
(a) Base Salary as set forth on Section 1 of Schedule 1 shall be reduced to $187,000.00; and
 
(b) Each use of the term “restricted stock” under the heading “Equity Bonus” in Section 2 of Schedule 1 shall be deleted in its entirety and replaced with the term “restricted stock and/or stock options”; and
 
(c)  The following sentence is added to the end of Section 2 of Schedule 1: “The Board of Directors, in its sole discretion, may determine whether to award options and/or restricted stock in satisfaction of the Company’s obligations under this Section 2.”
 
2.           The amendments set forth herein are limited precisely as written and shall not be deemed to be an amendment of any other term or condition of the Employment Agreement or any of the documents referred to therein.
 
 
 

 
 
3.           Whenever the Employment Agreement is referred to in any agreement, document or instrument, such reference shall be to the Employment Agreement as amended hereby.  Except as expressly amended hereby, the terms and conditions of the Employment Agreement shall continue in full force and effect.
 
4.           This Amendment may be signed in any number of counterparts, each of which shall be an original and all of which shall be deemed to be one and the same instrument, with the same effect as if the signatures thereto and hereto were upon the same instrument.  A facsimile signature shall be deemed to be an original signature for purposes of this Amendment.
 
[ Signature page follows ]
 
 
 

 
 
IN WITNESS WHEREOF , the parties hereto have duly executed this Amendment No. 1 to the Employment Agreement as of the day and year first above written.
 
CYALUME TECHNOLOGIES, INC.
 
EMPLOYEE
     
/s/ Michael Bielonko
 
/s/ Michael Bielonko
     
[Michael Bielonko, CFO]
   
     
/s/ Derek Dunaway
   
     
[Derek Dunaway], CEO
   
 
 
 

 

Amendment No. 2 to the
Employee Agreement of Edgar E. Cranor
 
This Amendment No. 2 (this “Amendment”) dated September 1, 2011, to the Employment Agreement (as defined below) is made by and among Cyalume Technologies, Inc., a Delaware corporation (the “ Company ”) and Edgar E. Cranor (the “ Employee ”).  Any capitalized term not defined herein shall have the meaning for such term specified in the Employment Agreement.
 
WHEREAS , the Company and the Employee entered into an Employment Agreement dated July 17, 2009, (the “ Employment Agreement ”), as amended May 9, 2011 pursuant to which the Employee shall earn a certain base salary and may earn a certain equity bonus; and
 
WHEREAS , the Company and the Employee desire to reduce the base salary and amend the terms of the equity bonus in the Employment Agreement to permit the award of restricted stock or stock options; and
 
WHEREAS , the Compensation Committee of the Board of Directors of the Company has authorized the Company’s Chief Financial Officer to enter into this Amendment.
 
NOW THEREFORE, in consideration of the foregoing and the representations, warranties, covenants and agreements herein contained and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows:
 
1.           The Employment Agreement is hereby amended as follows:
 
(a) Base Salary as set forth on Section 1 of Schedule 1 shall be reduced to $182,750.00; and
 
(b) Each use of the term “restricted stock” under the heading “Equity Bonus” in Section 2 of Schedule 1 shall be deleted in its entirety and replaced with the term “restricted stock and/or stock options”; and
 
(c)  The following sentence is added to the end of Section 2 of Schedule 1: “The Board of Directors, in its sole discretion, may determine whether to award options and/or restricted stock in satisfaction of the Company’s obligations under this Section 2.”
 
2.           The amendments set forth herein are limited precisely as written and shall not be deemed to be an amendment of any other term or condition of the Employment Agreement or any of the documents referred to therein.
 
 
 

 
 
3.           Whenever the Employment Agreement is referred to in any agreement, document or instrument, such reference shall be to the Employment Agreement as amended hereby.  Except as expressly amended hereby, the terms and conditions of the Employment Agreement shall continue in full force and effect.
 
