Cyalume
Cyalume Technologies Holdings, Inc. (Form: 10-Q, Received: 11/14/2014 14:42:03)

 

 

 

   

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, 2014

 

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.)
     
910 SE 17 th  Street, Suite 300, Fort Lauderdale, Florida   33316
(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  x No  ¨

 

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

 

Large accelerated filer  ¨   Accelerated filer  ¨  

Non-accelerated filer  ¨

(Do not check if a smaller
reporting company)

  Smaller reporting
company  x

 

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

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of November 12, 2014, there were outstanding 21,400,244 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 Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013 3
     
  Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2014 and 2013 (unaudited) 4
     
  Condensed Consolidated Statements of Changes in Preferred Stock and Stockholders' Equity for the nine months ended September 30, 2014 (unaudited) 5
     
  Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited) 6
     
  Notes to Condensed Consolidated Financial Statements (unaudited) 7
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
     
Item 4. Controls and Procedures 24
     
PART II—OTHER INFORMATION  
   
Item 1. Legal Proceedings 24
     
Item 1A. Risk Factors 25
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
     
Item 3. Defaults Upon Senior Securities 25
     
Item 4. Mine Safety Disclosures 25
     
Item 5. Other Information 25
     
Item 6. Exhibits 25
     
Signatures 26

  

1
 

  

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.

  

2
 

   

ITEM 1. Financial Statements

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except shares and per share information)

 

 

    September 30,
2014
(unaudited)
    December 31,
2013
 
Assets            
Current assets:            
Cash   $ 848     $ 865  
Accounts receivable, net of allowance for doubtful accounts of $49 and $44, respectively     3,888       3,788  
Inventories, net     9,121       10,782  
Income taxes refundable     0       163  
Deferred income taxes     3,847       3,847  
Prepaid expenses and other current assets     520       463  
Total current assets     18,224       19,908  
                 
Property, plant and equipment, net     7,123       8,001  
Goodwill     7,992       7,992  
Other intangible assets, net     7,365       17,948  
Other noncurrent assets     24       465  
Total assets   $ 40,728     $ 54,314  
Liabilities and Stockholders’ Equity                
Current liabilities:                
Line of credit   $ 1,750     $ 1,600  
Current portion of notes payable     1,893       1,925  
Accounts payable     4,437       6,182  
Accrued expenses     2,041       2,059  
Deferred revenue     91       80  
Income taxes payable     186       97  
Current portion of capital lease obligation     11       15  
Warrants liability     33       6,373  
Deferred rent     78       0  
Contingent legal obligation     0       3,986  
Other current liabilities     0       242  
Total current liabilities     10,520       22,559  
                 
Notes payable, net of current portion     14,251       14,969  
Note payable due to related parties     2,100       2,100  
Deferred income taxes     3,847       3,847  
Asset retirement obligation     201       194  
Capital lease obligation, net of current portion     0       7  
Contingent legal obligation, net of current portion     2,781       0  
Other noncurrent liabilities, net of current portion     72       79  
Total liabilities     33,772       43,755  
                 
Commitments and contingencies (Note 11)                
                 
Series C preferred stock, $0.001 par value; 1,000,000 shares of preferred stock authorized; 1,000 shares issued and outstanding     2,041       0  
Series A convertible preferred stock, $0.001 par value; 1,000,000 shares of preferred stock authorized; 123,077 shares issued and outstanding     4,430       4,055  
                 
Stockholders' equity:                
Series B convertible preferred stock, $0.001 par value; 1,000,000 shares of preferred stock authorized; 1,000 shares issued and outstanding     1,401       0  
Common stock, $0.001 par value; 100,000,000 shares authorized; 21,400,244 and 20,738,260 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively     21       21  
Additional paid-in capital     103,128       102,575  
Accumulated deficit     (103,549 )     (95,874 )
Accumulated other comprehensive loss     (516 )     (218 )
Total stockholders’ equity     485       6,504  
Total liabilities and stockholders' equity   $ 40,728     $ 54,314  

  

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

 

3
 

   

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(in thousands, except shares and per share information)

(Unaudited)

 

    Three     Three     Nine     Nine  
    Months Ended     Months Ended     Months Ended     Months Ended  
    September 30, 2014     September 30, 2013     September 30, 2014     September 30, 2013  
Revenues   $ 8,387     $ 7,461     $ 24,543     $ 25,006  
Cost of revenues     4,515       4,217       14,243       13,453  
Gross profit     3,872       3,244       10,300       11,553  
                                 
Other expenses (income):                                
Sales and marketing     966       1,200       2,831       3,650  
General and administrative     1,641       4,411       5,114       9,107  
Research and development     432       371       1,186       1,431  
Interest expense, net     526       620       1,563       1,790  
Interest expense – related party     68       122       291       174  
Amortization of intangible assets     564       434       1,557       1,303  
Provision for uncollectible receivable – related party     0       3,730       0       3,730  
Change in warrant liability fair value     197       0       (4,844 )     0  
Impairment loss on intangible assets     9,100       0       9,100       875  
Impairment loss on goodwill     0       0       0       168  
Legal settlement     0       2,038       0       2,038  
Loss on extinguishment of related party debt     527       0       527       0  
Other expenses, net     12       45       363       49  
Total other expenses, net     14,033       12,971       17,688       24,315  
                                 
Loss before income taxes     (10,161 )     (9,727 )     (7,388 )     (12,762 )
Provision for (benefit from) income taxes     112       (1,923 )     287       (3,100 )
Net loss     (10,273 )     (7,804 )     (7,675 )     (9,662 )
                                 
Other comprehensive (loss) income, net of tax:                                
Foreign currency translation adjustments     (246 )     199       (298 )     105
Unrealized gain on cash flow hedges, net of taxes of $0, $(14), $0 and $(28) respectively     0       22       0       70  
Other comprehensive (loss) income     (246 )     221       (298 )     175  
Comprehensive loss   $ (10,519 )   $ (7,583 )   $ (7,973 )   $ (9,487 )
                                 
Net loss   $ (10,273 )   $ (7,804 )   $ (7,675 )   $ (9,662 )
Series A convertible preferred stock dividends     (130 )     0       (375 )     0  
Series C preferred stock dividends     (41 )     0       (41 )     0  
Series A deemed dividend     (2,422 )     0       (2,422 )     0  
Series B deemed dividend     (1,098 )     0       (1,098 )     0  
Series C deemed dividend     (1,401 )     0       (1,401 )     0  
Net loss available to common stockholders   $ (15,365 )   $ (7,804 )   $ (13,012 )   $ (9,662 )
                                 
Net loss per common share:                                
Basic   $ (0.72 )   $ (0.38 )   $ (0.61 )   $ (0.47 )
Diluted   $ (0.72 )   $ (0.38 )   $ (0.61 )   $ (0.47 )
Weighted average shares used to compute net loss per common share:                                
Basic     21,400,244       20,716,901       21,258,011       20,711,352  
Diluted     21,400,244       20,716,901       21,258,011       20,711,352  

 

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

  

4
 

   

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Changes in Preferred Stock and Stockholders' Equity

(in thousands, except shares)

(Unaudited)

 

    Series A & Series C
Preferred Stock
   

 

Series B

Preferred Stock

    Common Stock                          
    Amount    

 

Number

of Shares

   

 

 

 

Amount

    Number
of Shares
    Amount     Additional Paid-In
Capital
    Accumulated
Deficit
    Accumulated Other Comprehensive
Loss
    Total Stockholders’
Equity
 
                                                       
Balance at December 31, 2013   $ 4,055       0       0       20,738,260     $ 21     $ 102,575     $ (95,874 )   $ (218 )   $ 6,504  
                                                                         
Proceeds received from issuance of Series C preferred stock     1,000       0       0       0       0       0       0       0       0  
Proceeds received from issuance of Series B convertible preferred stock     0       1,000       1,000       0       0       0       0       0       1,00 0  
Series A, B and C allocation of fair value     (401 )     0       401       0       0       0       0       0       401  
Series A, B and C preferred stock issuance costs     0       0       0       0       0       (321 )     0       0       (321 )
Dividends accrued on Series A and Series C preferred stock     416       0       0       0       0       (416 )     0       0       (416 )
Reversal of forfeited restricted awards     0       0       0       (3,333 )     0       0       0       0       0  
Warrants amended in connection with refinancing     0       0       0       0       0       (72 )     0       0       (72 )
Common stock issuance - payment of contingent consideration liability     0       0       0       350,000       0       241       0       0       241  
                                                                         
Shares issued to related party     0       0       0       242,308       0       157       0       0       157  
                                                                         
Shares issued – warrant exercise     0       0       0       73,009       0       45       0       0       45  
Excess of Amended JFC Note fair value over face value     0       0       0       0       0       483       0       0       483  
                                                                         
Termination of USVC common and preferred warrants (See Note 7)     0       0       0       0       0       1,524       0       0       1,524  
Series C deemed dividends (See Note 7)     1,401       0       0       0       0       (1,401 )     0       0       (1,401 )
Share-based compensation expense     0       0       0       0       0       313       0       0       313  
                                                                         
Net loss     0       0       0       0       0       0     (7,675 )     0     (7,675 )
                                                                         
Other comprehensive loss     0       0       0       0       0       0       0       (298 )     (298 )
                                                                         
