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CYLU > SEC Filings for CYLU > Form 10-Q on 15-Nov-2012All Recent SEC Filings

Show all filings for CYALUME TECHNOLOGIES HOLDINGS, INC.

Form 10-Q for CYALUME TECHNOLOGIES HOLDINGS, INC.


15-Nov-2012

Quarterly Report


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.

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

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.

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.

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.

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.

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