4.           This Amendment may be signed in any number of counterparts, each of which shall be an original and all of which shall be deemed to be one and the same instrument, with the same effect as if the signatures thereto and hereto were upon the same instrument.  A facsimile signature shall be deemed to be an original signature for purposes of this Amendment.
 
[ Signature page follows ]
 
 
 

 
 
IN WITNESS WHEREOF , the parties hereto have duly executed this Amendment No. 2 to the Employment Agreement as of the day and year first above written.
 
CYALUME TECHNOLOGIES, INC.
 
EMPLOYEE
     
/s/ Michael Bielonko
 
/s/ Edgar Cranor
     
[Michael Bielonko, CFO]
   

 
 

 
 
EXECUTION COPY

ASSET PURCHASE AGREEMENT

dated

August 31, 2011

among

CYALUME TECHNOLOGIES HOLDINGS, INC., a Delaware corporation,

as Parent of the Buyer,

CYALUME SPECIALTY PRODUCTS, INC., a Delaware corporation,

as Buyer,

JFC TECHNOLOGIES, LLC,
a New Jersey limited liability company,

as Seller,

and

Selling Members of Seller set forth on Schedule I

 
 

 
 
TABLE OF CONTENTS
 
       
Page
     
ARTICLE I DEFINITIONS
   
     
ARTICLE II PURCHASE AND SALE
 
19
2.1
 
Purchase and Sale
 
19
2.2
 
Excluded Assets
 
20
2.3
 
Assumption of Liabilities
 
21
2.4
 
Excluded Liabilities
 
22
2.5
 
Purchase Price
 
23
2.6
 
Payment of the Purchase Price
 
23
2.7
 
Adjustments; Post-Closing Adjustments
 
26
2.8
 
Collection of Accounts Receivable
 
28
2.9
 
Right of Endorsement
 
28
2.10
 
Allocation of the Purchase Price for Tax Purposes
 
29
2.11
 
Closing
 
30
2.12
 
Prorations and Utilities
 
30
     
ARTICLE III REPRESENTATIONS AND WARRANTIES OF SELLER AND SELLING MEMBERS
 
32
3.1
 
Corporate Existence and Power
 
32
3.2
 
Authorization and Enforceability
 
32
3.3
 
Governmental Authorization
 
33
3.4
 
Non-Contravention
 
33
3.5
 
Capitalization
 
33
3.6
 
Affiliates
 
34
3.7
 
Assumed Names
 
34
3.8
 
Subsidiaries
 
34
3.9
 
Consents
 
34
3.10
 
Financial Statements
 
34
3.11
 
Books and Records
 
35
3.12
 
Absence of Certain Changes
 
36
3.13
 
Properties; Title to the Purchased Assets
 
37
3.14
 
Litigation
 
37
3.15
 
Contracts
 
37
3.16
 
Insurance
 
39
3.17
 
Licenses and Permits
 
40
3.18
 
Compliance with Laws
 
40
3.19
 
Intellectual Property
 
41
3.20
 
Clients; Revenues
 
42
3.21
 
Accounts Receivable; Loans
 
43
3.22
 
Pre-payments
 
43
3.23
 
Employees
 
43
3.24
 
Employment Matters
 
43
3.25
 
Withholding
 
44
3.26
 
Benefit Plans
 
45
3.27
 
Real Property
 
45
3.28
 
Accounts
 
46

 
 

 

