Attached files

file filename
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R46.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R39.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R33.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R25.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R48.htm
EX-32.1 - EXHIBIT 32.1 - Cyalume Technologies Holdings, Inc.v326032_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Cyalume Technologies Holdings, Inc.v326032_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Cyalume Technologies Holdings, Inc.v326032_ex31-1.htm
EXCEL - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.Financial_Report.xls
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R5.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R2.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R1.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R8.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R7.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R3.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R6.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R4.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R9.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R30.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R11.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R29.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R14.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R38.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R50.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R40.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R28.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R19.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R17.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R34.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R51.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R41.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R31.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R24.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R42.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R18.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R27.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R35.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R16.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R13.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R26.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R21.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R22.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R23.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R20.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R36.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R45.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R44.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R49.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R12.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R32.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R47.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R43.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R10.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R37.htm
XML - IDEA: XBRL DOCUMENT - Cyalume Technologies Holdings, Inc.R15.htm

 

 

 

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, 2012

 

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   (I.R.S. Employer
incorporation or organization)   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 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 5, 2012, there were outstanding 18,288,260 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, 2012 (unaudited) and December 31, 2011   4
    Condensed Consolidated Statements of Comprehensive Loss for the three months ended September 30, 2012 and 2011 (unaudited)   5
    Condensed Consolidated Statements of Comprehensive Income (Loss) for the nine months ended September 30, 2012 and 2011 (unaudited)   6
    Condensed Consolidated Statements of Changes in Stockholders' Equity for the nine months ended September 30, 2012 (unaudited)   7
    Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 (unaudited)   8
    Notes to Condensed Consolidated Financial Statements (unaudited)   9
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations   20
Item 3.   Quantitative and Qualitative Disclosures About Market Risk   25
Item 4.   Controls and Procedures   25
         
PART II—OTHER INFORMATION    
Item 1.   Legal Proceedings   25
Item 1A.   Risk Factors   26
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   26
Item 3.   Defaults Upon Senior Securities   26
Item 4.   Mine Safety Disclosures   27
Item 5.   Other Information   27
Item 6.   Exhibits   27
Signatures   28

 

2
 

 

PART I—FINANCIAL INFORMATION

 

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

 

3
 

 

ITEM 1. Financial Statements

 

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except shares and per share information)

 

   September 30,
2012
(unaudited)
   December 31,
2011
 
Assets          
Current assets:          
Cash  $1,716   $2,951 
Accounts receivable, net of allowance for doubtful accounts of $188 and $206, respectively   4,144    3,339 
Inventories   10,718    11,393 
Income taxes refundable   200    38 
Deferred income taxes   383    386 
Prepaid expenses and other current assets   548    559 
Total current assets   17,709    18,666 
           
Property, plant and equipment, net   9,296    10,417 
Goodwill   8,160    55,329 
Other intangible assets, net   20,528    22,007 
Due from related party   3,811    3,721 
Restricted cash   0    600 
Other noncurrent assets   61    154 
Total assets  $59,565   $110,894 
           
Liabilities and Stockholders’ Equity          
Current liabilities:          
Current portion of notes payable  $1,509   $1,592 
Accounts payable   3,146    1,948 
Accrued expenses   2,213    2,179 
Note payable to related party   0    250 
Current portion of capital lease obligation   16    43 
Total current liabilities   6,884    6,012 
           
Notes payable, net of current portion   17,226    18,975 
Line of credit due to related party   0    755 
Deferred income taxes   5,242    7,145 
Contingent consideration   4,106    3,699 
Derivatives   196    273 
Asset retirement obligation   182    175 
Capital lease obligation, net of current portion   30    30 
Contingent legal obligation   3,761    3,627 
Total liabilities   37,627    40,691 
           
Commitments and contingencies (Note 12)          
           
Stockholders' equity          
Preferred stock, $0.001 par value; 1,000,000 shares authorized, no shares issued or outstanding   0    0 
Common stock, $0.001 par value; 50,000,000 shares authorized; 18,288,260 and 18,311,228 issued and outstanding, respectively   18    18 
Additional paid-in capital   100,607    100,334 
Accumulated deficit   (77,979)   (29,453)
Accumulated other comprehensive loss   (708)   (696)
Total stockholders’ equity   21,938    70,203 
Total liabilities and stockholders' equity  $59,565   $110,894 

 

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

 

4
 

 

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(in thousands, except shares and per share information)

(Unaudited)

 

   For the Three   For  the Three 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2012   2011 
Revenues  $10,095   $8,601 
Cost of goods sold   6,063    4,629 
Gross profit   4,032    3,972 
           
Other expenses:          
Sales and marketing   1,262    1,060 
General and administrative   1,679    1,503 
Research and development   441    489 
Interest expense, net   559    563 
Interest expense – related party   2    1 
Amortization of intangible assets   466    451 
Change in fair value of contingent consideration   19    0 
Impairment loss on equipment   273    0 
Impairment loss on intangible assets   281    0 
Impairment loss on goodwill   47,088    0 
Other, net   (31)   (232)
Total other expenses   52,039    3,835 
           
Income (loss) before income taxes   (48,007)   137 
Benefit from income taxes   (837)   (107)
Net income (loss)   (47,170)   244 
           
Other comprehensive income (loss), net of tax:          
Foreign currency translation adjustments   124    (338)
Unrealized gain on cash flow hedges, net of taxes of $(9) and $0, respectively   15    1 
Other comprehensive income (loss)   139    (337)
Comprehensive loss  $(47,031)  $(93)
           
Net income (loss) per common share:          
Basic  $(2.59)  $.01 
Diluted  $(2.59)  $.01 
           
Weighted average shares used to compute net income (loss) per common share:          
Basic   18,212,618    17,381,750 
Diluted   18,212,618    18,202,764 

 

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

 

5
 

 

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(in thousands, except shares and per share information)

(Unaudited)

 

   For the Nine   For the Nine 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2012   2011 
Revenues  $27,012   $26,355 
Cost of goods sold   15,461    13,613 
Gross profit   11,551    12,742 
           
Other expenses:          
Sales and marketing   4,229    3,258 
General and administrative   5,105    4,557 
Research and development   1,424    1,427 
Interest expense, net   1,675    1,771 
Interest expense – related party   18    35 
Amortization of intangible assets   1,420    1,256 
Change in fair value of contingent consideration   241    0 
Impairment loss on equipment   273    0 
Impairment loss on intangible assets   281    0 
Impairment loss on goodwill   47,088    0 
Other, net   (145)   (448)
Total other expenses   61,609    11,856 
           
Income (loss) before income taxes   (50,058)   886 
Benefit from income taxes   (1,532)   (574)
Net income (loss)   (48,526)   1,460 
           
