Table of Contents





UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-K


x
            Annual
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934
              For
      the fiscal year ended December 31,
2008




or


 ̈
            Transition
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934
              For
      the transition period from ______ to
______





Cyalume
      Technologies Holdings, Inc.(Exact
      name of registrant as specified in its
  charter)





Delaware
            
            000-52247
            
            20-3200738(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (Commission
      File Number)
            
            (I.R.S.
      Employer
              Identification
      No.)




96
Windsor Street, West Springfield, Massachusetts 01089


(address
of principal executive offices)  (Zip Code)




Registrant’s telephone
number, including area code:(413)
858-2500




Securities registered
pursuant to Section 12(b) of the Act: None




Securities registered
pursuant to Section 12(g) of the Act:




Title of each
      class
            Name of each exchange
      on which registeredCommon Stock, $0.001 par
      value
            Over-the-Counter
      Bulletin BoardCommon
      Stock Purchase Warrants
            Over-the-Counter
      Bulletin BoardUnits
      consisting of one share of Common Stock and one Common Stock Purchase
      Warrant
            Over-the-Counter
      Bulletin Board




Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.     Yes ̈Nox




Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act. Yes ̈Nox




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.                                             YesxNo ̈




Indicate by check mark if
disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of the registrant’s
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form
10-K. ̈




Indicate by check mark if the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer or a smaller reporting company. See the 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 ̈
            
            
            Smaller
      reporting company  x(Do
      not check if a smaller reporting company)




Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes ̈    Nox





The
aggregate market value of Common Stock held by non-affiliates of the registrant
(7,312,500 shares) based on the last reported sale price of the
registrant’s Common Stock on the OTCBB on June 30, 2008, which was the last
business day of the registrant’s most recently completed second fiscal quarter,
was $55,209,375. For purposes of this computation, all officers, directors, and
10% beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such officers,
directors, or 10% beneficial owners are, in fact, affiliates of the
registrant.




As of
March 24, 2009, there were outstanding 15,302,774 shares of the
registrant’s Common Stock, par value $.001 per share.




DOCUMENTS
INCORPORATED BY REFERENCE:





Portions
of the Registrant’s proxy statement for the 2009 Annual Meeting of Shareholders,
which is to be filed subsequent to the date hereof, are incorporated by
reference into Items 10 through 13 of this Form 10-K.









Table of Contents




CYALUME
TECHNOLOGIES HOLDINGS, INC.


ANNUAL
REPORT ON FORM 10-K


YEAR
ENDED DECEMBER 31, 2008





TABLE OF CONTENTS





Page
      No.Part IItem 1.
            Business
            3Item 1A.
            Risk Factors
            10Item 1B.
            Unresolved Staff Comments
            14Item 2.
            Properties
            14Item 3.
            Legal Proceedings
            14Item 4.
            Submission of Matters to a Vote of Security
      Holders
            14





Part IIItem 5.
            Market for Registrant's Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
            15Item 6.
            Selected Financial Data
            17Item 7.
            Management's Discussion and Analysis of Financial Condition
      and Results of Operations
            17Item 7A.
            Quantitative and Qualitative Disclosures About Market
      Risk
            24Item 8.
            Financial Statements and Supplementary
    Data
            24Item 9.
            Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure
            24Item 9A.
            Controls and Procedures
            24Item 9B.
            Other Information
            25





Part IIIItem 10.
            Directors, Executive Officers and Corporate
      Governance
            25Item 11.
            Executive Compensation
            25Item 12.
            Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
            25Item 13.
            Certain Relationships and Related Transactions, and
      Director Independence
            25Item 14.
            Principal Accountant Fees and Services
            26





Part IVItem 15.
            Exhibits and Financial Statement
    Schedules
            27SIGNATURES
            29







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PART I





The
statements contained in this annual report on Form 10-K, including under
the section titled "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and other sections of this annual 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 annual 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. These risks and
uncertainties include, but are not limited to, those factors described in the
section titled "Risk Factors." 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.





ITEM 1:    BUSINESS





Background




Cyalume
Technologies Holdings, Inc. (“Cyalume” or the “Company” and also f/k/a Vector
Intersect Security Acquisition Corp. (“Vector”)) is a Delaware corporation that
was incorporated on July 19, 2005 to acquire, through merger, capital stock
exchange, asset acquisition or other similar business combination, one or more
businesses in the homeland security, national security and/or command and
control industries or businesses relating to the manufacture of products for use
in such industries.






On
December 19, 2008, pursuant to the terms of a stock purchase agreement dated
February 14, 2008 and amended October 22, 2008, December 17, 2008 and December
18, 2008, we, through a wholly owned subsidiary, acquired all of the outstanding
securities of Cyalume Technologies, Inc. (“CTI”) from GMS Acquisition Partners
Holdings, LLC (“GMS”).  On that day, we filed a Fifth Amended and
Restated Certificate of Incorporation that, among other things, changed our name
to Cyalume Technologies Holdings, Inc., removed certain provisions that, giving
effect to Cyalume’s acquisition of CTI, were no longer applicable and folded the
acquisition subsidiary into Cyalume Technologies Holdings, Inc.





Pursuant
to the stock purchase agreement, at the closing of the acquisition, the
following consideration was paid by Cyalume:





·
            Repayment
      of $40.3 million of indebtedness of CTI, including $38.9 million in
      principal and $1.4 million in interest, prepayment penalties and other
      debt retirement expenses;·
            Payment
      of $425,000 of  unpaid acquisition expenses;·
            6,430,928
      shares of Cyalume’s common stock to the members of GMS;·
            $30.2
      million in cash to holders of GMS Acquisition’s Series A Preferred Units
      and Series B Preferred Units; and·
            $3,500
      to the escrow agent.




Pursuant
to the stock purchase agreement, as amended, 1,505,646 of the 6,430,928 shares
of Cyalume common stock paid to GMSat
the closing of the acquisition were deposited in escrow and 4,925,282 shares
were issued to GMS.  In March 2009, 138,165 additional shares were
issued to the 19 members of GMS at the direction of GMS pursuant to the working
capital provisions of the stock purchase agreement.




At the
closing, we also paid (i) SMH Capital, Inc. 150,000 shares of stock in lieu of
$1.2 million in cash due for a finder’s fee; (ii) $400,000 in fees to our
counsel; and, (iii) to Rodman & Renshaw, LLC in partial payment of $2.1
million of deferred underwriting expenses, $250,000 in cash and 93,750 shares of
common stock (which were returned on December 30, 2008 and exchanged with the
deferred underwriting fees for a note in the aggregate principal amount of $1.8
million) having an agreed-upon value of $750,000. We also agreed to pay $647,000
of the remaining acquisition expenses to counsel over a period of time after the
acquisition and to accept the liability for $425,000 of payments to GMS’
counsel.




On
December 19, 2008, Yaron Eitan resigned as President and Chief Executive Officer
and Isaac Applbaum and Marc Abramowitz resigned as directors. Also on December
19, 2008, Jason Epstein, Daniel Gaspar, Frank Kline, Yair Shamir and General
(Ret.) Jack Keane were appointed directors, Winston J. Churchill was appointed
Chairman of the Board, Yaron Eitan was appointed Vice Chairman of the Board,
Derek Dunaway was appointed President and Chief Executive Officer and Michael
Biekonko was elected Chief
Financial Officer.




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We
maintain our principal executive offices at 96 Windsor Street, West Springfield,
Massachusetts 01089. Our telephone number is 413-858-2500. Our website is
located at www.cyalume.com.
Through our website, we make available free of charge the various reports we
file with the SEC, including our annual reports on Form 10-K, our proxy
statements, our quarterly reports on Form 10-Q, and our current reports on Form
8-K. Our website also contains the charters for our Audit, Nominating and
Compensation Committees of the Board of Directors as well as our Code of Conduct
and Ethics and our Insider Trading Policy. The documents are also available free
of charge from our Corporate Secretary at our executive offices.





CTI’s
History and Current Business




We have
one subsidiary: Cyalume Technologies, Inc. (“CTI”). CTI is a Delaware
corporation formed on March 27, 1997 with headquarters also located in West
Springfield, MA. CTI has one subsidiary, Cyalume Technologies, SA (“CTSA”),
located in Aix- en-Provence, France.




CTI
primarily produces products based on a technology whereby light is generated
through a chemi­cal reaction, known as chemiluminescence. The base product
is known as a ‘‘light stick’’ and is typically 6 inches in length. A light stick
is a translucent flexible plastic tube that is partly filled with one chemical
ingredient and also with a glass container (‘‘ampoule’’) that contains a
complementary reactive chemical. When the tube is bent enough to break the glass
ampoule, the chemicals contained within the plastic tube mix and light is
generated. In addition, we also produce reflective (patches) and reflective plus
photoluminescent (fire tape) products, some of which incorporate infrared light
technology.




Chemiluminescent
products come in varying shapes and sizes, and provide light in different
colors, intensity and duration. Light sticks come in lengths ranging from 1.5
inches to 15 inches. Durations for speci­fied light output range from 5
minutes to 24 hours. In addition to light sticks, products include flat disks
employing a translucent aluminum pouch instead of an ampoule. These products
also come in different sizes and with adhesive backings (‘‘Tac-Glow’’). Colors
emitted include red, blue, white, yellow, green and orange. Additionally, both
light sticks and Tac Glow products can be produced to emit infrared light.
Reflective prod­ucts include patches that can reflect white light or
infrared, and safety belts. (See Product Applications for a discussion of the
many uses of these products.)




Products
are manufactured at both the West Springfield and Aix-en-Provence
locations.




The basic
research leading to today’s products took place during the latter part of the
1960’s by the U.S. Navy Lab at China Lake in concert with American Cyanamid
Corporation. By the early 1970’s, light sticks were being produced for military
applications, first with the U.S. Navy and soon after with the U.S. Army. In
1986, Omniglow Corporation was formed to produce and sell chemiluminescent
products. In 1993, Omniglow Corporation acquired the chemiluminescent
manufacturing business of American Cyanamid. On January 23, 2006 (effective
January 24, 2006), Omniglow Corporation was sold to GMS Acquisition Partners
Holdings, LLC. With this transaction, Omniglow Corporation was renamed Cyalume
Technologies, Inc.




Prior to
January 23, 2006, Omniglow Corporation manufactured and sold chemiluminescent
products into both the government/military and commercial markets. Products sold
into commercial markets included safety related products and novelty items
(e.g., children’s bracelets and necklaces for Halloween). To facilitate the sale
to GMS, Omniglow Corporation was divided into two divisions: the
govern­ment, military and safety business (which was sold to GMS and became
CTI) and the novelty business (purchased by GMS and immediately sold to certain
former Omniglow shareholders). Certain other miscellaneous assets and
liabilities, including receivables, payables and two small subsidiaries, were
distrib­uted to the former Omniglow shareholders.




Business
Strategy




Overall Approach:CTI has
developed a four pronged approach for ensuring long-term success.




·
            Patent Protection.CTI
      has and will continue to pursue patent protection of developed technology,
      and will continue to aggressively defend against violators of our patents.
      In support of this, CTI has been adding research and development
      capabilities the past two years and expects to continue doing so. CTI does
      not believe that direct competitors in the chemilumi­nescent field
      commit significant resources to research and development. By conducting
      research and development, we have a distinct competitive advantage in
      maintaining our market leading
position.




·
            Environmental Initiatives.As evidenced by the news media, governments and the public are
      becoming more and more concerned with the environment. Effective with the
      renewal of the contract with the NATO Maintenance and Supply Agency,
      (“NAMSA”), CTI offers a bio-degradable light stick according to NAMSA’s
      specifications in response to member countries’ concerns over landfill
      capacity. Also, California has passed a law banning the use of phthalates
      as a possible
      human health risk. CTI has launched or is in the process of launching
      several products to address current and future environ­mental
      concerns. These include: the 40 mm training round for the military that is
      non pyrotechnic and does not contain heavy metals; a bio-degradable light
      stick that is being introduced in conjunc­tion with the re-awarding of
      the NAMSA contract; and, a light stick that is phthalate free (also
      offered in the NAMSA
contract).






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·
            Product Diversification.CTI intends over the next several years to accelerate
      diversifica­tion into additional products and applications utilizing
      current technology and technology now under development. Product
      diversification will allow CTI to present a more complete line of products
      that are more up-to-date with user needs. As part of this process, CTI
      seeks to get customers such as the many militaries it serves, to upgrade
      their specifications. Additionally, product diversifi­cation may
      reduce CTI’s dependence on a small number of products for financial and
      competitive success. This also helps further distinguish CTI from
      competitors who do not focus on innovation to the same
    extent.




·
            Strategic Partnering.CTI actively seeks partners who can help CTI advance the technology
      or introduce products to the market. For example, for the 40mm training
      ammunition, CTI partners with Rheinmetall Waffe Munition, GmbH, a major
      global manufacturer of munitions and other products. CTI is actively
      pursuing additional calibers of training ammo with Rheinmetall. As another
      example, in the commercial safety sector, CTI is currently partnering with
      Brigham and Women’s Hospital, a prestigious hospital in Boston, MA, to
      develop medical products using CTI’s expertise in chemiluminescent
      light.




Markets




Our sales
are currently focused on three sectors: military, public safety (state and
municipal police and municipal fire departments) and commercial safety
(commercial distributors and retailers).




Within
the military sector, we envision that sales of training ammunition products will
eventually constitute a significant portion of our total revenues. For example,
while 2008 revenues from sales of our 40 mm training ammunition were $2.2
million, we believe that the training ammo market applicable to our product
offers an opportunity for revenue growth. Furthermore, the development of
additional calibers of training ammunition products over the next few years
should contribute to future sales.




Several
applications of chemiluminescent products for the medical sector are currently
in the development stage. These include the use of our products as an integral
part of a medical instrument as well as direct applications of our products
where certain wavelengths of the light spectrum play a direct role in
treatments. CTI, through a strategic medical partner, expects to begin clinical
trials on one application during 2009.




Existing
and established markets are subject to the following events, risks and
uncertainties that are critical to our business:




Military




·
            Chemical  —
      Critical events, risks and uncertainties regarding the chemical markets
      are: the continued renewal of the US and NATO contracts, the ability to
      remain on the cutting edge of chemical light technology for additional
      uses by various militaries around the world as well as managing costs to
      remain competitively priced. There are also uncertainties of future price
      increases customarily found in the renewal contracts which would affect
      revenues and results of operations.




·
            Ammunition
      — Critical events, risks and uncertainties regarding the ammunition market
      are: the expansion and acceptance of the existing product to other
      branches of the US military and to make inroads with other foreign
      militaries. The introduction of additional calibers is perceived as a
      vital opportunity to increase revenues and improve our results of
      operations over the long-term.




·
            Reflective
      — Critical to the recurring sales of reflective products is the continued
      inclusion of these products in the US and NATO contracts. A major risk and
      uncertainty is the ability to remain com­petitively priced while
      assuring production of quality, dependable
  products.




The
uncertainty of new products from competitors is always a risk that could dilute
our existing military market share of chemical and emergency light products as
well as the ammunition and reflective products.




Public
Safety




Management
views the public safety markets for chemical, ammunition and reflective products
as under-served. The critical risks and uncertainties in the market include the
continued introduction and promotion of products to police, fire and homeland
security departments. The ability to generate demand from potential customers is
the greatest factor in success or failure in this market.


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Commercial




The
Commercial market, being much more sensitive to pricing constraints, is subject
to higher risks and uncertainties than the military markets as margins are
stretched and customers may not return, but rather purchase goods for
distribution that are manufactured overseas. The consumer safety business is
subjected to the same pricing constraints, as well as the uncertainty of our
ability to market products and create demand.





For
additional risks refer to Item 1A Risk Factors.




Geographic
Expansion




We
currently sell our products in more than 25 countries outside of the U.S. We
believe that there are opportunities to increase sales to customers in these 25
countries as well as to acquire customers in other
countries.  Resources may be added in both the military and commercial
safety sectors to address these opportunities.




Sales
and Marketing




We define
ourselves as a manufacturer. For our military markets, the individual militaries
in effect serve as both as end-user and as distributors for our products to the
end-users (e.g., soldiers). We have found this to be an efficient and effective
model and are moving to better implement this model for the public and
commercial safety markets. Accordingly, in these two markets, we will be making
greater efforts to utilize the abilities of distributors who have established
key relations with end-users, rather than attempt to sell direct. The
distributors take deliveries from us and then resell our products through their
distribution networks to third-party customers, thereby expanding the market for
our products at minimal cost to us.




Regulations
prohibit companies from direct selling to soldiers, sailors, etc. to increase
product consump­tion.  CTI personnel provide training on utilizing
CTI’s products and thus are able to build demand by educating soldiers on how to
best utilize CTI’s products, with the products, in effect, selling themselves
based on their individual merit. By providing training, company personnel are
able to get first-hand feedback on the value of the products and use information
obtained to enhance existing products or create new ones.




Competitive
Strengths




CTI
believes it has many advantages as compared to competition. For example,
CTI:




·
            Owns
      more patents in the chemiluminescent light field than any
      competitor.




·
            Has
      an active research and development function focused on improving existing
      technologies and developing new ones for which patent protection will be
      obtained.




·
            Has
      a wide assortment of products that helps meet the needs of major customers
      such as the U.S. and NATO country militaries. These products are
      continuously enhanced or modified to meet the needs of current users such
      as the military troops in Afghanistan and
Iraq.




·
            Focuses
      on high quality, high performance products, while many of CTI’s
      competitors rely on lower pricing lower quality that do not meet military
      specifications.




·
            Has
      experienced personnel who have been active in the chemiluminescent field
      for a num­ber of years and who have developed the necessary expertise
      to support the achievement of our
objectives.




Customers




We sell
our products for military, commercial and public safety applications. We do not
sell any of our products as novelties.




•
            Military:For 2008, over
      90% of our total revenues were attributable to sales to the
      militar­ies of the U.S. and to the militaries of over twenty other
      countries, including the NATO member countries. Our business depends
      significantly on two key customers: the United States Department of
      Defense (“US DOD”) and the N.A.T.O. Maintenance and Supply Agency
      (“NAMSA”). These two key customers accounted for 68% and 69% of the
      Predecessor’s net revenues in the period ended December 19, 2008 and the
      year ended December 31, 2007, respectively. We sell to the US DOD and
      NAMSA under three contracts, discussed below, each of which accounted for
      more than 10% of total revenues in 2008. No other contracts or customers
      accounted for more than 10% of total rev­enues for
    2008.




•
            CTI
      has a direct contract with the U.S. DOD, referred to as the ‘‘40 Item
      Contract,’’ which was entered into on July 7, 2004. The 40 Item Contract
      had an initial term of two years with three one-year renewal terms. After
      the expiration of the initial two-year term, the 40 Item Contract was
      renewed in each of July 2006, 2007 and 2008. The current
      exten­sion provides a 2.5% price increase. Pursuant to this contract
      CTI is required to supply an indefinite quantity of 40 separate items to
      the U.S. military at a fixed price, subject to adjustment for certain
      economic factors. Each of these 40 items is classified by a National Stock
      Number (“NSN”). CTI believes that it is the only company that manufactures
      these 40 items to the U.S. military’s
    specifications.


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·
            CTI
      also supplies the U.S. DOD with 17 separate items through an agreement
      with LC Industries (‘‘LCI’’), a member of the National Industries for the
      Blind, under the program guidelines of the Javits/Wagner/O’Day Act of
      Congress (JWOD), a federal program that creates jobs for the blind and
      severely disabled. Under CTI’s agreement with LCI, CTI sells components
      for the 17 items to LCI, which assembles and packages the items and then
      sells them directly to the U.S. military under a supply contract (the ‘‘17
      Item Contract’’). Each of these 17 items is also represented by a NSN and
      CTI believes that it is the only com­pany to manufacture the products
      to the U.S. military’s specifications. CTI’s contract with LCI was entered
      into June 1, 2004 and has an initial term of five years, followed by three
      automatic five-year renewal terms unless the agreement is cancelled. The
      17 Item Contract between LCI and the U.S. military is also a fixed price,
      indefinite quantity contract with eco­nomic price adjustments. Under
      CTI’s contract with LCI, CTI has been granted the right to have
      substantial input on all matters related to pricing with respect to the 17
      Item Contract between LCI and the U.S.
military.




·
            Through
      CTSA, our subsidiary in France, CTI has a direct contract with NAMSA, the
      administrative services arm serving the non-U.S. NATO countries. Effective
      August 2008, CTSA renewed our contract with NAMSA. The base contract
      period is three years and there are options to extend for another two
      years.




·
            Public Safety:Our
      public safety sales include various municipalities’ police and fire
      depart­ments. In 2008 and 2007, sales in this category were under $1.0
      million, less than 2% of total revenues. Longer term, we expect that this
      category will experience significant growth as more resources are added to
      support sales efforts.




·
            Commercial Safety:Sales
      in this category are made to a number of distributors and retailers.
      Commercial safety sales were $3.8 million and $4.8 million in 2008 and
      2007, respectively, or 9.3% and 12.2% of total
  revenues.




Product
Applications




Chemiluminescent Products:Our
chemiluminescent products are used in support of military operations in
peacetime to support training and in live theater (i.e., wartime) to support
battle engagements. Applications include: the nighttime marking of drop and
landing zones, marking trails at night, triage marking of wounded soldiers, and
light for general illumination purposes.




The
following are some of the unique product attributes that make our
chemiluminescent products well suited for military use:




·       highly
reliable for light production after periods of storage of up to four
years,




·       provide
up to a 360 degree field of illumination,




·       highly
portable, waterproof and require no electrical source to work, and




·       safe
to use and non-toxic.




Beginning
in the second half of 2006, we began production of chemiluminescent products
provid­ing day/night marking and illumination as components of training
ammunition. Day/night marking rounds used as training ammunition increases the
effectiveness of weapons training by providing a night-time training ability
where, in many cases, one did not exist before. Chemical light training
munitions are preferable to traditional tracer or training rounds for two
reasons. Traditional tracer or pyrotechnic training munitions contain fire
producing elements that often start range fires. Additionally, traditional
tracer or pyrotechnic training munitions often experience ‘‘duds’’ or unexploded
rounds. These unexploded rounds present future safety hazardous and must be
found and defused. Chemical light training munitions cannot start range fires
and do not present future safety hazards from unexploded rounds. CTI currently
partners with a muni­tions company to manufacture and sell the 40mm training
ammunition to militaries, and has entered into agreements with other munitions
makers for various other sizes of training ammunition, which are expected to be
placed into service over the next five years.




In the
commercial safety markets, our products provide sources of light in emergency
situations and for general safety purposes. For example, a customer can purchase
a CTI product with assurance it can sit on the shelf for up to four years and
still work when needed in the event of a power outage. For marine and boating
purposes, we manufacture two specific products to meet the safety needs of
boaters. The first product is a base PML (personal marker light), which is a
chemiluminescent light stick, that is attachable to life jackets and can be
easily illuminated in an emergency situation within U.S. coastal waters. The
second product is a SOLAS PML (Safety of Life at Sea certification) that can be
used by boaters, workers on off-shore oil platforms and in other maritime
situations outside U.S. coastal waters. The SOLAS PML contains a battery powered
light emitting device that automatically activates when it hits the ocean waters
and a light stick. Both the chemiluminescent light sticks used in the PML and
SOLAS PML, and the
electric light used in the SOLAS PML, provide a higher degree of assurance of
being located for rescue purposes.




Reflective Products:Our
reflective products assist the military by allowing soldiers to identify
individuals as a ‘friend or foe’ by employing infrared technology. These
infrared products such as flag and general identification patches can only be
seen with the proper night vision goggles. These products help prevent injuries
and death due to friendly fire by providing the proper identification markings
during night activities. CTI also produces safety belts that are worn, for
example, by military police. These belts both reflect direct light back and
retain light energy for a short period of time so they continue to ‘‘glow’’
after the light source is removed.




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In the
commercial safety markets, our reflective products primarily serve police and
fire depart­ments. Personnel of these public services wear our products such
as safety belts and patches to adequately highlight themselves in the face of
traffic, and so they can be better seen in emergency situations such as in a
burning building.