TABLE OF CONTENTS CONTINUED
 
       
Page
         
3.29
 
Tax Matters
 
47
3.30
 
Environmental Matters
 
47
3.31
 
Finders’ Fees
 
49
3.32
 
Powers of Attorney and Suretyships
 
49
3.33
 
Software
 
49
3.34
 
Warranty Claims
 
50
3.35
 
Suppliers
 
51
3.36
 
Managers and Officers
 
51
3.37
 
Seller and Selling Member Investment Representations
 
51
3.38
 
Certain Business Practices
 
53
3.39
 
Money Laundering Laws
 
53
3.40
 
Other Information
 
54
     
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF BUYER
 
54
4.1
 
Corporate Existence and Power
 
54
4.2
 
Corporate Authorization
 
54
4.3
 
Governmental Authorization
 
54
4.4
 
Non-Contravention
 
54
4.5
 
Finders’ Fees
 
54
4.6
 
Real Estate Records
 
55
4.7
 
ISRA
 
55
4.8
 
Document Access
 
55
     
ARTICLE V COVENANTS OF SELLER AND SELLING MEMBERS PENDING CLOSING
 
55
5.1
 
Conduct of the Business
 
55
5.2
 
Access to Information
 
57
5.3
 
Notices of Certain Events
 
57
5.4
 
Exclusivity
 
58
5.5
 
Key Person Insurance
 
59
5.6
 
Interim Financial Statements
 
59
     
ARTICLE VI COVENANTS OF SELLER AND SELLING MEMBERS
 
59
6.1
 
Confidentiality
 
59
6.2
 
Injunctive Relief
 
59
6.3
 
Payment and Performance of Excluded Liabilities
 
60
6.4
 
Sale Restriction
 
60
6.5
 
No Distributions
 
60
6.6
 
Obtaining Consents
 
60
     
ARTICLE VII COVENANTS OF BUYER
 
60
7.1
 
Employee Benefits
 
60
     
ARTICLE VIII COVENANTS OF ALL PARTIES HERETO
 
61
8.1
 
Further Assurances
 
61
8.2
 
Confidentiality of Transaction
 
61
8.3
 
Payments and Obligations
 
62

 
ii

 
TABLE OF CONTENTS CONTINUED
 
       
Page
         
8.4
 
Earnout Covenants
 
62
8.5
 
Tax Matters
 
64
     
ARTICLE IX CONDITIONS TO CLOSING
 
64
9.1
 
Condition to the Obligations of the Parties
 
64
9.2
 
Conditions to Obligations of Buyer
 
64
9.3
 
Conditions to Obligations of Seller and Selling Members
 
67
     
ARTICLE X INDEMNIFICATION
 
68
10.1
 
Indemnification of Buyer
 
68
10.2
 
Indemnification of Seller and Selling Members
 
69
10.3
 
Procedure
 
69
10.4
 
Periodic Payments
 
71
10.5
 
Right of Set Off
 
71
10.6
 
Payment of Indemnification
 
71
10.7
 
Insurance
 
72
10.8
 
Right to Indemnification
 
72
10.9
 
Survival of Indemnification Rights and Timing of Indemnification Claims
 
72
     
ARTICLE XI DISPUTE RESOLUTION
 
73
11.1
 
Arbitration
 
73
11.2
 
Waiver of Jury Trial; Exemplary Damages
 
75
11.3
 
Governing law
 
76
11.4
 
Specific performance
 
76
     
ARTICLE XII TERMINATION
 
76
12.1
 
Termination Without Default; Expenses
 
76
12.2
 
Termination Upon Default
 
76
12.3
 
Survival
 
77
     
ARTICLE XIII MISCELLANEOUS
 
77
13.1
 
Notices
 
77
13.2
 
Amendments; No Waivers; Remedies
 
78
13.3
 
Arms’ length bargaining; no presumption against drafter
 
79
13.4
 
Publicity
 
79
13.5
 
Expenses
 
79
13.6
 
No Assignment or Delegation
 
79
13.7
 
Counterparts; facsimile signatures
 
79
13.8
 
Entire Agreement
 
79
13.9
 
Severability
 
80
13.10
 
Captions
 
80
13.11
 
Construction of certain terms and references; captions
 
80
13.12
 
Further Assurances
 
81
13.13
 
Third Party Beneficiaries
 
81
13.14
 
Seller and each Selling Members’ Representative
 
81
 
 
iii

 

TABLE OF CONTENTS CONTINUED
 
   
Page
     
[SCHEDULES]
 
 
     
SCHEDULE I - Selling Members
 
 
     