Other comprehensive income (loss), net of tax:          
Foreign currency translation adjustments   (60)   234 
Unrealized gain on cash flow hedges, net of taxes of $(30) and  $(2), respectively   48    5 
Other comprehensive income (loss)   (12)   239 
Comprehensive income (loss)  $(48,538)   1,699 
           
Net income (loss) per common share:          
Basic  $(2.67)  $.09 
Diluted  $(2.67)  $.08 
           
Weighted average shares used to compute net income (loss) per common share:          
Basic   18,192,805    16,549,504 
Diluted   18,192,805    18,279,284 

 

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

 

6
 

 

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Changes in Stockholders' Equity

(in thousands, except shares)

(Unaudited)

 

                   Accumulated     
   Common Stock   Additional       Other   Total 
   Number       Paid-In   Accumulated   Comprehensive   Stockholders’ 
   of Shares   Amount   Capital   Deficit   Loss   Equity 
Balance at December 31, 2011   18,311,228   $18   $100,334   $(29,453)  $(696)  $70,203 
Share-based compensation   260    0    262    0    0    262 
Repurchase and retirement of common stock   (39,895)   0    (139)   0    0    (139)
Modification of warrants   0    0    94    0    0    94 
Common stock issuance   22,500    0    56    0    0    56 
Reversal of forfeited restricted awards   (5,833)   0    0    0    0    0 
Net loss   0    0    0    (48,526)   0    (48,526)
Other comprehensive loss   0    0    0    0    (12)   (12)
Balance at September 30, 2012   18,288,260   $18   $100,607   $(77,979)  $(708)  $21,938 

 

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

 

7
 

 

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

   For the Nine   For the Nine 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2012   2011 
Cash flows from operating activities:          
Net income (loss)  $(48,526)  $1,460 
Adjustments to reconcile net income (loss) to net cash provided by operating activities:          
Depreciation of property, plant and equipment   1,031    819 
Amortization   2,044    1,578 
Provision for deferred income taxes   (1,677)   (1,265)
Share-based compensation expense   262    970 
Common stock issuance   56    0 
Change in fair value of contingent consideration   241    0 
Impairment loss on equipment   273    0 
Impairment loss on intangible assets   281    0 
Impairment loss on goodwill   47,088    0 
Other non-cash expenses   16    88 
Changes in operating assets and liabilities:          
Accounts receivable   (808)   (1,708)
Inventories   405    (1,283)
Prepaid expenses and other current assets   54    (76)
Restricted cash   (159)   0 
Accounts payable and accrued liabilities   1,238    483 
Income taxes payable   (160)   (765)
Net cash provided by operating activities   1,659    301 
           
Cash flows from investing activities:          
Payment relating to a business combination, net of $200 cash acquired   0    (2,300)
Purchases of long-lived assets   (430)   (959)
Net cash used in investing activities   (430)   (3,259)
           
Cash flows from financing activities:          
Proceeds from issuance of common stock   0    3,432 
Repayment of long-term notes payable   (1,938)   (1,278)
Repayment of related party note payable   (250)   0 
Principal payments on capital lease obligations   (27)   0 
Payments to reacquire and retire common stock   (139)   (134)
Payment of debt issuance costs   (70)   0 
Net cash provided by (used in) financing activities   (2,424)   2,020 
           
Effect of exchange rate changes on cash   (40)   213 
Net decrease in cash   (1,235)   (725)
Cash, beginning of period   2,951    4,086 
Cash, end of period  $1,716   $3,361 

 

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

 

8
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

1.BASIS OF PRESENTATION

 

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

 

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

 

These accompanying unaudited interim condensed consolidated financial statements recognize the effects of all subsequent events that provide additional evidence about conditions that existed at September 30, 2012, including the estimates inherent in the process of preparing financial statements.

 

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, 2011 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, 2011.

 

2.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.

 

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 us 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 our consolidated business operations.

 

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

 

CRI owns land located in Colorado Springs, Colorado.

 

CTS provides its customers with realistic training simulation devices and their associated consumables. These products allow military and law enforcement professionals to maintain operational readiness through safe, live training and hands-on situational exercises.

 

We are managed as one operating segment with four reporting units: Chemical Light (the operations of CTI and CTSAS), Training (the operations of CTS), Specialty Products (the operations of CSP) and Other (the operations of CRI and the parent company Cyalume Technologies Holdings, Inc.).

 

3.NEW ACCOUNTING PRONOUNCEMENTS

 

In October 2012, the Financial Accounting Standards Board (”FASB”) issued Accounting Standards Update No. 2012-04, Technical Corrections and Improvements (“ASU 2012-04”), which updates a wide range of topics in the FASB Codification. ASU 2012-04 includes technical corrections and improvements to FASB Codification and conforming amendments related to fair value measurements. ASU 2012-04 will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 is not expected to have a material impact on our financial position or results of operations.

 

9
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

In August 2012, the FASB issued Accounting Standards Update No. 2012-03, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22 (“ASU 2012-3”). ASU 2012-03 amends certain SEC-related sections of the FASB Codification for various recent SEC and FASB pronouncements. ASU 2012-03 was effective upon its issuance. The adoption of ASU 2012-03 did not have have a material impact on our financial position or results of operations.

 

In July 2012, the FASB issued Accounting Standards Update No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. (“ASU 2012-02”), which allows an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test for an indefinite-lived intangible asset. Under ASU 2012-02, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on qualitative assessment, that it is not more likely than not, the indefinite-lived intangible asset is impaired. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. ASU 2012-02 became effective for interim and annual impairment tests after September 15, 2012. Early adoption was permitted. We adopted ASU 2012-02 as of August 31, 2012. Our adoption of ASU 2012-02 did not have a material impact on these condensed consolidated financial statements.

 

4.IMPAIRMENT CHARGES

 

During the three months ended September 30, 2012 we recorded a $47,088,000  loss on goodwill impairment, a $281,000 loss on impairment of certain amortizing intangible assets and a $273,000 loss on impairment of certain manufacturing equipment. Our one non-amortizing intangible asset, Chemical Light’s trade name asset, was not considered to be impaired as of August 31, 2012. See Note 6 for activity affecting our goodwill asset during the nine months ending September 30, 2012. See Note 13 for fair value information on these assets.

