Cyalume Technologies 10Q 2010 Q2 Quarterly report

PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Statements of Operations (unaudited) for the three months ended June 30, 2010 and 2009	4

	Condensed Consolidated Statements of Operations (unaudited) for the six months ended June 30, 2010 and 2009	5

	Condensed Consolidated Balance Sheets as of June 30, 2010 (unaudited) and December 31, 2009	6

	Condensed Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the six months ended June 30, 2010 (unaudited)	7

	Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2010 and 2009	8

	Notes to Condensed Consolidated Financial Statements (unaudited)	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18

Item 4.	Controls and Procedures	18

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	18

Item 1A.	Risk Factors	19

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19

Item 3.	Defaults Upon Senior Securities	19

Item 4.	[Removed and Reserved]	19

Item 5.	Other Information	19

Item 6.	Exhibits	20

Signatures		21

PART I—FINANCIAL INFORMATION

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

ITEM 1.

Financial Statements

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except shares and per share information)

(Unaudited)

	For the Three			For the Three
	Months Ended			Months Ended
	June 30,			June 30,
	2010			2009
Revenues	$	9,404		$	7,959
Cost of goods sold		4,610			4,575
Gross profit		4,794			3,384

Other expenses (income):
Sales and marketing		776			746
General and administrative		1,253			1,377
Research and development		351			415
Interest, net		635			625
Interest – related party		16			15
Amortization of intangible assets		456			739
Other, net		(81	)		19
Total other expenses, net		3,406			3,936

Income (loss) before income taxes		1,388			(552	)
Provision for (benefit from) income taxes		357			(57	)
Net income (loss)	$	1,031		$	(495	)

Net income (loss) per common share:
Basic	$	.07		$	(.03	)
Diluted	$	.07		$	(.03	)

Weighted average shares used to compute net income (loss) per common share:
Basic		15,458,737			15,333,160
Diluted		15,505,764			15,333,160

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except shares and per share information)

(Unaudited)

	For the Six			For the Six
	Months Ended			Months Ended
	June 30,			June 30,
	2010			2009
Revenues	$	18,289		$	14,583
Cost of goods sold		9,212			8,436
Gross profit		9,077			6,147

Other expenses (income):
Sales and marketing		1,564			1,531
General and administrative		2,766			2,602
Research and development		733			808
Interest, net		1,300			1,252
Interest – related party		32			29
Amortization of intangible assets		912			1,734
Other, net		(91	)		63
Total other expenses, net		7,216			8,019

Income (loss) before income taxes		1,861			(1,872	)
Provision for (benefit from) income taxes		669			(604	)
Net income (loss)	$	1,192		$	(1,268	)

Net income (loss) per common share:
Basic	$	.08		$	(.08	)
Diluted	$	.08		$	(.08	)

Weighted average shares used to compute net income (loss) per common share:
Basic		15,443,234			14,956,448
Diluted		15,513,433			14,956,448

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except shares and per share information)

	June 30,
	2010 (unaudited)			December 31, 2009
Assets
Current assets:
Cash	$	2,580		$	2,003
Accounts receivable, net of allowance for doubtful accounts of $25 and $239 at June 30, 2010 and December 31, 2009, respectively		3,145			3,319
Inventories, net		8,839			9,320
Income taxes refundable		—			294
Deferred income taxes		459			682
Prepaid expenses and other current assets		413			382
Total current assets		15,436			16,000

Property, plant and equipment, net		8,632			8,384
Goodwill		51,244			51,244
Other intangible assets, net		21,498			22,548
Other noncurrent assets		113			67
Total assets	$	96,923		$	98,243

Liabilities and Stockholders’ Equity
Current liabilities:
Lines of credit	$	2,700		$	3,200
Current portion of notes payable		8,468			6,940
Accounts payable		2,818			3,222
Accrued expenses and other current liabilities		2,377			2,069
Advance due to related parties		9			9
Income taxes payable		313			—
Total current liabilities		16,685			15,440