SCHEDULE II - EBITDA Calculation Components
 
 
     
SCHEDULE 2.6(c)(i) - Earnout Schedule
 
 
     
SCHEDULE 2.6(c)(ii) - Proration of Earnout Payments Schedule
 
 
     
EXHIBIT A - Form of Registration Rights Agreement
 
 
     
EXHIBIT B - Line of Credit
 
 
     
EXHIBIT C - Form of Escrow Agreement
 
 
     
EXHIBIT D - Form of Bill of Sale and Assignment and Assumption Agreement
 
 
     
EXHIBIT E - Form of Employment Agreement
 
 
     
EXHIBIT F - Form of Legal Opinion by Counsel to Seller and Selling Members
 
 
     
EXHIBIT G - Form of Non-Compete Agreement
 
 
     
EXHIBIT H - Form of Stockholder's Agreement
 
 
     
EXHIBIT I - Royalty Letter
 
 
     
EXHIBIT J - Form of Lease Agreement
  
 

 
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ASSET PURCHASE AGREEMENT
 
This ASSET PURCHASE AGREEMENT (the “ Agreement ”), dated as of August 31, 2011, among Cyalume Technologies Holdings, Inc., a Delaware corporation (“ Parent ”), Cyalume Specialty Products, Inc., a Delaware corporation (“ Buyer ”), JFC Technologies, LLC, a New Jersey limited liability company (“ Seller ”), and the members of Seller listed on Schedule I hereto (each a “ Selling Member ” and collectively “ Selling Members ”).
 
WITNESSETH:
 
 
A.
Seller is in the business of providing specialty chemical manufacturing products and services;
 
 
B.
Selling Members are the sole members of Seller; and
 
 
C.
Pursuant to Section 13.15(a) , Selling Members desire to appoint James G. Schleck as their true and lawful agent and attorney-in-fact (the “ Representative ”).
 
The parties accordingly agree as follows:
 
ARTICLE I
DEFINITIONS
 
The following terms, as used herein, have the following meanings:
 
1.1           “ 2011 EBITDA ” means the EBITDA of the Core Business as owned and operated by Seller for the period beginning January 1, 2011 up to the Closing Date and by Buyer for the period beginning on the Closing Date and ending December 31, 2011.
 
1.2           “ 2011 EBITDA Deficit ” is defined in Section 2.6(c)(iii) .
 
1.3           “ 2012 EBITDA ” means the EBITDA with respect to the 2012 calendar year.
 
1.4           “ 2013 EBITDA ” means the EBITDA with respect to the 2013 calendar year.
 
1.5            “ Action ” means any legal action, suit, investigation, hearing, proceeding, or audit (including any audit for Taxes) or otherwise.
 
1.6           “ Actual Balance Sheet ” means the audited opening balance sheet of Buyer provided by Buyer pursuant to Section 2.7(b)(i) .
 
1.7           “ Actual Net Working Capital ” is defined in Section 2.7(b)(i) .
 
 
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1.8           “ Actual Working Capital ” means current assets (including cash, accounts receivable, prepaid expenses and inventory) less current liabilities (including accounts payable and accrued liabilities), as determined by Buyer, in accordance with GAAP as applied on a Consistent Basis.  During the Line of Credit Period, to the extent Buyer makes any capital expenditures in connection with its chemical light production business such capital expenditures shall be excluded from any calculation of Actual Working Capital.
 
1.9           “ Additional Agreements ” mean the Registration Rights Agreement, Escrow Agreement, Conveyance Documents, Employment Agreements, Non-Compete Agreements, Stockholder’s Agreement, Royalty/Licensing Agreement and Lease Agreement.
 
1.10         “ Additional Earnout Payment ” is defined in Section 2.6(d)(i) .
 
1.11         “ Additional Earnout Payment Shares ” is defined in Section 2.6(d)(i) .
 