Balance at September 30, 2014   $ 6,471       1,000     $ 1,401       21,400,244     $ 21     $ 103,128     $ (103,549 )   $ (516 )   $ 485  

 

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

  

5
 

 

 

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,  
    2014     2013  
Cash flows from operating activities:            
Net loss   $ (7,675 )   $ (9,662 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:                
Depreciation and amortization of property, plant and equipment     1,059       1,030  
Amortization     1,736       1,839  
Provision for uncollectible receivable – related party     0       3,730  
Non-cash interest expense     750       0  
Deferred income tax provision     0       (3,261 )
Share-based compensation expense     313       709  
Impairment loss on intangible assets     9,100       875  
Impairment loss on goodwill     0       168  
Change in fair value of warrant liability     (4,844 )     0  
Legal settlement     0       2,038  
Loss on extinguishment of debt - related party     527       0  
Other non-cash expenses     54       45  
Changes in operating assets and liabilities:                
Accounts receivable     (161 )     (252 )
Inventories     1,568       (1,701 )
Prepaid expenses and other current assets     290       (494 )
Accounts payable and accrued liabilities     (1,662 )     2,555  
Accrued interest on note payable to related party     188       0  
Deferred revenue and deferred rent     89       58  
Income taxes payable     261       43  
Net cash provided by (used in) operating activities     1,593       (2,280 )
                 
Cash flows from investing activities:                
Purchases of long-lived assets     (302 )     (801 )
Payment of trademark costs     (4 )     0  
Payment of patent costs     (154 )     0  
Payment of website development costs     (8 )     0  
Proceeds from disposal of long-lived assets     0       18  
Net cash used in investing activities     (468 )     (783 )
                 
Cash flows from financing activities:                
Net proceeds from line of credit     150       3,600  
Repayment of  long term notes payable     (1,437 )     (1,646 )
Principal payments on capital lease obligations     (11 )     (11 )
Proceeds from issuance of Series C and Series B preferred stock     2,000       0  
Proceeds received from warrant exercise     1       0  
Payment of preferred stock issuance costs     (321 )     0  
Payment in connection with legal settlement agreement     (1,465 )     0  
Payment of debt issuance and deferred financing costs     (21 )     0  
Net cash (used in) provided by financing activities     (1,104 )     1,943  
                 
Effect of exchange rate changes on cash     (38 )     32  
Net decrease in cash     (17 )     (1,088 )
Cash, beginning of period     865       2,695  
Cash, end of period   $ 848     $ 1,607  

 

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

  

6
 

  

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

1. ORGANIZATION

 

Cyalume Technologies Holdings, Inc. (the “Company”) was organized as a blank check company under the laws of the State of Delaware on July 19, 2005. At that time, the Company was named Vector Security Intersect Acquisition Corp. On December 19, 2008, the Company acquired Cyalume Technologies, Inc. (“CTI”) and changed the corporate name to the current name. CTI is a Delaware corporation formed on March 27, 1997 with headquarters located in Fort Lauderdale, Florida.

 

2. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to those rules and regulations. The Company believes that the disclosures made are adequate to make the information presented not misleading. All the adjustments which, in the opinion of management, are considered necessary for a fair presentation of the results of operations for the periods shown are of a normal recurring nature and have been reflected in the unaudited condensed consolidated financial statements. Results from operations for the three months and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2014. The consolidated balance sheet at December 31, 2013 has been derived from the audited consolidated financial statements at that date. The information included in these unaudited interim condensed consolidated financial statements should 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, 2013 filed on April 15, 2014.

 

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. While the Company believes that such estimates are fair when considered in conjunction with the condensed consolidated financial position and results of operations taken as a whole, the actual amount of such estimates, when known, may vary from these estimates.

 

3. DESCRIPTION OF BUSINESS

 

These consolidated financial statements and footnotes include the financial position and operations of Cyalume Technologies Holdings, Inc. (“Cyalume”), a holding company that is the sole shareholder of Cyalume Technologies, Inc. (“CTI”) and of Cyalume Specialty Products, Inc. (“CSP”). CTI is the sole shareholder of Cyalume Technologies, SAS (“CTSAS”), Cyalume Realty, Inc. (“CRI”) and Combat Training Solutions, Inc. (“CTS”). All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The Company’s primary focus is providing tactical and training solutions to the military of the U.S. and other countries through both products and services.

 

CTI and CTSAS manufacture and sell chemiluminescent products and reflective and photoluminescent materials to military, ammunition, commercial and public safety markets. CTSAS is located in France and represents the Company in certain international markets, primarily Europe and the Middle East. CTI sells to customers in all other geographic markets. CTI’s and CTSAS’ business operations constitute the majority, based on revenues and assets, of the Company’s consolidated business operations.

 

CSP manufactures and sells specialty chemical products to the defense, pharmaceutical, cosmetic and other markets. CSP’s operations are located in Bound Brook, New Jersey.

 

CRI previously owned land located in Colorado Springs, Colorado. The land was transferred in connection with a 2013 legal settlement.

 

CTS provides its customers with battlefield effects simulation products while its services include planning and implementing tactical training exercises simulating real-world experiences. These products allow military and law enforcement professionals to maintain operational readiness through safe, live training and hands-on situational exercises.

  

7
 

  

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

The Company’s business is managed and financial results are reported as one segment. The Company’s CEO, who is the Company’s chief operating decision maker, focuses on consolidated results to make strategic and tactical decisions. The Company’s one operating segment consists of three reporting units: Chemical Light (the operations of CTI and CTSAS), Specialty Products (the operations of CSP) and Other (the operations of CRI and the parent company Cyalume Technologies Holdings, Inc.).

 

The Company’s consolidated financial statements have been prepared assuming the Company will continue as a going concern. For the nine months ended September 30, 2014, the Company had a net loss of approximately $7.7 million, and generated approximately $1.6 million of cash in its operations. As of September 30, 2014, the Company had an accumulated deficit of approximately $103.5 million, total stockholders’ equity of approximately $0.5 million and the Company’s unrestricted cash balance was approximately $0.8 million.

 

Due to uncertainty about the Company’s ability to meet its current operating expenses and current obligations, in their report on the Company’s annual financial statements for the year ended December 31, 2013, the Company’s independent registered public accounting firm included an explanatory paragraph regarding the Company’s ability to continue as a going concern. The Company’s consolidated financial statements do not include any adjustments relating to the recoverability of assets and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern.

 

Management continues to evaluate various possibilities including but not limited to refinancing or restructuring the Company’s debt, reducing or eliminating operating expenses, and raising additional capital through the issuance of common or preferred stock or securities convertible into common stock. These possibilities, to the extent available, may be on terms that result in significant dilution to the Company’s existing stockholders, may reduce the value of the stockholders’ investment in the Company or may impact the Company’s stock price. On July 30, 2014, the Company entered into a Securities Purchase Agreement with Cova Small Cap Holdings, LLC (“Cova”), Bayonet Capital Fund I, LLC (“Bayonet”) (see Note 9) and another investor for the purchase of an aggregate of 1,000 units of securities of the Company for an aggregate purchase price of $2.0 million (see Note 14). Cova is a significant stockholder of the Company. Two members of the Board are affiliated with, and designees of, Cova. Bayonet is controlled by James Schleck, a member of the Company’s Board of Directors (the Board”) and a significant Stockholder of the Company.

 

4. IMPAIRMENT CHARGES

 

During the third quarter of 2014, the Company’s Chemical Light reporting unit recorded a loss on impairment of certain amortizing intangible assets of $9.1 million. See Note 12 for fair value information on these assets.

 

During the third quarter of 2014, management conducted an annual review of tangible and intangible assets for impairment. Before assessing whether any of the Company’s reporting units’ goodwill was impaired, the Company first assessed whether any long-lived assets were impaired. This assessment determined that the CTI patent asset was impaired by approximately $4.9 million and that CTI trademarks and trade names were impaired by approximately $4.2 million. Therefore, the Company recorded a $9.1 million impairment loss on these CTI intangible assets during the third quarter of 2014.

 

The “step 1” goodwill impairment assessment was performed by comparing the fair value of each reporting unit containing goodwill to those reporting units’ carrying values. The Company’s Chemical Light and Specialty Products reporting units have goodwill assets. Since there are no quoted market prices for the Company’s reporting units, the fair value of the Company’s reporting units were determined using a discounted present value technique utilizing each reporting unit’s forecasted after-tax cash flows. The “step 1” test determined that the fair value of the both the Chemical Light reporting unit and the Specialty Products reporting unit exceeded its carrying value, and therefore the goodwill did not need to be tested further under what is commonly known as “step 2” of the goodwill impairment assessment.

 

Under “step 2” of a goodwill impairment assessment, the implied fair value of a reporting unit’s goodwill is compared with the carrying amount of that goodwill. If the carrying amount of the goodwill exceeds the implied fair value of that goodwill, that excess must be recognized as an impairment loss. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied amount of a reporting unit’s goodwill. Intangible assets are identified and valued during this process, such as customer relationships, patents, trade names, non-compete agreements, and the Company’s workforce.