Notes payable, net of current portion		15,469			18,874
Notes payable due to related parties		1,097			1,065
Deferred income taxes		6,997			7,105
Derivatives		310			69
Asset retirement obligation, net of current portion		162			158
Total liabilities		40,720			42,711

Commitments and contingencies (Note 8)		—			—

Stockholders' equity:
Preferred stock, $0.001 par value; 1,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.001 par value; 50,000,000 shares authorized; 15,684,070 and 15,405,570 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively		16			15
Additional paid-in capital		88,526			87,926
Accumulated deficit		(31,201	)		(32,393	)
Accumulated other comprehensive loss		(1,138	)		(16	)
Total stockholders’ equity		56,203			55,532
Total liabilities and stockholders' equity	$	96,923		$	98,243

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

Cyalume Technologies Holdings, Inc.

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

(in thousands, except shares)

(Unaudited)

	Common Stock				Additional						Accumulated Other			Total
	Number of Shares		Amount		Paid-In Capital			Accumulated Deficit			Comprehensive Loss			Stockholders’ Equity			Comprehensive Income (Loss)
Balance at December 31, 2009		15,405,570	$	15	$	87,926		$	(32,393	)	$	(16	)	$	55,532		$	—
Stock issued		278,500		1		(1	)		—			—			—			—
Stock-based compensation expense		—		—		601			—			—			601			—
Foreign currency translation adjustments		—		—		—			—			(971	)		(971	)		(971	)
Unrealized loss on cash flow hedges, net of taxes of $90		—		—		—			—			(151	)		(151	)		(151	)
Net income		—		—		—			1,192			—			1,192			1,192
Comprehensive income		—		—		—			—			—			—		$	70
Balance at June 30, 2010		15,684,070	$	16	$	88,526		$	(31,201	)	$	(1,138	)	$	56,203

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

Cyalume Technologies Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

	For the Six			For the Six
	Months Ended			Months Ended
	June 30,			June 30,
	2010			2009
Cash flows from operating activities:
Net income (loss)	$	1,192		$	(1,268	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation of property, plant and equipment		329			320
Amortization		1,065			2,420
Provision for deferred income taxes		313			(869	)
Stock-based compensation expense		601			209
Other non-cash expenses		130			294
Changes in operating assets and liabilities:
Accounts receivable		34			(1,127	)
Inventories		187			(166	)
Prepaid expenses and other current assets		(70	)		(101	)
Accounts payable and accrued liabilities		(15	)		229
Income taxes payable		615			532
Accrued interest on notes payable to related parties		—			(2)
Net cash provided by operating activities		4,381			471

Cash flows from investing activities:
Purchases of long-lived assets		(1,003	)		(283	)
Net cash used in investing activities		(1,003	)		(283	)

Cash flows from financing activities:
Payments for common stock subject to redemption		—			(1,123	)
Net repayment of line of credit		(500	)		(200	)
Repayment of long-term notes payable		(2,081	)		(1,646	)
Payments to reacquire and retire common stock		—			(263	)
Refund (payment) of debt issuance costs		(50	)		10
Proceeds from exercises of warrants		—			27
Net cash used in financing activities		(2,631	)		(3,195	)

Effect of exchange rate changes on cash		(170	)		57
Net increase (decrease) in cash		577			(2,950	)
Cash, beginning of period		2,003			3,952
Cash, end of period	$	2,580		$	1,002

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

1.	BASIS OF PRESENTATION

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these interim condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period.

These accompanying unaudited interim condensed consolidated financial statements recognize the effects of all subsequent events that provide additional evidence about conditions that existed at June 30, 2010, including the estimates inherent in the process of preparing financial statements. Additionally, all significant intercompany accounts and transactions have been eliminated in consolidation.

Certain amounts in prior periods have been reclassified to conform to the 2010 presentation. These reclassifications had no effect on operating results as previously reported.