1.12         “ Affiliate ” means, with respect to any Person, any other Person directly or indirectly controlling, controlled by, or under common control with such Person.  With respect to any natural person, the term Affiliate shall also include any member of said person’s immediate family, any Person organized by or for said person and any trust, voting or otherwise, of which said person is a trustee or of which said person or any of said person’s immediate family is a beneficiary.  For purposes of this Agreement, each Selling Member and each of Brook Industrial Park, LLC, Eikos, Inc., Amerigen, Ltd. and GlucoNova LLC shall be deemed to be an Affiliate of Seller.
 
1.13         “ Agreement ” is defined in the Preamble.
 
1.14         “ Annual Financial Statements ” is defined in Section 3.10(a) .
 
1.15         “ Arbitrator ” is defined in Section 11.1 .
 
1.16         “ Assumed Liabilities ” is defined in Section 2.3(a) .
 
1.17         “ Attorneys’ Fees and Expenses ” is defined in Section 11.1(d) .
 
1.18         “ Authority ” means any governmental, regulatory or administrative body, agency or authority, any court or judicial authority, any arbitrator, or any public, private or industry regulatory authority, whether Federal, state, local or foreign.
 
1.19         “ Average EBITDA ” means the average of the 2012 EBITDA and the 2013 EBITDA.
 
1.20         “ Average Price ” means the volume weighted average (calculated based on each individual trade occurring on each day) thirty (30) preceding day market price of the Parent Common Stock at Closing, in the case of the Closing Payment, or, in the case of the Earnout Payment or Additional Earnout Payment (as the case may be), the volume weighted average (calculated based on each individual trade occurring on each day) thirty (30) preceding day market price of the Parent Common Stock on December 31, 2013.
 
 
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1.21         “ Basket ” is defined in Section 10.1 .
 
1.22         “ Board ” is defined in Section 8.5(b) .
 
1.23         “ Books and Records ” means all books and records, ledgers, employee records, customer lists, files, correspondence, material relating to the purchase of materials, supplies and services, research and commercial data, insurance policies and records, Environmental Records (and other records of every kind (whether written, electronic, or otherwise embodied) owned or used by a Person or in which a Person’s assets, the Business or its transactions are otherwise reflected, other than stock books, limited liability company record books, and minute books.
 
1.24         “ Budget ” is defined in Section 8.5(b)(iii) .
 
1.25         “ Business Day ” means any day other than a Saturday, Sunday or a legal holiday on which commercial banking institutions in New York are not open for business.
 
1.26         “ Buyer ” is defined in the Preamble.
 
1.27         “ Buyer Indemnifiable Loss Limit ” is defined in Section 10.2 .
 
1.28         “ Buyer Indemnitees ” is defined in Section 10.1 .
 
1.29         “ CERCLA ” means the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (42 U.S.C. §§ 9601 et seq.), as amended, and the rules and regulations promulgated thereunder, and any state law counterpart.
 
1.30         “ CERCLIS ” means the Comprehensive Environmental Response and Liability Information System, as provided for by 40 C.F.R. § 300.5.19.
 
1.31         “ Closing ” is defined in Section 2.11 .
 
1.32         “ Closing Cash Payment ” is defined in Section 2.5 .
 
1.33         “ Closing Date ” is defined in Section 2.11 .
 
1.34         “ Closing Line of Credit ” is defined in Section 2.5 .
 
1.35         “ Closing Payment ” is defined in Section 2.5 .
 
1.36         “ Closing Payment Shares ” means that amount of Parent Common Stock equal to the quotient of Two Million Five Hundred Thousand Dollars ($2,500,000) divided by the Average Price; provided , that, in any case if the quotient of the calculation of the Closing Payment Shares yields a fractional share, such fractional share of Closing Payment Shares shall be rounded to the nearest whole share.
 
 
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1.37         “ COBRA ” means the Consolidated Omnibus Budget Reconciliation Act of 1986, as amended.
 
1.38         “ Code ” means the Internal Revenue Code of 1986, as amended.
 