  

8
 

   

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

 

5. INVENTORIES

 

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

 

    September 30,
2014
    December 31,
2013
 
Raw materials   $ 5,277     $ 6,535  
Work-in-process     1,803       2,185  
Finished goods     2,041       2,062  
    $ 9,121     $ 10,782  

 

 

6. CREDIT LINE AND NOTES PAYABLE

 

Line of Credit

 

The Company has a line of credit with a maximum borrowing capacity of $5.0 million with TD Bank N.A. (“TD Bank”). The amount which may be borrowed from this line of credit is dependent mainly on accounts receivable and inventory balances. Interest is payable monthly and is determined based on the Prime Rate, plus 3%. The line of credit’s interest rate at September 30, 2014 was 6.25%. The line of credit expires on December 19, 2015. This line of credit is subject to (i) the same restrictive covenants and (ii) the same collateral and guarantees as the senior debt Term Loan and the senior debt Real Estate Loan as described below. At September 30, 2014, $1.8 million was outstanding on this line of credit and borrowing availability was approximately $1.1 million.

 

Notes Payable

 

Outstanding notes payable consist of (all amounts in thousands):

 

    September 30,
2014
    December 31,
2013
 
Senior Debt - Term Loan   $ 4,683     $ 6,023  
Senior Debt - Real Estate Loan     1,582       1,679  
Subordinated Term Loan     9,409       8,659  
Promissory Note Payable     860       1,075  
Total     16,534       17,436  
Less: Unamortized debt discount     (390 )     (542 )
Less: Current portion of notes payable, including current portion of unamortized debt discount     (1,893 )     (1,925 )
Notes payable, net of current portion   $ 14,251     $ 14,969  

 

Senior Debt

 

CTI has two loans payable to TD Bank, a term loan (the “Term Loan”) and a real estate loan (the “Real Estate Loan”), that were originally entered into on December 19, 2008, and which were amended twice during 2012 to modify certain financial and non-financial covenants required by these loans. The Fourth Amendment to the Amended and Restated Revolving Credit and Term Loan Agreement (the “Senior Amendment”) was entered into on November 19, 2013.

 

The Term Loan is payable in monthly principal installments of $148,000 along with monthly interest payments, plus a one-time principal payment of approximately $2.5 million due at maturity in December 2015. The Real Estate Loan is payable in monthly principal installments of approximately $10,000, along with monthly interest payments, plus a one-time principal payment of $1.4 million due at maturity in December 2015.

 

The TD Bank line of credit, the Term Loan and the Real Estate Loan are senior in payment priority to all other notes payable and lines of credit.

  

9
 

   

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

Subordinated Term Loan

 

On July 29, 2010, the subordinated term loan of $8.5 million (the “Subordinated Term Loan”) was issued to Granite Creek Partners Agent, LLC (“Granite Creek”) and on November 19, 2013, the Company entered into a Fourth Amendment to the Subordinated Term Loan (the “Subordinated Amendment”) which extended the maturity date to June 30, 2016. Pursuant to the Subordinated Amendment, interest is payable in kind through December 19, 2015 and then payable monthly in cash through the June 30, 2016 maturity date. Interest is payable monthly at a rate of 11% per annum. No principal payments are required until maturity. The Company has the right to prepay the loan in whole or in part at any time without penalty in the event that the Company’s indebtedness with TD Bank is repaid. The Subordinated Term Loan ranks junior to all debt held by TD Bank but senior to all other remaining long-term debt including existing and future subordinated debt. The Subordinated Term Loan is convertible at any time by Granite Creek into 2,666,667 shares of common stock at a conversion price of approximately $3.19 per share. No portion of the Subordinated Term Loan has been converted to our common stock. The Company previously determined that the convertible notes’ conversion feature was not a beneficial conversion feature under U.S. GAAP. Simultaneous with the issuance of the Subordinated Term Loan during 2010, the Company issued warrants (the “Subordinated Term Loan Warrants”) to repay certain costs of obtaining the convertible notes. These warrants initially allowed the holder to purchase 160,000 shares of common stock at $1.50 per share through July 19, 2018. A portion of the $8.5 million gross proceeds from the issuance of the loan was allocated to the warrants based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at time of issuance. The portion of the proceeds so allocated to the warrants ($207,000) was recorded as a debt discount and an increase to additional paid-in capital on our consolidated balance sheet. The warrant’s fair value was increased by $94,000 in 2012 due to (i) a decrease in the exercise price of the warrants and (ii) an extension of the term of the warrant. The Subordinated Term Loan Warrants were amended again during 2013 in connection with the Senior Amendment described above. An additional amount was added to debt discount and warrant liability during 2013 relating to (i) another decrease in the exercise price of the warrants to $0.01, (ii) an extension of the term of the warrants, and (iii) an increase to the number of shares of common stock that may be purchased upon exercise of the warrants to 455,514 shares of common stock. The debt discount is being amortized to interest expense using the effective interest method over the life of the convertible notes which have a maturity date of June 30, 2016. As a result of the amendment to the warrants, the warrants are no longer indexed to the Company’s stock, are considered a derivative and therefore, are being accounted for as a liability.

 

7. PREFERRED STOCK AND STOCK WARRANTS

 

Series A Convertible Preferred Stock

 

The Company is authorized to issue 1,000,000 shares of preferred stock in one or more series with such designations, voting and other rights and preferences as may be determined from time to time by our Board of Directors.

 

On November 19, 2013, the Company entered into a Securities Purchase Agreement (the “Series A Purchase Agreement”) with US VC Partners, L.P. (the “Series A Investor”) for the purchase by the Investor of 123,077 units of securities of the Company for an aggregate purchase price of $4.0 million (or $32.50 per unit). Each security issued is comprised of: 1) one share of Series A Convertible Preferred Stock of the Company, at a par value of $0.001 per share (the “Series A Preferred Stock”); 2) one common stock warrant ( the “Common Warrant”); and 3) one preferred stock warrant (the “Preferred Warrant”).

 

Each share of Series A Preferred Stock may be converted at any time at the option of the holder into a number of shares of common stock initially equal to 50 shares of common stock, determined by dividing the Liquidation Value per share of Series A Preferred Stock by the applicable conversion price per share of Series A Preferred Stock. The initial conversion price was equal to $0.65, subject to customary adjustments, including for any accrued but unpaid dividends and pursuant to certain anti-dilution provisions. Pursuant to the Series A Certificate of Designation amended on July 30, 2014 (the “Amended Series A Certificate of Designation”), the conversion price per share of Series A Preferred Stock is now equal to $0.13664587. The Series A Preferred Stock is not subject to mandatory conversion at any time.

 

Since the Common Warrant and the Preferred Warrant were not indexed to the Company’s stock, they were derivatives and therefore, were being accounted for as a liability. The Common Warrant and the Preferred Warrant were both terminated on July 30, 2014 in connection with the issuance of the Series B Convertible Preferred Stock and the Series C Preferred Stock discussed below. The warrants were marked to their market value of approximately $1.5 million as of July 30, 2014, at which time the liability was reclassified to equity.

 

Upon voluntary or involuntary liquidation, dissolution or winding up of the Company, each holder of Series A Preferred Stock is entitled to a liquidation preference of $32.50 per share, plus any accrued but unpaid dividends, subject to customary adjustments as set forth in the Certificate of Designation (the “Series A Liquidation Value”).

   

10
 

  

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

Dividends on the Series A Preferred Stock accrue (payable in cash or in kind), whether or not declared by the Board and whether or not funds are available for the payment of dividends, at a rate of 12% per annum on the sum of the liquidation preference plus all accrued and accumulated dividends and will be payable quarterly in arrears in a) cash or b) newly issued shares of Series A Preferred Stock having an aggregate liquidation preference equal to the amount of such accrued dividends (“PIK Dividends”) at the option of the Company. All accrued and accumulated dividends on the convertible preferred stock shall be paid prior to and in preference to any other class of securities of the Company.

 

Each share of Series A Preferred Stock will be entitled to a number of votes equal to the number of shares of common stock into which such share is convertible and shall be entitled to vote with holders of outstanding shares of common stock, voting together as a single class, with respect to any and all matters presented to the stockholders of the Company for their action or consideration.

 

The requisite holders of the Series A Preferred Stock will have the right to cause the Company to redeem, out of funds legally available, all but not less than all of the then outstanding shares of Series A Preferred Stock, for a price per share equal to the Series A Liquidation Value of such shares from and after the fifth anniversary of the closing date of the Series A Purchase Agreement. Additionally, the Company will have the right to redeem all of the outstanding shares of Series A Preferred Stock from and after the eighth anniversary of the closing date of the Series A Purchase Agreement at a redemption price equal to the Series A Liquidation Value. As a result of the redemption provisions, the Series A Preferred Stock has been classified outside of permanent equity.

 

The significant change in the conversion price of the Series A Preferred Stock was determined to be a substantive qualitative change of a conversion feature that is reasonably possible of being exercised. Therefore, the amendment to the terms of the Series A Preferred Stock made on July 30, 2014 was accounted for as an extinguishment in accordance with the derecognition accounting model under ASC 260-10-S99-2. The Series A Preferred Stock fair value on the extinguishment date was estimated at approximately $1.6 million. This resulted in the Company recognizing a deemed dividend of approximately $2.4 million to reflect the Series A Preferred Stock at its July 30, 2014 redemption value.