 

Before conducting of our annual goodwill impairment assessment, we first assessed whether any non-goodwill assets were impaired because we were concerned that such assets might be impaired due to the recent declines in our stock price and industry conditions discussed later in this Note 4. This assessment determined that Training’s patent asset was impaired $172,000, Training’s trade name asset was impaired $29,000 and Training’s non-compete agreement asset was impaired $80,000. Therefore, we recorded a $281,000 impairment loss on these intangible assets during the three months ended September 30, 2012. This assessment also determined that one piece of Chemical Light’s manufacturing equipment with a carrying value of $273,000 had no value, since we do not foresee using this equipment in the future, and therefore a $273,000 impairment loss was recognized during the three months ended September 30, 2012 as well.

 

We then assessed qualitative factors to determine whether it is more likely than not that the fair values of our reporting units that contain goodwill are less than their carrying value. In addition to these intangible asset impairments, we identified two other factors, adverse changes in our stock price and adverse changes in industry/market considerations, that led us to conclude that it was more likely than not that the fair value was less than the carrying value.

 

Regarding our stock price, the closing price of our stock at December 31, 2011 was $3.75 per share. Beginning in April 2012, the share price began steadily dropping to a closing price of $2.34 on August 31, 2012. Then on September 27, 2012, shares traded at $1.50 per share. In addition, on October 5, 2012, shares traded at $1.00 per share.

 

Regarding industry conditions, during the past several years, based on the success of the Chemical Light’s 40mm training round purchased by the U.S. Marines Corps that uses our chemical light technology, we have believed that the volume of this product would grow when adopted by the U.S. Army. During the fourth quarter of 2012, we will have completed production requirements under the Marines Corps contract, which expires in 2012. We recently learned that the Marines Corps contract will not be extended. In addition, the Army does not plan to purchase the product. Instead, we understand that the U.S. military is planning for a new 40mm training round that will be produced around 2015 and, that this new round is not based on chemical light technology. While this could change, we believe at this time it is more likely than not that the new round will not employ our chemical light technology. Consequently, at this time, these factors have led us to significantly reduce our long-term revenue growth projected for our ammunition sector. Whereas the ammunition sector had been expected to be the largest contributor to our total revenues, the forecasted reduction resulted in a significant decrease in projected cash flows.

 

We then performed what is commonly known as “step 1” of the goodwill impairment assessment by comparing the fair value of each reporting unit containing goodwill to those reporting units’ carrying values. Only our Chemical Light, Training, and Specialty Products reporting units have goodwill assets. Since there are no quoted market prices for our reporting units, the fair value of our 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 carrying values of the Training and the Chemical Light reporting units exceeded their fair values and therefore their goodwill needed to be tested further under what is commonly known as “step 2” of the goodwill impairment assessment.

 

10
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

Under “step 2” of the goodwill impairment assessment, we compared the implied fair value of Chemical Light’s and Training’s goodwill 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 was determined in the same manner as the amount of goodwill recognized in a business combination is determined. The excess of the fair value of each reporting unit over the amounts assigned to its assets and liabilities is the implied amount of the reporting unit’s goodwill. We identified several intangible assets that were valued during this process, including technology, customer relationships, trade names, non-compete agreements, and our workforce. The allocation process was performed only for purposes of goodwill impairment. We determined the fair value of these assets using various discounted cash flow-based methods that utilize assumptions such as the ability of these assets to generate future cash flows, present-value factors, income tax rates and customer attrition rates.

 

5.INVENTORIES

 

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

 

   September 30,
2012
   December 31,
2011
 
Raw materials  $6,653   $6,230 
Work-in-process   2,391    3,296 
Finished goods   1,674    1,867 
   $10,718   $11,393 

 

6.GOODWILL

 

Changes in our goodwill asset were as follows during the nine months ended September 30, 2012 (all amounts in thousands):

 

Balance at December 31, 2011 (1)  $55,329 
Impairment loss  (see Notes 4 and 13)   (47,088)
Adjustment to CTS goodwill due to the current period reduction of its deferred tax liability associated with the current period impairment of identified intangible assets (see Note 4)   (183)
Finalization of the fair value determination of contingent consideration in the CTS acquisition (2)   166 
Finalization of the CTS acquisition-related deferred tax liability (2)   (64)
Balance at September 30, 2012 (3)  $8,160 

 

(1)Gross amount of goodwill was $67,785,000 as of December 31, 2011. Accumulated impairment losses were $12,456,000 as of December 31, 2011.

 

(2)On December 22, 2011, CTI entered into a Stock Purchase Agreement (“SPA”) with CTS and the sole stockholder of CTS. A portion of the consideration paid to the sellers of CTS is contingent upon the financial performance of the acquired business during the combined calendar years 2012 and 2013 (see Note 12). The initial accounting for that contingent consideration liability was not complete as of December 31, 2011 since the fair value determination of that liability had not yet been finalized. The finalization of this accounting during the nine months ended September 30, 2012 resulted in a $166,000 increase in both CTS’ goodwill asset and contingent consideration liability. Additionally, the initial accounting for the CTS acquisition-related deferred tax liability had not yet been finalized as of December 31, 2011. The finalization of this accounting during the nine months ended September 30, 2012 resulted in a $64,000 decrease in both CTS’s goodwill asset and deferred tax liability.

 

(3)Gross amount of goodwill was $67,704,000 as of September 30, 2012. Accumulated impairment losses were $59,544,000 as of September 30, 2012.

 

11
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

7.DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

The derivative liabilities as of September 30, 2012 in our condensed consolidated balance sheet consist of the following (all amounts in thousands):

 

Derivative Instrument  Balance Sheet Location  Fair Value 
Interest rate swaps  Derivatives  $(195)
Currency forward contract  Derivatives   (1)

 

The derivative liabilities as of December 31, 2011 in our condensed consolidated balance sheet consist of the following (all amounts in thousands):

 

Derivative Instrument  Balance Sheet Location  Fair Value 
Currency forward contracts  Prepaid expenses and other current assets  $4 
Interest rate swaps  Derivatives   (273)

 

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 (loss). Such changes were due to unrealized gains and losses on the interest rate swaps. These unrealized gains and losses must be reclassified in whole or in part into earnings if, and when, a comparison of the swap(s) 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 with TD Bank, N.A., and therefore, we do not expect to reclassify any portion of these unrealized losses from accumulated other comprehensive loss to earnings in the future. See Note 13 for a description of how we estimate the fair value of these swaps.

 

Currency Forward Contracts

 

CTSAS’ functional currency is the Euro. Periodically, CTSAS purchases inventory from CTI, which requires payment in U.S. dollars. Beginning in 2009, and only under certain circumstances, we use currency forward contracts to mitigate CTSAS’ exposure to changes in the Euro-to-U.S. dollar exchange rate upon payment of 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 expenses, net on our consolidated statement of comprehensive income (loss). At September 30, 2012, we held one such currency forward contract. See Note 13 for a description of how we estimate the fair value of these contracts.