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

2.	DESCRIPTION OF BUSINESS

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

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

3.	NEW ACCOUNTING PRONOUNCEMENTS

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

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

4.	INVENTORIES

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

	June 30, 2010		December 31, 2009
Raw materials	$	4,568	$	4,548
Work-in-process		3,277		2,973
Finished goods		994		1,799
	$	8,839	$	9,320

5.	DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The derivative liabilities as of June 30, 2010 in our condensed consolidated balance sheet consist of the following (all amounts in thousands):

Derivative Instrument		Balance Sheet Location		Fair Value
Interest rate swaps		Derivatives (non-current liabilities)		$	(310	)

Interest Rate Swaps

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

Currency Forward Contracts

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

Effect of Derivatives on Statement of Operations

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of operations for the three months ended June 30, 2010 was as follows (all amounts in thousands):

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

	Gain (Loss)			Gain (Loss)		Gain (Loss)
	In AOCL (1)			Reclassified (2)		in Earnings (3)
Derivatives in cash flow hedging relationships:
Interest rate swaps	$	(76	)	$	—	$	—
Derivatives not designated as hedging instruments:
Forward currency contracts	$	—		$	—	$	2

(1)

Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the three months ended June 30, 2010.

(2)

Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the three months ended June 30, 2010.

(3)

Amount of gain (loss) recognized in earnings on the derivative (ineffective portion and amount excluded from effectiveness testing) reported in other loss (income) on the condensed consolidated statement of operations for the three months ended June 30, 2010.

The effect of derivative instruments (a) designated as cash flow hedges and (b) not designated as hedging instruments on our condensed consolidated statement of operations for the six months ended June 30, 2010 was as follows (all amounts in thousands):

	Gain (Loss)			Gain (Loss)		Gain (Loss)
	In AOCL (1)			Reclassified (2)		in Earnings (3)
Derivatives in cash flow hedging relationships:
Interest rate swaps	$	(151	)	$	—	$	—
Derivatives not designated as hedging instruments:
Forward currency contracts	$	—		$	—	$	(22	)

(1)

Amount recognized in accumulated other comprehensive loss (AOCL) (effective portion and net of taxes) during the six months ended June 30, 2010.

(2)

Amount of gain (loss) originally recorded in AOCL but reclassified from AOCL into earnings during the six months ended June 30, 2010.

(3)

6.	INCOME TAXES

For the three months ended June 30, 2010, the effective tax rate of 26% differed from the statutory rate of 34% due to true-ups including changes in repatriated earnings from CTSAS and valuation allowances against foreign tax credits. For the three months ended June 30, 2009, the effective tax rate of 10% differed from the statutory rate of 34% primarily due to the true-ups associated with the purchase price allocation of tangible and intangible assets.

The effective tax rates for the six months ended June 30, 2010 and six months ended June 30, 2009 were not significantly different from the statutory rate of 34%.

7.	NET INCOME (LOSS) PER COMMON SHARE

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. Potential common shares consist of (i) shares issuable upon the exercise of warrants and options and (ii) unvested restricted stock awards (using the treasury stock method).

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

	Three Months Ended June 30,					Six Months Ended June 30,
	2010		2009			2010		2009
Basic:
Net income (loss) (in thousands)	$	1,031	$	(495	)	$	1,192	$	(1,268	)
Weighted average shares		15,458,737		15,333,160			15,443,234		14,956,448
Basic income (loss) per common share	$	0.07	$	(0.03	)	$	0.08	$	(0.08	)
Diluted:
Net income (loss) (in thousands)	$	1,031	$	(495	)	$	1,192	$	(1,268	)
Weighted average shares		15,458,737		15,333,160			15,443,234		14,956,448
Effect of dilutive securities		47,027		—	(1)		70,199		—	(1)
Weighted average shares, as adjusted		15,505,764		15,333,160			15,513,433		14,956,448
Diluted income (loss) per common share	$	0.07	$	(0.03	)		0.08	$	(0.08	)

(1)

Since we experienced a loss during this period, common shares issuable upon exercise of convertible securities were excluded from the loss per share calculation because the effect would be antidilutive.