 

Series B Convertible Preferred Stock

 

On July 30, 2014, the Company entered into a Securities Purchase Agreement (the “Series Band C Purchase Agreement”) with Cova Small Cap Holdings, LLC (“Cova”), Bayonet Capital Fund I, LLC (see Note 9), and another investor (each, an “Investor”) for the purchase by the Investors of an aggregate of 1,000 units of securities of the Company (the “Units”) for an aggregate purchase price of $2.0 million (or $2,000.00 per Unit), with each Unit comprising (1) one share of Series B Convertible Preferred Stock of the Company, par value $0.001 per share (the “Series B Preferred Stock”), and (2) one share of Series C Preferred Stock of the Company, par value $0.001 per share (the “Series C Preferred Stock”). Approximately $1.3 million of the net proceeds from the sale of the Units was used to pay a contingent legal obligation pursuant to Civil Action No. 06-706 (see Note 11).

 

The shares of Series B Preferred Stock have the rights and preferences set forth in the Certificate of Designation of Series B Convertible Preferred Stock (the “Series B Certificate of Designation”). Pursuant to the Series B Certificate of Designation, each share of Series B Preferred Stock ranks senior to the Company’s common stock (the “Common Stock”) and the Company’s Series A Preferred Stock with respect to payment of dividends and distribution of assets upon liquidation, dissolution or winding up of the Company. Upon the Company’s liquidation, sale to or merger with another corporation or other “Change of Control” (as such term is defined in the Series B Certificate of Designation), each share of Series B Preferred Stock would be entitled to a liquidation preference in an amount equal to the amount per share that would have been payable had all shares of Series B Preferred Stock been converted into Common Stock immediately prior to such event in accordance with the terms of the Series B Certificate of Designation, excluding for purposes of such calculation the liquidation preference payable to the holders of Series A Preferred Stock. Holders of the Series B Preferred Stock are entitled to convert at any time all or any portion of the shares of Series B Preferred Stock into a number of shares of Common Stock initially equal to 35,713.147 shares of Common Stock per share of Series B Preferred Stock (the “Conversion Number”), such that the 1,000 shares of Series B Preferred Stock issued pursuant to the Purchase Agreement will initially be convertible into a number of shares of Common Stock representing approximately 40% of the total number of shares of Common Stock outstanding, calculated on a fully-diluted basis, assuming the conversion of all outstanding shares of Series A Preferred Stock and Series B Preferred Stock. The Conversion Number is subject to customary adjustments, including for dividends, stock splits and other reorganizations affecting the Common Stock. In addition, the Conversion Number is subject to anti-dilution protections, subject to certain exceptions, if the Company issues or sells shares of Common Stock or other equity securities for no consideration or for consideration that is based on an equity valuation of the Company of less than $2 million in the aggregate (a “Trigger Issuance”). In the event of a Trigger Issuance, the Conversion Number shall be increased as of the close of business on the effective date of the Trigger Issuance to a number calculated as follows: (i) two-thirds of the Common Stock deemed Outstanding (as defined in the Series A Certificate of Designation) immediately following such Trigger Issuance (excluding any Common Stock Deemed Outstanding as a result of the conversion of the Series B Preferred Stock) (ii) divided by 1,000. Each share of Series B Preferred Stock will automatically convert into shares of Common Stock on the tenth anniversary of its original issuance date, at the then-current Conversion Number. Each share of Series B Preferred Stock is entitled to a number of votes equal to the number of shares of Common Stock into which such share is convertible and will be entitled to vote with holders of outstanding shares of Common Stock, voting together as a single class, with respect to any and all matters presented to the stockholders of the Company for their action or consideration.

 

In connection with the issuance of the Series B Preferred Stock and the Series C Preferred Stock on July 30, 2014, the Company allocated the aggregate proceeds of $2.0 million to the Series B Preferred Stock and the Series C Preferred Stock on a relative fair value basis. This resulted in approximately $1.4 million allocated to the Series B Preferred Stock and approximately $0.6 million allocated to the Series C Preferred Stock.

 

At the issuance date, the Series B Preferred Stock is convertible into Common Stock having a fair value of approximately $2.5 million, which was in excess of the proceeds allocated to the Series B Preferred Stock. Therefore, the Company recognized a beneficial conversion feature of approximately $1.1 million in accordance with ASC 470-20. This initially recorded discount was then accreted back to its carrying value of the Series B Preferred Stock as the stock is immediately convertible at the option of the holder.

 

  

11
 

  

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

Series C Preferred Stock

 

The shares of Series C Preferred Stock have the rights and preferences set forth in the Certificate of Designation of Series C Preferred Stock (the “Series C Certificate of Designation”). Pursuant to the Series C Certificate of Designation, each share of Series C Preferred Stock ranks senior to the Common Stock, the Series A Preferred Stock and the Series B Preferred Stock with respect to payment of dividends and distribution of assets upon liquidation, dissolution or winding up of the Company. Upon the Company’s liquidation, sale to or merger with another corporation or other “Change of Control” (as such term is defined in the Series C Certificate of Designation), each share of Series C Preferred Stock would be entitled to a liquidation preference equal to the greater of (1) $3,000 per share or (2) $2,000 per share plus any accrued but unpaid dividends, in each case subject to customary adjustments as set forth in the Series C Certificate of Designation (the “Series C Liquidation Value”). The Series C Liquidation Value is the greater of (1) 150% of the Purchase Price ($3,000 per share) or (2) the Base Value ($2,000 per share plus accrued and unpaid dividends). Holders of the Series C Preferred Stock are entitled to cumulative quarterly dividends at a rate of 12% per annum, calculated based on an assumed price of $2,000 per share, payable in cash or in kind; provided that to the extent not paid in cash or by issuance of additional shares of Series C Preferred Stock on the last day of each calendar quarter (a “Dividend Payment Date”), all accrued dividends on any outstanding shares of Series C Preferred Stock shall accumulate and compound. In the event the Company has not paid in cash or by the issuance of additional shares of Series C Preferred Stock all accrued dividends on a Dividend Payment Date, at the election of holders of at least 75% of the outstanding shares of Series C Preferred Stock (the “Requisite Holders”), all such dividends accruing on the shares of Series C Preferred Stock will be paid in shares of Series C Preferred Stock. From and after the fifth anniversary of the issuance of the shares of Series C Preferred Stock, the Requisite Holders will have the right to elect to cause the Company to redeem, out of funds legally available therefore, all but not less than all of the then outstanding shares of Series C Preferred Stock, for a price per share equal to the Series C Liquidation Value for such shares. In addition, the Company has the right to redeem at any time, out of funds legally available therefor, all or any portion of the then outstanding shares of Series C Preferred Stock, for a price per share equal to the Series C Liquidation Value for such shares. The Series C Preferred Stock is not convertible into Common Stock or other securities of the Company, and does not have any voting rights.

 

The proceeds allocated to the Series C Preferred Stock fair on the issuance date were estimated at approximately $ 0.6 million . This resulted in the Company recognizing a deemed dividend of approximately $1.4 million to reflect the Series C Preferred Stock at its July 30, 2014 redemption value.

  

Common and Preferred Warrants

 

In connection with the Series A Preferred Stock issued on November 19, 2013, the Company also issued a Common Warrant for the purchase of up to 6,153,830 shares of common stock at an exercise price of $0.65 per share. This warrant was terminated on July 30, 2014. The change in the estimated fair value of the Common Warrant is reflected within the “Change in fair value of warrants liability” within the accompanying consolidated statements of comprehensive loss.

 

The fair value as of July 30, 2014 (prior to the termination of the Common Warrant) and December 31, 2013, respectively, of the Common Warrant was estimated using the Monte Carlo simulation method with the following inputs:

 

    Common
Warrant
July 30,
2014
    Common
Warrant
December 31,
2013
 
Stock price of underlying equity   $ 0.07     $ 0.69  
Exercise price   $ 0.65     $ 0.65  
Expected volatility (standard deviation)     100 %     100 %
Annual risk-free rate     2.49 %     3.04 %
Expected term (time to expiration years)     9.3       9.9  
Number of periods     485       514  
Period interval     0.019       0.019  
Period risk-free rate     0.048 %     0.058 %
Number of simulations     500,000       500,000  

  

 

In connection with the Series A Preferred Stock issued on November 19, 2013, the Company also issued a Preferred Warrant for the purchase of up to 123,077 shares of Series A Preferred Stock with an exercise price of $0.05 per share. This warrant was terminated on July 30, 2014. The change in the estimated fair value of the Preferred Warrant is reflected within the “Change in fair value of warrants liability” within the accompanying statements of comprehensive loss.