 

Effect of Derivatives on Statement of Comprehensive Income (Loss)

 

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of comprehensive loss for the three months ended September 30, 2012 was as follows (all amounts in thousands):

 

   Gain (Loss) 
   in AOCL (1)   Reclassified (2)   in Earnings (3) 
Derivatives designated as cash flow hedging relationships:               
Interest rate swaps, net of taxes of $(9)  $15   $0   $0 
Derivatives not designated as hedging instruments:               
Forward currency contracts  $0   $0   $3 

 

(1)Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the three months ended September 30, 2012.
(2)Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the three months ended September 30, 2012.
(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 comprehensive income for the three months ended September 30, 2012.

 

12
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of comprehensive income (loss) for the nine months ended September 30, 2012 was as follows (all amounts in thousands):

 

   Gain (Loss) 
   in AOCL (1)   Reclassified (2)   in Earnings (3) 
Derivatives designated as cash flow hedging relationships:               
Interest rate swaps, net of taxes of $(30)  $48   $0   $0 
Derivatives not designated as hedging instruments:               
Forward currency contracts  $0   $0   $(5)

 

(1)Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the nine months ended September 30, 2012.
(2)Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the nine months ended September 30, 2012.
(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 comprehensive income (loss) for the nine months ended September 30, 2012.

 

8.SEVERANCE AGREEMENTS

 

Effective March 30, 2012, CTI and its former Chief Executive Officer, Derek Dunaway, entered into a separation agreement and general release, pursuant to which Mr. Dunaway’s employment terminated effective May 14, 2012 (the “Termination Date”), provided that Mr. Dunaway ceased to have any authority or responsibility for the conduct of our affairs as of April 2, 2012 (“Cessation Date”). Under the separation agreement, we are obligated to pay Mr. Dunaway a total amount of $402,000. Additionally, any unvested option awards issued to Mr. Dunaway became vested in full upon May 14, 2012 and all unvested stock awards vested on the Cessation Date. In order to permit Mr. Dunaway to satisfy his tax obligations related to the vesting of the stock awards, we repurchased from Mr. Dunaway 9,999 shares of said stock awards on the same terms and conditions in effect at the time of vesting. All options to purchase our common stock shall terminate on the termination date specified in such option agreement as if Mr. Dunaway had continued to be employed by us until such date.

 

Effective April 30, 2012, CTI’s Executive Vice President resigned from his position pursuant to a Separation and Release Agreement with CTI. According to the Separation and Release Agreement, the former employee will receive $220,000 per year through April 30, 2013. Effective May 1, 2012, CTI entered into a renewable, one-year consulting agreement with the former employee under which he will provide certain consulting services to our Chief Executive Officer for $4,000 per month. The consulting agreement also clarifies that the former employee is still eligible to retain restricted stock and option awards granted to him in 2011 and 2010.

 

Additionally, CTI determined that it would not renew the employment contract for its Government Sales Vice President. That contract expired on May 15, 2012. Effective May 15, 2012, the former employee and CTI entered into a Separation and Release Agreement pursuant to which CTI will pay the former employee $185,000 for one year beginning on May 31, 2012.

 

As a result of these agreements, severance costs totaling $807,000 were recognized during the nine months ended September 30, 2012, of which $499,000 remains payable as of September 30, 2012 and is expected to be paid within one year.

 

9.RELATED PARTY TRANSACTION

 

In conjunction with the acquisition of CSP in August 2011, we incurred a $750,000 line of credit payable to one of the sellers of CSP, who also became one of our employees as a result of the CSP acquisition. Additionally, the line of credit was secured by $750,000 of restricted cash that could be used by us for general business purposes. Repayment of the line of credit was subject to CSP achieving certain financial goals. During 2012, CSP achieved these financial goals and the line of credit was repaid and the restricted cash was returned to the seller.

 

See Note 12 for a description of a management agreement with one of the members of our board of directors.

 

13
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

10.INCOME TAXES

 

For the three months ended September 30, 2012, the effective tax rate of 2% differed from the statutory rate of 34% primarily due to the impairment of our goodwill.

 

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 nine months ended September 30, 2012, the effective tax rate of 3% differed from the statutory rate of 34% primarily due to the impairment of our goodwill.

 

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.

 

Despite having a net loss for the nine months ended September 30, 2012, we believe our net deferred tax assets are realizable due to forecasted taxable income.

 

11.NET INCOME (LOSS) PER COMMON SHARE

 

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted net income (loss) 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, 
  2012   2011   2012   2011 
Basic:                    
Net income (loss) (in thousands)  $(47,170)  $244   $(48,526)  $1,460 
Weighted average shares   18,212,618    17,381,750    18,192,805    16,549,504 
Basic income (loss) per common share  $(2.59)  $.01   $(2.67)  $.09 
Diluted:                    
Net income (loss) (in thousands)  $(47,170)  $244   $(48,526)  $1,460 
Income (loss) available to common stockholders for diluted net income (loss) per common share (in thousands)  $(47,170)  $244   $(48,526)  $1,460 
Weighted average shares   18,212,618    17,381,750    18,192,805    16,549,504 
Effect of dilutive securities   0    821,014    0    1,729,780 
Weighted average shares, as adjusted   18,212,618    18,202,764    18,192,805    18,279,284 
Diluted net income (loss) per common share  $(2.59)  $.01   $(2.67)  $.08 

 

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

 

  Three Months Ended September 30,   Nine Months Ended September 30, 
  2012   2011   2012   2011 
Options and warrants   2,479,937    5,372,588    1,033,833    5,090,088 
Restricted stock awards   50,321    0    72,784    0 
Convertible notes payable   2,666,667    2,666,667    2,666,667    2,666,667 

 

14
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

12.COMMITMENTS AND CONTINGENCIES

 

Contingent Consideration

 

Acquisition of Cyalume Specialty Products, Inc.

 

In 2011, we 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 a combination of cash, shares of our common stock plus other consideration that is contingent on future financial performance of CSP. 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. Up to $5 million of the contingent payment is based on CSP achieving certain average earnings before interest, taxes, depreciation and amortization (“EBITDA”) thresholds for the calendar years ending December 31, 2012 and 2013.

 

An additional payment of $2 million is contingent upon CSP achieving average EBITDA of $1.8 million for calendar years ending December 31, 2012 and 2013. These payments will consist of a combination of cash and our common stock.

 

See Note 13 for an estimate of the fair value of this liability and a description of how we estimate its fair value.

 

Acquisition of Combat Training Solutions, Inc.