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
Warrants		4,250,756		4,370,256		4,250,756		4,370,256
Restricted stock awards		87,333		—		4,000		—
Options		2,330,000		1,745,000		2,330,000		1,745,000

8.	COMMITMENTS AND CONTINGENCIES

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

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

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

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

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

Management Agreement with Board Member

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

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

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

Advise and support us on our investor relations strategy;

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

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

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

On July 29, 2010 we amended our management agreement (the “Amended Management Agreement”) with Selway. Pursuant to the Amended Management Agreement, (i) the monthly compensation payable to Selway was reduced to $11,666.67 and (ii) we must issue to Selway 45,000 shares of our common stock in full satisfaction of all accrued and unpaid liabilities (including all management fees) we owe to Selway pursuant to this management agreement through July 2010.

9.	FAIR VALUE

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

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

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

As of June 30, 2010, our only assets and liabilities required to be reported at fair value on a recurring basis were the interest rate swaps and currency forward contracts described in Note 5, both of which are measured at fair value using level 2 inputs.

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

Cyalume Technologies Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

10.	COLLABORATIVE ARRANGEMENT

To increase the use of our technologies in the ammunitions market, we have entered into a Strategic Alliance Agreement with General Dynamics Ordnance and Tactical Systems to develop and market training, illumination and marking payloads for the U.S. military that use our chemiluminescent technology. This Strategic Alliance Agreement does not define specific projects to be completed; before such a project begins, the Strategic Alliance Agreement will be supplemented by additional agreements that define the project and each party’s role and responsibilities. Such supplemental agreements will dictate how related costs and revenues will be shares by the parties and how those costs and revenues, if any, would be reported by us. As of June 30, 2010, no such specific projects have begun.

11.	SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

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

	Six Months Ended June 30,
	2010			2009
Interest		$	1,174		$	970
Income taxes			194			395

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

	Six Months Ended June 30,
	2010		2009
Increase in the Acquisition date fair value of intangible assets (a reduction of goodwill)	$	—		2,024
Increase in the Acquisition date fair value of property, plant & equipment (a reduction of goodwill)		—		372
Accrual of costs directly related to the Acquisition (an increase to goodwill)		—		435
Reduction of goodwill resulting from subsequent recognition of deferred taxes		—		(549	)

12.	SUBSEQUENT EVENTS

In June 2010, TD Bank, N.A. agreed to extend a deadline from June 30, 2010 to July 31, 2010 for our requirement to receive at least $3.0 million in new subordinated debt or from an equity offering and to use the net proceeds from that subordinated debt or equity offering to reduce the outstanding principal balance on our senior debt held by TD Bank, N.A.

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

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

Simultaneous with the repayment of a portion of the TD Bank, N.A. senior debt, our interest rate swaps (see Note 5) were modified to incorporate this repayment since it was not anticipated in the original swap agreement. This allows us to continue to assume that these hedges meet the criteria for the shortcut method for assessing hedge effectiveness; therefore, the hedge is assumed to still be 100% effective.

Simultaneous with the issuance of the convertible notes, we amended our management agreement with Selway Capital, LLC (see Note 8).

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

Material Changes in Results of Operations – 3 Months Ended June 30, 2010 versus the 3 Months Ended June 30, 2009

Revenues: For the three-month period ended June 30, 2010, sales were higher than for the comparable period in 2009 due primarily to the volume of units sold. Price increases in the fourth quarter of 2009 provided some of the additional revenues for the most recent 3-month period.

Cost of goods sold: For the three-months ended June 30, 2010, cost of goods sold was consistent with the comparable period in 2009 despite the increase in units sold discussed above. Gross margin for the quarter was 50.9% compared to a 42.5% gross margin for the comparable prior-year period. 2010 margin improved partially due to price increases implemented in late 2009. Gross margin in the three months ended June 30, 2009 was depressed due to lower-than-normal sales of high margin chemical light sticks and the amortization of the inventory step-up to fair market value arising from our acquisition of CTI in December 2008.