   

12
 

  

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

The fair value as July 30, 2014 (prior to the termination of the Preferred Warrant) and December 31, 2013, respectively, of the Preferred Warrant was estimated using the Black-Scholes pricing model with the following inputs:

 

    Preferred
Warrant
July 30,
2014
    Preferred
Warrant
December 31,
2013
 
Stock price of underlying equity   $ 12.63     $ 32.50  
Exercise price   $ 0.05       0.05  
Expected term (years)     1.17       1.7  
Risk-free interest rate     0.20 %     0.13 %
Estimated dividend yield     None       None  
Volatility     70 %     70 %

 

The change in the fair value of the warrants liability during the nine months ended September 30, 2014 is as follows (amounts in thousands):

 

    Common
Warrant
    Preferred
Warrant
    JFC Warrant
(see Note 9)
    Subordinated
Term Loan
Warrants (see
Note 6)
    Total Warrant
Liability
 
Warrant liability at December 31, 2013   $ 4,081     $ 1,997     $ 54     $ 241     $ 6,373  
Warrants amended in connection with refinancing     0       0       0       72       72  
Warrant exercise     0       0       (44 )     0       (44 )
Change in fair value of warrants     (3,331 )     (1,223 )     (10 )     (280 )     (4,844 )
Termination of Common and Preferred Warrants     (750 )     (774 )     0       0       (1,524 )
Warrant liability at September 30, 2014   $ 0     $ 0     $ 0     $ 33     $ 33  

 

8. INCOME TAXES

 

The effective tax rate for the three months ended September 30, 2014 was approximately (1%) and the effective tax rate for the three months ended September 30, 2013 was approximately 20%, compared to the federal statutory rate of 34%. The effective tax rates for the nine months ended September 30, 2014 and September 30, 2013 were approximately (4%) and 24%, respectively, compared to the federal statutory rate of 34%. During the three and nine months ended September 30, 2014, the Company incurred approximately $112,000 and $269,000 of foreign tax expense on CTSAS’ income. The Company continues to have a full valuation allowance against its U.S. deferred tax assets. The Company has a valuation allowance of approximately $9.0 million as of September 30, 2014 against deferred tax assets generated primarily as a result of foreign tax credits and net operating losses.

 

9. RELATED PARTY TRANSACTIONS

 

Financing Arrangements and Agreements with Related Parties

 

In December 2012, the Company entered into a $2,100,000 unsecured promissory note with JFC Technologies, LLC (“JFC”), an entity controlled by James Schleck, a previous employee of CSP who is an owner of a significant amount of the Company’s common shares and is a Board member. On November 19, 2013, the unsecured promissory note was amended (the “Amended JFC Note”). Pursuant to the Amended JFC Note, interest accrues on the principal amount at the rate of 12% per annum, retroactive to the date of the original note. The entire principal amount and all accrued interest under the Amended JFC Note is due on the maturity date of December 31, 2016, or upon the refinancing of the Company’s existing indebtedness (subject to the availability of at least $5,000,000 in available credit after such repayment). Pursuant to the Amended JFC Note, up to $1.0 million of the principal amount is convertible, at the option of JFC, into the number of shares of Series A Preferred Stock equal to the portion of the principal amount being converted divided by the conversion price of $32.50 per share (subject to adjustment based on certain changes in capitalization affecting the Series A Preferred Stock). In addition, upon conversion of the first $499,980 of Amended JFC Note principal, JFC originally would have been entitled to receive: (1) warrants to purchase, for each $6.50 of principal amount converted, ten shares of the Company’s common stock, and (2) warrants to purchase for each $32.50 of principal amount converted, one share of Series A Preferred Stock.

 

13
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

In connection with the issuance of the Series B Convertible Preferred Stock and the Series C Preferred Stock (see Note 7), the Series A Investor and JFC entered into a Consent and Waiver Agreement with the Company, whereby the Series A Investor agreed to the termination of all of the warrants issued to it in connection with the Series A Preferred Stock and JFC agreed to terminate any right of JFC to receive any warrants otherwise issuable to it upon the conversion of any portion of the JFC Note pursuant to the terms thereof.

 

In accordance with ASC 470-50-40-10, the Company analyzed the Amended JFC Note and determined that the change in the conversion price of the Series A Preferred Stock was substantive. Therefore, the amendment to the terms of the JFC Note on July 30, 2014 resulted in a loss on extinguishment of approximately $0.5 million.

  

On November 19, 2013, the Company also issued a warrant to JFC to purchase up to 73,009 shares of the Company’s common stock. These warrants have an exercise price of $0.01 and expire on November 19, 2023. The warrant was exercised by JFC during February 2014.

 

Bayonet Capital Fund I, LLC and JFC are controlled by James Schleck, a member of the Company’s board of directors, and JFC is also a significant stockholder of the Company.

 

The Company also entered into a consulting agreement with James Schleck, effective January 1, 2014, for advisory professional services as assigned by the President and CEO or the Board of Directors of the Company. The initial consulting agreement provided for monthly fees payable to James Schleck of $1,000 monthly and the consulting agreement was amended effective June 1, 2014 to provide for monthly fees in the amount of $10,000 monthly. This consulting agreement was terminated effective September 30, 2014.

 

CSP leases property in Bound Brook, New Jersey, from Brook Industrial Park, LLC, an entity that is controlled by James Schleck. This lease requires monthly lease payments of $30,000 and ends on August 31, 2016, with extension options available.

 

Pursuant to an Amendment Agreement executed during December 2012, the Company was required to issue 350,000 shares of the Company’s common stock to JFC if the Company’s December 2013 common stock closing price was less than $1.75. The Company’s closing price on December 31, 2013 was $0.69 and therefore, the Company recorded approximately $242,000 within other current liabilities during 2013 and the 350,000 shares were issued to JFC on January 31, 2014.

 

Agreement with Board Member

 

On October 1, 2009, the Company entered into an agreement with Selway Capital, LLC (“Selway”) that provided for services to be performed by Selway on the Company’s behalf. This agreement was terminated effective March 31, 2014. The agreement previously stipulated that these services would be performed by Yaron Eitan, an employee of Selway and a member of the Company’s Board of Directors, with assistance, as needed, from other employees of Selway. Effective January 1, 2014, compensation for these services was $11,000 monthly. During April 2014, approximately $158,000 of 2013 Selway fees was settled by issuing 242,308 shares of the Company’s common stock.

  

 

10. NET LOSS PER COMMON SHARE

 

Basic loss per common share is computed by dividing net loss available to common stockholders by the basic weighted average number of common shares outstanding. Diluted loss per common share is computed by dividing net loss available to common stockholders 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 instruments using the “if-converted” method.

 

14
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

    Three Months Ended
September 30,
    Nine Months Ended
  September 30,
 
    2014     2013     2014     2013  
                         
Numerator (in thousands):                        
Net loss   $ (10,273 )   $ (7,804 )   $ (7,675 )   $ (9,662 )
Series A convertible preferred stock accrued dividend     (130 )     0       (375 )     0  
Series C preferred stock accrued dividend     (41 )     0       (41 )     0  
Series A deemed dividend     (2,422 )     0       (2,422 )     0  
Series B deemed dividend     (1,098 )     0       (1,098 )     0  
Series C deemed dividend     (1,401 )     0       (1,401 )     0  
Loss available to common stockholders – basic and diluted   $ (15,365 )   $ (7,804 )   $ (13,012 )   $ (9,662 )
                                 
Loss per common share:                                
Basic and diluted   $ (0.72 )   $ (0.38 )   $ (0.61 )   $ (0.47 )

  

 

 

 

 

 

The following potentially dilutive common share equivalents were excluded from the calculation of diluted net loss per common share because their effect was antidilutive for each of the periods presented:

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2014     2013     2014     2013  
Options     2,636,186       3,226,186       2,636,186       3,226,186  
Restricted stock     0       23,024       0       22,704  
Convertible debt     2,666,667       2,666,667       2,666,667       2,666,667  
Warrants     455,514       0       455,514       0  

  

15
 

   

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

11. COMMITMENTS AND CONTINGENCIES

 

Legal

 

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

 

On January 23, 2006, before the Company owned CTI, the former owners of CTI (from whom CTI was purchased) (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 (the “Court”).

 

On December 19, 2008, while Civil Action 06-706 was still unresolved, the Company acquired CTI (the “Acquisition”). According to the Stock Purchase Agreement between the Former Owners and the Company, 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 accrues 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 accrues beginning with the date of the final ruling.

 

On July 12, 2012, the Court issued an Amended Final Judgment and, on September 20, 2012, a Final Judgment. There were no changes to the previously described damage awards. In response, on October 17, 2012, the Company filed a Notice of Appeal and on August 2, 2013, the Company filed a Formal Appeal, which contained a number of bases for overturning the awards. Oral arguments were made by the parties before the Appellate Court during January of 2014. In May 2014, the Company received notice that its appeal of the Final Judgment had been denied. On July 1, 2014, CTI filed an Application for Further Appellate Review in the Massachusetts Supreme Judicial Court.

 

The Former Owners (1) previously retained the responsibility for paying the costs and liabilities associated with Civil Action No. 06-706 and (2) are related parties under U.S. GAAP due to their ownership interest in the Company and their membership on the Company’s board of directors. On November 19, 2013, a Release and Escrow Agreement was executed whereby the Company released affiliates of the Former Owners from being obligated on the costs and liabilities associated with Civil Action No. 06-706 in exchange for 625,139 shares of Cyalume stock placed in escrow (the “Escrowed Shares”). During 2013, 625,139 shares of the Company’s common stock were placed into escrow which were applied against any damages during July 2014 up to the value of the shares upon conversion to cash. The Escrowed Shares provided the Company with a source of recovery with respect to any loss, liability or expenses incurred by the Company in connection with Civil Action No. 06-706. The Company reflected the value of the 625,139 Escrowed Shares at December 31, 2013 based upon the close price of Cyalume’s stock on December 31, 2013. The value of the Escrowed Shares was previously included within the prepaid expenses and other current assets line item. The Escrow Shares were transferred during July 2014 in connection with the Confidential Settlement Agreement and Mutual Release discussed below.