 

On December 22, 2011, CTI entered into a Stock Purchase Agreement (“SPA”) with CTS and the sole stockholder of CTS. Pursuant to the SPA, CTI purchased all of the issued and outstanding capital stock of CTS using a combination of cash, shares of our common stock plus other consideration that is contingent on future financial performance of CTS. The contingent consideration ranges from $0 to $5.75 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 CTS’ financial performance is known. Up to $5.5 million of the contingent payment is based on CTS achieving certain cumulative gross margin thresholds during the calendar years ending December 31, 2012 and 2013. An additional payment of $250,000 in our common stock is contingent upon CTS achieving cumulative gross margin of $6,000,000 during calendar years ending December 31, 2012 and 2013. These payments will consist of a combination of cash and our common stock.

 

See Note 13 for an estimate of the fair value of this liability and a description of how we estimate its fair value.

 

Legal

 

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.

 

15
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

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, we filed our Notice of Appeal, which lists a number of bases for overturning the awards.

 

Although we have appealed the final judgment, we have recorded a contingent legal obligation in the full amount of the final ruling (approximately $3.7 million) on our condensed consolidated balance sheet as of September 30, 2012. 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 $3.8 million, which includes the $3.7 million contingent legal obligation and other costs we have incurred while litigating Civil Action No. 06-706, as due from related party on our consolidated balance sheet as of September 30, 2012. We believe that the related party receivable is collectible.

 

Complaint Regarding Failure to Deliver Warrants

 

On February 27, 2012, Raviv Shefet filed a complaint (Docket No. 3:12-cv-30040) in the Springfield, Massachusetts Federal District Court, alleging that we failed to deliver common stock warrants to Shefet on a timely basis for services rendered by Shefet prior to April 2008. On July 2, 2012, we executed a settlement agreement for this matter with Mr. Shefet and agreed to pay a one-time cash payment of $28,750 and 22,500 shares of our common stock, both of which have been remitted to Mr. Shefet. Under certain circumstances, if Mr. Shefet sells these 22,500 shares for less than $3.15 per share, then we also must reimburse Mr. Shefet so that he effectively receives $3.15 for each such share sold. Accordingly, we have recorded a liability of $14,625 for this matter as of September 30, 2012, which is included in accrued expenses on our consolidated balance sheet as of September 30, 2012.

 

Demand for Arbitration by 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 in return for consideration that included contingent consideration ranging from $0 to $5.75 million, which is based on CTS’ financial performance during the period of December 22, 2011 through December 31, 2013.

 

On June 15, 2012, we received a copy of a demand for arbitration filed by Mr. Colon with the American Arbitration Association. The demand alleges, among other things, that CTI has constructively terminated Mr. Colon’s employment without cause and that Cyalume and CTI have breached certain provisions of the SPA. Mr. Colon seeks, among other things, payment of the maximum potential contingent consideration amount of $5.75 million, payment of salary, wages, bonuses and benefits pursuant to Mr. Colon’s employment agreement with CTI, and reimbursement of his attorneys’ fees and costs related to this matter. 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 us. We are seeking dismissal of both the arbitration case and the lawsuit filed in Federal Court.

 

We consider the allegations by Mr. Colon to be without merit and therefore no liability has been recorded for this matter.

 

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.

 

16
 

 

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, which expired on October 1, 2012, was extended through December 31, 2013. Under the management agreement, we indemnify Selway and Selway indemnifies us against certain losses that could be incurred while carrying out its obligations under the management agreement. Per the amendment to extend the management agreement, Selway’s compensation for these services is $21,000 per month. We also reimburse Selway for costs incurred specifically on our behalf for these services.

 

13.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.

 

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, 2012 (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
 
Interest rate swaps (see Note 7) (1)  $0   $(195)  $0   $(195)
Currency forward contracts (see Note 7) (2)   0    (1)   0    (1)
Contingent consideration (see Note 12) (3)   0    0    (4,106)   (4,106)
   $0   $(196)  $(4,106)  $(4,302)

 

Assets and liabilities itemized below were measured at fair value on a recurring basis at December 31, 2011 (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
 
Interest rate swaps (see Note 7) (1)  $0   $(273)  $0   $(273)
Currency forward contracts (see Note 7) (2)   0    4    0    4 
Contingent consideration (see Note 12) (3)   0    0    (3,699)   (3,699)
   $0   $(269)  $(3,699)  $(3,968)

 

17
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

(1)The fair values of the swaps are determined by discounting the estimated cash flows to be received and paid due to the swaps over the swap’s contractual lives using an estimated risk-free interest rate for each swap settlement date (an income approach).

 

(2)The fair value of these contracts is determined by multiplying the notional amount of the contract by the difference between (a) the U.S. dollar amount due on the contract at maturity and (b) the foreign exchange rate as of the date the contract is valued (the balance sheet date). Because the contracts typically have a short duration, the value is not discounted using a present value technique (an income approach).

 

(3)The contingent consideration liabilities’ fair value is determined by calculating the present value of the estimated liability that is expected to be paid in the future (an income approach). We estimated the undiscounted liability we expect to pay in the future by developing various hypothetical scenarios in which the consideration could be earned and weighting those scenarios based on our expectations that those scenarios will actually occur.

 

We did not transfer any assets or liabilities between Levels 1, 2 or 3 during the nine months ended September 30, 2012. 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.

 

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

 

The table below presents a reconciliation for our only asset or liability (the contingent consideration liability) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2012 (all amounts in thousands):

 

   Contingent
Consideration
 
Balance at the beginning of period  $(3,699)
Finalization of the accounting for the acquisition of CTS (1)   (166)
Unrealized losses in earnings (2)   (241)
Balance at the end of period  $(4,106)

 

(1)Recorded as an increase to the goodwill asset on our condensed consolidated balance sheet (see Note 6).

 

(2)Recorded in change in fair value of contingent consideration on our consolidated statement of comprehensive income (loss). The contingent consideration liability incurred in the CTS acquisition decreased $2,067,000 during the nine months ended September 30, 2012. This decrease was a result of (i) the finalization of the CTS acquisition accounting, (ii) the time value of money, and (iii) a $3,375,000 decrease in the undiscounted estimated future liability (down from $3,375,000 from December 31, 2011). The contingent consideration liability incurred in the CSP acquisition increased $2,480,000 during the nine months ended September 30, 2012; a portion of this increase was due to a $2,800,000 increase (from $2,200,000 as of December 31, 2011) in the undiscounted estimated future liability while the remainder of the increase was a result of the time value of money.