Expenses: General and administrative expenses decreased 9.0% primarily due to expenses related to (i) the accrual of share-based awards in the second quarter of 2009 that did not recur in the second quarter of 2010 and (ii) lower fees related to SEC filings and other professional services, partially offset by management fees relating to our management agreement with Selway Capital, LLC, which had not yet been entered into as of June 30, 2009. Research and development expenses decreased primarily due to lower patent defense fees incurred.

Amortization of intangible assets: In December 2009, we recorded impairments on our trademark and customer relationship intangible assets that significantly reduced our amortization of intangible assets in the three months ended June 30, 2010 compared to same period in the prior year.

Provision for (benefit from) income taxes increased significantly for the three months ended June 30, 2010 as compared to the three months ended June 30, 2009 due to our generation of net income in 2010 and operating losses in 2009.

Other loss (income), net, consists primarily of the effects of changes in foreign exchange rates.

Material Changes in Results of Operations – 6 Months Ended June 30, 2010 versus the 6 Months Ended June 30, 2009

Revenues: For the six-month period ended June 30, 2010, sales were higher than for the comparable period in 2009 due primarily to the volume of units sold. Price increases in the fourth quarter of 2009 provided some of the additional revenues for the 2010 period.

Cost of goods sold: For the six-months ended June 30, 2010, cost of goods sold was 9.2% higher than the comparable period in 2009 due to the increase in units sold discussed above. Gross margin for the period was 49.6% compared to a 42.2% gross margin for the comparable prior-year period. 2010 margin improved partially due to price increases implemented in late 2009. Gross margin in the six months ended June 30, 2009 was depressed due to lower-than-normal sales of high margin chemical light sticks and the amortization of the inventory step-up to fair market value arising from our acquisition of CTI in December 2008.

Expenses: General and administrative expenses increased 6.3% primarily due to expenses related to (i) the accrual of share-based awards in 2010, which were not accrued in 2009 and (ii) management fees relating to our management agreement with Selway Capital, LLC, which had not yet been entered into as of June 30, 2009, partially offset by lower legal fees related to SEC filings. Research and development expenses decreased primarily due to lower patent defense fees incurred.

Amortization of intangible assets: In December 2009, we recorded impairments on our trademark and customer relationship intangible assets that significantly reduced our amortization of intangible assets in the six months ended June 30, 2010 compared to same period in the prior year.

Provision for (benefit from) income taxes increased significantly for the six months ended June 30, 2010 as compared to the six months ended June 30, 2009 due to our generation of net income in 2010 and operating losses in 2009.

Other loss (income), net, consists primarily of the effects of changes in foreign exchange rates.

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

Assets, other than cash: Assets, other than cash, were $94.3 million at June 30, 2010 compared to $96.2 million at December 31, 2009. The decrease is primarily due to intangible assets amortization combined with a decrease in inventories resulting from increased sales activity. The remaining changes in asset values are the result of normal business activities.

Liabilities: Liabilities were $40.7 million at June 30, 2010, compared to $42.7 million at December 31, 2009. The decrease is due to payments made on notes payable. Our derivatives liability increased since December 31, 2009 primarily due to a decrease in estimated future LIBOR rates used to estimate the fair value of our pay fixed/receive LIBOR interest rate swaps. The remaining changes are the result of normal business activities.

Liquidity and Capital Resources

Cash on hand was $2.6 million at June 30, 2010 and $2.0 million at December 31, 2009. The increase since December 31, 2009 resulted primarily improved sales levels offset by payments on debt and for property, plant and equipment.

During the six months ended June 30, 2010, we did not sell any shares of our common stock. However 278,500 common shares were issued for stock-based compensation awards.

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

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

Forecasted principal and interest payments on debt for the next 12 months are $10.8 million and will be funded from operating cash flows and the net proceeds of the convertible notes issued on July 29, 2010. All operating and capital expenditures are expected to be funded completely from operating cash flows.

Off-Balance Sheet Arrangements

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

Critical Accounting Policies

Use of Estimates

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

Revenue Recognition

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

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

Income Taxes

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

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 annual amortization. Goodwill is subject to an annual impairment review, and, if conditions warrant, an interim impairment review. Impairment charges, if any, are recorded in the period in which the impairment is determined.