 

On July 10, 2014, the Company entered into a Confidential Settlement Agreement and Mutual Release (the “Omniglow Settlement Agreement”) with the Former Owners and members of management of Omniglow Corporation (collectively, the “Omniglow Buyers”). Pursuant to the Omniglow Settlement Agreement, CTI agreed to either pay the full settlement amount of approximately $4.5 million or satisfy the settlement amount as follows: (i) an initial payment of $250,000, (ii) transfer the 625,139 Escrowed Shares, (iii) payment of $1.0 million in cash within 21 days from the execution of the Omniglow Settlement Agreement (see Note 14) and (iv) additional payments in cash and/or through cooperative marketing credits of $1.9 million if paid within 18 months from the date of the Omniglow Settlement Agreement, or of approximately $2.4 million if paid within 27 months from the date of the Omniglow Settlement Agreement. During July 2014, the Company fulfilled its obligations under items (i), (ii) and (iii) described above. Approximately $2.7 million of obligations related to this matter is included within the contingent legal obligation line items on the Company’s condensed consolidated balance sheet as of September 30, 2014.

 

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Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

Settlement of Arbitration with Former Employee

 

On December 22, 2011, CTI entered into a Stock Purchase Agreement (“SPA”) with Combat Training Solutions, Inc. (“CTS”) and Antonio Colon, the sole stockholder of CTS. Pursuant to the SPA, CTI purchased all of the issued and outstanding capital stock of CTS. On June 15, 2012, the Company received a copy of a demand for arbitration filed by Mr. Colon with the American Arbitration Association. Management considered the allegations by Mr. Colon to be without merit. On August 17, 2012, Mr. Colon filed suit in Federal Court and on September 11, 2012, he filed to have the arbitration withdrawn. In addition, on September 11, 2012, Mr. Colon chose to cease working for the Company. CTI filed a Motion to Dismiss the Complaint in Federal Court and to compel the controversy to arbitration before the American Arbitration Association. The District Court for the District of Delaware held a hearing on January 23, 2013, at which it dismissed the Complaint in Federal Court without prejudice and indicated that the arbitration should proceed. On September 23, 2013, the parties entered into an agreement to resolve this matter, and a settlement agreement was signed on November 19, 2013. The executed settlement agreement calls for the Company to make a series of payments over five years to Mr. Colon in the amount of $215,000 annually, for a total of $1,075,000 pursuant to the Promissory Note executed on November 19, 2013. The Company also made a settlement payment of $275,000 on November 20, 2013 and transferred the land located in Colorado (this land was originally acquired by CTI in connection with the 2011 CTS acquisition) to JasperCo, LLC pursuant to the terms of the executed settlement agreement with Antonio Colon. The total legal settlement amount recorded in the Company’s accompanying consolidated statement of comprehensive loss for the twelve months ended December 31, 2013 incurred in connection with settling the matter described above was approximately $2.0 million. Pursuant to the Promissory Note, a principal repayment of approximately $215,000 was made during the nine months ended September 30, 2014.

 

12. FAIR VALUES OF ASSETS AND LIABILITIES

 

Under U.S. GAAP, the Company is 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, “the Company” 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 “the Company” 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.

 

 There are three general valuation techniques that may be used to measure fair value, as described below:

 

Market Approach Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. Prices may be indicated by pricing guides, sale transactions, market trades, or other sources.
Cost Approach Based on the amount that currently would be required to replace the service capacity of an asset (replacement cost).
Income Approach

Uses valuation techniques to convert future amounts to a single present amount based on current market expectations about the future amounts (includes present value techniques and option-pricing models).

Net present value is an income approach where a stream of expected cash flows is discounted at an appropriate market interest rate.

 

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Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

Assets and liabilities itemized below were measured at fair value on a recurring basis at September 30, 2014 (all amounts in thousands):

 

    Level 1
Quoted
Prices in
Active
Markets
for
Identical
Assets
    Level 2
Significant
Other
Observable
Inputs
    Level 3
Significant
Unobservable
Inputs
    Assets/
(Liabilities)
At Fair
Value
 
Warrants (see Note 6)   (1)   $ 0     $ 0     $ (33 )   $ (33 )
    $ 0     $ 0     $ (33 )   $ (33 )

 

  (1) The Company has classified its warrants liability which could be potentially settled in cash within Level 3 because the fair values are determined using significant unobservable inputs into the Black-Scholes pricing model.

 

The Company did not transfer any assets or liabilities between Levels 1, 2 or 3 during the three and nine months ended September 30, 2014. Any such transfer would be based on a review of the inputs used that are significant to the fair value measurement of that asset or liability.

 

The Company has other financial instruments, such as cash, accounts receivable, other current assets, accounts payable, notes payable and a line of credit. The Company believes the carrying amounts of those assets and liabilities approximate their fair value since the Company has estimated those carrying amounts to approximate the exit price we would receive to sell these assets or pay to transfer these liabilities to a market participant.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

During the three months ended September 30, 2014, the following assets, all of which are Level 3 assets, were identified as impaired and were adjusted to their fair values (in thousands of dollars) (see Note 4).

  

    Cyalume Reporting
Unit (1)
  Loss
Recognized
    Fair Value  
Patents (2)   Training   $ 4,877     $ 2,700  
Trademarks and trade name (3)   Training   $ 4,223     $ 790  

 

 

  (1) The Company is managed as one operating segment with three reporting units: Chemical Light (the operations of CTI and CTSAS), Specialty Products (the operations of CSP) and Other (the operations of CRI and the parent company Cyalume Technologies Holdings, Inc.). Both Chemical Lights’ goodwill and Specialty Products’ goodwill was not considered to be impaired and our Other reporting unit does not have a goodwill asset.

 

  (2) The fair value of the impaired patent asset was determined using the “relief from royalty” method, which calculates the present value of a stream of estimated future royalty payments that an entity would be willing to pay in order to utilize the patents, net of estimated income taxes (an income approach).

 

  (3) The fair value of the impaired trademarks and trade names asset was determined using the “relief from royalty” method, which calculates the present value of a stream of estimated future royalty payments that an entity would be willing to pay in order to utilize the trademarks and trade names, net of estimated income taxes (an income approach).

 

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Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

 

13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

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

 

    Nine Months Ended September 30  
    2014     2013  
Interest   $ 456     $ 1,250  
Income taxes     171       120  

 

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

 

    Nine Months Ended September 30,  
    2014     2013  
Series A Convertible Preferred stock accrued dividend   $ 375     $ 0  
Series C Preferred stock accrued dividend     41       0  
Litigation award payable accounted for as a receivable due from related party     0       134  
Adjustment to warrant liability upon warrant exercise     44       0  
Issuance of 350,000 shares to JFC in connection with settling a contingent consideration liability resulting from the acquisition of CSP     241       0  
Issuance of 242,308 shares to Selway     157       0  

 

 

14. NEW ACCOUNTING PRONOUNCEMENTS

 

The following are recent accounting pronouncements that have affected the Company’s consolidated financial statements or may affect them in the future.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. ASU 2014-09 requires recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step process in which judgments and estimates may be required within the revenue recognition process. ASU 2014-09 is effective for annual and interim periods beginning on or after December 15, 2016, permits the use of either a retrospective or a cumulative effect transition method, and early adoption is not permitted. The Company is in the process of evaluating the effect, if any, ASU 2014-09 will have on its consolidated financial statements and related disclosures.

  

In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists (“ASU 2013-11”) to clarify that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss (“NOL”) carry-forward, a similar tax loss, or a tax credit carry-forward, with some allowed exceptions. ASU 2013-11 does not impose any new recurring disclosure requirements because it does not affect the recognition or measurement of uncertain tax positions. ASU 2013-11 is effective for fiscal years beginning after December 15, 2013. The adoption of ASU 2013-11 did not have a material impact on the Company’s financial position or results of operations.

 

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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 and in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. 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 are a global, technology-based manufacturer primarily providing tactical and training solutions to the military of the U.S. and other select countries, through both products and services. We manufacture chemical light, reflective and battlefield effects simulator products while our services include planning and implementing tactical training exercises simulating real world experiences. In addition, and to a lesser extent, we also sell these products into the law enforcement, commercial public safety and other markets. In addition, we provide specialty chemical products to the defense, pharmaceutical, cosmetic and other markets. We do not sell products as novelties.

 

We maintain principal executive offices at 910 SE 17 th Street, Suite 300, Fort Lauderdale, Florida 33316. We have two direct U.S.-based subsidiaries: Cyalume Technologies, Inc. (“CTI”) and Cyalume Specialty Products, Inc. (“CSP”). CTI is located in West Springfield, Massachusetts and CSP is located in Bound Brook, New Jersey. CTI has one non-U.S.-based subsidiary, Cyalume Technologies, SAS (“CTSAS”), located in Aix-en-Provence, France, and two U.S.-based subsidiaries, Cyalume Realty, Inc. (“CRI”) and Combat Training Solutions, Inc. (“CTS”), based in West Springfield, Massachusetts. We manufacture products in the West Springfield, Bound Brook, and Aix-en-Provence locations.

 

Impairment Charges

 

During the third quarter of 2014, our Chemical Light reporting unit recorded a loss on impairment of certain amortizing intangible assets of $9.1 million. For fair value information on these assets, see Note 12 within the Notes to Condensed Consolidated Financial Statements included elsewhere within this quarterly report on Form 10-Q.