1.39         “ Collection Period ” is one hundred twenty (120) days from the Closing Date.
 
1.40         “ Consistent Basis ” is defined in the definition of the Seller Current Assets.
 
1.41         “ Contracts ” is defined in Section 2.1(d) .
 
1.42         “ Conveyance Documents ” is defined in Section 2.11(b) .
 
1.43         “ Copyright Rights ” means any and all published and unpublished works of authorship in all forms and media (including without limitation software, databases, source code, object code, documentation, internet site content, advertising and marketing materials, artwork, audio and video recordings, derivative works and compilations) whether copyrightable or not, all rights therein and thereto including all rights to copy, prepare derivative works based on, distribute copies of, perform and display such published and unpublished works of authorship, all U.S. and foreign registrations and applications therefor, all renewals, extensions, restorations and reversions thereof, and all rights granted under any U.S. or foreign laws, and under any international treaties, now or hereafter granted.
 
1.44         “ Core Business ” means the entire business of Seller, comprised of the Purchased Assets and the Assumed Liabilities, and excluding the Excluded Assets.  For clarity, the Core Business does not include the portion of the business of Seller comprised of sales to the Parent as a customer of Seller.
 
1.45         “ Disputed Matter ” is defined in Section 11.1(a) .
 
1.46         “ Earnout Payment ” is defined in Section 2.6(c) .
 
1.47         “ Earnout Schedule ” is defined in Section 2.6(c) .
 
1.48         “ Earnout Shares ” is defined in Section 2.6(c)(i).
 
1.49         “ EBITDA ” means, with respect to any period and the Core Business only, on a basis determined in accordance with GAAP as applied on a Consistent Basis, an amount equal to (i) the sum, without duplication, of the amounts for such period of (a) net income, (b) interest expense, (c) provisions for taxes based on income, to the extent they were included as a deduction in the calculation of net income, (d) depreciation expense, to the extent included as a deduction in the calculation of net income, (e) amortization expense, to the extent included as a deduction in the calculation of net income, and (f) other non-cash items reducing net income (but excluding any such non-cash item to the extent it represents an accrual or reserve for potential cash items in any future period) to the extent they were included as a deduction in calculating net income, less (ii) other non-cash items increasing net income (but excluding any such non-cash item to the extent it represents the reversal of an accrual or reserve for potential cash items in any period prior to the calculation of EBITDA) and, plus or minus, (iii) other items, including those relating to the chemical light business of Parent, as agreed upon and as identified on Schedule II ; provided , further , that upon the determination by Buyer’s accountants that the lease set forth under the Lease Agreement is a capitalized lease (determined in accordance with GAAP as applied on a Consistent Basis), then any such payments made by Buyer pursuant to such Lease Agreement shall be included in any calculation of EBITDA.
 
 
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1.50         “ EBITDA Thresholds ” means, collectively, Threshold I, Threshold II, Threshold III, Threshold IV, Threshold V and Threshold VI, each as set forth on the Earnout Schedule.
 
1.51         “ Effective Date ” means September 1, 2011.
 
1.52         “ Employment Agreements ” is defined in Section 9.2(m) .
 
1.53         “ Environmental Assessment ” means any soil or groundwater test, survey, environmental assessment or other inspection, test or inquiry (including analytical data, boring logs, photographs and other imaging) conducted by Seller or any agent of Seller, or in the possession of Seller or its agents, relating to any real property, facilities, or improvements presently or formerly owned, occupied, or leased by Seller for the benefit of the Core Business or used in connection with the Core Business.
 