Intangible Assets

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

Inventories

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

Foreign Operations and Currency

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

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

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 June 30, 2010. Based upon that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that the design and operation of our disclosure controls and procedures were effective as of June 30, 2010.

Changes in Internal Control over Financial Reporting

During the three months ended June 30, 2010, we finished validation of and began using a new enterprise resource planning (“ERP”) system that significantly changed the manner in which we capture and record much of the accounting-related information and transactions throughout our organization. This new ERP system was not implemented as a result of a weakness or deficiency in internal controls in our previous ERP system. There were no other changes in our internal control over financial reporting that occurred during the three months ended June 30, 2010 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

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

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

CTI is considering its alternatives relating to the suit in light of the Findings. We have not recorded or reported any amounts since payment of damages or loss is not yet deemed to be probable since all of our legal remedies have not been exhausted.

ITEM 1A. RISK FACTORS

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

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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

None.

Purchases of Equity Securities by the Company and Affiliated Purchasers

None.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.

[REMOVED AND RESERVED]

ITEM 5.

OTHER INFORMATION

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

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		Extension of deadline contained in the Second Amendment to the Credit Agreement and Limited Waiver with TD Bank, N.A. (1)
10.2		Extension of deadline contained in the Second Amendment to the Credit Agreement and Limited Waiver with TD Bank, N.A. (2)
10.3		Subordinated Loan Agreement dated as of July 29, 2010 among Cyalume Technologies, Inc., Cyalume Technologies Holdings, Inc., the Lenders and other financial institutions or other entities from time to time parties thereto and Granite Creek Partners Agent, LLC as Agent. (3)
10.4		Subordinated Security and Pledge Agreement dated as of July 29, 2010 between Cyalume Technologies, Inc. and Granite Creek Partners Agent, LLC. (3)
10.5		Subordinated Guaranty Agreement dated as of July 29, 2010 entered into by Cyalume Technologies Holdings, Inc. for the benefit of Granite Creek Partners Agent, LLC. (3)
10.6		Subordinated Stock Pledge Agreement dated as of July 29, 2010 entered into by Cyalume Technologies Holdings, Inc. (3)
10.7		Amended and Restated Revolving Credit and Term Loan Agreement dated as of July 29, 2010 among Cyalume Technologies, Inc., Cyalume Technologies Holdings, Inc., the Lenders and the other financial institutions or other entities from time to time parties thereto and TD Bank, N.A., a national banking association, as Agent and as Lender. (3)
10.8		Form of Warrant issued to Granite Creek FlexCap I, L.P. (3)
10.9		Form of Warrant issued to Patriot Capital II, LP. (3)
10.10		Registration Rights Agreement between CTHI and Granite Creek FlexCap I, L.P. (3)
10.11		Registration Rights Agreement between CTHI and Patriot Capital II, LP. (3)
10.12		Amended Management Agreement with Selway Capital, LLC. (3)
10.13	*	Employment agreement of Monte Pickens, Executive Vice President, Cyalume Technologies, Inc.
31.1	*	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	*	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	*	Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith.

(1)	Incorporated by reference to the Current Report on Form 8-K dated April 30, 2010 and filed with the Commission May 6, 2010.

(2)	Incorporated by reference to the Current Report on Form 8-K dated June 30, 2010 and filed with the Commission July 8, 2010.

(3)	Incorporated by reference to the Current Report on Form 8-K dated July 29, 2010 and filed with the Commission August 3, 2010.

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: August 11, 2010	By:	/s/ DEREK DUNAWAY

		Derek Dunaway, Chief Executive Officer
		(Principal Executive Officer)

Date: August 11, 2010	By:	/s/ MICHAEL BIELONKO

		Michael Bielonko, Chief Financial Officer
		(Principal Financial Officer)

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Cyalume Technologies (CYLU) Inactive 10-Q2010 Q2 Quarterly report

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