 

During the third quarter of 2014, management conducted an annual review of tangible and intangible assets for impairment. Before assessing whether any of our reporting units’ goodwill was impaired, we first assessed whether any non-goodwill assets were impaired. This assessment determined that the CTI patent asset was impaired by approximately $4.9 million and that CTI trademarks and trade names were impaired by approximately $4.2 million. Therefore, we recorded $9.1 million of an impairment loss on these CTI intangible assets during the third quarter of 2014.

 

 

Material Changes in Results of Operations – Three and Nine Months Ended September 30, 2014 versus the Three and Nine Months Ended September 30, 2013

 

Revenues for 2014 and 2013 were as follows:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
Category ($ in millions)   2014     2013     2014     2013  
                         
Chemical Light   $ 5.5     $ 3.7     $ 16.7     $ 15.9  
Ammunition     0.0       0.0       0.0       0.1  
Training and Simulation     0.2       1.3       0.4       1.9  
Specialty Products     2.7       2.5       7.4       7.1  
Total   $ 8.4     $ 7.5     $ 24.5     $ 25.0  

 

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Chemical Light revenues increased for both the three months and nine months ended September 30, 2014 from the corresponding prior year periods due to increased sales to our largest existing customer, LC Industries. There were no Ammunition revenues for the three months or the nine months ended September 30, 2014 as we are in-between contracts for military training rounds utilizing our technology and there has been a delay of a new program utilizing our chemiluminescence technology. A new contract for 40mm low-velocity training ammunition is expected to result in production starting during 2015, at which time we expect Ammunition revenue to resume. Training and Simulation revenues for the three and nine months ended September 30, 2014 decreased by approximately $1.1 million and $1.5 million, respectively, due to fewer CTS devices being purchased. Specialty Products revenue during the first three quarters of 2014 increased by approximately $0.2 million and $0.3 million, respectively, compared to the corresponding prior year periods.

 

Cost of goods sold for the third quarter of 2014 of approximately $4.5 million increased from the prior year amount of $4.2 million. Cost of goods sold for the nine months ended September 30, 2014 of approximately $14.2 million increased from the prior year amount of $13.5 million. The gross margin for the third quarter of 2014 was approximately 46.2% versus 43.5% for the third quarter of 2013. The increase in gross margin during the third quarter of 2014 is due to higher-margin product mix changes between the years. The gross margin for the nine months ended September 30, 2014 was approximately 42.0% versus 46.2% for the nine months ended September 30, 2013. This decrease was largely attributable to higher unabsorbed production overhead, primarily during the first six months of 2014, and from increased inventory reserve charges during the first six months of 2014 for slow moving and obsolete goods.

 

Sales and marketing expenses for the three and nine months ended September 30, 2014 were approximately $1.0 million and $2.8 million, respectively, versus approximately $1.2 million and $3.7 million, respectively, for the corresponding prior year periods. The decrease of approximately $0.2 million for the three months ended September 30, 2014 and the decrease of approximately $0.9 million for the nine months ended September 30, 2014 were attributable to a decrease in sales and marketing personnel and therefore, a decrease in sales and marketing payroll expenses. Additionally, there was a significant decrease in sales and marketing related travel expenses during 2014.

 

General and administrative expenses for the three and nine months ended September 30, 2014 were approximately $1.6 million and $5.1 million, respectively, versus approximately $4.4 million and $9.1 million, respectively, for the corresponding prior year periods. This decrease of approximately $2.8 million for the three months ended September 30, 2014 and the decrease of approximately $4.0 million for the nine months ended September 30, 2014 was attributable to a decrease in personnel and personnel-related expenses during 2014 and a decrease in legal expenses associated with the previous arbitration case with a former employee, which was settled during 2013.

 

Research and development expenses for the three and nine months ended September 30, 2014 were approximately $0.4 million and $1.2 million, respectively, compared to approximately $0.4 million and $1.4 million, respectively, for the corresponding prior year periods. This decline year over year relates to an overall reduction of the number of research and development activities and projects during 2014.

 

During the first three quarters of 2014, we recorded tax expense of approximately $0.3 million during the nine months ended September 30, 2014 on foreign income generated by our CTSAS subsidiary. We continue to have a full valuation allowance against our U.S. deferred tax asset due to management’s assessment that it is more likely than not that a portion of certain deferred tax assets may not be realized. We have a valuation allowance of approximately $9.0 million as of September 30, 2014 against deferred tax assets generated primarily as a result of foreign tax credits and net operating losses. During the three months ended September 30, 2013 we recorded a tax benefit of approximately $1.9 million on a pre-tax loss of $9.7 million resulting in an effective rate of approximately 20%. During the nine months ended September 30, 2013, we recorded a tax benefit of approximately $3.1 million on a pre-tax loss of $12.8 million, yielding an effective rate of approximately 24%.

 

Material Changes in Financial Condition – September 30, 2014 versus December 31, 2013

 

Cash of approximately $0.8 million at September 30, 2014 remained relatively the same compared to cash of approximately $0.9 million at December 31, 2013. Accounts receivable remained relatively the same at September 30, 2014 compared to December 31, 2013. Inventories as of September 30, 2014 decreased by approximately $1.7 million due primarily to reducing carrying levels of certain items and also from an increase in reserves for slow moving and obsolete goods.

 

Accounts payable and accrued expenses combined were approximately $6.5 million at September 30, 2014 versus approximately $8.2 million at December 31, 2013. This decrease of approximately $1.7 million was due to the payment of prior year accruals and vendor payments. Our line of credit, used to meet temporary working capital needs, was approximately $1.8 million at September 30, 2014 versus approximately $1.6 million at December 31, 2013.

 

The current portion of notes payable was approximately $1.9 million at both September 30, 2014 and December 31, 2013.

 

Liquidity and Capital Resources

 

As of September 30, 2014 and December 31, 2013, we had $0.8 million and $0.9 million, respectively, of cash on hand. The major sources and uses of cash during 2014 were all in the normal course of business.

  

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Capital expenditures were approximately $0.5 and $0.8 million the nine months ended September 30, 2014 and 2013. We expect to fund capital expenditures for the remainder of 2014 from existing cash and operating cash flows.

 

CTI has a line of credit with a maximum borrowing capacity of $5.0 million with TD Bank N.A. (“TD Bank”). The amount which may be borrowed from this line of credit is dependent mainly on accounts receivable and inventory balances. Interest is payable monthly and is determined based on (i) the Prime Rate, plus 3%. The line of credit’s interest rate at September 30, 2014 was 6.25%. The line of credit expires on December 19, 2015. This line of credit is subject to (i) the same restrictive covenants and (ii) the same collateral and guarantees as the senior debt Term Loan and the senior debt Real Estate Loan. At September 30, 2014, $1.8 million was outstanding on this line of credit and borrowing availability was approximately $1.1million at September 30, 2014. At December 31, 2013, $1.6 million was outstanding on this line of credit and borrowing availability was approximately $840,000.

 

The Term Loan is payable in monthly principal installments of $148,000 along with monthly interest payments, plus a one-time principal payment of approximately $2.5 million due at maturity in December 2015.

 

The Real Estate Loan is payable in monthly principal installments of approximately $10,000, along with monthly interest payments, plus a one-time principal payment of $1.4 million due at maturity in December 2015.

 

On July 29, 2010 the Subordinated Term Loan of $8.5 million was issued to Granite Creek Partners Agent, LLC (“Granite Creek”) and on November 19, 2013, the Company entered into a Fourth Amendment to the Subordinated Term Loan (the “Subordinated Amendment”) which extended the maturity date to June 30, 2016. Pursuant to the Subordinated Amendment, interest is payable in kind through December 19, 2015 and then payable monthly in cash through the June 30, 2016 maturity date. Interest is payable monthly at a rate of 11% per annum. No principal payments are required until maturity. The Company has the right to prepay the loan in whole or in part at any time without penalty in the event that the TD Bank Senior Debt is repaid. The Subordinated Term Loan ranks junior to all debt held by TD Bank, N.A. but senior to all other remaining long-term debt including existing and future subordinated debt. The Subordinated Term Loan is convertible at any time by Granite Creek into 2,666,667 shares of common stock at a conversion price of approximately $3.19 per share. No portion of the Subordinated Term Loan has been converted to our common stock. The Company’s common stock’s closing market price on September 30, 2014 was $0.07 per share.

  

We were in compliance with the financial covenants related to these loans as of September 30, 2014.

 

We did not pay a dividend in the nine months ended September 30, 2014 and we do not intend to pay a common dividend in the future. We are accruing dividends in connection with the Series A Convertible Preferred Stock issued on November 19, 2013 and the Series C Preferred Stock issued on July 30, 2014.

 

On July 30, 2014, we entered into a Securities Purchase Agreement with Cova Small Cap Holdings, LLC (“Cova”), Bayonet Capital Fund I, LLC and another investor (collectively, the “Investors”) for the purchase of an aggregate of 1,000 units of securities of the Company for an aggregate purchase price of $2.0 million (or $2,000 per unit). The Investors purchased an aggregate of 1,000 units of securities of the Company (the “Units”), with each Unit comprising (1) one share of Series B Convertible Preferred Stock of the Company and (2) one share of Series C Preferred Stock of the Company. Each share of Series B Convertible Preferred Stock is initially convertible into 35,713.147 shares of common stock. Holders of the Series C Preferred Stock are entitled to cumulative quarterly dividends at a rate of 12% per annum, calculated based on an assumed price of $2,000 per share, payable in cash or in kind. Approximately $1.3 million of the net proceeds from the sale of the Units was used to pay a legal settlement amount in connection with the Omniglow Settlement Agreement (as described in Note 11 of the accompanying Condensed Consolidated Financial Statements). Cova is a significant stockholder of the Company. Two members of the Board are affiliated with, and designees of, Cova. Bayonet Capital Fund I, LLC and JFC are controlled by James G. Schleck, a member of our board of directors, and JFC is also a significant stockholder of the Company (see Note 9 of the accompanying Condensed Consolidated Financial Statements). $250,000 of the purchase price paid by Cova for its Units was paid by means of the satisfaction and cancellation in full of indebtedness of the Company to Cova incurred on July 10, 2014.