1.54         “ Environmental Claim ” means any written notice, or to the Knowledge of Seller, oral notice, service of process, claim, demand or other written or electronic communication (each hereinafter a “claim”) by any other Governmental or Regulatory Entity or any person or entity alleging or asserting liability under statute, common law or any theory of law for damages, investigatory costs, cleanup costs, response costs, damages to natural resources or other property, personal injuries, fines or penalties arising out of, based on or resulting from (a) the presence, Release or threatened Release into the indoor or outdoor environment, of any Hazardous Material at any location whether intentional or non-intentional and whether in compliance with Environmental Law at the time of its occurrence, or (b) circumstances forming the basis of any violation, or alleged violation, of any Environmental Law or any Environmental Permit, regardless of whether Seller deems such claims to have merit or not.  The term “Environmental Claim” shall include any claim asserted by any Governmental or Regulatory Entity or any third party for enforcement, penalties, termination or withdrawal of an Environmental Permit, cleanup, removal, response, remedial or other actions or damages pursuant to any applicable Environmental Law, and any claim by any third party seeking penalties, damages, contribution, indemnification, cost recovery, compensation, injunctive or other equitable relief resulting from the presence of Hazardous Materials or arising from alleged injury or threat of injury to health, safety or the environment, and shall also include any request for information under Section 104(e) of CERCLA or any claim from a person or entity designated as or representing a “potentially responsible party” alleging liability of Seller under CERCLA relating to the operation of the Core Business.
 
 
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1.55         “ Environmental Law s” shall mean all federal, state, foreign and local statutes, regulations, directives, ordinances and other rules, orders, decrees, judgments, treaties, standards, policies or guidelines having the effect of law, principles of common law, and other standards of practice which pertain to protection of human health and safety and the environment.  Environmental Laws include those relating to (1) the import, manufacture, processing, use, labeling, distribution, treatment, storage, discharge, disposal, recycling, generation or transportation of Hazardous Materials; (2) air (including indoor air), soil, surface, subsurface, groundwater or noise pollution; (3) Releases or threatened Releases; (4) protection of wildlife, endangered species, wetlands or natural resources; (5) Tanks; (6) health and safety of employees and other persons; (7) the presence or content of Hazardous Materials in a product, item or article, whether a component or finished product; (8) land use or zoning; and (9) notification requirements relating to the foregoing.  Without limiting the above, Environmental Law also includes the following within the United States:  (i) CERCLA; (ii) the Solid Waste Disposal Act, as amended by RCRA; (iii) the Emergency Planning and Community Right to Know Act of 1986 (42 U.S.C. §§ I 101 et seq.), as amended; (iv) the Clean Air Act (42 U.S.C. §§ 7401 et seq.), as amended; (v) the Clean Water Act (33 U.S.C. §§ 1251 et seq.), as amended; (vi) the Toxic Substances Control Act (15 U.S.C. §§ 2601 et seq.), as amended; (vii) the Hazardous Materials Transportation Act (49 U.S.C. §§ 1801 et seq.), as amended; (viii) the Federal Insecticide, Fungicide and Rodenticide Act (7 U.S.C. §§ 136 et seq.), as amended; (ix) the Federal Safe Drinking Water Act (42 U.S.C. §§ 300 et seq.), as amended; (x) the Federal Radon and Indoor Air Quality Research Act (42 U.S.C. §§ 7401 et seq.); (xi) the Occupational Safety and Health Act (29 U.S.C §§ 651 et seq.), as amended; and (xii) any state, county, municipal or local statutes, laws or ordinances similar or analogous to (including the New Jersey Industrial Site Recovery Act, N.J.S.A. 13:1K-6 et seq., as amended by the Site remediation Reform Act, N.J.S.A. 58:10C-1 et seq., and the regulations promulgated thereunder (collectively, “ ISRA ”), the New Jersey Spill Compensation and Control Act, N.J.S.A. 58-10-23.11 et seq., as amended and the regulations promulgated thereunder, as well as counterparts of) any of the statutes listed above.
 
1.56         “ Environmental Permits ” shall mean the licenses, certificates, permits, permissions, registrations, approvals, agreements, authorizations, variances, and consents which are required under or are issued pursuant to an Environmental Law.
 
1.57         “ Environmental Property Transfer Act ” shall mean an Environmental Law that conditions, restricts, prohibits, or requires notice or disclosure in land records,