Competition




For
chemiluminescent products for the U.S. and non-U.S. NATO member country military
markets, CTI believes that it has no direct competitor. For these two markets we
believe that our products are the only ones being produced in the U.S. and
Europe that currently meet official military specifications. There are several
Asian manufacturers of novelty quality products that occasionally attempt to
direct sell their products as military quality, including the fraudulent use of
military stock numbers that are placed on the products which have not passed
testing. In these cases CTI relies on the appropriate U.S. and NAMSA agency
offices to inspect and reject such products as being non-compliant. We maintain
an active program of monitoring this situation and bringing any such
transgressions to the attention of the appropriate agency
personnel.




With
other military products, such as the 40 mm training ammunition, the development
period before final testing and acceptance by the military can be many years. We
do not believe that any of our direct or indirect competitors are investing in
the research and development necessary to bring a new product, such as the 40 mm
training ammunition, successfully to market. It is more likely that these
competitors will attempt to reverse engineer our products. CTI defends against
this by continuing to invest in technology upgrades in order to stay ahead of
the competitors. In addition, CTI files, where appropriate, patents to protect
newly developed technology. Also, we review all products submitted by
competitors in Military contract bidding processes to determine whether they
meet specifications. With regard to reflective products, there are several
businesses which have competed against us in the past and are expected to
compete against us from time to time depending on the stringency of the product
specifications.




In the
commercial safety markets, we compete with manufacturers of novelty products and
several other manufacturers. While these manufacturers appear to lack the
quality, market presence and ability to upgrade existing products, customers in
these markets may seek lower prices without consideration for these other
factors. Competitors include: Lumica (Japan), Tianjin Dragon (China), Bandi
(Korea), Jow Tung (China), Beijing Brite (China), and Ameriglo (U.S. based
company purchasing Chinese products).




Employees




As of
December 31, 2008 we had 202 employees of which 9 were temporary employees.
Temporary employees are used to manage peaks in production and represent
entry-level positions. After sufficient expertise and experience is acquired,
temporary employees can achieve permanent status. We operate in local labor
markets that provide an adequate supply of labor to compensate for any turnover.
CTI is not party to any collective bargaining agreements, has not experienced
any work stoppages and considers our relationship with employees to be
sound.




On March
6, 2009, as a result of both the weak economy and first quarter sales, we
discontinued our second manufacturing shift in West Springfield and reduced our
workforce to 154 employees.




Employee
Benefits




CTI
offers permanent employees wages and benefits that we consider to be competitive
in the markets in which we operate. Benefits include medical, dental, life, and
disability insurance coverage, paid vacations and holidays and an employee
401(k) savings plan.




Supply
Chain




CTI
purchases key raw materials, primarily chemicals, plastics, glass and packaging
materials from a limited number of suppliers. CTI has long-term relationships
with these suppliers, and maintains annual purchase orders or, in the case of
major chemicals, has a ten year contract in place which does not expire until
2012. In the event of a disruption in the supply of any of the key items, CTI
has identified
alternative sources of supply. A stock of raw materials is kept on hand to
continue production of CTI’s products for up to six to nine months in the event
of supply disruptions. Raw materials are not considered to be a scarce commodity
and we have not experienced supply disruptions in the past.




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The West
Springfield facility purchases most of chemicals from China. Nearly all other
materials forming finished goods, including plastics and glass, are purchased
domestically. The Aix-en-Provence facility purchases most chemicals from the
West Springfield facility after they have been modified for specific
applications. Glass, plastics and most other materials are purchased from within
the European community.




Research
and Development





CTI has
an active research and development department that operates out of the West
Springfield headquarters and has chemists and engineers on staff and consulting
chemists under contractual arrangements who specialize in chemiluminescent and
reflective light technology. CTI’s research and development group is focused on
maintaining the high level of quality of existing products; researching and
developing improvements to existing products; and, researching and developing
new technologies and products with viable commercial applications. CTI maintains
an active program of soliciting feedback and ideas from end-users of products.
This is especially true for military applications where CTI has developed
several notable improvements to products being used by military personnel in
live theater application. CTI incurred research and development costs of $1.3
million and $1.4 million during the years ended December 31, 2008 and 2007,
respectively.





Intellectual
Property





CTI
relies on the ability to develop patentable technology to help ensure the
commercial success of products and technology. Once patents are issued, we
follow an active program of monitoring competitors’ products to ensure that our
intellectual property is not violated. CTI currently holds and maintains 33
active U.S. patents, many of which are registered in certain foreign countries.
These include a chemiluminescent formula for the color red, formulas for
creating a more consistent light for longer periods, a bio-degradable light
stick, and reflective tape that not only reflects light but retains light energy
and emits light after the initial light source is removed. CTI expects to file
additional patents during 2009 and regularly thereafter. Patents typically have a
20-year life from date of filing. There were no key patents that expired in
2008.We do
not anticipate a near-term decline in our sales as a result of any expiring
patents.  We have one patent expiring in 2009 and we do not believe the
sales of the product will be adversely affected by competitors producing and
selling a similar product.





Government
Regulations





CTI is
subject to the jurisdiction of the State Department of the United States under
the International Traffic in Arms Regulations (ITAR). Specifically, CTI’s
infrared products, which are exported from the West Springfield facility to
foreign militaries, are subject to these regulations. CTI must periodically
re-register with the State Department for exporting purposes and last did so in
June 2007. The renewal, which was granted, expires June 30, 2009 and is subject
to renewal again at that time. CTI is in good standing with the State Department
and the ITAR. CTI must obtain approval from the State Department for each and
every export shipment of infrared products.





Environmental





We are in
compliance with all local, state and national environmental regulations under
which it is subject to regulation. The cost of compliance with environmental
regulations has been and is expected to continue to be negligible.





Backlog





CTI does
not maintain a meaningful backlog per se. Due to the nature of our products,
many are sold under indefinite quantity type contracts whereby we fulfill orders
as they are placed by customers.





Dividends





We have
never declared or paid cash dividends on our capital stock and do not anticipate
declaring or paying cash dividends on our common stock in the foreseeable
future. Payments of future dividends on our common stock, if any, will be at the
discretion of our board of directors after taking into account various factors,
including our financial condition, operating results, current and anticipated
cash needs, plans for expansion and other factors that our board of directors
may deem relevant. In addition, our credit facility places limitations on our
ability to pay dividends on our common stock.




Segments





We have
only one segment for financial reporting purposes under accounting principles
generally accepted in the United States.




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ITEM 1A.    Risk Factors




Budget
constraints of the federal or foreign governments could reduce our
revenue.




Contracts
for which federal or foreign governments and militaries thereof are the ultimate
customer, accounted for more than 90% of our business in 2008. Budget reductions
or spending constraints affecting military spending could cause delays, reduce
the scope of, or result in cancellations of orders for products, which could
reduce our revenues.




CTI’s
failure to obtain and/or maintain required export and other licenses could
reduce our revenue.




A portion
of CTI’s business depends upon obtaining and maintaining required export
licenses. Failure to obtain or maintain required licenses could result in the
termination of certain of products being sold. In addition, CTI and/or our
employees may be required in the future to maintain certain facility security
clearances. If CTI or our employees were found not to be in compliance, CTI
could be excluded from bidding on certain contracts, removed from projects
and/or fined, all of which would adversely impact our financial condition and
good standing.




CTI
operates under fixed price contracts and failure to accurately control costs may
reduce profitability.




Much of
CTI’s revenues result from fixed price contracts. Unanticipated increases in the
cost of raw materials, labor and overhead could result in less profitability for
CTI on such contracts.  Some of CTI’s raw materials are affected by
the prices of other commodities that are not under the control of
CTI.  These include certain chemicals and plastics whose costs are a
function of oil prices.  Another example is the cost of electricity,
which CTI needs to operate manufacturing processes and over the cost of which we
have no control.




Several
of CTI’s military contracts include provisions for annual price escalations,
based on bench-marks such as the consumer price index or the producers’ price
index. Annual escalations received may or may not correlate exactly to the price
changes in the materials and services that CTI purchases.




If
CTI is unable to design, manufacture, and market product offerings in a timely
and efficient manner, we may not remain competitive.




Some of
CTI’s markets are characterized by continuing technological advancement, changes
in customer requirements, and evolving product
standards.  Accordingly, CTI devotes a substantial amount of resources
to product development. To compete successfully, CTI must develop and market new
products that provide increasingly higher levels of performance and reliability.
Product development is highly uncertain and CTI cannot guarantee that it will
successfully develop new products. CTI’s inability to develop and market these
products or to achieve customer acceptance of these products could limit our
ability to com­pete in the market or to grow revenues at desired rates of
growth.




In
addition, CTI offers a wide variety of products. If the design, manufacturing or
marketing of a product, or products, is not successful and CTI must allocate
more resources to ensure the products’ success, it could lower the profitability
of the product, or products, or affect customer perceptions as to the quality of
the products and services being offered.




CTI
purchases the majority of raw materials from a limited number of venders. A
disruption in supply may cause delays in manufacturing.




The
majority of chemicals, plastics and glass are purchased from a limited number of
venders. A disruption in supply from any of these venders could affect CTI’s
ability to manufacture finished goods for sale on a timely basis. CTI maintains
a safety margin of inventory of these raw materials to rely on in the event of a
disruption. However, CTI may not maintain an adequate safety stock in the event
of an extensive disruption.




Changes
in foreign currency exchange rates could affect our financial
results.




CTI
manufactures and sells products from both the U.S. and France. Products sold
from the U.S. are priced in U.S. dollars and most raw material components are
purchased in U.S. dollars. Products sold from France are priced predominantly in
euros and most raw material purchases are priced in euros, although some of
France’s materials are purchased from the U.S. parent company in U.S. dollars.
Significant changes in foreign exchange rates will affect reported financial
results. In the first quarter of 2009 CTI began entering
into financial hedges against currency risk through short-term hedges (less than
six months in duration) relating to the billing and collection of revenues from
the sale of products to CTSA from the U.S. manufacturing site.




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CTI
is subject to various government regulations that could cause delays in the
delivery of new products and may subject the Company to audits or other similar
review processes.




As a
supplier to agencies of various federal, state and local, and foreign
governments, CTI is obli­gated to comply with a variety of regulations
governing operations and the workplace. Unforeseen problems may impact CTI’s
ability to bring new products to market on a timely basis, secure new contracts
or require it to make potentially costly changes to operations which could
reduce profitability in order to obtain contracts. Furthermore, some of CTI’s
new products have been developed in conjunction with the U.S. Military, which
largely dictates the timing of the product development process and over which
CTI has limited control.




Inability
to effectively integrate future acquisitions could reduce
profitability.




While no
specific acquisitions are being contemplated as of the date this prospectus,
Cyalume plans to make a number of acquisitions in future years, which will
require that it integrate operations and systems and personnel from those
businesses into CTI. This process requires, among other things, that CTI
continually evaluate operational and financial systems and controls and enhance
those sys­tems and controls as necessary. If CTI is unable to successfully
integrate these acquisitions, it could reduce profitability and detract from
future growth opportunities.




CTI
may need additional financing for working capital, capital expenditures, and to
finance future acquisitions, and any such additional financing may not be
available on favorable terms.




In order
to operate and grow the business, CTI may need to obtain additional working
capital, make significant capital expenditures, or finance an acquisition. In
order to do any of those things, CTI may need to obtain additional capital.
Therefore, CTI’s ability to operate and grow is dependent upon, and may be
limited by, among other things, the availability of financing arrangements. If
CTI is not able to obtain the additional capital necessary to pursue new
projects or maintain operations we may not be able to grow as quickly as it
plans. In addition, even if CTI is able to obtain additional financing, the
additional financing may not be on terms which are favorable to CTI and could
hamper profitability.




CTI
is reliant upon key personnel and the loss of key personnel could result in the
deterioration or loss of relationships with certain customers or suppliers,
which could result in a loss of business.




CTI
depends on the expertise, experience and continued services of senior management
and key employees. CTI’s operations and most decisions concerning the business
of CTI will be made or significantly influenced by such individuals. The loss of
members of senior management or key employees could result in the deterioration
or loss of relationships with certain customers or suppliers, which could result
in a loss of business for CTI.




CTI’s
quarterly revenue, operating results and profitability will fluctuate, which may
lead to volatility in the market price of Cyalume’s common stock.




CTI’s
revenue, operating results and profitability will likely fluctuate. Changes in
sold product mix and the timing of sales by customers, together or individually,
may contribute to the material variability of CTI’s quarterly revenue, operating
results or profitability. Such volatility may not meet the expectations of
management, securities analysts or investors, which in turn may result in
significant fluctuations in the market price of Cyalume’s common
stock.




CTI’s
quarterly revenue, operating results and profitability may be reduced by any
major redeployment of the troops stationed in Iraq.




Many of
CTI’s military products are used both for training and live theater purposes.
Generally, per capita soldier consumption of these products is relatively
consistent between the two purposes.  President Obama has stated his
intentions to reduce the number of American military personnel on the ground in
Iraq. Any major troop realignments/reductions in the forces in Iraq, if
significant enough in number, could result in a tempo­rary reduction in
overall product consumption until troops are redeployed for training or another
live theater application.




CTI
operates in increasingly competitive market segments, which may make it more
difficult for CTI to successfully bid on contracts in the future.




CTI
expects competition to increase in the future. CTI also expects that some
competi­tors, or potential competitors, will feel increasing pressure to
underbid government and commercial projects, in order to deploy their workforces
and maintain or step up their activity levels. This may make it more difficult
for CTI to prevail on competitive bids for projects to the degree CTI has
historically enjoyed, to increase revenue, and to maintain
profitability.




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Most
of CTI’s new contracts will likely be subject to competitive bidding, which adds
difficulty to accurately predicting the timing of sales and the allocation of
resources.




Most
governmental agencies and many commercial customers require that their
significant contracts be competitively bid. Typically they utilize the ‘‘Request
for Proposal’’ (RFP) method where several competitors submit their sealed
proposals for a particular project, or the ‘‘Request for Qualifications’’ (RFQ)
process where competitors submit their qualifications for consideration by the
customer. Some contracts open for bidding utilize the standard ‘‘Straight Bid’’
process where the detailed specifications for products are published and lenders
submit a ‘‘Bid’’ or fixed price, for the contract. Other competitive bidding
processes are also utilized. CTI’s success in responding to an RFP, RFQ,
Straight Bid, or other competitive bidding process is depen­dent upon the
quality of our estimating process, knowledge of the industry, knowledge of our
customers and other factors requiring significant judgment and expertise.
Because of the nature of the bidding process, CTI cannot know if we will be
successful on any given bid, which adds difficulty to accurately predicting the
timing of sales and the allocation of resources.




CTI’s
ability to win new contracts depends on factors outside our control, the
inability of which to obtain would limit our growth.




CTI’s
growth is generally dependent upon the ability to win new contracts. This
depends on a num­ber of factors CTI cannot control, including substitution
of CTI’s products with products based on an alternative technology. For example,
currently, certain battery or electrically powered products may be used as
alternatives to some of CTI’s products.




Governmental
agencies may investigate and audit CTI’s contracts and, if any improprieties are
found, CTI may be required to refund revenues, pay unexpected taxes, forego
anticipated revenues and/or may be subject to penalties and sanctions, including
prohibitions on CTI’s bidding in response to competitive bidding
processes.




Governmental
agencies generally have the authority to audit and investigate CTI’s contracts
with them. As part of that process, some governmental agencies may review CTI’s
performance on the contract, pricing practices, change orders, and compliance
with the terms of the contracts, and applicable laws, regulations and standards.
If the agency determines that CTI has improperly billed the governmental entity
in violation of the terms of the contract, CTI could be required to refund
revenues, or forgo antici­pated revenues. If a government audit uncovers
improper or illegal activities by CTI, or CTI otherwise determines that these
activities have occurred, CTI may be subject to civil and criminal penalties and
administrative sanctions, including termination of contracts, forfeitures of
profits, suspension of payments, fines and suspension or disqualification from
doing business with the government.




If
CTI fails to satisfy contractual obligations, CTI’s ability to compete for
future contracts could be limited.




CTI’s
failure to comply with contract requirements or to meet customer’s performance
expectations when fulfilling a contract could injure CTI’s reputation, which, in
turn, could impact CTI’s ability to compete for new contracts. CTI’s failure to
meet contractual obligations could also result in substantial lost
revenues.




CTI
was not required to be compliant with the provisions of the Sarbanes-Oxley Act
prior to the Aquisition, and therefore has not determined if we are compliance
with the Act, which may lead to financial records being improperly
maintained.




CTI is
currently taking steps to determine what, if any, changes need to be made to
become compli­ant with the provisions of the Sarbanes-Oxley Act of 2002 that
relate to management’s assessments and certifications regarding internal
controls over financial reporting. Although CTI currently maintains disclosure
controls and procedures and internal controls over financial reporting, it is
currently assessing those controls to ensure that such controls will comply with
the rules applicable to public companies, including (1) that the controls
satisfy the requirements of the control framework to which Cyalume has chosen to
adhere (the Committee of Sponsoring Organizations of the Treadway Commission’s
Internal Control — Integrated
Framework),(2) developing a system of gathering and maintaining evidence
to support management’s assessment of disclosure controls and procedures and
internal controls over financial reporting and (3) assessing the internal
controls over financial reporting at CTI’s wholly-owned subsidiary in
France.




CTI may
be unsuccessful in resolving pending litigation relating to contractual disputes
with Omniglow, LLC, which could result in CTI having to pay damages to Omniglow,
LLC. Omniglow, LLC purchased the novelty business of CTI’s predecessor on
January 23, 2006. Omniglow, LLC is a separate entity from the organization of
former stockholders of Omniglow Corporation and this litigation is distinct from
the litigation that was settled in January 2008.





CTI is in
the process of resolving pending litigation relating to several contractual
disputes arising from the separation of our businesses from Omniglow, LLC. If
CTI is not successful in settling the litigation and if CTI does not prevail on
the merits of the case, then a judgment may be entered against CTI, which could
require it to pay damages to Omniglow, LLC. Omniglow, LLC seeks compensatory
damages of $1.4 million, to be trebled, and, recovery of costs and legal fees.
CTI believes Omniglow, LLC’s claims to be without merit. CTI has filed for
damages of $368,000.




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Because
Cyalume does not intend to pay dividends on common stock, stockholders will
benefit from an investment in our common stock only if it appreciates in
value.




Cyalume
has never declared or paid any cash dividends on common stock. Cyalume currently
intends to retain all future earnings, if any, for use in the operations and
expansion of the business. As a result, we do not anticipate paying cash
dividends in the foreseeable future. Any future determination as to the
declaration and payment of cash dividends will be at the discretion of Cyalume’s
Board of Directors and will depend on factors our Board of Directors deems
relevant, including among others, our results of operations, financial condition
and cash requirements, business prospects, and the terms of our credit
facilities and other financing arrangements. The debt financing arrangements
Cyalume put into place in connection with the acquisition of CTI prohibit CTI
from providing Cyalume with funds to pay a dividend. Accordingly, realization of
a gain on stockholders’ investments will depend on the appreciation of the price
of our common stock. There is no guarantee that our common stock will appreciate
in value.




Our
securities are quoted on the Over-the-Counter Bulletin Board, which may limit
the liquidity and price of our securities more than if the securities were
quoted or listed on the NASDAQ market.




Our
securities are quoted on the Over-the-Counter Bulletin Board, a NASD-sponsored
and operated inter-dealer automated quotation system. Quotation of Cyalume’s
securities on the Over-the-Counter Bulletin Board will limit the liquidity and
price of securities more than if the securities were quoted or listed on
NASDAQ.




Cyalume
currently has a small number of beneficial holders, which may result in limited
trading and also limit the liquidity and price of
securities.  Furthermore, this may result in unexpected price
volatility.




If
CTI fails to meet financial covenants with our senior lender, the lender would
be able to declare an event of default.




If CTI
were unable to meet the financial covenants specified in the senior loan
documents, the senior lender would be able to declare an event of default. If an
event of default were declared, all of CTI’s debts to the senior lender would
become due and payable immediately, which could result in our ceasing operations
unless new arrangements were made. The terms of our loan with our senior lender
are described more fully in the Section titled “Management’s Discussion &
Analysis of Financial Condition and Results of Operations.”




Cyalume
may choose to redeem outstanding warrants at a time that is disadvantageous to
the warrant holders.




Subject
to there being a current prospectus under the Securities Act of 1933, Cyalume
may redeem all outstanding warrants at any time after they become exercisable at
a price of $.01 per warrant, upon a minimum of 30 days prior written notice of
redemption, if and only if, the last sale price of our common stock equals or
exceeds $11.50 per share for any 20 trading days within a 30 trading day period
ending three business days before Cyalume sends the notice of redemption.
Calling all of our outstanding warrants for redemption could force the warrant
holders:




§
            To
      exercise the warrants and pay the exercise price for such warrants at a
      time when it may be disadvantageous for the holders to do
    so;




§
            To
      sell the warrants at the then current market price when they might
      otherwise wish to hold the warrants;
or




§
            To
      accept the nominal redemption price which, at the time the warrants are
      called for redemption, is likely to be substantially less than the market
      value of the warrants.




Our
warrant holders may not be able to exercise their warrants, which may create
liability for Cyalume.




Holders
of the warrants we issued in our initial public offering and private placement
will be able to receive shares upon exercise of the warrants only if (i) a
current registration statement under the Securities Act of 1933 relating to the
shares of common stock underlying the warrants is then effective and (ii) such
shares are qualified for sale or exempt from qualification under the applicable
securities laws of the states in which the various holders of warrants reside.
Although we have agreed to use our best efforts to maintain a current
registration statement covering the shares underlying the warrants to the extent
required by federal securities laws, and we intend to comply with such
agreement, we cannot assure that we will be able to do so. In addition, some
states may not permit us to register the shares issuable upon exercise of
warrants for sale. The value of the warrants will be greatly reduced if a
registration statement covering the shares issuable upon the exercise of the
warrants is not kept current or if the securities are not qualified, or exempt
from qualification, in the states in which the holders of warrants reside.
Holders of warrants who reside in jurisdictions in which the shares underlying
the warrants are not qualified and in which there is no exemption will be unable
to exercise their warrants and would either have to sell their warrants in the
open market or allow them to expire unexercised. If and when the warrants become
redeemable by us, we may exercise our redemption right even if we are unable to
qualify the underlying securities for sale under all applicable state securities
laws. Since our obligations in this regard are subject to a ‘‘best efforts’’
standard, it is possible that, even if we are able to successfully assert a
defense to a claim by warrant hold­ers due to the impossibility of
registration, a court may impose monetary damages on us to compensate warrant
holders due to the change in circumstances that led to our being unable to
fulfill obligations.




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ITEM 1B.    UNRESOLVED STAFF
COMMENTS





None.




ITEM 2.    PROPERTIES





Cyalume
owns the West Springfield, MA facility which houses all corporate functions,
including research and development. The facility is located in an industrial
area and has 200,000 square feet of office, manufacturing and warehousing space.
There is adequate space available in the facility to accommodate an increase in
operations and staffing. The facility sits on ten acres of land in an industrial
area. There are no known matters of ground contamination or air quality
discharges that exceed acceptable limits. The facility is older and contains
asbestos, which is consistent with buildings of its era, but there is no known
damaged asbestos requiring remediation. The facility is subject to inspections
by various environmental agencies from time to time and no significant
violations of any environmental standards have been noted during the period of
ownership by the current or predecessor owners. Environmental violations are not
believed to represent a material risk. The headquarters is subject to a
mortgage.





The
facility in Aix-en-Provence, France is also owned by Cyalume and houses all
foreign operations. The facility has 10,000 square feet of office and
manufacturing space sitting on two acres and is in good condition. There are no
known environmental violations pertaining to the facility and, environmental
violations are not believed to represent a material risk. The facility is
collateral for outstanding notes payable.