 

The only significant unobservable inputs used in the fair value measurement of the contingent consideration liability incurred in the CTS acquisition is the estimated gross margin (revenues less cost of revenues) for the calendar years 2012 and 2013. For the contingent consideration liability incurred in the CTS acquisition, that estimated gross margin was $3,257,000 and $6,777,000 as of September 30, 2012 and December 31, 2011, respectively. The maximum payout under this arrangement occurs when the estimated gross margin is $8,500,000; at such an amount, the fair value of this liability would be $4,384,000 as of September 30, 2012. If the estimated gross margin were below $6,000,000 (which is the case as of September 30, 2012), then the fair value of this liability would be $0 as of September 30, 2012.

 

The only significant unobservable inputs used in the fair value measurement of the contingent consideration liability incurred in the CSP acquisition is the estimated EBITDA for the calendar years 2012 and 2013. For the contingent consideration liability incurred in the CSP acquisition, that estimated EBITDA was $1,654,000 and $1,007,000 as of September 30, 2012 and December 31, 2011, respectively. The maximum payout under this arrangement occurs when the estimated EBITDA is $1,800,000; at such an amount, the fair value of this liability would be $5,757,000 as of September 30, 2012. If the estimated EBITDA were below $700,000, then the fair value of this liability would be $0 as of September 30, 2012.

 

18
 

 

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

During the three months ended September 30, 2012, 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 also Notes 4 and 6):

 

  Cyalume Reporting Unit (1)  Loss Recognized   Fair Value 
Goodwill (2)  Chemical Light  $46,230   $5,014 
Goodwill (2)  Training   858    351 
Patents (3)  Training   172    210 
Trade name (4)  Training   29    30 
Non-compete agreements (5)  Training   80    40 
Certain equipment (6)  Chemical Light   273    0 

 

(1)We are managed as one operating segment with four reporting units: Chemical Light (the operations of CTI and CTSAS), Training (the operations of CTS), Specialty Products (the operations of CSP) and Other (the operations of CRI and the parent company Cyalume Technologies Holdings, Inc.). 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 goodwill asset was determined calculating the excess of the fair value of the reporting unit over the fair values assigned to its assets and liabilities and utilized present value techniques utilizing each reporting unit’s forecasted after-tax cash flows.

 

(3)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).

 

(4)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).

 

(5)The fair value of the impaired non-compete agreement asset was determined using the “comparative business valuation” method, which compares the present value of two streams of the reporting unit’s estimated future cash flows; one stream assuming the non-compete agreements are in place and the other stream assuming the agreements are not in place (an income approach).

 

(6)The fair value of the impaired equipment was determined estimating the present value of cash flows expected to result from the use and disposition of the equipment (an income approach).

  

14.OPTION AWARDS

 

In September 2012, we awarded options to purchase 1,036,104 shares of our common stock to East Shore Ventures, LLC as part of compensation for Chief Executive Officer services provided by East Shore Ventures, LLC’s owner and employee under an agreement entered into on April 2, 2012. The options allow East Shore Ventures, LLC to purchase shares of our common stock at $1.50 per share and can be exercised as to 207,221 shares on each of April 2, 2013, 2014, 2015 and 2016 and as to 207,220 shares on April 2, 2017. Because East Shore Ventures, LLC is not considered to be an employee under U.S. GAAP rules for accounting for share-based payments, we must estimate the fair value of these options every reporting period and adjust the related compensation cost accordingly. As of September 30, 2012, we estimated, based upon a Black-Scholes model, that the fair value of these options was $0.77 per option (or $798,000 in the aggregate), using an expected term of 6 years, an expected dividend to be paid during the expected term of $0, volatility of 25.84%, a risk-free rate of 0.83%, and an underlying market price of the stock of $2.00. The estimated fair value of these options will be expensed over the vesting period. These options expire on April 2, 2022 or earlier if forfeited by East Shore Ventures, LLC.

 

Also in September 2012, we awarded options to purchase 350,000 shares of our common stock to our Chief Operating Officer as part of his employment compensation. The options allow our Chief Operating Officer to purchase shares of our common stock at $1.50 per share and can be exercised as to 70,000 shares on each of September 10, 2013, 2014, 2015, 2016 and 2017. We estimated, based upon a Black-Scholes model, that the fair value of these options on the award date was $1.09 per option (or $381,500 in the aggregate), using an expected term of 6.5 years, an expected dividend to be paid during the expected term of $0, volatility of 25.82%, a risk-free rate of 1.10%, and an underlying market price of the stock of $2.34. The estimated fair value of these options will be expensed over the vesting period. These options expire on September 10, 2022 or earlier if forfeited.

 

15.SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

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

 

  Nine Months Ended September 30, 
  2012   2011 
Interest  $1,346   $1,405 
Income taxes   345    1,461 

 

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

 

  Nine Months Ended September 30, 
  2012   2011 
Litigation award payable accounted for as a receivable due from related party  $134   $3,676 
Adjustment to the fair value of warrants issued in July 2010 in conjunction with issuance of subordinated term loan   94    7 
Adjustment to goodwill acquired and contingent consideration incurred in the acquisition of CTS due to the finalization of the fair value of the contingent consideration   166    0 
Adjustment to goodwill acquired and deferred tax liability incurred in the acquisition of CTS due to the finalization of the fair value of the business combination   64    0 
Adjustment to CTS goodwill due to the current period reduction of its deferred tax liability associated with the current period impairment of identified intangible assets (see Note 6)   183    0 
Issued 712,771 shares of our common stock to effect a business combination   0    2,500 
Issued 483,046 shares of our common stock to repay note payable and accrued interest thereon   0    2,212 
Issued 253,288 shares of our common stock to repay notes payable to three stockholders and accrued interest thereon   0    1,160 

 

19
 

 

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 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. With the acquisition of CSP in 2011, we also manufacture and sell chemical products to the pharmaceutical, military and other markets.

 

We do not sell products as novelties.

 

We manufacture products in West Springfield, MA; Bound Brook, NJ; and Aix-en-Provence, France.

 

We maintain principal executive offices at 96 Windsor Street, West Springfield, Massachusetts 01089. 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.

 

Impairment Charges

 

In the three month period ending September 30, 2012, we recorded a goodwill and intangible impairment charges, which we discuss here, in lieu of discussing it in the following sections: Material Changes in Results of Operations for both three and nine months, and Material Changes in Financial Condition.

 

Under accounting principles generally accepted in the United States of America, as part of our annual assessment of goodwill impairment, we first assessed whether any non-goodwill assets were impaired. This assessment determined that CTS’ patent asset was impaired $172,000, CTS’ tradename asset was impaired $29,000 and CTS’ non-compete agreement asset was impaired $80,000. Therefore, we recorded a $281,000 impairment loss on these intangible assets during the three months ended September 30, 2012.

 

We then assessed qualitative factors to determine whether it is more likely than not that the fair values of our reporting units that contain goodwill are less than their carrying value. In addition to these intangible asset impairments, we identified two other factors, adverse changes in our stock price and adverse changes in industry/market considerations, that led us to conclude that it was more likely than not that the fair value was less than the carrying value.

