Cyalume Technologies Holdings, Inc. - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.	Financial_Report.xls
EX-32.1 - EXHIBIT 32.1 - Cyalume Technologies Holdings, Inc.	v239766_ex32-1.htm
EX-10.6 - EXHIBIT 10.6 - Cyalume Technologies Holdings, Inc.	v239766_ex10-6.htm
EX-10.8 - EXHIBIT 10.8 - Cyalume Technologies Holdings, Inc.	v239766_ex10-8.htm
EX-10.5 - EXHIBIT 10.5 - Cyalume Technologies Holdings, Inc.	v239766_ex10-5.htm
EX-10.7 - EXHIBIT 10.7 - Cyalume Technologies Holdings, Inc.	v239766_ex10-7.htm
EX-31.1 - EXHIBIT 31.1 - Cyalume Technologies Holdings, Inc.	v239766_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - Cyalume Technologies Holdings, Inc.	v239766_ex31-2.htm
EX-10.9 - EXHIBIT 10.9 - Cyalume Technologies Holdings, Inc.	v239766_ex10-9.htm
EX-10.10 - EXHIBIT 10.10 - Cyalume Technologies Holdings, Inc.	v239766_ex10-10.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

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

For the transition period from to

Commission File Number 000-52247

Cyalume Technologies Holdings, Inc.

(Exact name of registrant as specified in its charter)

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

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

(413) 858-2500

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

(Do not check if a smaller reporting company)

Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of November 7, 2011, there were outstanding 18,177,644 shares of the registrant’s Common Stock, par value $.001 per share.

Cyalume Technologies Holdings, Inc.

FORM 10-Q

INDEX

PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Statements of Income for the three months ended September 30, 2011 and 2010 (unaudited)	4

	Condensed Consolidated Statements of Income for the nine months ended September 30, 2011 and 2010 (unaudited)	5

	Condensed Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010	6

	Condensed Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the nine months ended September 30, 2011 (unaudited)	7

	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (unaudited)	8

	Notes to Condensed Consolidated Financial Statements (unaudited)	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22

Item 4.	Controls and Procedures	22

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	22

Item 1A.	Risk Factors	23

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23

Item 3.	Defaults Upon Senior Securities	23

Item 4.	[Removed and Reserved]	23

Item 5.	Other Information	23

Item 6.	Exhibits	24

Signatures		25

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.

ITEM 1.

Financial Statements

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Income

(in thousands, except shares and per share information)

(Unaudited)

	For the Three			For the Three
	Months Ended			Months Ended
	September 30,			September 30,
	2011			2010
Revenues	$	8,601		$	11,570
Cost of goods sold		4,629			5,483
Gross profit		3,972			6,087

Other expenses (income):
Sales and marketing		1,060			917
General and administrative		1,503			1,343
Research and development		489			402
Interest, net		563			631
Interest – related party		1			17
Amortization of intangible assets		451			441
Other, net		(232	)		91
Total other expenses, net		3,835			3,842

Income before income taxes		137			2,245
Provision for (benefit from) income taxes		(107	)		916
Net income	$	244		$	1,329

Net income per common share:
Basic	$	.01		$	.09
Diluted	$	.01		$	.06

Weighted average shares used to compute net income per common share:
Basic		17,381,750			15,511,183
Diluted		18,202,764			17,524,995

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Income

(in thousands, except shares and per share information)

(Unaudited)

	For the Nine			For the Nine
	Months Ended			Months Ended
	September 30,			September 30,
	2011			2010
Revenues	$	26,355		$	29,859
Cost of goods sold		13,613			14,695
Gross profit		12,742			15,164

Other expenses (income):
Sales and marketing		3,258			2,481
General and administrative		4,557			4,109
Research and development		1,427			1,135
Interest, net		1,771			1,931
Interest – related party		35			49
Amortization of intangible assets		1.256			1,353
Other, net		(448	)		—
Total other expenses, net		11,856			11,058

Income before income taxes		886			4,106
Provision for (benefit from) income taxes		(574	)		1,585
Net income	$	1,460		$	2,521

Net income per common share:
Basic	$	.09		$	.16
Diluted	$	.08		$	.14

Weighted average shares used to compute net income per common share:
Basic		16,549,504			15,466,133
Diluted		18,279,284			16,240,932

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except shares and per share information)