ITEM 3.    LEGAL PROCEEDINGS





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





CTI is
currently named a defendant in Civil Action No. 06-706 in Superior Court of the
State of Massachusetts. Filing suit against CTI is Omniglow, LLC (the former
novelty business of CTI which was sold on January 23, 2006). CTI sold certain
assets and liabilities related to the novelty and retail business to certain
former shareholders and management (the “Omniglow Buyers”).  This was
done because CTI sought to retain only the Omniglow Corporation the business
activities associated with 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 seek compensatory damages of $1.4 million, to be trebled, and
recovery of costs and legal fees. CTI has filed for damages of $368,000 against
the Omniglow Buyers.  CTI continues to rigorously defend our position
on these matters, as we believe the Omniglow Buyers’ claims to be without merit.
Court hearings were held and completed in October 2008. A decision is expected
in late 2009.




ITEM 4:    SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS





On
December 19, 2008 a special meeting of stockholders of Cyalume was held to vote
upon the following three items:





-
            Proposal 1: The proposed
      acquisition by a wholly-owned subsidiary of Cyalume of all the outstanding
      securities of CTI and the transactions contemplated by the stock purchase
      agreement dated February 14, 2008 and amended October 22, 2008 and again
      on December 17 and December 18, 2008, among Cyalume, a wholly-owned
      subsidiary and the sole stockholder of CTI
  (GMS).


-
            Proposal 2: Amending
      Cyalume’s (f/k/a Vector) Fourth Amended and Restated Certificate of
      Incorporation to change Vector’s name to
  Cyalume.


-
            Proposal 3: Amending
      Vector’s Fourth Amended and Restated Certificate of Incorporation to
      remove those provisions regarding certain procedural and approval
      requirements applicable to Vector prior to the consummation of a business
      combination that will no longer be operative upon consummation of
      CTI.





There
were 9,368,750 shares of common stock outstanding on the record date of November
28, 2008 and 8,801,427 shares of common stock present at the special meeting in
person or represented by proxy, which was 93.94% of total outstanding shares and
thus representing a quorum.




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Regarding
item number one, pursuant to Vector’s Fourth Amended and Restated Certificate of
Incorporation, Vector was required to obtain a majority of the votes in favor of
the proposal and fewer than 20% of the public stockholders must have elected to
redeem their shares. There were 7,645,830 shares voted in favor of the
acquisition, which was 86.87% of the total. 1,011,297 shares voted against the
acquisition, of which 989,647 shares then elected to redeem their shares;
therefore, item number one was approved.





Summary
of Votes at December 19, 2008 Special Meeting of Stockholders





Number
      of Votes “For”
            
            
            Percentage
            
            
            Votes
      “Against”
            
            
            “Abstain”
            
            ResultProposal
      1
            
            
            7,645,830
            
            
            
            86.87
            %
            
            
            1,011,297
            
            
            
            144,300
            
            ApprovedProposal
      2
            
            
            7,640,930
            
            
            
            81.56
            %
            
            
            1,014,697
            
            
            
            145,800
            
            ApprovedProposal
      3
            
            
            7,638,930
            
            
            
            81.54
            %
            
            
            1,014,697
            
            
            
            147,800
            
            Approved





Proxies
for the meeting were solicited pursuant to regulation 14A under the Act.
Information pertaining to this special meeting is contained in Form 14A filed
December 3, 2008; Forms A14A filed December 16 and 18, 2008; and Forms 8-K filed
December 18 and 23, 2008; Forms 8-K filed January 7 and February 10, 2009; and
Form 8-K/A filed January 8, 2009.




PART II




ITEM 5:    MARKET FOR REGISTRANT'S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES





Market
Information





Our
common stock, warrants and units, are quoted on the Over-the-Counter Bulletin
Board under the symbols ‘‘CYLU,’’ ‘‘CYLUW,’’ and ‘‘CYLUU,’’ respectively. The
units have been quoted on the Bulletin Board since May 1, 2007 and the common
stock and warrants since July 9, 2007. Our securities did not trade on any
market or exchange prior to May 1, 2007. The following table sets forth the high
and low sales information for our units for the period from May 1, 2007 through
March 24, 2009 and our common stock and common stock purchase warrants for the
period from July 9, 2007 through March 24, 2009. The Over-the-Counter Bulletin
Board quotations reflect inter-dealer prices, are without retail markup,
markdowns or commissions, and may not represent actual
transactions.





Common
      Stock
            
            
            Warrants
            
            
            UnitsHigh
            
            
            Low
            
            
            High
            
            
            Low
            
            
            High
            
            
            LowFirst
      quarter 2007
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Second
      quarter 2007
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            8.10
            
            
            $
            7.62Third
      quarter 2007
            
            $
            7.46
            
            
            $
            7.28
            
            
            $
            1.07
            
            
            $
            0.79
            
            
            $
            8.50
            
            
            $
            8.10Fourth
      quarter 2007
            
            $
            7.45
            
            
            $
            7.32
            
            
            $
            0.97
            
            
            $
            0.66
            
            
            $
            8.25
            
            
            $
            8.10First
      quarter 2008
            
            $
            7.55
            
            
            $
            7.40
            
            
            $
            0.68
            
            
            $
            0.23
            
            
            $
            8.10
            
            
            $
            7.70Second
      quarter 2008
            
            $
            7.58
            
            
            $
            7.39
            
            
            $
            0.91
            
            
            $
            0.26
            
            
            $
            8.47
            
            
            $
            7.65Third
      quarter 2008
            
            $
            7.95
            
            
            $
            7.39
            
            
            $
            1.49
            
            
            $
            0.57
            
            
            $
            9.30
            
            
            $
            8.00Fourth
      quarter 2008
            
            $
            7.88
            
            
            $
            6.50
            
            
            $
            1.80
            
            
            $
            0.45
            
            
            $
            9.24
            
            
            $
            7.60First
      quarter 2009 through March 24, 2009
            
            $
            14.15
            
            
            $
            2.50
            
            
            $
            2.30
            
            
            $
            0.32
            
            
            $
            15.00
            
            
            $
            3.50




Number
of Holders of Common Stock





As of
March 24, 2009, there were of record 36 holders of common stock, one
holders of warrants and one holder of units. Cyalume believes that the number of
beneficial holders of each of these securities is greater than the number of
record holders.


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Equity
Compensation Plan





As of
December 31, 2008, we had no equity compensation plans.





On March
3, 2009, the Board of Directors adopted the Cyalume Technologies Holdings, Inc.
2009 Omnibus Securities and Incentive Plan (the “Plan”). The purpose of the Plan
is to benefit the stockholders by assisting us to attract, retain and provide
incentives to key management employees and non-employee directors of, and
non-employee consultants to, the Company and Affiliates, and to align the
interests of such employees, non-employee directors and non-employee consultants
with those of the stockholders. Accordingly, the Plan provides for the granting
of Distribution Equivalent Rights, Incentive Stock Options, Non-Qualified Stock
Options, Performance Share Awards, Performance Unit Awards, Restricted Stock
Awards, Stock Appreciation Rights, Tandem Stock Appreciation Rights,
Unrestricted Stock Awards or any combination of the foregoing, as may be best
suited to the circumstances of the particular Employee, Director or Consultant
as provided herein. Under the Plan, two million shares have been reserved. On
March 3, 2009, the Board of Directors authorized the following (i) 30,000
restricted shares of common stock to non-employee consultants; (ii) 114,000
restricted shares of common stock and 200,000 restricted options to officers and
other management; and, (iii) a total of 33,000 options to
directors.  Subsequent to approval by shareholders at the 2009 Annual
Meeting of Shareholders, we expect to file Form S-8 with the SEC to register the
shares under the Plan.





Dividends





We have
never declared or paid cash dividends on our capital stock and do not anticipate
declaring or paying cash dividends on our common stock in the foreseeable
future. Payments of future dividends on our common stock, if any, will be at the
discretion of our board of directors after taking into account various factors,
including our financial condition, operating results, current and anticipated
cash needs, plans for expansion and other factors that our board of directors
may deem relevant. In addition, our credit facility places limitations on our
ability to pay dividends on our common stock. CTI, which is currently Cyalume’s
only operating subsidiary, is not permitted by its credit facility agreement to
make any payments to Cyalume, other than the following, unless waivers are
obtained: (i) $500,000 per fiscal year for any management fees levied by Cyalume
to CTI; (ii) up to $500,000 per fiscal year for out-of-pocket expenses including
legal and accounting fees incurred by Cyalume; and (iii) a distribution to
Cyalume not to exceed $600,000 per fiscal year in support of any unpaid costs
incurred in connection with the acquisition of CTI.





Recent
Sales of Unregistered 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 ProgramsOctober
      1 to October 31
            
            
            600,000
            (1)
            
            $
            7.91
            
            
            
            600,000
            
            
            $
            —November
      1 to November 31
            
            
            —
            
            
            
            
            
            
            
            —December
      1 to December 31
            
            
            2,442,547
            (2)
            
            $
            8.01
            
            
            
            2,442,547
            (2)
            
            $
            —





(1) The
shares were purchased in a block transaction with two sellers.





(2) Of
the 2,442,547 shares of common stock repurchased in December 2008 (i) 2,099,000
shares were purchased in privately negotiated transactions prior to our Special
Meeting of Shareholders on December 19, 2008 at purchase prices ranging from
$8.00 - $8.01 per share, (ii) 989,647 shares where repurchased at $8.03 per
share from stockholders who voted against our acquisition of CTI and elected to
have us redeem their shares, and (iii) 93,750 shares were repurchased from an
affiliate of Rodman & Renshaw LLC, the underwriter of our IPO, in a
privately negotiated transaction at a price of $8.00 per share.





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ITEM 6:    SELECTED FINANCIAL
DATA





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




ITEM 7:    MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS





Overview





Our
Business Prior to the Acquisition of CTI





Previously,
our legal name was Vector Intersect Security Acquisition Corporation
(‘‘Vector’’), a Delaware corporation incorporated on July 19, 2005 in order to
serve as a vehicle for the acquisition of an operating business (through a
merger, capital stock exchange, asset acquisition or other similar business
combination).





On April
25, 2007, Vector completed a private placement to raise initial capital. On May
1, 2007, Vector consummated an initial public offering of 7,312,500 units. Each
unit consists of one share of common stock and one common stock purchase
warrant. Each warrant entitles the holder to purchase from Vector one share of
Vector common stock at an exercise price of $5.00. Vector common stock and
warrants started trading separately as of July 9, 2007. Vector did not engage in
any substantive commercial business until the acquisition of Cyalume
Technologies, Inc. (“CTI”), as described below.





On
December 19, 2008, the purchase of the issued and outstanding capital stock of
CTI located in West Springfield, MA, for a total consideration of $125.2 million
was completed (the “Acquisition”). In connection with the closing of the
Acquisition, We changed our name from Vector Intersect Security Acquisition
Corporation to Cyalume Technologies Holdings, Inc. (“Cyalume”).





Our
Business Subsequent to the Acquisition of Cyalume Technologies,
Inc.





In the
following discussion of our operating business, unless the context otherwise
requires, references to Cyalume, we, us, our, etc., include Cyalume, Cyalume
Technologies, Inc. and Cyalume Technologies, S.A; references to “CTI” include
only Cyalume Technologies, Inc. and its wholly-owned subsidiary Cyalume
Technologies, S.A. (“CTSA”).





CTI is a
global, technology based, manufacturer primarily producing products where light
is generated through a chemical reaction known as chemiluminescence. Our most
popular product is a 6 inch light stick. In addition, a variety of reflective
products are produced that both reflect direct light back and retain energy for
a short period of time so they continue to glow after the light source is
removed. Reflective products include a variety of patches and safety belts. Both
chemiluminescencent and reflective products may employ infrared technology that
allows observation of the product with proper night vision goggles.





The
majority of CTI’s revenues are derived from sales to the U.S. Military and
various other militaries around the globe, most significantly to two key
customers: the United States Department of Defense and the N.A.T.O. Maintenance
and Supply Agency (“NAMSA”), which account for 68% of net revenues. A smaller
percentage of revenues are derived from sales into the public safety (police,
fire departments) and commercial markets. In the military market there are
longer-term contracts of generally three to five years as well as higher margins
because the products are more technologically advanced than those of
competitors. In the commercial market advanced technology is generally not as
important and therefore competition is greater, resulting in lower
margins.





Although
sales are made into several markets and manufacturing plants are operated in
both the U.S. and Europe, the business is managed and financial results are
reported as one segment. Senior management focuses on consolidated results to
make strategic and tactical decisions. There are several reasons for this.
Products are similar in each market and based on the same technology. Thus
management pays attention to individual products as well as individual customers
and contracts in terms of pricing and costing. For the largest selling product
line, the 6 inch light stick (in its various permutations of color and
duration), the manufacturing processes are similar and both the U.S. and
European plants make these products. Therefore, the 6 inch light sticks, can and
are made at both plants and can be produced and shipped from one plant to the
other to help meet peak periods of demand. In addition, important functions such
as marketing and, research and development (R&D) manage their activities and
allocate their resources from a strategic viewpoint, and generally not on the
basis of where a product is made or who it might be sold to.





Overall
financial performance is evaluated based on: revenues; gross profit and gross
margin; selling/research and development/administrative expenses; and cash flow.
EBITDA (earnings before interest, taxes, depreciation and amortization) is used
as a performance measure of operational cash flows. Product performance is
evaluated based on unit cost of production and number of units produced and
sold. All of these measures are evaluated against results for the prior period
and against budgets.


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Cyalume
is currently a smaller reporting company based on our float being under $75
million. CTI, though not a public company, would also be considered a smaller
reporting company based on the revenue test set out in Exchange Act Rule 12b-2
as revenues for both 2007 and 2008 were below $50 million. Therefore, only two
years of audited financial statements, are presented.




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





Income
taxes are accounted for in accordance with SFAS No. 109, Accounting for Income
Taxes.  Under this method, 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.





We
adopted the provisions of FASB Interpretation No. 48 Accounting for Uncertainty
in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”) on
January 1, 2007.  There have been no unrecognized tax benefits and
there was no effect on our financial condition or results of operations as a
result of adopting FIN 48. 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, management believes 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 benefits 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





We apply
the provisions of SFAS No. 142, Goodwill and Other Intangible Assets to
goodwill. Goodwill is deemed to have an indefinite life and accordingly, is not
subject to annual amortization.  Goodwill is subject to annual
impairment reviews, and, if conditions warrant, interim reviews based upon its
estimated fair value.  Impairment charges, if any, are recorded in the
period in which the impairment is determined.


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Intangible
Assets





Intangible
assets include developed technologies and patents, trademarks and trade names,
customer relationships and non-compete agreements, which are amortized over
their estimated useful lives (with the exception of 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 established for potential obsolescence. Determining
adequate reserves for inventory obsolescence requires management’s judgment.
Conditions impacting the realizability of our inventory could cause actual asset
write-offs to be materially different than reported inventory reserve
balances.





Foreign
Operations and Currency





Accounts
of our foreign subsidiary are translated using their local currency as the
functional currency. Income statement accounts are converted to U.S. dollars
using the average exchange rate for the period covered by the income statement.
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 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 loss in the statement of income in the period the gain or loss
occurred.




Results
of Operations





Years
Ended December 31, 2008 and 2007, in thousands





The
information below is summarized from the audited financial statements and
includes the operations of Cyalume (the former Vector) for the years ended
December 31, 2008 and 2007, plus the operations of CTI from the date of the
Acquisition through December 31, 2008.




Year
      Ended December 31,2008
            
            
            2007Revenues
            
            $
            316
            
            
            $
            —Cost
      of goods sold
            
            
            89
            
            
            
            —Gross
      profit
            
            
            227
            
            
            
            —Other
      expenses (income):Sales
      and marketing, general and administrative expenses and research and
      development
            
            
            1,057
            
            
            
            448Other
      loss (income), net
            
            
            23
            
            
            
            —Amortization
      of intangible assets
            
            
            131
            
            
            
            —Interest
      expense (income), net
            
            
            (960
            )
            
            
            (1,332
            )Provision
      for (benefit from) income taxes
            
            
            (600
            )
            
            
            87Net
      income
            
            $
            576
            
            
            $
            797





Revenues:    We
did not engage in any substantive commercial business until the acquisition of
CTI on December 19, 2008, and as such there were no sales prior to
that date. The only revenue recorded in 2008 was CTI sales during the period
December 20, 2008 through December 31, 2008.





Expenses:    Sales,
general and administrative expense increased $671,000 for the year ended
December 31, 2008 as compared to December 31, 2007. $483,000
of this is a year over year increase for parent company expenses, primarily for
legal, professional, insurance costs and non-income taxes. Costs incurred
specifically related to the acquisition of CTI were capitalized as part of the
purchase price. The remaining increase is CTI expenses for the last 12 days of
2008 and there were no comparable operating expenses in 2007.





Interest
expense (income), net: Interest expense (income), net for the parent company
declined $285,000 due to lower interest rates on funds
invested in the trust fund. The remaining decline of $87,000 is CTI interest
expense for the last 12 days of 2008 where 2007 has no comparable interest
expense.




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Provision
for income taxes: The change occurred primarily as a result of the recognition
of $523,000 of deferred tax benefit from Cyalume’s net operating losses as the
utilization of these losses on a consolidated tax return with CTI are
anticipated in the near-term.  CTI also generated $77,000 of deferred tax
benefit, primarily from net operating losses sustained during the period from
December 20, 2008 through December 31, 2008.








Balance
Sheet





All the
significant changes to our balance sheet resulted from the Acquisition of CTI
and are better understood by through the non-U.S. GAAP-basis discussion
below.








Liquidity
and Capital Resources





As of
December 31, 2008 and 2007, we had $4.0 million and $58.9 million, respectively,
in cash and investments in trust.





On April
25, 2007, we completed a private placement of 187,500 units to our Chief
Executive Officer and one of our directors and received net proceeds of $1.5
million. On May 1, 2007, we consummated our initial public offering of 7,312,500
units. Each unit in both the private placement and the public offering consisted
of one share of common stock and one redeemable common stock purchase warrant.
Each warrant entitles the holder to purchase one share of our common stock at an
exercise price of $5.00.





The
proceeds from the sale of units were $58.5 million. Offering expenses were $4.0
million, including underwriting discounts of $3.5 million. $58.3 million of the
proceeds from the initial public offering and the private placement were placed
in a trust account for our benefit. Except for $1.5 million in interest that is
earned on the funds contained in the trust account that may be released to us to
be used as working capital, we could not access the amounts held in
the trust until we consummated a business combination. The $2.3 million of
deferred compensation would be paid to the underwriters only in the event
of a business combination. The amounts held outside of the trust account were
available to be used to provide for business, legal and accounting due diligence
on prospective acquisitions and continuing general and administrative expenses.
From July 19, 2005 (the date of our inception) through December 31, 2007, we had
operating expenses of $567,000 and deferred offering costs of $0. The proceeds
deposited into the trust fund remained on deposit in the trust account earning
interest. As of December 31, 2007, we had $58.3 million held in the trust
account. Additionally, as of December 31, 2007, we had $570,000 outside the
trust account to fund working capital requirements.





On May 1,
2007, we entered into a $500,000 revolving credit agreement with SCP Private
Equity Management Company, LLC, (“SCP”) which owns stock in Cyalume and of
which three of our Directors are members. Any amounts outstanding under the
revolving credit agreement were to bear interest at a rate of 5.5% per year. Any
funds outstanding under the revolving credit agreement were to become due and
payable by us upon our consummation of a business combination. Through the
Acquisition date we did not borrow any amounts under this facility and the
agreement expired upon the consummation of the CTI acquisition.





During
2008 we used $69.8 million to complete the Acquisition of CTI, including $30.2
million to purchase the outstanding common stock of CTI and $38.9 million to
retire CTI’s existing debt. Concurrent with the acquisition we borrowed $32.0
million from TD Bank, NA (“TD Bank”) consisting of two notes payable, a $25.5
million Term A Note and a $2.5 million Term B Note, and a $4.0 million line of
credit, of which $3.5 million is outstanding at December 31, 2008.  We
also borrowed $1.0 million from SCP, which owns stock in Cyalume and of which
four of our Directors are members.





On
December 10, 2008, Vector Investment Fund LLC (‘‘VIF’’), an entity controlled by
Yaron Eitan, currently the Vice Chairman of the Board and at that time our Chief
Executive Officer, President and Vice Chairman of the Board, entered into a note
purchase agreement by and among VIF, Cyalume and Centurion Credit Group Master
Fund L.P. (“Centurion”)
pursuant to which Centurion agreed to provide a loan to VIF in the
principal amount of up to $12 million. Pursuant to the note purchase agreement,
the proceeds of the loan were to be utilized to purchase shares of Cyalume’s
common stock from a limited number of its public stockholders, at a price per
share not exceeding the liquidation value of each public share, determined upon
amounts held in Cyalume’s trust account.





In
connection with the loan from Centurion, Cyalume agreed to purchase from VIF the
shares of Cyalume common stock that VIF purchased using the proceeds of the
loan, concurrent with the closing of Cyalume’s acquisition of CTI, at a purchase
price equal to the aggregate purchase price that VIF paid for the shares. The
proceeds from the sale of the shares were applied by VIF to repay the loan.
Interest on the loan accrued at a rate of 18% per annum. On the closing of the
acquisition of CTI, Cyalume paid accrued interest due on the senior promissory
note issued by VIF. In connection with the loan, CTI paid the Lender a $200,000
commitment fee, $20,000
of prepaid interest on the note and $50,000 of the Centurion’s legal fees.
Centurion also received 40,000 shares of Cyalume’s common stock and three-year
warrants to purchase 100,000 shares of common stock exercisable at an exercise
price of $8.00 per share, subject to adjustment in certain events, and has been
granted certain demand and piggyback registration rights with respect to the
40,000 shares and the shares issuable upon exercise of the warrants. All amounts
due and owing under the loan were paid in full to Centurion on December 19,
2008.




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In
connection with the note purchase agreement, as security for the repayment of
the loan, Centurion had been granted a security interest in the shares and Mr.
Eitan’s interest in VIF, as its sole member, pursuant to the terms of the stock
pledge agreement and security agreement, respectively. The shares were released
from escrow after the closing of the acquisition of CTI and the repayment of the
Loan.





Forecast
principal and interest payments on long-term debt for 2009 are $5.5 million,
compared to $40.8 million in 2008 (including CTI principal and interest paid off
at the Acquisition), and will be funded from operating cash flows. In 2008, CTI
made principal and interest payments of $7.8 million prior to the
Acquisition.





On
December 19, 2008, we acquired CTI and the deferred underwriting fee described
above became payable in full. Before December 19, 2008, as full payment of these
costs, the underwriter agreed to accept a cash payment of $250,000 and 93,750
shares of our common stock with the rest of the fee ($1.1 million) remaining as
deferred underwriting fees.  On December 30, 2008, the underwriter
exchanged the deferred underwriting fee obligation and the 93,750 shares in
exchange for a $1.8 million note payable.





Upon the
consummation of the Acquisition we owed SMH Capital an advisory services fee of
$1.2 million in cash. Before December 19, 2008, SMH agreed to accept 150,000
shares of our common stock as full payment for this obligation.





At
December 31, 2008, there were seven unsecured notes payable to six stockholders.
Four of these notes totaling $1.0 million were payable to 4 partners of SCP,
bore interest at 6% and are payable in one combined installment on June 19,
2014. The remaining notes totaled $55,000, are payable to two stockholders, pay
interest at 4% and have an indeterminate maturity.





During
the first quarter of 2009 we repurchased 139,850 shares of common stock from
stockholders who voted against the acquisition of CTI for $1.1
million.





On March
3, 2009, our Board of Directors adopted the Cyalume Technologies Holdings, Inc.
2009 Omnibus Securities and Incentive Plan (the “Plan”). Under the Plan, two
million shares have been reserved for potential issuance as incentives to
certain employees and non-employees.  See Note 25 in the Notes to
Consolidated Financial Statements for further discussion of the Plan. No awards
have yet been made under the Plan. Subsequent to approval by shareholders at the
2009 Annual Meeting of Shareholders, we expect to file Form S-8 with the SEC to
register the shares under the Plan. Issuance of shares under the Plan will not
provide capital and will cause dilution of earnings per share.