 

Other than immaterial operating leases, we did not have any off-balance sheet arrangements during 2014 or 2013.

 

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; determining asset retirement obligations; and determining the fair value of contingent consideration. 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.

 

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Revenue Recognition

 

Revenue from the sale of products or the providing of services is recognized when the earnings process is complete, the amount of recognizable revenue can be determined, the risks and rewards of ownership have transferred to the customer and collectability is reasonably assured. Depending on the terms of the individual sales arrangement with our customer, product sales are recognized at either the shipping point or upon receipt by the customer. Costs and related expenses to manufacture the products are recorded as costs of goods sold when the related revenue is recognized. Additionally, if the right of return is granted to the buyer in a product sale, revenue is deferred until enough historical customer data is available to reasonably estimate returns and related costs. 

 

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

 

We also provide research and development services for customers for which we earn payments that are contingent upon achieving a specific result (“milestones”). We recognize payments upon achieving such milestones as revenue provided the payment is (i) related to past performance, (ii) reasonable relative to all of the deliverables and payment terms within the arrangement with our customer, and (iii) nonrefundable.

 

Warrants Liability

 

The Company uses fair values as determined by significant unobservable inputs. These estimated values are significant inputs into the Monte Carlo simulation method and the Black Scholes pricing model used to calculate the estimated fair value of common warrants and preferred warrants potentially settle able in cash, which are recorded as warrants liability. The estimated fair value of the common warrants and the preferred warrants are determined at each balance sheet date and the change in the estimated fair value of the warrants is reflected within the Company’s statements of comprehensive loss. Certain common and preferred warrants were terminated on July 30, 2014.

 

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.

 

In assessing the realization of long-term deferred income tax assets, we consider whether it is more likely than not that the deferred income tax assets will be realized. The realization of deferred income tax assets depends upon future taxable income in years before net operating loss carry forwards expire. We evaluate the recoverability of deferred income tax assets on a quarterly basis. If we determine that it is more likely than not that deferred income tax assets will not be recovered, we establish a valuation allowance against some or all deferred income tax assets.

 

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, if such a position existed, would be reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. There were no such positions as of September 30, 2014 or December 31, 2013.

 

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

 

In February 2012, we completed an audit by the IRS of our tax returns for the years 2008 and 2009. There were no adjustments to those tax returns. Tax returns filed for the years 2010, 2011 and 2012 are still open for audit. The tax return for 2013 was filed under a filing extension on September 15, 2014.

 

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.

 

We perform the traditional two-step process for assessing goodwill for impairment. The first step of the two-step process requires a comparison of our estimated fair value for each reporting unit versus our carrying (book) value. If our carrying value exceeded our fair value, further analysis (step 2 of the two-step process) is required to determine the amount, if any, that our goodwill was impaired. To determine the amount of fair value, we used a discounted cash flow analysis.

 

23
 

 

Intangible Assets

 

Intangible assets include developed technologies and patents, customer relationships, customer backlog, non-compete agreements and certain trade names and trademarks, which are amortized over their estimated useful lives. The carrying amounts of intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that those carrying amounts may not be recoverable. Additionally, the carrying amounts of non-amortizing intangible assets are reviewed for impairment annually every August 31. 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.

 

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 inventory. Provisions are recorded for potential obsolescence which requires management’s judgment. Conditions impacting the realizability of inventory could cause actual write-offs to be materially different than provisions for obsolescence.

  

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 month in which they were recorded. 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 income, net in the statement of comprehensive loss 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

 

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, 2014. 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, 2014.

 

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, 2014 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

 

As disclosed in the Form 8-K filed by the Company on July 16, 2014, on July 10, 2014, the Company entered into a Confidential Settlement Agreement and Mutual Release (the “Omniglow Settlement Agreement”) with the former owners and members of management of Omniglow Corporation (collectively, the “Omniglow Buyers”), which settled the previously disclosed proceedings known as Civil Action No. 06-706 filed n the Superior Court of the Commonwealth of Massachusetts. Pursuant to the Omniglow Settlement Agreement, CTI agreed to either pay the full settlement amount of approximately $4.5 million or satisfy the settlement amount as follows: (i) an initial payment of $250,000, (ii) transfer the 625,139 Escrowed Shares, (iii) payment of $1.0 million in cash within 21 days from the execution of the Omniglow Settlement Agreement and (iv) additional payments in cash and/or through cooperative marketing credits of $1.9 million if paid within 18 months from the date of the Omniglow Settlement Agreement, or of approximately $2.4 million if paid within 27 months from the date of the Omniglow Settlement Agreement. See Note 11 to the Notes to Condensed Consolidated financial Statements contained elsewhere in this quarterly report for more information regarding Civil Action No. 06-706.

 

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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

 

Other than as previously reported on a current report on Form 8-K, none.

 

Purchases of Equity Securities by the Company and Affiliated Purchasers

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

The information contained in Item 1 of Part II of this quarterly report is incorporated in this Item by reference.

 

ITEM 6.    EXHIBITS

 

Exhibit

Number

  Description
3.1 (1) Amended and Restated Certificate of Designation of Series A Convertible Preferred Stock filed by the Company with the Secretary of State of the State of Delaware on July 30, 2014.
     
3.2 (1) Certificate of Designation of Series B Convertible Preferred Stock filed by the Company with the Secretary of State of the State of Delaware on July 30, 2014.
     
3.3 (1) Certificate of Designation of Series C Preferred Stock filed by the Company with the Secretary of State of the State of Delaware on July 30, 2014.
     
10.1 (1) Securities Purchase Agreement, dated July 30, 2014.
     
10.2 (1) Registration Rights Agreement, dated July 30, 2014.
     
10.3 (1) Sixth Amendment to Amended and Restated Revolving Credit and Term Loan Agreement and Limited Consent and Waiver, dated July 30, 2014.
     
10.4 (1) Amendment No. 1 to Amended and Restated Promissory Note, dated July 30, 2014.
     
10.5 (1) Consent and Waiver Agreement, dated July 30, 2014.
     
10.6 (2) Confidential Settlement Agreement and Mutual Release dated July 10, 2014.
     
10.7 (3) Supply Agreement between Cyalume Technologies, Inc. (f/k/a Omniglow Corporation) and LC Ind., Inc., dated June 2004 (confidential treatment has been requested for certain portions of this agreement which have been redacted).
     
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.
     
101.INS * XBRL Instance Document
     
101.SCH * XBRL Taxonomy Extension Schema
     
101.CAL * XBRL Taxonomy Extension Calculation Database
     
101.DEF * XBRL Taxonomy Extension Definition Linkbase
     
101.LAB * XBRL Taxonomy Extension Label Linkbase
     
101.PRE * XBRL Taxonomy Extension Presentation Linkbase
     
  (1) Incorporated by reference to an exhibit to the Current Report on Form 8-K filed by the Company on August 5, 2014.
     
  (2) Incorporated by reference to an exhibit to the Quarterly Report on Form 10-Q filed by the Company on August 14, 2014.
     
  (3)

Incorporated by reference to Exhibit 10.21 to the Annual Report on Form 10-K filed by the Company on March 22, 2010.

     
  * Filed herewith.

  

25
 

  

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, 2014 By: /s/ Zivi Nedivi
     
    Zivi Nedivi, Chief Executive Officer
     (Principal Executive Officer)
     
Date: November 14, 2014 By: /s/ Michael Bielonko
     
    Michael Bielonko, Chief Financial Officer
    (Principal Financial Officer)

 

26

  

 

Exhibit 31.1

 

CERTIFICATION

 

I, Zivi Nedivi, certify that:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Date: November 14, 2014  
  /s/ Zivi Nedivi
  Zivi Nedivi, Chief Executive Officer

 

 

 

 

Exhibit 31.2

 

CERTIFICATION

 

I, Michael Bielonko, certify that:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Date: November 14, 2014 /s/ Michael Bielonko
  Michael Bielonko, Chief Financial Officer

 

 

  

Exhibit 32.1

 

CERTIFICATION

 

Each of the undersigned officers of Cyalume Technologies Holdings, Inc. (the "Company") hereby certifies that, to his knowledge, the Company's Quarterly Report on Form 10-Q to which this certification is attached (the "Report"), as filed with the Securities and Exchange Commission on the date hereof, fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Date: November 14, 2014 /s/ Zivi Nedivi
   
  Zivi Nedivi, Chief Executive Officer
  (the Principal Executive Officer)
Date: November 14, 2014  
   
  /s/ Michael Bielonko
   
  Michael Bielonko, Chief Financial Officer
   (the Principal Financial Officer)

 

This certification is being furnished and not filed, and shall not be incorporated into any document for any purpose, under the Securities Exchange Act of 1934 or the Securities Act of 1933.