	September 30,
	2011 (unaudited)			December 31, 2010
Assets
Current assets:
Cash	$	3,361		$	4,086
Accounts receivable, net of allowance for doubtful accounts of $76 and $62 at September 30, 2011 and December 31, 2010, respectively		3,972			1,925
Inventories, net		12,223			9,920
Deferred income taxes		348			931
Prepaid expenses and other current assets		559			429
Total current assets		20,463			17,291

Property, plant and equipment, net		9,651			8,509
Goodwill		54,222			51,244
Other intangible assets, net		21,049			20,912
Restricted cash		750			—
Due from related party		3,676			—
Other noncurrent assets		186			286
Total assets	$	109,997		$	98,242

Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of notes payable	$	1,594		$	1,453
Accounts payable		3,000			2,185
Accrued expenses and other current liabilities		2,383			2,362
Notes payable due to related parties		—			1,131
Income taxes payable		—			700
Total current liabilities		6,977			7,831

Notes payable, net of current portion		19,371			22,715
Line of credit due to related party		751			—
Deferred income taxes		6,376			8,147
Contingent consideration due to business combination		1,573			—
Other noncurrent liabilities		4,085			531
Total liabilities		39,133			39,224

Commitments and contingencies (Note 10)		—			—

Stockholders' equity:
Preferred stock, $0.001 par value; 1,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.001 par value; 50,000,000 shares authorized; 18,177,719 and 15,748,570 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively		18			16
Additional paid-in capital		99,597			89,452
Accumulated deficit		(28,320	)		(29,780	)
Accumulated other comprehensive loss		(431	)		(670	)
Total stockholders’ equity		70,864			59,018
Total liabilities and stockholders' equity	$	109,997		$	98,242

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income

(in thousands, except shares)

(Unaudited)

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

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

	For the Nine			For the Nine
	Months Ended			Months Ended
	September 30,			September 30,
	2011			2010
Cash flows from operating activities:
Net income	$	1,460		$	2,521
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation of property, plant and equipment		819			577
Amortization		1,578			1,593
Provision for deferred income taxes		(1,265	)		1,068
Stock-based compensation expense		970			875
Other non-cash expenses		88			186
Changes in operating assets and liabilities:
Accounts receivable		(1,708	)		(920	)
Inventories		(1,283	)		377
Prepaid expenses and other current assets		(76	)		(28	)
Accounts payable and accrued liabilities		483			(169	)
Income taxes payable		(765	)		777
Net cash provided by operating activities		301			6,857

Cash flows from investing activities:
Payment relating to a business combination, net of $200 cash acquired		(2,300	)		—
Proceeds from disposal of long-lived assets		—			207
Purchases of long-lived assets		(959	)		(1,219	)
Net cash used in investing activities		(3,259	)		(1,012	)

Cash flows from financing activities:
Proceeds from issuance of common stock		3,432			—
Net repayment of line of credit		—			(3,200	)
Repayment of notes payable		(1,278	)		(9,859	)
Proceeds from convertible notes payable		—			7,942
Payments to reacquire and retire common stock		(134	)		—
Payment of debt issuance costs		—			(250	)
Net cash provided by (used in) financing activities		2,020			(5,367	)

Effect of exchange rate changes on cash		213			(9	)
Net increase (decrease) in cash		(725	)		469
Cash, beginning of period		4,086			2,003
Cash, end of period	$	3,361		$	2,472

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

1.	BASIS OF PRESENTATION

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, these interim condensed consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period.

These accompanying unaudited interim condensed consolidated financial statements recognize the effects of all subsequent events that provide additional evidence about conditions that existed at September 30, 2011, including the estimates inherent in the process of preparing financial statements. Additionally, all significant intercompany accounts and transactions have been eliminated in consolidation.

We believe all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation have been included in these interim condensed consolidated financial statements. Operating results for the three and nine-month periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the full year. The consolidated balance sheet at December 31, 2010 has been derived from the audited consolidated financial statements at that date. We suggest that these unaudited interim condensed consolidated financial statements be read in conjunction with the consolidated financial statements and footnotes thereto in our Annual Report on Form 10-K for the year ended December 31, 2010.