The 2009
capital expenditures budget will be funded completely from operating cash
flows.




Off-Balance
Sheet Arrangements





We did
not have any off-balance sheet arrangements during 2008 or 2007




Contractual
Obligations





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




Results
of Operations – Adjusted Pro Forma Basis
 
 As a
result of the acquisition of CTI on December 19, 2008 the audited financial
statements include the consolidated statements of income of Cyalume for 2008 and
2007 and also CTI, as Predecessor, for the period from January 1, 2008 to
December 19, 2008 and the year ended December 31, 2007. To assist investors in
better understanding the changes in our business for the years ended December
31, 2008 and 2007, we are presenting below a reconciliation of our audited net
income to adjusted pro forma net income (as described below). We derived the pro
forma results and adjusted pro forma results from the audited consolidated
financial statements of Cyalume for the years ended December 31, 2008 and 2007
and from the audited consolidated financial statements of the Predecessor for
the period from January 1, 2008 to December 19, 2008 and the year ended December
31, 2007. Pro forma results are included in Note 2 to our audited consolidated
financial statements.


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Adjusted
pro forma net income is an alternative view of performance used by management
and we believe that investors’ understanding of our performance is enhanced by
disclosing this information. We define adjusted pro forma net income as the pro
forma net income of Cyalume excluding the effects of the purchase of CTI. The
adjusted pro forma net income measure is not, and should not be viewed as, a
substitute for U.S. GAAP net income. Adjusted pro forma net income is an
important internal measurement for us. We measure the performance of the overall
company on this basis. The following are examples of how we use adjusted pro
forma net income:
 
 ·
              Senior
      management receives a monthly analysis of our operating results that is
      prepared on an adjusted pro forma net income
  basis;
 ·
              Our
      annual budget for 2009 is prepared on an adjusted pro forma net income
      basis
 ·
              Certain
      annual compensation computations, including annual cash bonuses, are
      calculated in part on an adjusted pro forma net income
    basis.
 
 Despite
the importance of this measure to management in goal setting and performance
measurement, we stress that adjusted pro forma net income is a non-GAAP
financial measure that has no standardized meaning under U.S. GAAP and
therefore, has limits in its usefulness to investors. Due to its
non-standardized definition, adjusted pro forma net income (unlike U.S. GAAP net
income) may not be comparable with the calculation of similar measures for other
companies. Adjusted pro forma net income is presented solely to permit investors
to more fully understand how management assesses our performance.
 
 Cyalume
Technologies Holdings, Inc.
 Reconciliation
of GAAP Net Income to Pro Forma Net Income and Adjusted Pro Forma
 (in
thousands)
 
 Year Ended December 31,2008
                    
                    
                    2007GAAP
      net income
                    
                    $
                    576
                    
                    
                    $
                    797Adjusted
      pro forma adjustmentCTI
      net income
                    
                    
                    3,406
                    
                    
                    
                    23Adjusted
      pro forma net income
                    
                    $
                    3,982
                    
                    
                    $
                    820Pro
      forma adjustments – addbacks (reductions)Amortization
      of stepped up inventory value
                    
                    
                    -
                    
                    
                    
                    (736
                    )Depreciation
      expense on revalued assets
                    
                    
                    239
                    
                    
                    
                    35Amortization
      of intangible expense
                    
                    
                    (1,631
                    )
                    
                    
                    (1,631
                    )Interest
      expense
                    
                    
                    2,720
                    
                    
                    
                    4,122Interest
      income
                    
                    
                    (1,053
                    )
                    
                    
                    (1,347
                    )Restructuring
      costs
                    
                    
                    1,193
                    
                    
                    
                    -Income
      taxes
                    
                    
                    (568
                    )
                    
                    
                    (343
                    )Pro
      forma net income
                    
                    $
                    4,882
                    
                    
                    $
                    920
 
 As we had
no material business operations prior to the Acquisition, we believe that the
operations of CTI are of most interest to our investors. As the full year 2008
operations of CTI are not presented in the audited financial statements, we are
presenting a Management’s Discussion and Analysis section below based on the
adjusted pro forma consolidated statements of net income. This discussion
provides insight for the full years that is not available in the GAAP discussion
presented above. Except for results occurring after the date of the Acquisition,
combining each company’s results in this manner does not reflect (a) purchase
accounting resulting from the acquisition or (b) other pro forma adjustments
that could have been used to show how results may have appeared if that purchase
accounting was applied as of January 1, 2008 or January 1,
2007.  Adjusted pro forma information is useful as it assists
management in understanding our performance over the last two years, which would
not be possible by reviewing the U.S. GAAP information.  Investors may
find it useful for this purpose as well. The adjusted pro forma information
should not be considered an alternative to, or more meaningful than, the
financial information in accordance with U.S. GAAP, since it does not include
the effects of purchase accounting or pro-forma adjustments.  Adjusted
pro forma information, as calculated, may not be comparable to similarly titled
measures reported by other companies.
 
 Table of
Contents
  Cyalume
Technologies Holdings, Inc.
 Adjusted
Pro Forma Consolidated Statements of Income
 (in
thousands)
 
 Year Ended December 31,2008
                          
                          
                          2007
                          
                          
                          ChangeRevenues
                          
                          $
                          40,757
                          
                          
                          $
                          39,026
                          
                          
                          $
                          1,731Cost
      of goods sold
                          
                          
                          20,478
                          
                          
                          
                          19,072
                          
                          
                          
                          1,406Gross
      profit
                          
                          
                          20,279
                          
                          
                          
                          19,954
                          
                          
                          
                          325Other
      expenses (income):Sales
      and marketing
                          
                          
                          2,994
                          
                          
                          
                          3,412
                          
                          
                          
                          (418
                          )General
      and administrative
                          
                          
                          5,014
                          
                          
                          
                          6,845
                          
                          
                          
                          (1,831
                          )Research
      and development
                          
                          
                          1,294
                          
                          
                          
                          1,417
                          
                          
                          
                          (123
                          )Other
      loss (income), net
                          
                          
                          (1,123
                          )
                          
                          
                          (543
                          )
                          
                          
                          (580
                          )Amortization
      of intangible assets
                          
                          
                          2,674
                          
                          
                          
                          2,612
                          
                          
                          
                          62Interest
      expense (income), net
                          
                          
                          3,820
                          
                          
                          
                          5,019
                          
                          
                          
                          (1,199
                          )Interest
      expense – related party
                          
                          
                          8
                          
                          
                          
                          15
                          
                          
                          
                          (7
                          )Income
      (loss) before income taxes
                          
                          
                          5,598
                          
                          
                          
                          1,177
                          
                          
                          
                          4,421Provision
      for (benefit from) income taxes
                          
                          
                          1,616
                          
                          
                          
                          357
                          
                          
                          
                          1,259Adjusted
      pro forma net income
                          
                          $
                          3,982
                          
                          
                          $
                          820
                          
                          
                          $
                          3,162
  Adjusted
Pro Forma Results of Operations
 
 Revenues:
CTI experienced significant growth in the volume of military reflective product
sales in 2008, with revenue increasing $2.9 million over 2007. Due to the nature
of our products, many are sold under indefinite quantity type contracts whereby
we fulfill orders as they are placed by customers. We do not have insight into
why our customers order at the times or quantities that they do. This was offset
by decreased sales volume in our commercial division of $1.0
million.  2008 non-reflective military sales were consistent with
2007, with price increases contributing $1.4 million in additional revenue to
offset lower sales volumes. Based on orders received so far in 2009, we
anticipate growth in sales of military ammunition and reflective products in
2009. See further discussion of first quarter orders below. We also anticipate
growth in commercial sales as our revised sales strategies begin to impact
revenues.
 
 Expenses:
Sales and marketing expenses declined significantly as CTI withdrew from the
direct-to-consumer market and revamped its commercial sales strategies to make
more extensive use of distributors who have established key relations with
end-users, rather than trying to sell direct to consumers. General and
administrative expenses declined with the settlement of arbitration proceedings
with the former owners of CTI in January 2008. CTI had spent $1.4 million on
this litigation in 2007. Additionally, in 2007 CTI incurred $266,000 in
severance pay that was not experienced in 2008. Our forecast for 2009 calls for
increased advertising expense as we continue to roll out our revised commercial
sales strategies. We also anticipate incurring $1.0 million in additional costs
associated with being a publicly held company, compared to the expenses incurred
in 2008.
 
 Other
loss (income), net: During 2008, a restructuring was implemented to facilitate
the sale of CTI to Cyalume pursuant to which the CEO and two Vice-Presidents
left CTI, resulting in a restructuring charge of $1.1 million. Commercial sales
and sales and marketing expenses declined in 2008 as CTI revamped our commercial
sales strategies. In the third quarter CTI began implementing a distributor
based commercial sales model which is anticipated to result in increased sales
volumes in 2009. Cash payments of restructuring charges were primarily incurred
in 2008 with $260,000 to be made in 2009 before June 30, 2009.
 
 In 2008
CTI reached settlement with the previous owners of CTI on all matters. CTI
received $3.0 million in cash, resulting in a net gain of $2.8 million on the
settlement. Other income in 2007 consisted primarily of $586,000 in research
expense reimbursements from the federal government.
 
 Interest:
Interest expense declined in 2008 due to the decline in the LIBOR rates
underlying CTI’s interest rates on long-term debt and due to reduced debt
outstanding as $3.1 million in principal payments were made prior to the
Acquisition. CTI began 2007 with $51.1 million in debt and ended 2008 with $33.8
million in debt after the Acquisition. Interest income declined due to lower
interest rates on funds invested in Cyalume’s trust fund. Forecast interest
expense for 2009 is $2.3 million.
 
 Provision
for income taxes: The significant growth of $4.4 million in pre-tax net income,
as described above, is the primary factor in the $1.3 million increase in the
2008 provision for income taxes over 2007. The effective tax rate for 2008 and
2007 is consistent at 29% and 30%, respectively.
 
 Foreign
exchange rates: If 2008 operations in foreign currencies had been translated
using the foreign exchange rate used in 2007, revenues would have been $513,000
lower than reported and gross margin would have decreased $280,000. Net income
would have been $106,000 lower than reported.


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During
the first quarter of 2009 we experienced a reduction in sales to the U.S.
Military compared to the same period a year earlier. We believe this
reduced demand for our products is temporary and is due
to several factors.  In February of 2009 President Obama
announced plans to withdraw a significant number of American troops from Iraq
over the next 18 months. This event, which was anticipated by
the military, has lessened immediate demand for certain of our
products as the military is drawing down existing supplies in
preparation for the troop reductions.  Although the military budget
covering the procurement of our products does not appear to be directly impacted
at this time, the resulting budget uncertainty has also impacted short-term
demand for certain of our products.  In order to more closely align our
short-term costs with our projected revenue, we have taken steps to reduce
our costs including a 23% reduction in our workforce in March 2009.
Estimated annualized savings from these cost reducing measures are $1.0
million.
 
 In prior
years we have sold reflective flags to a number of customers for use on U.S.
military uniforms. The U.S. military has combined all flag purchases onto a
single contract and started a competitive bid process. We have submitted a bid
for the contract and expect an announcement in April 2009. If we are
successful the contract will result in sales between $2.1 million and $10.4
million over the next three years. In 2008 and 2007 we sold $3.9 million and
$894,000, respectively, of U.S. flags.
 
 In
February 2009, we received purchase orders for ammunition products totaling $7.7
million, to be delivered over the next 17 months. In all of 2008 and 2007 we
sold $2.2 million and $2.0 million, respectively, of ammunition
products.
 
 Balance
Sheet– Adjusted Pro Forma Basis
 
 Inventories
increased $2.7 million in 2008 due primarily to a $2.0 million decrease in
reserves for slow-moving and obsolete inventory and a $698,000 step-up to fair
market value at December 19, 2008 (at the closing date of the
Acquisition).
 
 Property,
plant and equipment declined $2.1 million primarily due to the revaluation of
the West Springfield facility to fair market value at the Acquisition date,
reducing the carrying value of this asset by $2.0 million. This lower valuation
will result in decreased levels of depreciation for this asset in future
years.
 
 In
connection with the Acquisition of CTI, we recorded certain intangible assets at
their fair market value and also recorded goodwill for the excess of purchase
price over identified assets and liabilities. These values were in excess of the
amounts carried by the Predecessor prior to the Acquisition, resulting in an
increase in the reported value for intangible assets and goodwill. Fair market
values were determined by applying the principles of SFAS No. 141, Business
Combinations. Costs incurred to renew or extend the term of our intangible
assets are expensed when incurred. We do not consider any of our intangible
assets to have a residual value. Our trademarks can be renewed without
substantial cost. On average, our trademarks renew in approximately 7
years.
 
 At
December 31, 2007, we had a $2.3 million liability for deferred underwriting
costs on our balance sheet. During 2008, $250,000 of this obligation was paid in
cash and the remaining portion was converted into a note payable, which is
included in long-term debt at December 31, 2008.
 
 Common
stock subject to redemption was $1.1 million and $11.1 million at December 31,
2008 and 2007, respectively. At December 31, 2007, this amount was estimated to
be the maximum it could be since it was unknown at the time how much stock would
be redeemed. At December 31, 2008, most of the redemptions had occurred and the
remaining amount to be redeemed was known, significantly reducing the account
balance. The 2007 amount was reported as long-term as the redemption date was
not known at the time. The 2008 amount is presented as current as the
redemptions were finalized in the first quarter of 2009.
 
 Net
non-current deferred income tax liabilities increased from $4.9 million in 2007
to $9.2 million in 2008 as a result of recording increases to the fair market
value of various identified intangible assets as a result of the acquisition of
CTI in December 2008.  The utilization of net operating losses during
2008 also had the effect of increasing deferred income tax liabilities as
long-term deferred tax assets such as net operating losses, are net against
long-term deferred income tax liabilities.


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In
assessing the realization of our 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 our deferred income tax assets depends upon
future taxable income in years before our net operating loss carryforwards
expire. We evaluate the recoverability of our deferred income tax assets on a
quarterly basis. If we determine that it is more likely than not that our
deferred income tax assets will not be recovered, we establish a valuation
allowance against some or all of our deferred income tax assets. Recording a
valuation allowance or reversing a valuation allowance could have a significant
effect on our future results of operations and financial position.
 
 A
valuation allowance of approximately $1.1 million was provided on our deferred
federal tax assets for the carryforward of foreign tax credits, which we do not
anticipate using in the near-term. The utilization of this asset is dependent
upon our generation of significant revenues from sources outside the
U.S.
 
 We had
federal net operating loss carryforwards amounting to $10.3 million and $17.9
million at December 31, 2008 and 2007, respectively. The net operating loss
carryforward at December 31, 2008 expires in fiscal years 2025 through 2028.
Internal Revenue Code Section 382 limits utilization of these losses to $3.2
million per year. It is possible that future changes in our ownership could
result in changes to the amounts allowed by IRC Section 382.  State
net operating loss carryforwards amounted to $7.2 million and $18.3 million as
of December 31, 2008 and 2007,
respectively.


ITEM 7A.    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 8.    FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA





Selected
Quarterly Financial Data





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





Financial
Statements





The
information required by this item may be found beginning on page F-1 of
this Form 10-K.




ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE





None.




ITEM 9A.    CONTROLS AND
PROCEDURES





Disclosure
controls and procedures and changes in internal control over financial reporting
during the latest quarter





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.





Prior to
our acquisition of CTI on December 19, 2008, our disclosure controls and
procedures were designed and reviewed by our Chief Executive Officer and Chief
Financial Officer, with the assistance of a third party accounting service
provider. As of the Acquisition date, our current Chief Executive Officer and
Chief Financial Officer assumed responsibility for all disclosure controls and
procedures and terminated the engagement of such third party.





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 December 31, 2008. 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 December 31, 2008.




- 24
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Management's
Report on Internal Control over Financial Reporting





On
December 19, 2008 we acquired CTI, an operating company, and CTI management
immediately took full responsibility for all accounting and finance functions
for us. This constituted a significant change to internal controls over
financial reporting in the latest quarter. At December 31, 2008 and for the year
ended December 31, 2008 CTI represented 98.7% of our consolidated assets and
100% of our consolidated revenue. Because the only meaningful internal controls
over financial reporting that exist at December 31, 2008 belong to those of the
newly acquired company, and there has not been sufficient time to document and
test those controls, management has excluded the report on internal controls
over financial reporting from this Form 10-K.  Since CTI was acquired
by us near the end of 2008, CTI is not required to make an assessment of its
internal controls over financial reporting in 2008.





Our
management, including our Chief Executive Officer and Chief Financial Officer,
is responsible for establishing and maintaining adequate internal control over
financial reporting, as defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as amended.





Under the
supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, we are currently documenting
and evaluating the effectiveness of our internal control over financial
reporting based on the criteria in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission.





This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual
report.




ITEM 9B.    OTHER
INFORMATION





None.




PART III








ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS
AND CORPORATE GOVERNANCE





The
information required by this Item is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2009 Annual Meeting of Shareholders.




ITEM 11.    EXECUTIVE
COMPENSATION





The
information required by this Item is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2009 Annual Meeting of Shareholders.




ITEM 12.    SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS





The
information required by this Item is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2009 Annual Meeting of Shareholders.




ITEM 13.    CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE





The
information required by this Item is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2009 Annual Meeting of Shareholders.





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ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND
SERVICES





CCR LLP
audited our consolidated financial statements for the year ended December 31,
2008 and Miller, Ellin and Company LLP audited our consolidated financial
statements for the year ended December 31, 2007. CCR LLP also audited the
Predecessor (CTI) for the period from January 1, 2008 to December 19, 2008 and
for 2007. CCR LLP is our principal accountant as of December 31,
2008.





Audit
Fees





2008 fees
for audit services provided by CCR LLP included:


·
            $279,000
      related to CTI financial statement audits for 2008, related quarterly
      reviews and review of the SEC Schedule 14A filed December 4,
      2008.


·
            $140,000
      related to CTI financial statement audits for
  2007.


·
            $32,000
      related to Cyalume financial statement audits for
  2008.





2008 fees
for audit services provided by Miller, Ellin and Company included:


·
            $13,000
      related to review of 2008 Form 10-Q filings and review of the SEC Schedule
      14A filed December 4, 2008.





2007 fees
for audit services provided by Miller, Ellin and Company included:


·
            $28,000
      related to Cyalume financial statement audits for 2007 and related Form
      10-Q filings.





Audit-Related
Fees





Fees for
audit-related services provided by CCR LLP totaled $3,000 in 2008 and $0 in
2007. Audit-related services principally include advice on compliance with
Sarbanes-Oxley. There were no audit related fees paid to Miller Ellin in 2008 or
2007.





Tax
Fees





There
were no fees for tax related services from CCR LLP in 2008 or
2007.  Fees for tax services provided by Miller, Ellin including tax
compliance, tax advice and tax planning, totaled $0 and $1,000 in 2008 and 2007,
respectively.





All
Other Fees





There
were no fees for other professional services from CCR LLP or Miller Ellin during
2008 or 2007.





Audit
Committee Pre-Approval Policies and Procedures





At
December 31, 2008 we did not have an audit committee. As a result, our entire
Board of Directors performed the duties of an audit committee during the fiscal
year ended December 31, 2008. Our Board of Directors evaluates and approves in
advance the scope and cost of the engagement of an auditor before the auditor
renders audit and non-audit services.





On
January 13, 2009, following the December 19, 2008 Acquisition of CTI, the Board
of Directors formed an Audit Committee in accordance with Section 3(a)(58)(A) of
the Securities Exchange Act of 1934, and elected the following members to serve
on this committee: Thomas Rebar (Chairman), Yair Shamir, Joseph Gorman and
Daniel Gaspar. Thomas Rebar is an ‘‘audit committee financial expert’’. The
Board of Directors has determined that each member of the Audit Committee is
independent as defined in Rule 4350(d) of the NASDAQ Marketplace Rules. The
Audit Committee will recommend to the Board of Directors the annual engagement
of a firm of independent accountants and review with the independent accountants
the scope and results of audits, our internal accounting controls and audit
practices and professional services rendered to us by our independent
accountants. The Audit Committee adopted a written charter on January 13, 2009.
The charter is available on our website, www.cyalume.com. The charter sets forth
the responsibilities, authority and specific duties of the Audit
Committee.





On
December 19, 2008, the Board of Directors appointed CCR LLP to be principal
accountant for Cyalume and engaged them to perform the 2008 audit for Cyalume.
In February 2009, the newly formed Audit Committee met with the principal
accountants, CCR LLP, to discuss the audit and reporting process for preparing
the audited financial statements and the Annual Report on Form 10-K. CCR LLP had
been CTI’s principal accountant prior to the Acquisition and it had been engaged
by CTI to perform the 2008 audit of CTI’s financial statements prior to the
Acquisition.




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PART IV




ITEM 15.    EXHIBITS AND FINANCIAL
STATEMENT SCHEDULES





Financial
Statements


A(1)   Financial
      statements filed as part of this report
              Page


·
            Consolidated
      Statements of Income for the years ended December 31, 2008 and 2007
            F-5


·
            Predecessor
      Statements of Income for the period ended December 19, 2008 and the year
      ended December 31, 2007
            F-5


·
            Consolidated
      Balance Sheets at December 31, 2008 and 2007
            F-6


·
            Predecessor
      Balance Sheet at December 31, 2007
            F-6


·
            Consolidated
      Statements of Changes in Stockholders’ Equity and Comprehensive Income for
      the years ended December 31,  2008 and 2007
            F-7


·
            Consolidated
      Statements of Cash Flows for the years ended December 31, 2008 and
      2007
            F-8


·
            Predecessor
      Statements of Cash Flows for the period ended December 19, 2008 and the
      year ended December 31, 2007
            F-8




Financial
Statement Schedules


A(2)   Schedule
      II – Valuation and Qualifying Accounts
            S-3







- 27
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Exhibits




Exhibit
              Number
            
            Description2.1
            
            Stock
      Purchase Agreement dated February 14, 2008 by and among Vector Intersect
      Acquisition Corporation, as the Parent, Cyalume Acquisition Corp., a
      Delaware corporation, as the Purchaser, Cyalume Technologies, Inc. and GMS
      Acquisition Partners Holdings, LLC (1)2.2
            
            Amendment
      No. 1 to Stock Purchase Agreement, dated October 22, 2008
    (2)2.3
            
            Amendment
      No. 2 to Stock Purchase Agreement, dated December 17, 2008
    (3)2.4
            
            Amendment
      No. 3 to Stock Purchase Agreement, dated December 18, 2008
    (3)3.1
            
            Fifth
      Amended and Restated Certificate of Incorporation (3)3.2
            
            By-laws
      (4)4.1
            
            Specimen
      Common Stock Certificate (4)4.2
            
            Specimen
      Unit Certificate (4)4.3
            
            Specimen
      Warrant Certificate (4)4.4
            
            Form
      of Unit Purchase Option to be granted to the
    representative(4)10.1
            
            Form
      of Stock Escrow Agreement among the Registrant, American Stock Transfer
      & Trust Company and the Initial Stockholders (4)10.2
            
            Form
      of Registration Rights Agreement among the Registrant, the Initial
      Stockholders and the Private Placement Purchasers (4)10.3
            
            Centurion
      Credit Group Master Fund L.P. Note Purchase Agreement dated December 10,
      2008 (5)10.4
            
            Centurion
      Credit Group Master Fund L.P. Letter Agreement dated December 10, 2008
      (5)10.5
            
            Centurion
      Credit Group Master Fund L.P. Escrow Agreement dated December 10, 2008
      (5)10.6
            
            Warrant
      issued to Centurion Credit Group Master Fund L.P. dated December 10, 2008
      (5)10.7
            
            Subscription
      Agreement with Catalyst Equity Management dated September 5, 2008
      (5)10.8
            
            Form
      of Warrant Agreement in favor of Catalyst Private Equity Partners (Israel)
      II, LP (6)10.9
            
            Letter
      Agreement by and between the Registrant and Vector Investment Fund LLC
      dated December 10, 2008 (5)10.10
            *
            Employment
      Agreement with Derek Dunaway dated April 1, 200810.11
            *
            Employment
      Agreement with Michael Bielonko dated January 23, 200610.12
            *
            Employment
      Agreement with Thomas McCarthy dated January 23, 200610.13
            *
            Employment
      Agreement with Earl Cranor dated January 23, 200610.14
            *
            TD
      Bank Revolving Credit and Term Loan Agreement dated December 19,
      200810.15
            *
            TD
      Bank Security and Pledge Agreement dated December 19,
  200810.16
            *
            TD
      Bank Mortgage, Assignment of Leases and Rents and Security Agreement dated
      December 19, 200821.1
            *
            Subsidiaries
      of the Registrant23.1
            *
            Consent
      of CCR LLP, independent registered public accounting
  firm23.2
            *
            Consent
      of Miller, Ellin & Company, LLP, independent registered public
      accounting firm31.1
            *
            Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200231.2
            *
            Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1
            *
            Certification
      of Principal Executive Officer and Principal Financial Officer pursuant to
      Section 906 of the Sarbanes-Oxley Act of
2002




(1)
            Incorporated
      by reference to the Current Report on Form 8-K dated February 14, 2008 and
      filed with the Commission February 21,
2008.