 

Regarding our stock price, the closing price of our stock at December 31, 2011 was $3.75 per share. Beginning in April 2012, the share price began steadily dropping to a closing price of $2.34 on August 31, 2012. Then on September 27, 2012, shares traded at $1.50 per share. In addition, on October 5, 2012, shares traded at $1.00 per share.

 

Regarding industry conditions, during the past several years, based on the success of the 40mm training round purchased by the Marines Corps that uses our chemical light technology, we have believed that the volume of this product would grow when adopted by the Army. During the fourth quarter of this year, we will have completed production requirements under the contract, which expires in 2012. We recently learned that the contract will not be extended. In addition, the Army does not plan to purchase the product. Instead, we understand that the military is planning for a new 40mm training round that will be produced around 2015 and, that this new round is not based on chemical light technology. While this could change, we believe at this time it is more likely than not that the new round will not employ our chemical light technology. Consequently, at this time, these factors, in addition to others have led us to significantly reduce our long-term revenue growth projected for our ammunition sector. Whereas the ammunition sector had been expected to be the largest contributor to our total revenues, the forecasted reduction resulted in a significant decrease in projected cash flows.

 

20
 

 

To determine the amount of impairment, we use a discounted cash flow analysis, which is highly dependent on the nature of the long-term forecast. As a result of the current forecast projecting significantly reduced future cash flows compared to the past, we have recorded impairment charges reducing income before income taxes by $47,088,000.

 

Material Changes in Results of Operations – 3 Months Ended September 30, 2012 versus the 3 Months Ended September 30, 2011

 

Revenues for the third quarter of 2012 of $10.1 million increased from the prior year by $1.5 million, or 17% as shown in the following table of revenues by sector. Clearly, this increase was the result of the acquisition of CSP, which was acquired on August 31, 2011. Nonetheless, revenues for the third quarter of this year were $1.2 million, or 13% higher than for the second quarter of this year.

 

Category ($ in millions)  2012   2011   Change 
Military (non-ammunition)  $6.7   $5.8   $0.9 
Ammunition   0.5    1.4    (0.9)
Law enforcement / commercial public safety   0.8    1.0    (0.2)
Specialty products   2.1    0.4    1.7 
Total  $10.1   $8.6   $1.5 

 

For 2012, military non-ammunition revenues increased from the prior year due to increased orders by the U.S Military. In addition, in July 2012, price increases of approximately 5% went into effect for products sold through LCI, our largest direct customer. Revenues from LCI for 2012 were approximately $3.1 million versus $1.7 million in the prior year. Ammunition revenues for 2012 decreased due to lower purchases of existing products and delays in selling new products. Regarding specialty product revenues, CSP was acquired on August 31, 2011 and thus these revenues only existed for us for one month in 2011.

 

Cost of goods sold for 2012 of approximately $6.1 million increased from the prior year amount of $4.6 million primarily due to higher revenues and the recording of a reserve for slow moving / obsolete goods of $0.5 million. Increases in product costs over the prior year, due to raw material price increases and labor cost increases, were not significant. Gross profit margin for 2012 was 39.9% versus 46.2% for the prior year. This decrease in margin was largely attributable to the inventory reserve recorded and, to a much lesser extent, to a change in product mix.

 

Sales and marketing expenses increased in 2012 primarily due to additional sales personnel being added, mostly via the acquisitions of CSP and CTS.

 

General and administrative expenses increased in 2012 primarily due to higher payroll expenses, mostly resulting from the acquisitions of CSP and CTS.

 

Research and development expenses decreased in 2012 primarily due to a decrease in CTI payroll related expenses partially offset by 2012 research and development expenses incurred by CSP and CTS.

 

The change in fair value of contingent consideration is due to the fact that this amount is driven by changes in the fair value of the contingent consideration liabilities that resulted from the acquisitions of CSP and CTS.

 

Other, net was higher in 2011 due to our earning reimbursement of certain product development costs from customers. Fewer of those transactions occurred in 2012.

 

For 2012, we had a tax benefit primarily due to the recognition of deferred tax benefits resulting from our net operating loss versus a tax benefit in 2011 that was the result of (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 majority of our goodwill is not tax deductible; therefore, our benefit from income taxes has not been impacted by the impairment recognized during the third quarter of 2012.

 

Material Changes in Results of Operations – 9 Months Ended September 30, 2012 versus the 9 Months Ended September 30, 2011

 

Revenues for 2012 of $27.0 million were up from the prior year by $0.6 million, as shown in the following table of revenues by sector.

 

Category ($ in millions)  2012   2011   Change 
Military (non-ammunition)  $16.7   $19.0   $(2.3)
Ammunition   2.1    4.2    (2.1)
Law enforcement / commercial public safety   2.3    2.8    (0.5)
Specialty products   5.9    0.4    5.5 
Total  $27.0   $26.4   $0.6 

 

21
 

 

For 2012, military non-ammunition revenues decreased from the prior year due to a decrease in European military sales, partially offset by an increase in sales to the U.S. Military attributable to the acquisition of CTS. Ammunition revenues for 2012 decreased due to lower purchases of existing products and delays in selling new products. Regarding specialty product revenues, CSP was acquired on August 31, 2011 and thus these revenues only existed for one month for us in 2011.

 

Cost of goods sold for 2012 of approximately $15.5 million increased from the prior year amount of $13.6 million by approximately $1.9 million due to higher revenues and a reserve for slow moving obsolete inventory. The resulting gross profit margin for 2012 was 42.8% versus 48.3% for 2011. The decrease in margins was largely attributable to a product mix change and from the recording of the inventory reserve.

 

Sales and marketing expenses and general and administrative expenses increased in 2012 primarily due to increases in such costs added via the acquisitions of CSP and CTS, which took place in September 2012 and December 2012, respectively.

 

The change in fair value of contingent consideration is due to the fact that this amount is driven by changes in the fair value of the contingent consideration liabilities that resulted from the acquisitions of CSP and CTS, both of which occurred after September 30, 2011.

 

Other, net was higher in 2011 due to our earning reimbursement of certain product development costs from customers. Fewer of those transactions occurred in 2012.

 

For 2012, we had a tax benefit primarily due to the recognition of deferred tax benefits resulting from our net operating loss versus a tax benefit in 2011 that was the result of (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. Despite having a net loss for the nine months ended September 30, 2012, we believe our net deferred tax assets are realizable due to forecasted taxable income. The majority of our goodwill is not tax deductible; therefore, our benefit from income taxes has not been impacted by the impairment recognized during 2012.