2.	DESCRIPTION OF BUSINESS

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

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

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

3.	NEW ACCOUNTING PRONOUNCEMENT

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

4.	BUSINESS COMBINATION

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

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

The purchase price consisted of (in thousands):

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

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

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

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

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

Cash	$	200
Restricted cash (1)		750
Accounts receivable, net		359
Inventories, net		1,015
Other current assets		1
Property, plant and equipment		1,062
Patents		50
Customer backlog		140
Customer relationships		920
Non-compete agreements		160
Goodwill (2)		2,978
Total assets		7,635

Accounts payable		130
Accrued expenses		122
Customer prepayments		4
Line of credit (1)		750
Deferred tax liability		56
Total liabilities		1,062
Net assets	$	6,573

(1)

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

(2)

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

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

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

CSP’s revenues and net income are included in our condensed consolidated statements of income and total $446,000 and $16,000 since we acquired CSP.

5.	INVENTORIES

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

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

6.	DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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

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

Interest Rate Swaps

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

Currency Forward Contracts

CTSAS’ functional currency is the Euro. Periodically, CTSAS purchases inventory from CTI, which requires payment in U.S. dollars. For such transactions of $50,000 or more, we use currency forward contracts to mitigate CTSAS’ exposure to changes in the Euro-to-U.S.-dollar exchange rate upon CTSAS’ payment to CTI for these inventory purchases. Such currency forward contracts typically have durations of less than six months. We report these currency forward contracts at their fair value. This relationship has not been designated as a hedge and therefore all changes in these currency forward contracts’ fair value are recorded in other, net in our condensed consolidated statements of income. The fair value of these contracts are determined by taking the difference between (a) the U.S. dollar amount due on the contract at maturity and (b) the present value of estimated cash flows developed using, among other data, expectations of future currency exchange rates over the remaining term of the contract discounted at an estimated risk-free interest rate. At September 30, 2011, we held three such currency forward contracts.

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

Effect of Derivatives on Statement of Operations

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

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

(1)

Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the three months ended September 30, 2011.

(2)

Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the three months ended September 30, 2011.

(3)

Amount of gain (loss) recognized in earnings on the derivative (ineffective portion and amount excluded from effectiveness testing) reported in other, net in the condensed consolidated statement of income for the three months ended September 30, 2011.

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

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

(1)

Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the nine months ended September 30, 2011.

(2)

Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the nine months ended September 30, 2011.

(3)

7.	INCOME TAXES

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

For the nine months ended September 30, 2011, the effective tax rate of (65)% differed from the statutory rate of 34% primarily due to the following: (i) foreign tax credits created during 2011 as a result of a declared dividend from CTSAS, (ii) a reduction in the valuation allowance against foreign tax credits which is based on changes to our anticipated future use of those credits in the near-term to offset future current U.S. federal income taxes; and (iii) changes in repatriated earnings from CTSAS as a result of current year-to-date earnings of CTSAS. For the nine months ended September 30, 2010, the effective tax rate of 39% differed from the statutory rate of 34% primarily due to state and foreign taxes and prior year true-ups, including changes in the valuation allowance against deferred tax assets.

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

8.	DEBT TRANSACTIONS

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

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

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

9.	NET INCOME PER COMMON SHARE

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Basic:
Net income (in thousands)	$	244		$	1,329		$	1,460		$	2,521
Weighted average shares		17,381,750			15,511,183			16,549,504			15,466,133
Basic income per common share	$	.01		$	.09		$	.09		$	.16
Diluted:
Net income (in thousands)	$	244		$	1,329		$	1,460		$	2,521
Adjustments to net income assuming convertible notes payable are converted to common stock:
Reversal of interest expense on convertible notes payable (in thousands)		—	(1)		167			—	(1)		167
Write off of unamortized costs of issuing convertible notes payable (in thousands)		—			(889	)		—			(889	)
Adjustment’s estimated effect on provision for income taxes (in thousands)		—			427	(2)		—			443	(3)
Income available to common stockholders for diluted net income per common share (in thousands)	$	244		$	1,034		$	1,460		$	2,242
Weighted average shares		17,381,750			15,511,183			16,549,504			15,466,133
Effect of dilutive securities		821,014			2,013,812			1,729,780			774,799
Weighted average shares, as adjusted		18,202,764			17,524,995			18,279,284			16,240,932
Diluted net income per common share	$	.01		$	.06		$	.08		$	.14

(1)

Assumes convertible notes payable are not converted to common stock because the effect would be antidilutive.

(2)

Assumes an effective tax rate of 40.8%.

(3)

Assumes an effective tax rate of 38.6%.

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

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

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

10.	COMMITMENTS AND CONTINGENCIES

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

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

On December 19, 2008, while Civil Action 06-706 was still unresolved, we acquired CTI (the “Acquisition”). According to the Stock Purchase Agreement between the Former Owners and us, the Former Owners retained the responsibility for paying for all costs and liabilities associated with Civil Action No. 06-706.