(2)
            Incorporated
      by reference to the Current Report on Form 8-K dated October 22, 2008 and
      filed with the Commission November 4,
2008.


(3)
            Incorporated
      by reference to the Current Report on Form 8-K dated December 17, 2008 and
      filed with the Commission December 23,
2008.


(4)
            Incorporated
      by reference to the Registration Statement on Form S-1 (File No.
      333-127644) filed August 18, 2005.


(5)
            Incorporated
      by reference to the Current Report on Form 8-K dated December 10, 2008 and
      filed with the Commission on December 16,
2008.


(6)
            Incorporated
      by reference to the Registration Statement on Form S-1 (File No.
      333-157827) filed March 11, 2009





*
            Filed
      herewith.


- 28
-
 Table of Contents




SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) 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:
      March 24, 2009
            
            By:
            /s/  Derek
      DunawayDerek
      Dunaway, Chief Executive Officer

              (Principal
      Executive Officer)








Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant on the dates
and in the capacities indicated below.





Name
            
            Title
            
            Date





/s/  Derek
      Dunaway
            
            President
      and Chief Executive Officer
            
            March
      24, 2009Derek
      Dunaway
            
            (Principal
      Executive Officer)





/s/  Michael
      Bielonko
            
            Chief
      Financial Officer
            
            March
      24, 2009Michael
      Bielonko
            
            (Principal
      Financial Officer)





/s/  Winston
      Churchill
            
            Director
      and Chairman
            
            March
      26, 2009Winston
      Churchill





/s/  Yaron
      Eitan
            
            Director
      and Vice Chairman
            
            March
      26, 2009Yaron
      Eitan





/s/  Archie
      Clemins
            
            Director
            
            March
      26, 2009Archie
      Clemins





/s/  Doron
      Cohen
            
            Director
            
            March
      26, 2009Doron
      Cohen





/s/  Daniel
      Gaspar
            
            Director
            
            March
      25, 2009Daniel
      Gaspar





DirectorJason
      Epstein




/s/  Joseph
      T. Gorman
              
              Director
              
              March
      25, 2009Joseph
      T. Gorman
  /s/  General
      (Ret.) Jack Keane
                
                Director
                
                March
      26, 2009General
      (Ret.) Jack Keane
  /s/  Frank
      Kline
                  
                  Director
                  
                  March
      26, 2009Frank
      Kline
  /s/  Thomas
      G. Rebar
                    
                    Director
                    
                    March
      25, 2009Thomas
      G. Rebar
  /s/  Yair
      Shamir
                      
                      Director
                      
                      March
      29, 2009Yair
      Shamir
   - 29
-
 Table of
Contents




INDEX
TO FINANCIAL STATEMENTS





Cyalume
Technologies Holdings, Inc.





Years
ended December 31, 2008 and 2007





Page





Report of Independent Registered Public
      Accounting Firm
              Report of Independent Registered Public Accounting
      Firm
              Report of Independent Registered Public Accounting
      Firm
            
            F-2
              F-3
              F-4





Consolidated
      Financial Statements





Consolidated Statements of Income
            
            F-5





Consolidated Balance Sheets
            
            F-6





Consolidated Statements of Changes in Stockholders' Equity and
      Comprehensive Income
            
            F-7





Consolidated Statements of Cash Flows
            
            F-8





Notes to Consolidated Financial
    Statements
            
            F-9





Report of Independent Registered Public
      Accounting Firm on Financial Statement Schedule
                    
                    S-1Report of Independent Registered Public
      Accounting Firm on Financial Statement Schedule
                    
                    S-2Schedule II—Valuation and Qualifying
      Accounts
                    
                    S-3








F-1
 Table of Contents




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM




To the
Board of Directors and


Stockholders
of Cyalume Technologies Holdings, Inc.




We have
audited the accompanying consolidated balance sheet of Cyalume Technologies
Holdings, Inc. (the “Company”) as of December 31, 2008, and the related
consolidated statements of income, stockholders’ equity and comprehensive
income, and cash flows for the year then ended. These financial statements are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audit.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Cyalume Technologies
Holdings, Inc. as of December 31, 2008, and the consolidated results of its
operations and its cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of
America.




/s/ CCR
LLP


March 27,
2009




F-2
 Table of Contents




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM




To the
Board of Directors and


Stockholder
of Cyalume Technologies, Inc. and Subsidiary




We have
audited the accompanying consolidated balance sheet of Cyalume Technologies,
Inc. and Subsidiary (the “Company”) as of December 31, 2007, and the related
consolidated statements of income, and cash flows for the period January 1, 2008
to December 19, 2008 and the year ended December 31, 2007. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Cyalume Technologies,
Inc. and Subsidiary as of December 31, 2007, and the consolidated results of
their operations and their cash flows for the period January 1, 2008 to December
19, 2008 and the year ended December 31, 2007 in conformity with accounting
principles generally accepted in the United States of America.






/s/ CCR
LLP


March 27,
2009




F-3
 Table of Contents




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM





To the
Board of Directors and Stockholders


Vector
Intersect Security Acquisition Corp.





We have
audited the accompanying balance sheet of Vector Intersect Security Acquisition
Corp. (a corporation in the development stage) as of December 31, 2007 and the
related statements of income, stockholders’ equity and cash flows for the year
ended December 31, 2007 and the period from July 19, 2005 (inception) to
December 31, 2007. These financial statements are the responsibility of the
Corporation’s management. Our responsibility is to express an opinion on these
financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free from material misstatement. The Corporation is not required
to have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Corporation’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Vector Intersect Security
Acquisition Corp. as of December 31, 2007 and the results of its operations and
its cash flows for the year ended December 31, 2007, in conformity with U.S.
generally accepted accounting principles.





/s/
Miller Ellin & Company, LLP


April 10,
2008




F-4
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)


Consolidated Statements of Income


(in
thousands, except shares and per share information)





PredecessorFor
      the Period
            
            
            PredecessorFor
      the Year
            
            
            For
      the Year
            
            
            January
      1, 2008
            
            
            For
      theEnded
            
            
            Ended
            
            
            to
            
            
            Year
      EndedDecember
      31,
            
            
            December
      31,
            
            
            December
      19,
            
            
            December
      31,2008
            
            
            2007
            
            
            2008
            
            
            2007Revenues
            
            $
            316
            
            
            $
            —
            
            
            $
            40,441
            
            
            $
            39,026Cost
      of goods sold
            
            
            89
            
            
            
            —
            
            
            
            20,389
            
            
            
            19,072Gross
      profit
            
            
            227
            
            
            
            —
            
            
            
            20,052
            
            
            
            19,954Other
      expenses (income):Sales
      and marketing
            
            
            72
            
            
            
            —
            
            
            
            2,922
            
            
            
            3,412General
      and administrative
            
            
            942
            
            
            
            448
            
            
            
            4,072
            
            
            
            6,397Research
      and development
            
            
            43
            
            
            
            —
            
            
            
            1,251
            
            
            
            1,417Interest
      expense (income), net
            
            
            (968
            )
            
            
            (1,347
            )
            
            
            4,788
            
            
            
            6,366Interest
      expense – related party
            
            
            8
            
            
            
            15
            
            
            
            —
            
            
            
            —Amortization
      of intangible assets
            
            
            131
            
            
            
            —
            
            
            
            2,543
            
            
            
            2,612Other
      loss (income), net
            
            
            23
            
            
            
            —
            
            
            
            (1,146
            )
            
            
            (543
            )Total
      other expenses (income)
            
            
            251
            
            
            
            (884
            )
            
            
            14,430
            
            
            
            19,661Income
      (loss) before income taxes
            
            
            (24
            )
            
            
            884
            
            
            
            5,622
            
            
            
            293Provision
      for (benefit from) income taxes
            
            
            (600
            )
            
            
            87
            
            
            
            2,216
            
            
            
            270Net
      income
            
            $
            576
            
            
            $
            797
            
            
            $
            3,406
            
            
            $
            23Net
      income per common share:Basic
            
            $
            0.06
            
            
            $
            0.11Diluted
            
            $
            0.05
            
            
            $
            0.09Weighted
      average shares used to compute net income per common
share:Basic
            
            
            9,550,362
            
            
            
            6,912,329Diluted
            
            
            12,001,471
            
            
            
            8,530,207






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




F-5
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)


Consolidated Balance Sheets


(in
thousands, except shares and per share information)




December 31,
                  
                  December 31,
                  
                  
                  Predecessor
                    December 31,2008
                  
                  2007
                  
                  
                  2007AssetsCurrent
      assets:Cash
                  $
                  3,952
                  
                  $
                  570
                  
                  
                  $
                  5,743Cash
      held in trust
                  
                  —
                  
                  
                  58,309
                  
                  
                  
                  —Accounts
      receivable, net of allowance for doubtful accounts of $452, $0 and
      $596
                    at
      December 31, 2008, 2007 and 2007, respectively
                  
                  3,508
                  
                  
                  —
                  
                  
                  
                  3,329Inventories,
      net
                  
                  11,447
                  
                  
                  —
                  
                  
                  
                  8,743Income
      taxes refundable
                  
                  701
                  
                  
                  —
                  
                  
                  
                  —Deferred
      income taxes
                  
                  317
                  
                  
                  —
                  
                  
                  
                  553Prepaid
      expenses and other current assets
                  
                  195
                  
                  
                  94
                  
                  
                  
                  440Total
      current assets
                  
                  20,120
                  
                  
                  58,973
                  
                  
                  
                  18,808Property,
      plant and equipment, net
                  
                  7,882
                  
                  
                  —
                  
                  
                  
                  9,974Goodwill
                  
                  60,896
                  
                  
                  —
                  
                  
                  
                  24,419Other
      intangible assets, net
                  
                  49,426
                  
                  
                  —
                  
                  
                  
                  31,805Other
      noncurrent assets
                  
                  188
                  
                  
                  —
                  
                  
                  
                  385Total
      assets
                  $
                  138,512
                  
                  $
                  58,973
                  
                  
                  $
                  85,391Liabilities
      and Stockholders’ EquityCurrent
      liabilities:Lines
      of credit
                  $
                  3,500
                  
                  $
                  —
                  
                  
                  $
                  —Current
      portion of notes payable
                  
                  3,621
                  
                  
                  —
                  
                  
                  
                  3,152Accounts
      payable
                  
                  3,230
                  
                  
                  —
                  
                  
                  
                  2,603Deferred
      underwriting costs
                  
                  —
                  
                  
                  2,340
                  
                  
                  
                  —Accrued
      expenses
                  
                  2,550
                  
                  
                  88
                  
                  
                  
                  3,592Common
      stock subject to mandatory redemption
                  
                  1,123
                  
                  
                  —
                  
                  
                  
                  —Notes
      payable and advance due to related parties
                  
                  64
                  
                  
                  214
                  
                  
                  
                  —Income
      tax payable
                  
                  5
                  
                  
                  85
                  
                  
                  
                  1,305Total
      current liabilities
                  
                  14,093
                  
                  
                  2,727
                  
                  
                  
                  10,652Notes
      payable, net of current portion
                  
                  25,581
                  
                  
                  —
                  
                  
                  
                  37,737Notes
      payable due to related parties, net of current portion
                  
                  1,000
                  
                  
                  —
                  
                  
                  
                  —Deferred
      income taxes
                  
                  9,237
                  
                  
                  —
                  
                  
                  
                  4,949Derivatives
                  
                  163
                  
                  
                  —
                  
                  
                  
                  —Asset
      retirement obligation, net of current portion
                  
                  128
                  
                  
                  —
                  
                  
                  
                  166Total
      liabilities
                  
                  50,202
                  
                  
                  2,727
                  
                  
                  
                  53,504Common
      stock, subject to possible redemption
                  
                  —
                  
                  
                  11,144
                  
                  
                  
                  —Commitments
      and contingencies
                  
                  —
                  
                  
                  —
                  
                  
                  
                  —Stockholders'
      equityPreferred
      stock, $0.001 par value; 1,000,000 shares authorized, no shares issued or
      outstanding
                  
                  —
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, $0.001 par value; 50,000,000 authorized; 13,719,035 and 9,375,000
      issued and outstanding at December 31, 2008 and 2007, respectively
      (including 1,462,449 shares subject to possible redemption at December 31,
      2007)
                  
                  14
                  
                  
                  9
                  
                  
                  
                  —Predecessor
      common stock, $.0001 par value; 30,000,000 authorized, issued and
      outstanding 11,555,331 at December 31, 2007
                  
                  —
                  
                  
                  —
                  
                  
                  
                  1Additional
      paid-in capital
                  
                  87,348
                  
                  
                  44,440
                  
                  
                  
                  34,134Retained
      earnings (accumulated deficit)
                  
                  1,229
                  
                  
                  653
                  
                  
                  
                  (3,496
                  )Accumulated
      other comprehensive income (loss)
                  
                  (281
                  )
                  
                  —
                  
                  
                  
                  1,248Total
      stockholders’ equity
                  
                  88,310
                  
                  
                  45,102
                  
                  
                  
                  31,887Total
      liabilities and stockholders' equity
                  $
                  138,512
                  
                  $
                  58,973
                  
                  
                  $
                  85,391






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




F-6
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)


Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Income


(in
thousands, except shares)





Common
      Stock
            
            
            Additional
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
            
            
            Total
            
            
            ComprehensiveNumber
              of Shares
            
            
            Amount
            
            
            Paid-In
                Capital
            
            
            (Accumulated
              Deficit)
            
            
            Comprehensive
              Loss
            
            
            Stockholders’
              Equity
            
            
            Income
              (Loss)Balance
      at December 31, 2006
            
            
            1,875,000
            
            
            $
            2
            
            
            $
            23
            
            
            $
            (144
            )
            
            $
            —
            
            
            $
            (119
            )
            
            
            —Issuance
      of common stock -  private placement
            
            
            187,500
            
            
            
            —
            
            
            
            1,500
            
            
            
            —
            
            
            
            —
            
            
            
            1,500
            
            
            
            —Issuance
      of common stock
            
            
            7,312,500
            
            
            
            7
            
            
            
            58,493
            
            
            
            —
            
            
            
            —
            
            
            
            58,500
            
            
            
            —Expenses
      of June 30, 2007 common stock issuance
            
            
            —
            
            
            
            —
            
            
            
            (4,432
            )
            
            
            —
            
            
            
            —
            
            
            
            (4,432
            )
            
            
            —Less:
      proceeds subject to possible redemption of 1,462,499 shares of common
      stock and associated deferred interest
            
            
            —
            
            
            
            —
            
            
            
            (11,144
            )
            
            
            —
            
            
            
            —
            
            
            
            (11,144
            )
            
            
            —Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            797
            
            
            
            —
            
            
            
            797
            
            
            
            797Comprehensive
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            $
            797Balance
      at December 31, 2007
            
            
            9,375,000
            
            
            
            9
            
            
            
            44,440
            
            
            
            653
            
            
            
            —
            
            
            
            45,102Adjustment
      of common stock subject to redemption
            
            
            —
            
            
            
            —
            
            
            
            11,144
            
            
            
            —
            
            
            
            —
            
            
            
            11,144
            
            
            
            —Issuance
      of common stock
            
            
            7,308,428
            
            
            
            8
            
            
            
            56,114
            
            
            
            —
            
            
            
            —
            
            
            
            56,122
            
            
            
            —Issuance
      of warrants in conjunction with Acquisition
            
            
            —
            
            
            
            —
            
            
            
            33
            
            
            
            —
            
            
            
            —
            
            
            
            33
            
            
            
            —Exchange
      of note payable for common stock
            
            
            (93,750
            )
            
            
            —
            
            
            
            (750
            )
            
            
            —
            
            
            
            —
            
            
            
            (750
            )
            
            
            —Estimated
      Acquisition purchase price adjustment (see Note 2)
            
            
            138,165
            
            
            
            —
            
            
            
            1,056
            
            
            
            —
            
            
            
            —
            
            
            
            1,056
            
            
            
            —Exercise
      of warrants
            
            
            79,839
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Common
      stock repurchased
            
            
            (2,948,797
            )
            
            
            (3
            )
            
            
            (23,566
            )
            
            
            —
            
            
            
            —
            
            
            
            (23,569
            )
            
            
            —Common
      stock mandatorily redeemable due to the Acquisition
            
            
            (139,850
            )
            
            
            —
            
            
            
            (1,123
            )
            
            
            —
            
            
            
            —
            
            
            
            (1,123
            )
            
            
            —Foreign
      currency translation adjustments
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (179
            )
            
            
            (179
            )
            
            
            (179
            )Unrealized
      loss on cash flow hedges, net of taxes of $61
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (102
            )
            
            
            (102
            )
            
            
            (102
            )Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            576
            
            
            
            —
            
            
            
            576
            
            
            
            576Comprehensive
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            $
            295Balance
      at December 31, 2008
            
            
            13,719,035
            
            
            $
            14
            
            
            $
            87,348
            
            
            $
            1,229
            
            
            $
            (281
            )
            
            $
            88,310








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




F-7
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)


Consolidated Statements of Cash Flows


(in
thousands, except shares)




For the Year
                
                
                For the Year
                
                
                Predecessor
                    For the Period
                  January 1, 2008
                
                
                Predecessor
                    For the YearEnded
                
                
                Ended
                
                
                to
                
                
                EndedDecember 31,
                
                
                December 31,
                
                
                December 19,
                
                
                December 31,2008
                
                
                2007
                
                
                2008
                
                
                2007Cash
      flows for operating activities:Net
      income
                
                $
                576
                
                
                $
                797
                
                
                $
                3,406
                
                
                $
                23Adjustments
      to reconcile net income to net cash
                  provided
      by operating activities:Depreciation
      of property, plant and equipment
                
                
                23
                
                
                
                —
                
                
                
                848
                
                
                
                610Amortization
                
                
                147
                
                
                
                —
                
                
                
                2,865
                
                
                
                2,948Provision
      for deferred income taxes
                
                
                (592
                )
                
                
                —
                
                
                
                1,370
                
                
                
                (1,673
                )Other
      non-cash expenses
                
                
                61
                
                
                
                —
                
                
                
                809
                
                
                
                1,463Changes
      in operating assets and liabilities, net of effect of
                  acquisition:Accounts
      receivable
                
                
                936
                
                
                
                —
                
                
                
                (1,201
                )
                
                
                (1,083
                )Inventories
                
                
                (309
                )
                
                
                —
                
                
                
                (1,526
                )
                
                
                (1,648
                )Prepaid
      expenses and other current assets
                
                
                113
                
                
                
                (94
                )
                
                
                224
                
                
                
                (70
                )Restricted
      cash
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                617Due
      from Vector
                
                
                —
                
                
                
                —
                
                
                
                (995
                )
                
                
                —Accounts
      payable and accrued liabilities
                
                
                (226
                )
                
                
                (114
                )
                
                
                (1,901
                )
                
                
                652Income
      taxes payable, net
                
                
                (87
                )
                
                
                85
                
                
                
                (2,028
                )
                
                
                493Accrued
      interest on notes payable to stockholders
                
                
                18
                
                
                
                6
                
                
                
                —
                
                
                
                —Net
      cash provided by operating activities
                
                
                660
                
                
                
                680
                
                
                
                1,871
                
                
                
                2,332Cash
      flows for investing activities:Payments
      from (to) trust account
                
                
                58,309
                
                
                
                (58,309
                )
                
                
                —
                
                
                
                —Purchases
      of long-lived assets
                
                
                (11
                )
                
                
                —
                
                
                
                (1,508
                )
                
                
                (1,828
                )Remediation
      costs paid relating to asset retirement obligation
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (44
                )Purchase
      of CTI common stock, net of cash purchased
                
                
                (28,668
                )
                
                
                —
                
                
                
                —
                
                
                
                —Net
      cash provided by (used in) investing activities
                
                
                29,630
                
                
                
                (58,309
                )
                
                
                (1,508
                )
                
                
                (1,872
                )Cash
      flows from financing activities:Repayment
      of advances from and notes payable to related parties
                
                
                (150
                )
                
                
                (167
                )
                
                
                —
                
                
                
                —Proceeds
      from private placement
                
                
                —
                
                
                
                1,500
                
                
                
                —
                
                
                
                —Proceeds
      from initial public offering
                
                
                —
                
                
                
                58,500
                
                
                
                —
                
                
                
                —Payment
      of expenses of offering
                
                
                —
                
                
                
                (1,659
                )
                
                
                —
                
                
                
                —Net
      proceeds from line of credit
                
                
                3,500
                
                
                
                —
                
                
                
                —
                
                
                
                —Payments
      of Predecessor notes payable
                
                
                (40,346
                )
                
                
                —
                
                
                
                (3,495
                )
                
                
                (10,803
                )Proceeds
      from long-term notes payable
                
                
                28,000
                
                
                
                —
                
                
                
                —
                
                
                
                —Proceeds
      from related party notes payable
                
                
                1,000
                
                
                
                —
                
                
                
                —
                
                
                
                —Proceeds
      from issuance of common stock
                
                
                4,750
                
                
                
                —
                
                
                
                —
                
                
                
                —Payments
      to reacquire and retire common stock
                
                
                (23,569
                )
                
                
                —
                
                
                
                —
                
                
                
                —Payment
      of debt issue costs
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (268
                )Investment
      by GMS Acquisition Partners Holdings LLC
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                13,000Net
      cash provided by (used in) financing activities
                
                
                (26,815
                )
                
                
                58,174
                
                
                
                (3,495
                )
                
                
                1,929Effect
      of exchange rate changes on cash
                
                
                (93
                )
                
                
                —
                
                
                
                26
                
                
                
                314Net
      increase (decrease) in cash and cash equivalents
                
                
                3,382
                
                
                
                545
                
                
                
                (3,106
                )
                
                
                2,703Cash,
      beginning of year
                
                
                570
                
                
                
                25
                
                
                
                5,743
                
                
                
                3,040Cash,
      end of year
                
                $
                3,952
                
                
                $
                570
                
                
                $
                2,637
                
                
                $
                5,743






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




F-8
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)


Notes to Consolidated Financial Statements








1.
            BACKGROUND
      AND DESCRIPTION OF BUSINESS





Before
December 19, 2008, we conducted business under the name Vector Intersect
Security Acquisition Corporation (‘‘Vector’’). Vector was a blank check
development stage company, as it had no principal operations. Its objective was
to acquire through merger, capital stock exchange, asset acquisition or
otherwise one or more businesses in the homeland security, national security
and/or command and control industries.





On
December 19, 2008, Vector acquired all of the outstanding ownership units of
Cyalume Technologies, Inc (“CTI”) from GMS Acquisition Partners Holdings, LLC
(“GMS”) (the “Acquisition”). GMS was the sole stockholder in CTI, which also had
a wholly-owned subsidiary (Cyalume Technologies, S.A. or “CTSA”). The
Acquisition is discussed in detail in Note 2. At the Acquisition date, Vector
changed its name to Cyalume Technologies Holdings, Inc (“Cyalume”). In these
financial statements and footnotes Cyalume’s operating results include the
operations of the former Vector for 2007 and 2008 and CTI’s operations after the
Acquisition date. CTI’s operations prior to the Acquisition date are presented
as Predecessor.