 

Material Changes in Financial Condition – September 30, 2012 versus December 31, 2011

 

Our accounts receivable increased due to higher sales in the month of September 2012 versus the month of December 2011. Our receivables are generally collected within 30 days, thus revenues recorded in the 30-day period preceding the measurement date significantly influence the reported balances. We have no significant collection problems with our accounts receivable.

 

Our inventory balance at September 30 of $10.7 million was $0.7 million lower than the balance at December 31, 2011. This was primarily due to reserves being increased by $0.5 million for slow moving / obsolete goods and to a lesser extent a planned drawdown of stocks. During the third quarter of this year, a concentrated effort was made to lower our stock levels. Consequently, our inventory balance at September 30 was $1.4 million lower than the June 30 balance of $12.1 million; the planned reduction accounted for the majority of this reduction.

 

Restricted cash and the line of credit due to a related party decreased to $0 due to returning that restricted cash to repay that line of credit in full.

 

Accounts payable and accrued expenses, on combined basis, increased primarily due to the end of the year being a period during which reduced purchasing takes place. Note payable to related party decreased as the note was paid during the second quarter of 2012. Our notes payable decreased due to scheduled principal payments made during 2012, net of amortization of debt issuance costs.

 

Contingent consideration liabilities resulting from the acquisitions of CTS and CSP increased due to (i) the passage of time, (ii) changes in estimates used to determine the liabilities’ fair value and (iii) the finalization of the initial accounting of the CTS acquisition. The most significant changes within the gross liability balance were the changes in estimates used to determine fair value of the individual liabilities; the CTS-related contingent consideration decreased from $2,067,000 at December 31, 2011 to $0 at September 30, 2012, while the CSP-related contingent consideration increased from $1,632,000 at December 31, 2011 to $4,106,000 at September 30, 2012.

 

22
 

 

Our deferred tax liability decreased since December 31, 2011 primarily due to the decreases to the carrying value of various identified intangible assets as a result of annual amortization expense and the estimated increases in the following items: (i) temporarily non-deductible stock-based compensation and (ii) foreign tax credits being created during 2012.

 

Income taxes refundable increased due to required estimated tax payments by CTSAS during 2012 which we believe will be refunded when CTSAS’ 2012 tax forms are filed.

 

Liquidity and Capital Resources

 

As of September 30, 2012 and December 31, 2011, we had $1.7 million and $3.0 million, respectively, of cash on hand. The major sources and uses of cash during 2012 were all in the normal course of business.

 

Forecasted principal and interest payments on debt for the next 12 months are $3.9 million. All operating and capital expenditures are expected to be funded completely from operating cash flows and net proceeds from our revolving line of credit. At September 30, 2012, no funds were outstanding under the revolving line of credit.

 

We achieved our lenders’ financial covenants for the period ending September 30, 2012. Beginning with the measurement period ending December 31, 2012, several of our financial covenants become more stringent. To guard against the possibility of not meeting these financial covenants, we have obtained preliminary agreement with our lenders to amend certain financial covenants through the measurement period ending September 30, 2013. For this amendment, we have agreed to pay total fees to our lenders of $230,000 upon execution of the amendment, which we expect to occur prior to December 31, 2012. In addition, our senior debt lender has agreed to extend the maturity of our revolving line of credit to December 19, 2013, from its current maturity date of December 19, 2012.

 

We have recorded an approximately $3.7 million payable for ongoing litigation 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

 

Other than immaterial operating leases, we did not have any off-balance sheet arrangements during 2012 or 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; 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.

 

Revenue Recognition

 

Revenue from the sale of products or providing of services is recognized when the earnings process is complete 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 are recorded as costs of goods sold when the related revenue is recognized.

 

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

 

23
 

 

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

 

Contingent Consideration

 

We purchased both CSP and CTS using a combination of cash, common stock and contingent consideration. The contingent consideration represents the present value of payments expected to be made in 2014 to the sellers of the businesses following the achievement of certain financial performance targets in 2012 and 2013. The contingent consideration is updated to fair value at the end of each reporting period.

 

Considerable judgment is applied by management when estimating the fair value of the contingent consideration. The contingent consideration liabilities’ fair value is determined by calculating the present value of the estimated liability that is expected to be paid in the future. This requires the use of (i) estimated future discount rates and (ii) hypothetical scenarios in which the consideration could be earned and weighting those scenarios based on our expectations that those scenarios will actually occur. Such assumptions may not reflect actual future results.

 

24
 

 

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 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

 

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, 2012. 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, 2012.

 

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, 2012 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

 

Demand for Arbitration by 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 in return for consideration that included contingent consideration ranging from $0 to $5.75 million, which is based on CTS’ financial performance during the period of December 22, 2011 through December 31, 2013.

 

On June 15, 2012, we received a copy of a demand for arbitration filed by Mr. Colon with the American Arbitration Association. The demand alleges, among other things, that CTI has constructively terminated Mr. Colon’s employment without cause and that Cyalume and CTI have breached certain provisions of the SPA. Mr. Colon seeks, among other things, payment of the maximum potential contingent consideration amount of $5.75 million, payment of salary, wages, bonuses and benefits pursuant to Mr. Colon’s employment agreement with CTI, and reimbursement of his attorneys’ fees and costs related to this matter. 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 us. We are seeking dismissal of both the arbitration case and the lawsuit filed in Federal Court.

 

25
 

 

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.

 

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, we filed our Notice of Appeal, which lists a number of bases for overturning the awards.

 

Other than the issue described in the previous two paragraphs, there have been no material developments in the legal proceedings described in Item 3 “Legal Proceedings” in our Form 10-K for the year ended December 31, 2011.

 

ITEM 1A.    RISK FACTORS

 

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

 

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

 

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

 

None.

 

Purchases of Equity Securities by the Company and Affiliated Purchasers

 

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 31              $ 
August 1 to August 31   3,500(1)  $2.50         
September 1 to September 30                

 

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

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

26
 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

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, 2012.

 

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 (1) Employment Agreement between Daniel S. Baker and Cyalume Technologies, Inc. effective September 10, 2012  (10.1)
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
*Filed herewith.

 

(1)Incorporated by reference to the Current Report on Form 8-K dated July 19, 2012 and filed with the Commission July 25, 2012. The number given in parenthesis indicates the corresponding exhibit number in such Form 8-K.

 

27
 

 

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 15, 2012 By: /s/ Zivi Nedivi
     
    Zivi Nedivi, Chief Executive Officer
    (Principal Executive Officer)

 

Date: November 15, 2012 By: /s/ Michael Bielonko
     
    Michael Bielonko, Chief Financial Officer
    (Principal Financial Officer)

 

28