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

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

Management Agreement with Board Member

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

Strategic development and implementation as well as consultation to our chief executive officer on a regular basis as per his reasonable requests;

Identifying strategic partners with companies with which Selway has relationships and access. In this connection, Selway will focus on building partnerships with companies in Israel, Singapore, India and Europe. The focus will be on the expansion of our munitions business;

Advise and support us on our investor relations strategy;

Advise and support our future fund raising, including identifying sources of capital in the United States; and

Support our mergers and acquisitions strategy and play an active role in our due diligence and analysis.

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

The management agreement stipulates that these services would be performed by Yaron Eitan, an employee of Selway and a member of our Board of Directors, with assistance, as needed, from other employees of Selway. The management agreement expires on October 1, 2012 and can be terminated by either us or Selway upon 30-days written notice or upon our default in payment or Selway’s failure to perform services under the management agreement. Under the management agreement, we indemnified Selway and Selway indemnified us against certain losses that could have been incurred while carrying out its obligations under the management agreement. Per the management agreement and subsequent amendments thereto, Selway’s compensation for these services is $11,667 per month. We also reimburse Selway for costs incurred specifically on our behalf for these services.

Lease with Related Party

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

11.	FAIR VALUE

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

Level 1

Quoted prices for identical assets or liabilities in active markets to which we have access at the measurement date.

Level 2

Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3

Unobservable inputs for the asset or liability.

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

As of September 30, 2011, our only assets and liabilities required to be reported at fair value on a recurring basis were the interest rate swaps and currency forward contracts described in Note 6, which are measured at fair value using level 2 inputs, and the contingent consideration liability described in Note 4, which is measured at fair value using level 3 inputs. The contingent consideration liability’s fair value of $1.6 million has not changed since the liability was incurred. The contingent consideration liability’s fair value is determined by calculating the present value of the estimated liability that is expected to be paid in 2014.

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

12.	SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

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

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

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

	Nine Months Ended September 30,
	2011		2010
Adjustment to the accounting for warrants issued in July 2010 in conjunction with issuance of subordinated term loan	$	7	$	—
Issued 712,771 shares of our common stock to effect a business combination		2,500		—
Issued 483,046 shares of our common stock to repay note payable and accrued interest thereon		2,212		—
Issued 253,288 shares of our common stock to repay notes payable to three stockholders and accrued interest thereon		1,160		—
Warrants issued in conjunction with issuance of convertible notes		—		205
Stock issued as payment for accounts payable		—		146
Debt issuance costs withheld from convertible note proceeds		—		558

ITEM 2.

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

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

Company Overview

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

CTI and CTSAS primarily produce products based on technologies whereby light is generated through a chemical reaction known as chemiluminescence. Our base product is known as a ‘‘light stick’’ and is typically 6 inches in length. A light stick is a translucent flexible plastic tube that is partly filled with one chemical ingredient and also with a glass container (‘‘ampoule’’) that contains a complementary reactive chemical. When the tube is bent enough to break the glass ampoule, the chemicals contained within the plastic tube mix and light is generated. In addition, we also produce reflective (patches) and reflective plus photoluminescent (fire tape) products. Chemiluminescent products come in varying shapes, sizes and functions, and provide light in different colors, intensity and durations.

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

We manufacture products at all of our locations.

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

Revenues in 2011 were lower than for the comparable period in 2010 due to a decrease in units sold, partially offset by price increases. The decrease in units sold caused a decrease in revenue of approximately $3.7 million, while price increases provided approximately $300,000 of additional revenue. $446,000 in new revenues were generated by the CSP operations acquired September 1, 2011. Many products are sold under indefinite quantity type contracts whereby we fulfill orders as they are placed by customers. We do not have insight into why military customers order at the times or in the quantities that they do. However, we see no indication that the underlying usage of our products has diminished. We believe that the global recession and constraints on budgets worldwide negatively affected revenues in both 2011 and 2010.

Cost of goods sold in 2011 was lower than the comparable period in 2010. That decrease is due primarily to the decrease in units sold as discussed above. Changes in product mix sold and reduced recovery of fixed overhead costs due to lower sales volume and, to a lesser extent, cost increases accounted for the change in gross margin from 52.6% in 2010 to 46.1% in 2011.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Income taxes payable decreased due to payments to federal and state tax authorities during 2011.