CTI
manufactures and sells chemiluminescent products and reflective and
photoluminescent materials to military, commercial and public safety markets.
CTSA is geographically located in France and represents us in certain
international markets, primarily Europe and Asia.





The
accompanying consolidated financial statements include the accounts of Cyalume,
CTI and CTSA and are prepared in accordance with accounting principles generally
accepted in the United States of America.  All significant
intercompany balances and transactions have been eliminated in
consolidation.





2.
            ACQUISITION





Accounting
for the Acquisition follows the requirements of Statement of Financial
Accounting Standards No. 141, Business Combinations(‘‘SFAS
No. 141’’), which requires that purchase accounting treatment of the Acquisition
be reflected as a new basis of accounting, resulting in the adjustment of all
assets and liabilities to their respective fair values as of the acquisition
date. That adjustment to fair value has been determined using the guidance in
SFAS No. 141, whereby the purchase price, including assumed liabilities,
deferred financing and other transaction costs, has been allocated to the fair
value of the tangible and identifiable intangible assets acquired and
liabilities assumed, with the excess allocated to goodwill. The factors that
contributed to a purchase price that resulted in the recognition of goodwill
include (a) CTI’s strong core business position, (b) CTI’s long-term contracts
with significant customers (c) the considerable upside of CTI’s ammunition
business and (d) valuation analyses and metrics compiled independently by
consultants.





The
consideration for the Acquisition consisted of the following (all amounts in
thousands):




Consideration
            
            
            Cash
      Acquired
            
            
            Cash Paid,
      Net of Cash AcquiredCyalume
      equity issued to acquire CTI equity
            
            $
            52,460Cash
      paid for CTI equity and closing costs
            
            
            31,305
            
            
            $
            2,637
            
            
            $
            28,668Assumption
      of debt
            
            
            40,346Liabilities
      incurred for closing costs
            
            
            1,058Total
      consideration
            
            $
            125,169






F-9
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


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





Cyalume
      Technologies, Inc. (“CTI”)
            
            
            Cyalume
      Technologies, S.A. (“CTSA”)
            
            
            Eliminations
            
            
            TotalCash
            
            $
            2,567
            
            
            $
            70
            
            
            $
            —
            
            
            $
            2,637Accounts
      receivable, net
            
            
            3,730
            
            
            
            1,272
            
            
            
            (450
            )
            
            
            4,552Inventories,
      net
            
            
            9,246
            
            
            
            2,053
            
            
            
            —
            
            
            
            11,299Other
      current assets
            
            
            126
            
            
            
            91
            
            
            
            —
            
            
            
            217Deferred
      income taxes
            
            
            281
            
            
            
            707
            
            
            
            —
            
            
            
            988Property,
      plant and equipment
            
            
            6,214
            
            
            
            1,715
            
            
            
            —
            
            
            
            7,929Developed
      technologies, including patents
            
            
            10,810
            
            
            
            —
            
            
            
            —
            
            
            
            10,810Trade
      name / trademarks
            
            
            7,390
            
            
            
            —
            
            
            
            —
            
            
            
            7,390Customer
      relationships
            
            
            28,870
            
            
            
            2,246
            
            
            
            —
            
            
            
            31,116Non-compete
      agreements
            
            
            293
            
            
            
            —
            
            
            
            —
            
            
            
            293Investment
      in CTSA
            
            
            11,420
            
            
            
            —
            
            
            
            (11,420
            )
            
            
            —Debt
      issue costs, net
            
            
            808
            
            
            
            —
            
            
            
            —
            
            
            
            808Goodwill
            
            
            56,288
            
            
            
            4,535
            
            
            
            —
            
            
            
            60,823Total
      assets
            
            
            138,043
            
            
            
            12,689
            
            
            
            (11,870
            )
            
            
            138,862Accounts
      payable
            
            
            1,615
            
            
            
            919
            
            
            
            (450
            )
            
            
            2,084Accrued
      expenses
            
            
            1,232
            
            
            
            350
            
            
            
            —
            
            
            
            1,582Deferred
      income taxes
            
            
            9,852
            
            
            
            —
            
            
            
            —
            
            
            
            9,852Asset
      retirement obligation
            
            
            175
            
            
            
            —
            
            
            
            —
            
            
            
            175Total
      liabilities
            
            
            12,874
            
            
            
            1,269
            
            
            
            (450
            )
            
            
            13,693Net
      assets
            
            $
            125,169
            
            
            $
            11,420
            
            
            $
            (11,420
            )
            
            $
            125,169





The stock
purchase agreement dated February 14, 2008, as amended, provided for a purchase
price adjustment based on the net amount of our current assets and current
liabilities as of December 19, 2008. We have provided for an additional 138,165
shares of our common stock that is due to the former owners of CTI in the total
consideration of the Acquisition.





The above
purchase price allocation has not been finalized because the valuation of the
intangible assets acquired has not yet been finalized. Any differences between
the amounts reported herein as of December 31, 2008 for developed technologies,
trade name / trademarks, customer relationships and non-compete agreements and
the finalized valuations thereof are not expected to be material.





Pro
Forma Financial Summary (Unaudited)





The
following unaudited pro forma financial summary is presented as if the
Acquisition was completed as of January 1, 2007. The pro forma combined results
are not necessarily indicative of the actual results that would have occurred
had the Acquisition been consummated on that date, or of the future operations
of the combined entities. The pro forma results include adjustments for
depreciation, intangible asset amortization, inventory step-up amortization,
interest expense, interest income and certain allowable restructuring costs. The
pro-forma results do not exclude significant nonrecurring items such as the $1.1
million restructuring charge incurred by the Predecessor in 2008 (see Note 20)
and the $2.8 million arbitration award received by the Predecessor in 2008 (see
Note 17).




F-10
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Year
      Ended December 31,2008
            
            
            2007Revenues
      (in thousands)
            
            $
            40,757
            
            
            $
            39,026Net
      income (in thousands)
            
            $
            4,882
            
            
            $
            920Net
      income per common share:Basic
            
            $
            0.51
            
            
            $
            .10Diluted
            
            $
            0.41
            
            
            $
            .08Weighted
      average shares used to compute net income per common
share:Basic
            
            
            9,550,362
            
            
            
            9,550,362Diluted
            
            
            12,001,471
            
            
            
            12,001,471





3.
            SIGNIFICANT
      ACCOUNTING POLICIES





Foreign
Operations





Accounts
of CTSA are translated using the local currency as the functional currency.
Translation gains and losses are recorded as a separate component of
stockholders’ equity. Gains and losses resulting from transactions which are
denominated in other than the functional currencies are classified as foreign
currency gains and losses in the accompanying consolidated statements of
income.




Comprehensive
Income





Comprehensive
income, as defined by SFAS No. 130, Reporting Comprehensive Income,accounts for changes in stockholders’ equity resulting from
non-stockholder sources.  All transactions that would cause
comprehensive income to differ from net income have been recorded and disclosed
and relate to (i) the translation of the accounts of our foreign subsidiary and
(ii) the effective portion of hedging activities.





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.




Fair
Value of Financial Instruments





Effective
January 1, 2008, we adopted Statement of Financial Accounting Standard No. 157,
Fair Value
Measurements, (“SFAS No. 157”), which establishes a framework for
measuring fair value and requires enhanced disclosures about fair value
measurements.  SFAS No. 157 is effective for fiscal years beginning
after November 15, 2007, except as it relates to nonrecurring fair value
measurements of nonfinancial assets and liabilities for which the standard is
effective for fiscal years beginning after November 15, 2008.  SFAS
No. 157 clarifies that fair value is 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. SFAS No. 157 also requires disclosure
about how fair value is determined for assets and liabilities and establishes a
hierarchy for which these assets and liabilities must be grouped, based on
significant levels of inputs.





Based on
the three hierarchical levels of categorization defined by SFAS No. 157, we have
one financial instrument (interest rate swaps) that requires disclosure under
SFAS No. 157.  As a result, to the extent the adoption of
SFAS No. 157 is required; it did not have a material impact on our
consolidated financial statements.  In addition, we are evaluating the
impact of SFAS No. 157 for measuring non-financial assets and liabilities on
future results of operations and financial position.




F-11
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


In
February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial
Assets and Financial Liabilities(“SFAS No. 159”), which
permits entities to choose to measure many financial assets and financial
liabilities at fair value. Unrealized gains and losses on items for which the
fair value option has been elected would be reported in earnings. SFAS No. 159
is effective for financial statements issued for fiscal years beginning after
November 15, 2007. We have not elected to measure any financial assets or
liabilities at fair value, and therefore, our consolidated financial statements
were not affected by adoption of SFAS No. 159.





See Note
22 for more information, including a listing of our assets and liabilities
required to be measured at fair value on a recurring basis and where they are
classified within the hierarchy as of December 31, 2008. We have other financial
instruments, such as cash, accounts receivable, accounts payable, accrued
expenses and long-term debt, whose carrying amounts approximate fair
value.





Accounts
Receivable





Accounts
receivable are recorded at the aggregate unpaid amount less any allowance for
doubtful accounts.  The allowance is based on historical bad debt
experience and the specific identification of accounts deemed uncollectible. We
determine an account receivable’s delinquency status based on its contractual
terms. Interest is not charged on outstanding balances.  Accounts are
written-off only when all methods of recovery have been exhausted. We control
credit risk through initial credit evaluations and approvals, credit limits, and
monitoring procedures. We perform ongoing credit evaluations of our customers,
but do not require collateral to support accounts receivable.





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 established for potential obsolescence. Determining
adequate reserves for inventory obsolescence requires management’s judgment.
Conditions impacting the realizability of our inventory could cause actual asset
write-offs to be materially different than the inventory reserve balances as of
year-end.




Property,
Plant and Equipment





Property,
plant and equipment are stated at cost.  Depreciation is computed
under the straight-line method over the estimated useful lives of four to seven
years for equipment and 15 to 30 years for buildings and
improvements.




Goodwill





We apply
the provisions of SFAS No. 142, Goodwill and Other Intangible
Assets to goodwill. Goodwill is deemed to have an indefinite life and
accordingly, is not subject to annual amortization.  Goodwill is
subject to annual impairment reviews, and, if conditions warrant, interim
reviews based upon its estimated fair value.  Impairment charges, if
any, are recorded in the period in which the impairment is
determined.





Debt
Issue Costs





As
required by Accounting Principles Board Opinion No. 21, Interest on Receivables and
Payables, costs paid to lenders to obtain original financing are
presented as discounts on the related debt and are amortized to interest expense
over the term of the related financing, using the effective interest method
(unless the financing is a line of credit, in which case the straight-line
method is used). Such costs paid to third parties are presented as assets and
are amortized to interest expense in the same manner as costs paid to
lenders.




F-12
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Intangible
Assets





Intangible
assets are amortized over their estimated useful lives.  Costs associated
with renewing or extending the terms associated with the intangible assets are
expensed as incurred.  The useful lives used for amortization of the
intangible assets are as follows:




Patents
      and developed technologies
            9 yearsPurchased
      customer relationships
            12 -13
    yearsNon-compete
      agreements
            2
  years





Trademarks
and trade names have an indefinite life.  The Predecessor amortized these
assets over useful lives ranging from 10 -18 years.





Long-Lived
Assets





Following
the provisions of SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets(“SFAS No. 144”), long-lived assets are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Such reviews are
based on a comparison of the asset’s undiscounted cash flows to the recorded
carrying value for the asset. If the asset’s recorded carrying value exceeds the
sum of the undiscounted cash flows expected to result from the use and eventual
disposition of the asset, the asset is written-down to its estimated fair value.
To estimate that fair value, we will use the most appropriate valuation
technique for the circumstances and for which sufficient data is
available.





Impairment
charges, if any, are recorded in the period in which the impairment is
determined. Identifiable assets will continue to be amortized over their useful
lives and be reviewed for impairment in accordance with SFAS No.
144.





Derivatives





Derivatives
are recorded at their fair value as of the balance sheet date. On the
consolidated statement of cash flows, cash flows from derivative instruments
accounted for as cash flow hedges are classified in the same category as the
cash flows from the items being hedged.





Common
Stock Purchase Warrants





Pursuant
to Emerging Issues Task Force Issue 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock(“EITF 00-19”), common stock purchase warrants issued by us and currently
outstanding are recorded at initial fair value and reported in stockholders’
equity as increases to additional paid-in capital. These warrants are reported
as equity, rather than liabilities, since they meet EITF 00-19’s
equity-classification requirements, such as (i) the warrants may not be net-cash
settled, (ii) the warrant contract limits the number of shares to be delivered
in a net-share settlement and (iii) we have sufficient unissued common shares
available to settle outstanding warrants. Subsequent changes in fair value from
the warrants’ initial fair value are not recognized as long as the warrants
continue to merit classification as equity.





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.




F-13
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Taxes
Collected from Customers





Sales
taxes collected from customers are not considered revenue and are included in
accounts payable and accrued liabilities until remitted to the taxing
authorities.





Shipping
and Handling Costs





Outbound
shipping and handling costs are included in selling expenses in the accompanying
consolidated statements of income.  These costs were $5,000 and nil
for the years ended December 31, 2008 and 2007, respectively.  The
Predecessor’s shipping and handling costs for the period ended December 19, 2008
and the year ended December 31, 2007 were $514,000 and $647,000,
respectively.





Advertising
Costs





Advertising
costs are expensed as incurred and are primarily included in selling expenses in
the accompanying consolidated statements of income. Advertising expense was
$2,000 and nil for the year ended December 31, 2008 and 2007, respectively.The Predecessor’s
advertising costs for the period ended December 19, 2008 and the year ended
December 31, 2007 were $83,000 and $129,000, respectively.





Income
Taxes





Income
taxes are accounted for in accordance with SFAS No. 109, Accounting for Income
Taxes.  Under this method, 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.





We
adopted the provisions of FASB Interpretation No. 48 Accounting for Uncertainty in Income
Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”) on January
1, 2007.  There were no unrecognized tax benefits and there was no
effect on our financial condition or results of operations as a result of
adopting FIN 48. 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 benefits
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.





Our 2005
through 2008 tax years remain subject to examination by the federal and New
Jersey tax authorities.  CTI’s tax years 2005 through 2008 remain
subject to examination by federal and various state tax jurisdictions. CTSA’s
tax years 2006 and 2007 remain subject to examination as the French tax
authorities have completed audits of CTSA’s 2004 and 2005 tax
years.





We
classify interest on tax deficiencies as interest expense and income tax
penalties as other miscellaneous expenses.  For the years ended December
31, 2008 and 2007, interest expense and penalties relating to tax deficiencies
were not significant.





Net
Income Per Common Share





We
account for and disclose net income per common share in accordance with SFAS
No. 128, Earnings per
Share. Basic net income per common share is computed by dividing net
income by the weighted average number of common shares outstanding. Diluted net
income per common share is computed by dividing net income by the weighted
average number of common shares and dilutive potential common share equivalents
then outstanding. Potential common shares consist of shares issuable upon the
exercise of warrants (using the treasury stock method).




F-14
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Year
      Ended December 31,2008
            
            
            2007Basic:Net
      income (in thousands)
            
            $
            576
            
            
            $
            797Weighted
      average shares
            
            
            9,550,362
            
            
            
            6,912,329Basic
      income per common share
            
            $
            0.06
            
            
            $
            0.11Diluted:Net
      income (in thousands)
            
            $
            576
            
            
            $
            797Weighted
      average shares
            
            
            9,550,362
            
            
            
            6,912,329Effect
      of dilutive warrants
            
            
            2,451,109
            
            
            
            1,617,878Weighted
      average shares, as adjusted
            
            
            12,001,471
            
            
            
            8,530,207Diluted
      income per common share
            
            $
            0.05
            
            
            $
            0.09





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






Year
      Ended December 31,2008
            
            
            2007Warrants
      Issued for Acquisition-Related Costs (see Note 18)
            
            
            100,000
            
            
            
            —Other
      Warrants Sold (see Note 18)
            
            
            118,750
            
            
            
            —Options
      (see Note 18)
            
            
            1,462,500
            
            
            
            1,462,500





The
dilutive effect of outstanding warrants as of December 31, 2008 was considered
in computing diluted income per common share. After December 31, 2008, 3,273,494
warrants were exercised, resulting in 1,635,171 common shares being
issued.





Reclassifications





Certain
amounts in the prior year have been reclassified to conform to the 2008
presentation.





Segments





We
operate in a single segment as defined under SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information.





Recent
Accounting Pronouncements





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51
(“SFAS No. 160”). SFAS No. 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
The objective of this Statement is to improve the relevance, comparability, and
transparency of the financial information that a reporting entity provides in
its consolidated financial statements. We anticipate that the adoption of SFAS
No. 160 will not have a significant impact on our consolidated financial
statements.





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No.
133. (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about
an entity’s derivative instruments and hedging activities with a view toward
improving the transparency of financial reporting and is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008, with early application encouraged. SFAS No. 161 encourages, but does
not require, comparative disclosures for earlier periods at initial adoption.
Due to our minimal hedging activities and investments in derivatives, we
anticipate that the adoption of SFAS No. 161 will not have a significant impact
on our consolidated financial statements.




F-15
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


In April
2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, Determination
of the Useful Life of Intangible Assets. This FSP amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized asset under SFAS No. 142, Goodwill
and Other Intangible Assets (“SFAS 142”). The objective of this FSP is to
improve the consistency between the useful life of a recognized intangible asset
under SFAS 142 and the period ofexpected
cash flows used to measure the fair value of the asset under SFAS 141(R) and
other accounting principles generally accepted in the United States of America.
This FSP applies to all intangible assets, whether acquired in a business
combination or otherwise; and shall be effective for financial statements issued
for fiscal years beginning after December 15, 2008 and interim periods within
those fiscal years and applied prospectively to intangible assets acquired after
the effective date. Early adoption is prohibited. We are currently evaluating
this new FSP and anticipate that it will not have a significant impact on our
consolidated financial statements.





4.
            INVENTORIES





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




Year
      Ended December 31,2008
            
            
            2007
            
            
            (Predecessor)
              2007Raw
      materials
            
            $
            5,822
            
            
            $
            —
            
            
            $
            4,753Work-in-process
            
            
            3,484
            
            
            
            —
            
            
            
            2,316Finished
      goods
            
            
            2,141
            
            
            
            —
            
            
            
            1,674$
            11,447
            
            
            $
            —
            
            
            $
            8,743





Provision
for potential obsolescence was $(2,000) and nil for the years ended December 31,
2008 and 2007, respectively. The Predecessor’s provision for potential
obsolescence was $71,000 and $883,000 for the period ended December 19, 2008 and
for the year ended December 31, 2007, respectively. Such provisions are reported
as adjustments to our cost of goods sold in the accompanying consolidated
statements of income.





5.
            PREPAID
      EXPENSES AND OTHER CURRENT ASSETS





Prepaid
expenses and other current assets consist of the following (all amounts in
thousands):




Year
      Ended December 31,2008
            
            
            2007
            
            
            (Predecessor)
              2007Value
      added taxes receivable
            
            $
            60
            
            
            $
            —
            
            
            $
            281Prepaid
      expenses
            
            
            127
            
            
            
            94
            
            
            
            131Other
            
            
            8
            
            
            
            —
            
            
            
            28$
            195
            
            
            $
            94
            
            
            $
            440





6.
            PROPERTY,
      PLANT AND EQUIPMENT





Property,
plant and equipment consist of the following (all amounts in
thousands):




Year
      Ended December 31,2008
            
            
            2007
            
            
            (Predecessor)
              2007Land
            
            $
            1,042
            
            
            $
            —
            
            
            $
            1,382Building
      and improvements
            
            
            3,427
            
            
            
            —
            
            
            
            5,330Machinery
      and equipment
            
            
            3,430
            
            
            
            —
            
            
            
            4,3097,899
            
            
            
            —
            
            
            
            11,021Less:
      Accumulated depreciation
            
            
            17
            
            
            
            —
            
            
            
            1,047$
            7,882
            
            
            $
            —
            
            
            $
            9,974





7.
            GOODWILL





Goodwill
represents the excess of the cost of acquiring CTI over the net fair value
assigned to assets acquired and liabilities assumed. No goodwill existed as of
December 31, 2007. The Predecessor’s goodwill as of December 31, 2007 of $24.4
million was due to a previous business combination.




F-16
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Our
goodwill was not impaired as of December 31, 2008 pursuant to SFAS No. 142,
Goodwill and Other Intangible
Assets due to the December 19, 2008 valuation of goodwill in connection
with the Acquisition.





8.
            OTHER
      INTANGIBLE ASSETS





Intangible
assets as of December 31, 2008 consist of the following (all amounts in
thousands):




Cost
            
            
            Accumulated
      Amortization
            
            
            Net
      Book ValueDeveloped
      technologies, including patents
            
            $
            10,810
            
            
            $
            40
            
            
            $
            10,770Trademarks
      and trade names
            
            
            7,390
            
            
            
            —
            
            
            
            7,390Purchased
      customer relationships
            
            
            31,063
            
            
            
            85
            
            
            
            30,978Non-compete
      agreements
            
            
            293
            
            
            
            5
            
            
            
            288$
            49,556
            
            
            $
            130
            
            
            $
            49,426





Trademarks
and trade names have indefinite lives and therefore, they are not amortized. The
Predecessor amortized trademarks over estimated lives of 10-18 years. All other
intangible assets have similar lives to those used by the
Predecessor.





Trademarks
can be renewed without substantial cost. On average, our trademarks renew in
approximately 7 years.





Amortization
of intangible assets was $131,000 and nil for the years ended December 31, 2008
and 2007, respectively. We do not consider any of our intangible assets to have
residual value. We did not have any intangible assets as of December 31,
2007.





As
required by SFAS No. 144, we reviewed events and circumstances for indications
of possible impairment of the above intangible assets and determined that
testing for possible impairment was not necessary at December 31, 2008 due to
the December 19, 2008 valuation of the assets in connection with the
Acquisition.





The
Predecessor’s intangible assets as of December 31, 2007 consisted of the
following (all amounts in thousands):




Cost
            
            
            Accumulated
      Amortization
            
            
            Net
      Book ValueDeveloped
      technologies, including patents
            
            $
            8,009
            
            
            $
            1,393
            
            
            $
            6,616Trademarks
      and trade names
            
            
            4,255
            
            
            
            453
            
            
            
            3,802Purchased
      customer relationships
            
            
            23,670
            
            
            
            2,829
            
            
            
            20,841Non-compete
      agreements
            
            
            885
            
            
            
            339
            
            
            
            546$
            36,819
            
            
            $
            5,014
            
            
            $
            31,805





The
Predecessor’s amortization of intangible assets was $2.5 million and $2.6
million for the period ended December 19, 2008 and for the year ended December
31, 2007, respectively.





The
future amortization expense relating to intangible assets for the next five
years and beyond is estimated at December 31, 2008 to be (all amounts in
thousands):




Year
      Ending December 31,2009
            
            $
            3,9222010
            
            
            3,9182011
            
            
            3,7762012
            
            
            3,7762013
            
            
            3,776Thereafter
            
            
            22,868$
            42,036





9.
            OTHER
      NONCURRENT ASSETS





Other
noncurrent assets of $188,000 primarily consist of unamortized costs paid to
third parties to obtain our long-term debt and lines of credit (“capitalized
debt issue costs”). Such costs were $185,000 and nil as of December 31, 2008 and
2007, respectively. As of December 31, 2007, the Predecessor’s unamortized
capitalized debt issue costs were $385,000.




F-17
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Amortization
of capitalized debt issue costs was $2,000 and nil for the years ended December
31, 2008 and 2007, respectively. The Predecessor’s amortization of capitalized
debt issue costs was $97,000 and $99,000 for the period ended December 19, 2008
and for the year ended December 31, 2007, respectively.