Liquidity and Capital Resources

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

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

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

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

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

Off-Balance Sheet Arrangements

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

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

Critical Accounting Policies

Use of Estimates

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

Revenue Recognition

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

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

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

Income Taxes

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

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

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

Goodwill

Goodwill is deemed to have an indefinite life and accordingly, is not subject to amortization. Goodwill is subject to an annual impairment review, and, if conditions warrant, interim impairment reviews. Impairment charges, if any, are recorded in the period in which the impairment is determined.

Intangible Assets

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

Inventories

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

Foreign Operations and Currency

Accounts of our foreign subsidiary are recorded using their local currency (the euro) as the functional currency. For consolidation, revenues and expenses are converted to U.S. dollars using the average exchange rate for the monthly period being reported. Assets and liabilities are converted to U.S. dollars using the exchange rate in effect as of the balance sheet date. Equity transactions are converted to U.S. dollars using the exchange rate in effect as of the date of the transaction. Translation gains and losses are reported as a component of accumulated other comprehensive income or loss. Gains and losses resulting from transactions which are denominated in other than the functional currencies are reported as other (expense) income in the statement of income in the period the gain or loss occurred.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

Our management carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of September 30, 2011. Based upon that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that the design and operation of our disclosure controls and procedures were effective as of September 30, 2011.

Changes in Internal Control over Financial Reporting

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

PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

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

CTI is currently named a defendant in Civil Action No. 06-706 in Superior Court of the State of Massachusetts. Filing suit against CTI is Omniglow, LLC (the former novelty business of CTI which was sold on January 23, 2006). CTI sold certain assets and liabilities related to the novelty and retail business to certain former shareholders and management (the “Omniglow Buyers”). During 2006, CTI and the Omniglow Buyers commenced litigation and arbitration proceedings against one another. Claims include breaches of a lease and breaches of various other agreements between CTI and the Omniglow Buyers.

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

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

ITEM 1A. RISK FACTORS

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

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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

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

Purchases of Equity Securities by the Company and Affiliated Purchasers

Period	Total Number of Shares Purchased			Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number (or Approximate Dollar Value) of Shares that May yet be Purchased under the Plans or Programs

July 1 to July 30		3,500	(1)	$	3.90		—	$	—
August 1 to August 31		—			—		—		—
September 1 to September 30		—			—		—		—

(1)

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

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.

[REMOVED AND RESERVED]

ITEM 5.

OTHER INFORMATION

There were no changes to the procedures by which security holders may recommend nominees to our Board of Directors during the three months ended September 30, 2011.

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

ITEM 6. EXHIBITS

Exhibit Number		Description
10.1		Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Winston Churchill dated July 7, 2011. (1) (10.2)
10.2		Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Thomas Rebar dated July 7, 2011. (1) (10.3)
10.3		Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Wayne Weisman dated July 7, 2011. (1) (10.4)
10.4		Securities Exchange Agreement between Cyalume Technologies Holdings, Inc. and Rodman Principal Investments, LLC dated June 30, 2011. (1) (10.1)
10.5	*	Amendment No. 2 to the Employee Agreement of Derek Dunaway.
10.6	*	Amendment No. 1 to the Employee Agreement of Michael Bielonko.
10.7	*	Amendment No. 2 to the Employee Agreement of Edgar E. Cranor.
10.8	*	Asset Purchase Agreement dated August 31, 2011 among Cyalume Technologies Holdings, Inc., Cyalume Specialty Products, Inc., JFC Technologies, LLC and Selling Members of Seller.
10.9	*	Registration Rights Agreement between Cyalume Technologies Holdings, Inc., James G. Schleck, James R. Schleck, Jame Fine Chemical, Inc., and JFC Technologies, LLC dated as of August 31, 2011.
10.10	*	Lease Agreement between Brook Industrial Park, LLC and Cyalume Specialty Products, Inc.
31.1	*	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	*	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	*	Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith.

(1)	Incorporated by reference to the Current Report on Form 8-K dated June 30, 2011 and filed with the Commission July 7, 2011. The number given in parenthesis indicates the corresponding exhibit number in such Form 8-K.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Cyalume Technologies Holdings, Inc.

Date: November 14, 2011	By:	/s/ DEREK DUNAWAY

		Derek Dunaway, Chief Executive Officer
		(Principal Executive Officer)

Date: November 14, 2011	By:	/s/ MICHAEL BIELONKO

		Michael Bielonko, Chief Financial Officer
		(Principal Financial Officer)

Attached files

Cyalume Technologies Holdings, Inc. Reports

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