The
future amortization expense for each of the five succeeding years and beyond
relating to capitalized debt issue costs is estimated at December 31, 2008 to be
(all amounts in thousands):





Year
      Ending December 31,2009
            
            $
            532010
            
            
            492011
            
            
            422012
            
            
            252013
            
            
            16$
            185





10.
            LINES
      OF CREDIT




We have a
line of credit with a maximum borrowing capacity of $5.0 million with TD Bank
N.A (“TD Bank”).  Interest is payable monthly and is determined, at
our discretion, based on (i) the Prime Rate, plus 3% (not to be less than 6% in
total) or (ii) an adjusted LIBOR rate (subject to a 3% interest rate floor),
plus a margin percentage that is based on financial performance.  The
line of credit’s interest rate at December 31, 2008 was 6.25%. The line of
credit expires on December 19, 2011. This line of credit is subject to (i) the
same restrictive covenants imposed on and (ii) the same collateral and
guarantees as the Term A Note and Term B Note described in Note 11. At December
31, 2008, there was a $3.5 million outstanding borrowing on this line of
credit.





On May 1,
2007, we entered into a $500,000 revolving credit agreement with SCP Private
Equity Management Company, LLC, (“SCP”), which owns stock in Cyalume and of
which three of our Directors are members. Any amounts outstanding under the
revolving credit agreement bear interest at a rate of 5.5% per year. Any funds
outstanding under the revolving credit agreement were due and payable upon our
consummation of a business combination. We have never borrowed funds under this
revolving credit agreement which expired on the date of the
Acquisition.





CTSA has
lines of credit with a combined maximum borrowing capacity of €1.1 million ($1.5
million as of December 31, 2008), under which there were no outstanding
borrowings at December 31, 2008 and 2007. The lines’ interest rates are
variable, based on the Euro Overnight Index Average and the 3-month Euro
Interbank Offered Rate. The lines are collateralized by substantially all
business assets of CTSA. The lines have indefinite termination dates, but can be
renegotiated periodically.





As of
December 31, 2007, CTI had a line of credit with a maximum borrowing capacity of
$2.0 million.  Interest was determined using the same methodology used to
determine interest on the Predecessor’s Senior Tranche A Note (see Note 11). The
line of credit was collateralized by substantially all assets of CTI. No
borrowings were ever made on this line of credit and it was terminated due to
and on the date of the Acquisition.





11.
            NOTES
      PAYABLE





CTI has
two notes payable to TD Bank; a $25.5 million Term A Note and a $2.5 million
Term B Note, that were entered into in conjunction with the
Acquisition.





The Term
A Note is payable in monthly principal installments ranging from $319,000 to
$468,000, plus monthly interest payments as described below, that commence on
February 1, 2009, with a final principal payment of $2.8 million at maturity
(December 19, 2013). Interest payments on the 60% of the Term A Note’s principal
balance are hedged using a pay-fixed, receive-variable interest rate swap to
reduce exposure to changes in cash payments caused by changes in interest rates
on the Term A Note.  See Note 15 for details on the interest rate
swap. Interest on 60% interest rate-swapped portion of the Term A Note is
payable monthly and determined based on 1-month LIBOR, plus a margin percentage
that is based on financial performance. At December 31, 2008, interest on that
portion of the Term A Note was 5.08%, before considering the effect of the
interest rate hedging relationship. Interest on the remaining 40% of the Term A
Note is also payable monthly and is determined based on 1-month LIBOR (subject
to a 3% interest rate floor) plus a margin percentage that is based on our
financial performance. At December 31, 2008, that portion of the Term A Note was
7.5%. The Term A Note is collateralized by all of the assets of CTI (except
CTI’s equity interests in CTSA, of which only 65% are collateral of the Term A
Note) and is guaranteed by Cyalume. The Term A Notes require various restrictive
financial and nonfinancial covenants, such as maximum leverage ratios and
limitations on capital expenditures and dividends. Outstanding principal on the
Term A Note is $25.5 million at December 31, 2008.




F-18
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)





The Term
B Note is payable in monthly principal installments of $10,000, plus monthly
interest payments as described below, that commence on February 1, 2009, with a
final principal payment of $1.9 million at maturity (December 19, 2013).
Interest payments on the Term B Note’s principal balance are hedged using a
pay-fixed, receive-variable interest rate swap to reduce our exposure to changes
in cash payments caused by changes in interest rates on the Term B
Note.  See Note 15 for details on the interest rate swap. Interest is
payable monthly and is determined based on 1-month LIBOR plus a margin
percentage that is based on our financial performance. The Term B Note’s
interest rate at December 31, 2008 was 5.08% before considering the effect of
the interest rate hedging relationship discussed in Note 15. The Term B Note is
collateralized by all of the assets of CTI (except CTI’s equity interests in
CTSA, of which only 65% are collateral of the Term B Note) and is guaranteed by
Cyalume. The Term B Notes require various restrictive financial and nonfinancial
covenants, such as such as maximum leverage ratios and limitations on capital
expenditures and dividends.  Outstanding principal on the Term B Note
is $2.5 million at December 31, 2008.





The Term
A Note, Term B Note and the TD Bank line of credit described in Note 10 are
senior in payment priority to all of our other notes payable described here and
in Note 10.





We have a
$1.8 million note payable to our underwriter that was entered into in
conjunction with the Acquisition. The note bears an interest rate of 8%, which
is paid-in-kind (added to the unpaid principal balance of the note) quarterly.
The note is unsecured and all principal and accrued interest is payable at
maturity (June 30, 2014).  Outstanding principal on this note is $1.8
million at December 31, 2008.  See Note 12 for further discussion of
this note.





As of
December 31, 2008, future minimum payments due for long-term debt for each of
the five succeeding years and beyond are as follows (all amounts in
thousands):




Year
      Ending December 31,2009
            
            $
            3,6212010
            
            
            4,1842011
            
            
            4,6732012
            
            
            5,1822013
            
            
            10,340Thereafter
            
            
            1,81829,818Less:
      unamortized debt discount
            
            
            (616
            )$
            29,202





Amortization
of the debt discount was $4,000 and nil for the years ended December 31, 2008
and 2007, respectively. The Predecessor’s amortization of debt discount was
$225,000 and $237,000 for the period ended December 19, 2008 and for the year
ended December 31, 2007, respectively.





CTSA had
a mortgage loan with a bank, which was due in monthly installments of €7,000
($10,000), including interest. The loan bore interest at a fixed rate of 5.95%
per year. The mortgage loan was collateralized by the real property of
CTSA.  The loan was repaid in full during 2008.





In 2006,
we issued two notes with an aggregate principal amount of $144,000 to
SCP.  The notes bore interest at a rate of 5.5% per annum, with
principal and accrued interest due no later than April 24, 2008 (the first
anniversary of the initial public offering). We repaid these notes in full
during 2007.





Before
the Acquisition, CTI had notes payable to various lenders with a total original
principal amount of $53.0 million. These notes payable consisted of $27.5
million Senior Tranche A Notes, $12.5 million Senior Tranche B Notes and $13.0
million Subordinated Notes.  The Senior Tranche A Notes were senior in
payment priority to the Senior Tranche B Notes, which were all senior in payment
priority to the Subordinate Notes. All of these notes were paid in full in
conjunction with the Acquisition.








F-19
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


The
Senior Tranche A Notes were payable in quarterly principal installments of
$700,000, which commenced on April 23, 2006 and were scheduled to end on October
23, 2010 (except for (a) April 23, 2007, on which a $10.0 million principal
payment was required and (b) July 23 and October 23, 2007 and January 23, 2008,
on which no principal payments were required) with one final payment of $7.0
million due on January 23, 2011. Outstanding principal was $14.7 million at
December 31, 2007. Interest was also payable quarterly and was determined
based on the unpaid principal balance at a margin percentage that was based on
financial performance, plus either (a) the greater of (i) the Prime Rate or (ii)
the Federal Funds Effective Rate, plus 0.5% or (b) the average British Bankers
Association Interest Settlement Rate (adjusted for certain Federal Reserve
System reserves) until the note was repaid in full.  The interest rate
charged as of December 31, 2007 was 8.80%. The Senior Tranche A Notes were
collateralized by substantially all assets of CTI and required various
restrictive financial and nonfinancial covenants, such as minimum EBITDA
thresholds, maximum leverage ratios and a restriction on dividends. In January
2008, CTI reached an arbitration settlement with the Sellers (see Note 17)
pursuant to which CTI received $3.0 million in cash. A provision of the debt
agreements required CTI to make an additional one-time principal payment equal
to the amount of any settlement received, less direct third-party costs incurred
in pursuit of the settlement. Accordingly, in May 2008 a principal payment of
$950,000 was made on the Senior Tranche A Notes in addition to the principal
payments described above.




The
Senior Tranche B Notes were originally payable in one principal installment of
$12.5 million on July 23, 2011. Interest was payable quarterly and was
determined based on the unpaid principal balance at a margin percentage that was
based on CTI’s financial performance plus either (a) the greater of (i) the
Prime Rate or (ii) the Federal Funds Effective Rate, plus 0.5% or (b) the
average British Bankers Association Interest Settlement Rate (adjusted for
certain Federal Reserve System reserves) until the notes were repaid in full.
The interest rate charged as of December 31, 2007 was 13.9%. The Senior Tranche
B Notes were collateralized by substantially all assets of CTI and required
various restrictive financial and nonfinancial covenants, such as minimum EBITDA
thresholds, maximum leverage ratios and a restriction on dividends.




The
Subordinated Notes bore interest at 15.5% (11% of which was payable quarterly in
cash, while the remaining 4.5% was paid-in-kind (added to the unpaid principal
balance of the Subordinated Notes) and was determined based on the unpaid
principal balance. The Subordinated Notes were originally payable in one
principal installment of $13.0 million plus all paid-in-kind interest on January
23, 2012.  Outstanding principal, including paid-in-kind interest, was
$14.1 million at December 31, 2007. The Subordinated Notes were collateralized
by substantially all assets of CTI.





12.
            DEFERRED
      UNDERWRITING COSTS





On April
25, 2007, we completed a private placement (the ‘‘Private Placement’’) and
received gross proceeds of $1.5 million. On May 1, 2007, we consummated our
initial public offering and received gross proceeds of $58.5 million. Of the
combined gross proceeds of $60.0 million, $2.3 million would be paid for
deferred underwriting compensation fees to Rodman & Renshaw, LLC (“Rodman”)
if, and only if, we acquired a target business and 100% of the shares voted
approved the acquisition. On December 19, 2008, we acquired CTI with less than
100% of shares  voting to approve the Acquisition (as discussed in
Note 2) and therefore $2.1 million of these fees became payable to Rodman.
Before December 19, 2008, however, as full payment of these costs, Rodman
accepted a cash payment of $250,000, $1.1 million in deferred underwriting fees
and 93,750 shares of our common stock.  On December 30, 2008, Rodman
exchanged the deferred underwriting fee obligation and the 93,750 shares in
exchange for the $1.8 million note payable described in Note 11.





13.
            ACCRUED
      EXPENSES





Accrued
expenses consist of the following (all amounts in thousands):




Year
      Ended December 31,2008
            
            
            2007
            
            
            (Predecessor)
              2007Payroll
            
            $
            1,649
            
            
            $
            —
            
            
            $
            1,260Interest
            
            
            107
            
            
            
            —
            
            
            
            918Professional
      fees
            
            
            357
            
            
            
            —
            
            
            
            598Other
            
            
            437
            
            
            
            88
            
            
            
            816$
            2,550
            
            
            $
            88
            
            
            $
            3,592






F-20
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


14.
            NOTES
      PAYABLE AND ADVANCE DUE TO RELATED
PARTIES





There are
seven unsecured notes payable to six stockholders at December 31,
2008.





Four of
these notes were entered into December 19, 2008, and are payable to Messrs.
Yaron Eitan, Winston Churchill, Thomas Rebar and Wayne Weisman (partners of SCP)
in principal amounts of $150,000, $650,000, $100,000 and $100,000,
respectively.  Each note bears interest at 6%, which is calculated
quarterly and paid in-kind (added to the unpaid principal balance). These notes
are payable in one combined installment of $1.0 million, plus all paid-in-kind
interest on June 19, 2014. At December 31, 2008, outstanding principal on these
notes totaled $1.0 million.





The
remaining three notes are payable to two stockholders (Messrs. Isaac Applbaum
and Marc Abramowitz) in original principal amounts totaling $118,000 and
$87,000, respectively. Each note bears interest at 4% and is calculated on an
annual basis.  These three notes were due to be paid in 2006, but
under mutually satisfactory arrangement, remain unpaid.  At December
31, 2008 the total outstanding balance on these notes is $55,000.





In 2006,
a stockholder advanced us a total of $32,000 to pay operating expenses. We
repaid $23,000 to the stockholder in 2007. The amount outstanding at December
31, 2008 of $9,000 is non-interest bearing and due on demand.





15.
            DERIVATIVE
      INSTRUMENTS AND HEDGING ACTIVITIES





Simultaneous
with the Acquisition and the incurrence of the Term A Note and Term B Note
discussed in Note 11, 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 the Term A Note and the Term B Note. 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 consolidated other comprehensive income. See Note 18 for a
description of changes in accumulated other comprehensive income due to
derivatives and hedging activities. Such changes were due to unrealized losses
on the interest rate swaps. These unrealized 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 and therefore we do not expect to
reclassify any portion of these unrealized losses from consolidated other
comprehensive income to earnings in the future.





The fair
value of these interest rate swaps at December 31, 2008 is $(163,000) and is
presented as a liability on our consolidated balance sheet. The fair values of
the swaps were determined by discounting the estimated cash flows to be received
and paid due to the swaps over the swap’s contractual life using an estimated
risk-free rate for each swap settlement date.





We did
not hold any derivative instruments before the Acquisition and have not engaged
in any other hedging activities.





16.
            ASSET
      RETIREMENT OBLIGATION





As part
of the Acquisition, we assumed CTI’s asset retirement obligation associated with
remediation of certain known occurrences of asbestos at the manufacturing
facility in West Springfield, Massachusetts.





The
significant assumptions used to estimate the obligation are:





Annual
      inflation rate
            5.01%Credit-adjusted
      risk-free rate
            5.37%Range
      of estimated remediation completion dates
            September
      30, 2007 to September 30, 2015Initial
      estimated remediation costs (undiscounted and not adjusted for
      inflation)
            $200,000








F-21
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


The
following is a reconciliation of the beginning and ending aggregate carrying
amounts of asset retirement obligation for the years ended December 31, 2008 and
2007 (all amounts in thousands):




Year
      Ended December 31,
            
            
            (Predecessor)
              For
      the Period January 1, 20082008
            
            
            2007
            
            
            (Predecessor)
              2007
            
            
            to
      December 19,
              2008Balance,
      beginning
            
            $
            —
            
            
            $
            —
            
            
            $
            200
            
            
            $
            166Liability
      assumed at Acquisition
            
            
            175
            
            
            
            —
            
            
            
            —
            
            
            
            —Additional
      liabilities incurred
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Liabilities
      settled
            
            
            —
            
            
            
            —
            
            
            
            (44
            )
            
            
            —Accretion
      expense
            
            
            1
            
            
            
            —
            
            
            
            10
            
            
            
            9Revisions
      in estimated cash flows
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Balance,
      ending
            
            $
            176
            
            
            $
            —
            
            
            $
            166
            
            
            $
            175





Accretion
expense on the asset retirement obligation is included in general and
administrative expenses in the accompanying consolidated statements of
income.





As of
December 31, 2008, future settlement payments for each of the five succeeding
years and beyond are estimated to be as follows (all amounts in
thousands):




Year
      Ending December 31,2009
            
            $
            482010
            
            
            —2011
            
            
            522012
            
            
            —2013
            
            
            58Thereafter
            
            
            64Total
      estimated undiscounted payments (adjusted for estimated
      inflation)
            
            $
            222





The
$48,000 expected to be paid in 2009 per the above table is reported as accrued
expenses in our consolidated balance sheet as of December 31, 2008.





The
difference between the $176,000 liability as of December 31, 2008 and the
estimated undiscounted future payments of $222,000 is the time value of money at
the credit-adjusted risk-free rate of 5.37%.






F-22
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


17.
            COMMITMENTS
      AND CONTINGENCIES





Operating
Leases with Third Parties





We lease
certain equipment, automobiles and other assets under cancelable and
non-cancelable operating leases.  Expenses associated with these
leases total $3,000 in 2008. There was no expense in 2007.The Predecessor’s lease
expense for such equipment, automobiles and other assets for the period ended
December 19, 2008 and the year ended December 31, 2007 was $52,000 and $14,000,
respectively. Future minimum lease payments under non-cancelable lease
obligations at December 31, 2008 are as follows (all amounts in
thousands):




Year
      Ending December 31,2009
            
            $
            362010
            
            
            222011
            
            
            112012
            
            
            92013
            
            
            7Thereafter
            
            
            —$
            85




Operating
Leases with Related Parties





We
previously occupied office space provided by SCP, which had agreed that, until
we acquired a target business, it would make such office space, as well as
certain accounting, office and secretarial services, available to us. We agreed
to pay SCP $8,000 per month for such services commencing April 25, 2007.
Payments made under this agreement were $90,000 for the years ended December 31,
2008 and 2007. Use of this office space and these services ceased in 2008, after
the Acquisition of CTI.





Legal





We do not
expect that the various legal proceedings we are involved in, including those
discussed in the following paragraph, will have a material adverse effect on our
future financial position, operating results, or cash flows.





As
discussed in Note 2, we acquired CTI on December 19, 2008. As part of the
Acquisition we acquired CTI’s exposure to litigation that existed at the
acquisition date. On January 23, 2006, GMS acquired all of the outstanding
capital stock of Omniglow Corporation (the “Transaction”) and changed the name
of the company to Cyalume Technologies, Inc. (CTI). 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 seek
compensatory damages of $1.4 million, to be trebled, and recovery of costs and
legal fees. We have filed for damages of $368,000 against the Omniglow
Buyers.  We continue to rigorously defend our position on these
matters, as we believe the Omniglow Buyers’ claims to be without
merit.





During
2006, CTI and the former stockholders of Omniglow (“Sellers”) commenced
arbitration proceedings against one another that are separate and distinct from
those discussed in the previous paragraph. These arbitration proceedings
included claims with respect to certain representations, warranties, contracts,
covenants and other agreements in connection with the transaction and a number
of other unrelated items.  In January 2008, CTI reached settlement with the
Sellers on all matters, which resulted in CTI receiving $3.0 million in cash.
The terms of the settlement, which was reached to minimize the parties' risk,
time and cost of further litigation, gave no explicit consideration as to
whether the disputes being resolved arose in the purchase process or pursuant to
subsequent events. As a result, CTI followed the guidance in SFAS No. 141, Business Combinations and
SFAS No. 16, Prior Period
Adjustments and reflected the settlement as a gain in 2008, rather than
an adjustment to the purchase price. The net gain of $2.8 million is included in
other income on the accompanying consolidated financial statements of the
Predecessor for the period ended December 19, 2008.






F-23
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Other
Commitments





On April
25, 2007, we had engaged the representative of the underwriters of our initial
public offering, on a non-exclusive basis for five years, as an agent for the
solicitation of an acquisition target. We agreed to pay the representative of
the underwriters a cash transaction fee equal to 3% of the aggregate
consideration paid in such an acquisition with a target business the
representative of the underwriters introduced to us, if the acquisition was
consummated within twenty-four months of the introduction.





On April
25, 2007, we engaged the representative of the underwriters of our initial
public offering, on a non-exclusive basis for five years, as our agent for the
solicitation of the exercise of our common stock purchase warrants (see Note 18
for a description of those warrants). To the extent not inconsistent with the
guidelines of the NASD and the rules and regulations of the Securities and
Exchange Commission, we agreed to pay the representative of the underwriter for
bona fide services rendered a commission equal to 3% of the exercise price for
each common stock purchase warrant exercised more than one year after April 25,
2007 (the effective date of our initial public offering) if the exercise was
solicited by the representative. In addition to soliciting, either orally or in
writing, the exercise of the common stock purchase warrants, the
representative’s services may also include disseminating information, either
orally or in writing, to warrant holders about our Company or the market for our
securities, and assisting in the processing of the exercise of the warrants. No
compensation will be paid to the representative upon the exercise of the
warrants if:





•
            The
      market price of the underlying shares of common stock is lower than the
      exercise price;


•
            The
      holder of the warrants has not confirmed in writing that the
      representative solicited the
exercise;


•
            The
      warrants are held in a discretionary
account;


•
            The
      warrants are exercised in an unsolicited transaction;
  or


•
            The
      representative has not provided to the holder of the warrants solicited
      for exercise, a copy of the prospectus with respect to the shares of
      common stock underlying the
warrants.





There is
no compensation due under this agreement.





On June
19, 2007, we entered into a consulting agreement with Derek Dunaway prior to Mr.
Dunaway becoming our CEO. Mr. Dunaway’s duties were to assist our officers with
our reporting obligations and in our search for a target business to acquire.
Pursuant to the consulting agreement, Mr. Dunaway received $10,000 per month
(including retroactive compensation to May 2, 2007) and the agreement could have
been terminated by either party on 15 days prior written notice to the other
party. Under the agreement, if we consummated a business combination, we were
required to (i) pay Mr. Dunaway $10,000 for each month he performed as a
consultant for us and (ii) issue Mr. Dunaway warrants to purchase 100,000 shares
of our common stock, exercisable at $5.00 per share.  In February 2008
Mr. Dunaway became CEO of CTI and ceased being a consultant for us. Therefore,
we discontinued the $10,000 monthly consulting payments to him.





Mr.
Dunaway is still owed the $10,000 per month fee due upon successful completion
of a business combination. On December 19, 2008, we consummated such a business
combination when we acquired CTI (as discussed in Note 2). This obligation has
been included in G&A expense for 2008 and is an accrued expense at December
31, 2008. Mr. Dunaway has declined the warrants and therefore none were issued
to him and no expense has been accrued for them.





18.
            STOCKHOLDERS’
      EQUITY





Preferred
Stock





We are
authorized to issue 1,000,000 shares of preferred stock with such designations,
voting and other rights and preferences as may be determined from time to time
by our Board of Directors. No preferred stock was issued or outstanding as of
December 31, 2008 or 2007.





Common
Stock





We are
authorized to issue 50,000,000 shares of common stock. Stockholders are entitled
to one vote for each share held of record on all matters to be voted on by
stockholders. Stockholders have no conversion, preemptive or other subscription
rights and there are no sinking fund or redemption provisions applicable to the
common stock.






F-24
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


At
December 31, 2007, 1,462,499 (or 19.99%) of the 7,312,500 common stock shares
issued in our initial public offering were subject to possible redemption.
Holders of common stock that voted against our acquisition of CTI had the right
to demand redemption of their common stock for a pro rata portion of the cash
and cash equivalents held in trust. That pro rata share at December 31, 2007 was
estimated to be $7.62 per common share or $11.1 million. After the December 19,
2008 approval of the Acquisition of CTI, holders of common stock who voted
against the Acquisition were owed $8.03 per common share, or $7.9 million, of
which $6.8 million was paid in 2008 and $1.1 million was still payable as of
December 31, 2008.





Common
Stock Purchase Warrants





As of
December 31, 2008, we had 7,468,750 common stock purchase warrants (“warrants”)
outstanding, of which 7,062,500 were sold in a public offering, 187,500 were
sold in a private placement, 100,000 were issued as payment of
Acquisition-related costs and 118,750 were sold to a third party.





Public
Offering Warrants





On May 1,
2007 we sold 7,312,500 units in our initial public offering for $58.5 million,
or $8.00 per unit.  Each unit consisted of one share of our common
stock and one common stock purchase warrant.  Each warrant entitles
the holder to purchase one share of common stock at an exercise price of $5.00
per share. These warrants may be exercised now that, among other things, we have
completed the acquisition of a business (which occurred on December 19, 2008).
These warrants expire April 25, 2012 unless earlier redeemed. These warrants are
redeemable by us at a price of $0.01 per warrant upon 30 days notice, only in
the event that the last sales price of the common stock is at least $11.50 per
share for any 20 trading days within a 30- trading-day period ending on the
third business day prior to date on which notice of redemption is
given. 225,000 of these warrants were exercised in December 2008. See Note
25 for information on exercises in 2009.





Holders
of warrants (a) sold in a public offering and (b) included as part of the units
underlying the option sold (see below) will be able to receive shares upon
exercise of the warrants only if (i) a current registration statement under the
Securities Act of 1933 relating to the shares of common stock underlying the
warrants is then effective and a current prospectus is then available or such
shares are exempt from registration and (ii) such shares are qualified for sale
or exempt from qualification under the applicable securities laws of the states
in which the various holders of warrants reside. Such a registration became
effective on February 9, 2009.





Private
Placement Warrants





On April
25, 2007 we sold 187,500 units in a private placement to two current Directors,
Yaron Eitan, Chief Executive Officer at that time, and Winston Churchill,
Chairman of the Board at that time, for $1.5 million.  Each unit
consisted of one share of common stock and one common stock purchase
warrant.  Each warrant entitled the holder to purchase one share of
common stock at an exercise price of $5.00 per share. These warrants may be
exercised now that we have completed an acquisition of a business (which
occurred on December 19, 2008). These warrants expire April 25, 2012 unless
earlier redeemed. These warrants are redeemable by us at a price of $0.01 per
warrant upon 30 days notice after the warrant becomes exercisable, only in the
event that the last sales price of the common stock is at least $11.50 per share
for any 20 trading days within a 30- trading-day period ending on the third
business day prior to date on which notice of redemption is given. These
warrants were exercised in February 2009.





Warrants
Issued for Acquisition-Related Costs





On
December 10, 2008, we issued 100,000 common stock purchase warrants as payment
for Acquisition-related costs. Each warrant entitles the holder to purchase one
share of common stock at an exercise price of $8.00 per share. These warrants
expire three years from the date of the Acquisition (December 19, 2011) unless
earlier redeemed. We estimated, based upon a Black-Scholes model, that the fair
value of the purchase option, on the date of sale is $0.33 per share (or $33,000
in the aggregate), using an expected life of 3 years, volatility of 27.14%, and
a risk-free rate of 1.21%. However, because our common stock did not have a
trading history that was representative of an operating company as of December
10, 2008, the volatility assumption was derived using historical data of another
public company operating in our industry. We believe the volatility estimate
calculated from that company is a reasonable benchmark to use in estimating the
expected volatility of our common stock; however, that estimated volatility may
not necessarily be representative of the volatility of the underlying securities
in the future.






F-25
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Warrants
Sold to a Third Party





On
October 15, 2008, we sold 118,750 common stock purchase warrants and 593,750
shares of common stock for a combined price of $4.8 million. Each warrant
entitles the holder to purchase one share of common stock at an exercise price
of $8.00 per share. These warrants expire three years from the date of the
Acquisition (December 19, 2011) unless earlier redeemed.





Options





In
connection with our initial public offering on April 25, 2007, we sold to the
representative of the underwriter an option to purchase up to a total of 731,250
units for $100.  Each unit consists of one share of common stock and
one common stock purchase warrant.  Each warrant entitles the holder
to purchase one share of common stock at an exercise price of $5.50 per share,
which may be exercised on a cashless basis. This option is exercisable at $8.80
per unit upon the completion of an acquisition of a business (which occurred on
December 19, 2008). This option expires five years from the date of our initial
public offering (April 25, 2012).





We
accounted for this purchase option as a cost of raising capital and have
included the instrument as equity in the financial statements. Accordingly,
there was no net impact on our financial position or results of operations,
except for the recording of the proceeds from the sale. We estimated, based upon
a Black-Scholes model, that the fair value of the purchase option, on the date
of sale is $3.40 per unit (or $2.5 million in the aggregate), using an expected
life of 5 years, volatility of 44%, and a risk-free rate of 5%. However, because
these units did not have a trading history, the volatility assumption was based
on information then available to management. The volatility estimate was derived
using historical data of public companies in the proposed industry. We believe
the volatility estimate calculated from these companies is a reasonable
benchmark to use in estimating the expected volatility of our units; however,
the use of an index to estimate volatility may not necessarily be representative
of the volatility of the underlying securities.





Accumulated
Other Comprehensive Income (Loss)





The
ending accumulated balances for each item in accumulated other comprehensive
income and loss are as follows (all amounts in thousands):




Year
      Ended December 31,2008
            
            2007
            
            (Predecessor)
              2007Foreign
      currency translation adjustments
            
            $
            (179
            )
            
            $
            —
            
            
            $
            1,248Unrealized
      gain (loss) on cash flow hedges, net of taxes
            
            
            (102
            )
            
            
            —
            
            
            
            —$
            (281
            )
            
            $
            —
            
            
            $
            1,248





Changes
in accumulated other comprehensive income due to derivatives and hedging
activities are as follows (all amounts in thousands):





Balance
      December 31, 2007
            
            $
            —Unrealized
      losses on interest rate swaps
            
            
            (102
            )Unrealized
      losses (gains) reclassified to current period earnings
            
            
            —Balance,
      December 31, 2008
            
            $
            (102
            )





Changes
in accumulated other comprehensive income due to currency translation
adjustments (all amounts in thousands):





Balance
      December 31, 2007
            
            $
            —Adjustments
      due to translation of CTSA financial statements from Euros into U.S.
      Dollars
            
            
            (179
            )Reclassifications
      to current period earnings
            
            
            —Balance,
      December 31, 2008
            
            $
            (179
            )






F-26
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


19.
            INCOME
      TAXES





Income
taxes consisted of the following (all amounts in thousands):




Year
      Ended December 31,
            
            
            Predecessor2008
            
            
            2007
            
            
            For
      the Period January 1, 2008 to December 19, 2008
            
            
            For
      Year Ended December 31, 2007Current:Federal
            
            $
            —
            
            
            $
            87
            
            
            $
            —
            
            
            $
            —State
            
            
            5
            
            
            
            —
            
            
            
            —
            
            
            
            —Foreign
            
            
            (13
            )
            
            
            —
            
            
            
            846
            
            
            
            1,943Deferred:Federal
            
            
            (575
            )
            
            
            —
            
            
            
            980
            
            
            
            (1,343
            )State
            
            
            (17
            )
            
            
            —
            
            
            
            390
            
            
            
            (330
            )Foreign
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Provision
      for (benefit from) income taxes
            
            $
            (600
            )
            
            $
            87
            
            
            $
            2,216
            
            
            $
            270





Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.  The principal sources of
these differences include the carrying value of inventories, fixed asset
depreciation, debt issue costs and certain accruals and reserves for financial
statement purposes which are not deductible for tax purposes.





Deferred
income tax assets and liabilities consist of the following (all amounts in
thousands):




December
      31, 2008
            
            
            December
      31, 2007
            
            
            (Predecessor)
              December
      31, 2007Current
            
            
            Non-current
            
            
            Current
            
            
            Non-current
            
            
            Current
            
            
            Non-currentDeferred
      tax assets:Federal
            
            $
            477
            
            
            $
            6,730
            
            
            $
            —
            
            
            $
            —
            
            
            $
            465
            
            
            $
            6,734State
            
            
            112
            
            
            
            1,056
            
            
            
            —
            
            
            
            —
            
            
            
            109
            
            
            
            1,586Foreign
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Less:
      valuation allowance
            
            
            —
            
            
            
            (1,068
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —589
            
            
            
            6,718
            
            
            
            —
            
            
            
            —
            
            
            
            574
            
            
            
            8,320Deferred
      tax liabilities:Federal
            
            
            (220
            )
            
            
            (12,931
            )
            
            
            —
            
            
            
            —
            
            
            
            (16
            )
            
            
            (10,753
            )State
            
            
            (52
            )
            
            
            (3,024
            )
            
            
            —
            
            
            
            —
            
            
            
            (5
            )
            
            
            (2,516
            )Foreign
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —(272
            )
            
            
            (15,955
            )
            
            
            —
            
            
            
            —
            
            
            
            (21
            )
            
            
            (13,269
            )Deferred
      tax assets (liabilities)
            
            $
            317
            
            
            $
            (9,237
            )
            
            $
            —
            
            
            $
            —
            
            
            $
            553
            
            
            $
            (4,949
            )






F-27
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


Principal
components of our net liability representing deferred income tax balances are as
follows (all amounts in thousands):




Year
      Ended December 31,2008
            
            
            2007
            
            
            (Predecessor)
              2007Intangible
      assets
            
            $
            (15,856
            )
            
            $
            —
            
            
            $
            (12,293
            )Property,
      plant and equipment
            
            
            (221
            )
            
            
            —
            
            
            
            (976
            )U.S.
      loss carryforwards and tax credits
            
            
            4,070
            
            
            
            —
            
            
            
            7,079Subsidiary
      dividend income
            
            
            2,107
            
            
            
            —
            
            
            
            646Provisions
      for expenses
            
            
            758
            
            
            
            —
            
            
            
            988Suspended
      capital loss on sale of subsidiary
            
            
            161
            
            
            
            —
            
            
            
            160Interest
      rate swaps
            
            
            61
            
            
            
            —
            
            
            
            —$
            (8,920
            )
            
            $
            —
            
            
            $
            (4,396
            )





Income
taxes computed using the federal statutory income tax rate differ from our
effective tax rate primarily due to the following (all amounts in
thousands):




Year
      Ended December 31,
            
            
            Predecessor2008
            
            
            2007
            
            
            For
      the Period January 1, 2008 to December 19, 2008
            
            
            For
      Year Ended December 31, 2007Provision
      for federal income taxes expected at 34% statutory rate
            
            $
            (8
            )
            
            $
            301
            
            
            $
            1,911
            
            
            $
            100Increase
      (reduction) resulting from:Tax
      on global activities
            
            
            (15
            )
            
            
            —
            
            
            
            (38
            )
            
            
            376State
      income taxes, less federal income tax benefit
            
            
            (14
            )
            
            
            87
            
            
            
            257
            
            
            
            (218
            )Exempt
      interest income
            
            
            (358
            )
            
            
            (301
            )
            
            
            —
            
            
            
            —Change
      in valuation account
            
            
            (205
            )
            
            
            —
            
            
            
            —
            
            
            
            —Other
            
            
            —
            
            
            
            —
            
            
            
            86
            
            
            
            12Provision
      for (benefit from)income
      taxes
            
            $
            (600
            )
            
            $
            87
            
            
            $
            2,216
            
            
            $
            270





The
majority of the deferred tax assets relate to domestic net operating loss
carryforwards that expire in 2025 through 2028. The realization of these assets
is based on estimates of future taxable income.





Deferred
income taxes on undistributed earnings of CTSA have not been recognized, since
such earnings are considered to be reinvested indefinitely.  If the
earnings, which were $4.1 million through December 31, 2008, were distributed in
the form of dividends, they would be subject, in certain cases, to both United
States income taxes and foreign withholding taxes. Because of the availability
of U.S. foreign tax credits, it is not practicable to determine the U.S. federal
income tax liability that would be payable if such earnings were not reinvested
indefinitely. Deferred taxes are provided for earnings of the subsidiary when we
plan to remit those earnings.






F-28
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


20.
            RESTRUCTURING
      COSTS





During
the period ended December 19, 2008, the Predecessor underwent a corporate
restructuring pursuant to which the CEO and two Vice-Presidents left the
Company, resulting in a restructuring charge of $1.1 million.  The
following table summarizes restructuring cost activity from December 31, 2007
through December 31, 2008 (all amounts in thousands):




Balance
      on December 31, 2007 (Predecessor)
            
            $
            —Restructuring
      charges
            
            
            1,087Cash
      payments
            
            
            (830
            )Balance
      on December 19, 2008 assumed at the Acquisition
            
            
            257Cash
      payments
            
            
            (28
            )Balance
      on December 31, 2008
            
            $
            229





The
$229,000 of accrued and unpaid restructuring costs as of December 31, 2008 is
included in accrued liabilities on the accompanying consolidated balance sheet.
The $1.1 million of restructuring charges is included in the Predecessor’s
consolidated statement of income as an other loss for the period ended December
19, 2008.





21.
            EMPLOYEE
      BENEFIT PLANS





The CTI
Employee Savings and Retirement Plan (the “Plan”), is intended to be qualified
under Section 401(k) of the Internal Revenue Code.  Employees of CTI
who have reached the age of 18 are eligible for participation on the first entry
date after three months of service. Entry dates are the first day of January,
April, July and October. At December 31, 2007, employees of CTI who had reached
the age of 21 were eligible for participation after completing six months of
service. Employees may defer receiving compensation up to the maximum permitted
under the Internal Revenue Code. Matching contributions to the Plan
equal  (i) 3% of employee compensation plus (ii) 50% of between 3% and
5% of employee compensation. For the year ended December 31, 2008, employer
matching contributions were $7,000.  For the period ended December 19,
2008 and the year ended December 31, 2007, the Predecessor’s employer matching
contributions were $184,000 and $145,000, respectively.





22.
            FAIR
      VALUE





SFAS 157
(see Note 3) requires disclosure about how fair value is determined for assets
and liabilities and establishes a hierarchy for which such assets and
liabilities must be grouped, based on significant levels of inputs as
follows:





Level
      1
            Quoted
      prices in active markets for identical assets or
    liabilities.Level
      2
            Quoted
      prices in active markets for similar assets or liabilities and inputs that
      are observable for the asset or liability.Level
      3
            Unobservable
      inputs for the asset or liability, such as discounted cash flow models or
      valuations.






F-29
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


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 December 31, 2008, the only liabilities required to be
measured at fair value on a recurring basis were the interest rate swaps
described in Note 15, both of which are measured at fair value using level 3
inputs and presented as derivatives on the December 31, 2008 consolidated
balance sheet. The following table reflects their activity for the year ended
December 31, 2008 (all amounts in thousands):




Interest
      Rate SwapsBalance
      as of December 31, 2007
            
            $
            —Transfers
      into level 3 from level 1 or level 2
            
            
            —Transfers
      out of level 3 into level 1 or level 2
            
            
            —Total
      gains or (losses), realized or unrealized:Included
      in earnings
            
            
            —Included
      in comprehensive income
            
            
            163Purchases,
      issuances and settlements, net
            
            
            —Balance
      as of December 31, 2008
            
            $
            163





As
discussed in the Recent Accounting Pronouncements section of Note 3, SFAS 157 is
does not apply to the nonrecurring fair value measurements of our nonfinancial
assets and liabilities, such as for intangible assets and goodwill, until
January 1, 2009.





23.
            CONCENTRATIONS





Our
business depends significantly on two key customers: the United States
Department of Defense (“US DOD”) and the N.A.T.O. Maintenance and Supply Agency
(“NAMSA”), which accounted for 34% of net revenues for the year ended December
31, 2008. These two key customers accounted for 68% and 69% of the Predecessor’s
net revenues in the period ended December 19, 2008 and the year ended December
31, 2007, respectively.





Three
customers, including the US DOD, account for 68% of net revenues for the year
ended December 31, 2008 and a different set of three customers, including the US
DOD, account for 55% of gross accounts receivable as of December 31, 2008 due to
the limited period for sales between the December 19, 2008 Acquisition of CTI
and December 31, 2008.  The US DOD accounted for 30% of the
Predecessor’s gross accounts receivable as of December 31, 2007. We did not have
any revenues during the year ended December 31, 2007 or accounts receivable at
December 31, 2007.





We sell
to customers located in the United States of America and in international
markets, including NAMSA.  Revenues to customers outside the United
States represent 10% of net revenues for the year ended December 31,
2008.  Revenues from the Predecessor’s customers outside the United
States represented 29% of net revenues for the period ended December 19, 2008
and 38% of net revenues for the year ended December 31, 2007.





We
maintain cash in several different financial institutions in amounts that
typically exceed U.S. federally insured limits and in financial institutions in
international jurisdictions where insurance is not provided. We have not
experienced any losses in such accounts and believe we are not exposed to
significant credit risk.





24.
            SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION





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





Year
      Ended December 31,
            
            
            Predecessor2008
            
            
            2007
            
            
            For
      the Period January 1, 2008 to December 19, 2008
            
            
            For
      Year Ended December 31, 2007Interest
            
            $
            624
            
            
            $
            9
            
            
            $
            4,186
            
            
            $
            5,418Income
      taxes
            
            $
            31
            
            
            $
            —
            
            
            $
            2,874
            
            
            $
            1,456






F-30
 Table of Contents




Cyalume
Technologies Holdings, Inc.
 (Formerly
Vector Intersect Security Acquisition Corporation)
 Notes
to Consolidated Financial Statements (Continued)


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




Year
      Ended December 31,
            
            
            Predecessor2008
            
            
            2007
            
            
            For
      the Period January 1, 2008 to December 19, 2008
            
            
            For
      Year Ended December 31, 2007Accrual
      of deferred underwriting costs
            
            $
            —
            
            
            $
            2,340
            
            
            $
            —
            
            
            $
            —Change
      in estimate of deferred underwriting costs
            
            
            272
            
            
            
            —
            
            
            
            —
            
            
            
            —Payment
      of deferred underwriting costs via issuance of note
payable
            
            
            1,818
            
            
            
            —
            
            
            
            —
            
            
            
            —Fair
      value of warrants issued in conjunction with the
    Acquisition
            
            
            33
            
            
            
            —
            
            
            
            —
            
            
            
            —Fair
      value of common stock issued in conjunction with the
      Acquisition
            
            
            52,460
            
            
            
            —
            
            
            
            —
            
            
            
            —Unpaid
      capitalized debt issuance costs
            
            
            154
            
            
            
            —
            
            
            
            —
            
            
            
            —Adjustment
      of property, plant and equipment to fair value due to the
      Acquisition
            
            
            (2,373
            )
            
            
            —
            
            
            
            —
            
            
            
            —Adjustment
      of inventory to fair value due to the Acquisition
            
            
            738
            
            
            
            —
            
            
            
            —
            
            
            
            —Adjustment
      of intangible assets to fair value due to the Acquisition
            
            
            20,192
            
            
            
            —
            
            
            
            —
            
            
            
            —





25.
            SUBSEQUENT
      EVENTS





During
the first quarter of 2009 we paid $1.1 million to repurchase 139,850 shares of
common stock from stockholders who voted against the Acquisition of
CTI.





On
February 9, 2009, we registered the issuance of shares of our common stock upon
exercise of warrants issued in our May 2007 initial public offering. Between
February 10, 2009 and February 17, 2009, 3,267,994 of those warrants were
exercised on a cashless basis into 1,629,671 common shares.





On March
3, 2009, our Board of Directors adopted the Cyalume Technologies Holdings, Inc.
2009 Omnibus Securities and Incentive Plan (the “Plan”). The purpose of the Plan
is to benefit our stockholders by assisting us to attract, retain and provide
incentives to key management employees and non-employee directors of, and
non-employee consultants to, Cyalume Technologies Holdings, Inc. and its
subsidiaries, and to align the interests of such employees, non-employee
directors and non-employee consultants with those of our stockholders.
Accordingly, the Plan provides for the granting of Distribution Equivalent
Rights, Incentive Stock Options, Non-Qualified Stock Options, Performance Share
Awards, Performance Unit Awards, Restricted Stock Awards, Stock Appreciation
Rights, Tandem Stock Appreciation Rights, Unrestricted Stock Awards or any
combination of the foregoing, as may be best suited to the circumstances of the
particular employee, director or consultant as provided herein., Two million
shares have been reserved under the Plan. On March 3, 2009, the Board of
Directors authorized the following (i) 30,000 restricted shares of common stock
to non-employee consultants; (ii) 114,000 restricted shares of common stock and
200,000 restricted options to officers and other management; and, (iii) a total
of 33,000 options to directors.  Subsequent to approval by
shareholders at the 2009 Annual Meeting of Shareholders, we expect to file Form
S-8 with the SEC to register the shares under the Plan.




F-31
 Table of Contents




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM


ON
FINANCIAL STATEMENT SCHEDULE








To the
Board of Directors and


Stockholders
of Cyalume Technologies Holdings, Inc.








We have
audited the consolidated financial statements of Cyalume Technologies Holdings,
Inc. (the “Company”) as of December 31, 2008, and for year then ended, and have
issued our report thereon dated March 25, 2009. Such consolidated financial
statements and report thereon are included in the Company’s Form 10-K filed with
Securities and Exchange Commission for the year ended December 31,
2008.  Our audit also included the financial statement schedule for
the year ended December 31, 2008 of the Company, listed in Item 15. This
financial statement schedule is the responsibility of the Company’s
management.  Our responsibility is to express an opinion on this
financial statement schedule based on our audit.  In our opinion, such
financial statement schedule, when considered in relation to the basic
consolidated financial statements as of December 31, 2008, and for the year then
ended, taken as a whole, presents fairly, in all material respects, the
information set forth therein.













/s/ CCR
LLP


March 27,
2009






S-1
 Table of Contents




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM


ON
FINANCIAL STATEMENT SCHEDULE








To the
Board of Directors and


Stockholder
of Cyalume Technologies, Inc. and Subsidiary








We have
audited the consolidated financial statements of Cyalume Technologies, Inc. and
Subsidiary (the “Company”) as of December 31, 2007, and for the period from
January 1, 2008 to December 19, 2008 and the year ended December 31, 2007, and
have issued our report thereon dated March 25, 2009. Such consolidated financial
statements and report thereon are included in the Cyalume Technologies Holdings,
Inc. Form 10-K filed with the Securities and Exchange Commission for the year
ended December 31, 2008.  Our audits also included the financial
statement schedule for the period from January 1, 2008 to December 19, 2008 and
the year ended December 31, 2007 of the Company, listed in Item
15.  This financial statement schedule is the responsibility of the
Company’s management.  Our responsibility is to express an opinion on
this financial statement schedule based on our audits.  In our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements as of December 19, 2008 and December 31,
2007, and for the period from January 1, 2008 to December 19, 2008 and the year
ended December 31, 2007, taken as a whole, presents fairly, in all material
respects, the information set forth therein.













/s/ CCR
LLP


March 27,
2009






S-2
 Table of Contents




Cyalume
Technologies Holdings, Inc.


(Formerly
Vector Intersect Security Acquisition Corporation)
 Consolidated
Financial Statement Schedule
 Schedule
II – Valuation and Qualifying Accounts


AdditionsDescription
            
            Balance
      at Beginning of Period
            
            
            Charged
      to costs and expenses
            
            
            Charged
      to other accounts (Describe)
            
            
            Deductions
      (Describe)
            
            
            Balance
      at End of PeriodYear
      ended December 31, 2008Allowance
      for Doubtful Accounts
            
            $
            —
            
            
            $
            62
            
            
            $
            458
            (1)
            
            $
            (68
            )(2)
            
            $
            452Deferred
      Tax Asset Valuation Allowance
            
            
            —
            
            
            
            —
            
            
            
            1,068
            (1)
            
            
            —
            
            
            
            1,068Year
      ended December 31, 2007Allowance
      for Doubtful Accounts
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Deferred
      Tax Asset Valuation Allowance
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —




(1)Acquired as part of the
acquisition of Cyalume Technologies, Inc.


(2) Write-offs and currency
translation.






For
the Predecessor:


AdditionsDescription
            
            Balance
      at Beginning of Period
            
            
            Charged
      to costs and expenses
            
            
            Charged
      to other accounts (Describe)
            
            
            Deductions
      (Describe)
            
            
            Balance
      at End of PeriodPeriod
      ended December 19, 2008Allowance
      for Doubtful Accounts
            
            $
            596
            
            
            $
            (26
            )
            
            $
            —
            
            
            $
            (112
            )(1)
            
            $
            458Deferred
      Tax Asset Valuation Allowance
            
            
            —
            
            
            
            1,068
            
            
            
            —
            
            
            
            —
            
            
            
            1,068Year
      ended December 31, 2007Allowance
      for Doubtful Accounts
            
            
            646
            
            
            
            (76
            )
            
            
            26
            (2)
            
            
            —
            
            
            
            596Deferred
      Tax Asset Valuation Allowance
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —




(1) Write-offs and currency
translation.


(2) Currency
translation.