EMPLOYMENT AGREEMENT

AGREEMENT, dated as of the 30th day of January, 2006, by and between Cyalume Technologies, Inc., a Delaware corporation with principal executive offices at 96 Windsor Street, West Springfield, Massachusetts 01089 (the “ Company ”), and Thomas C. McCarthy, residing at 58 Falmouth, Longmeadow, MA  01106 (“ Employee ”).

WHEREAS the Company is presently engaged in the business of developing, manufacturing and selling luminescent chemical devices and materials for sale primarily to customers in the government, military and commercial safety fields of use worldwide (the “ Business ”); and

WHEREAS the Employee, who shall serve as Vice President and General Manager, Worldwide Government & Safety Division of the Company, and the Company are desirous of formalizing their understanding for Employee’s employment, all upon the terms and subject to the conditions hereinafter provided.

NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, the parties hereto, intending to be legally bound, agree as follows:

The Company agrees to employ Employee, and Employee agrees to be employed by the Company, upon the terms and subject to the conditions of this Agreement.

The term of this Agreement shall be for a period of three (3) years commencing on the date hereof (the “Commencement Date”) and continuing automatically for successive one (1) year periods thereafter unless terminated by the Company no less than six (6) months prior to the third anniversary hereof or the end of any subsequent period (the “Term”).

(a)           Employee shall serve as Vice President and General Manager, Worldwide Government & Safety Division of the Company, and shall report directly to the President of the Company and to such person or persons as may be designated by the Board of Directors of the Company (the “Board”).  Employee shall be responsible for managing and growing worldwide sales and marketing of products to military and government customers, establishing strategies and goals related to such sales, managing relationships with existing military/government customers and establishing relationships with new military/ government customers, coordinating with the Company’s research and development department to develop new products for military/government customers and launching such new products, coordinating orders for military/government customers and managing, hiring and firing members of sales and marketing team for military/government customers.  During the Term, Employee shall also have such other powers and duties as may be from time to time prescribed by the Board or its designees which are consistent with Employee’s position and duties hereunder.

(b)           Employee shall perform his duties, responsibilities and functions to the Company to the best of his abilities and in a manner consistent with the office of a Vice President and General Manager, Worldwide Government & Safety Division, and shall comply with the lawful policies and procedures of the Company.  In performing his duties and exercising his authority under this Agreement, Employee shall support and implement the lawful business and strategic plans approved from time to time by the Board and shall support and cooperate with the Company’s efforts to expand its businesses and operate profitably and in conformity with law and the business and strategic plans approved by the Board.  Employee shall devote all of his business time, attention and energies, on a full time and exclusive basis, to the business and affairs of the Company and shall not during the Term be engaged in any other business activities, whether or not such business activities are pursued for gain, profit or other pecuniary advantage, without Board consent; provided, however, that, it shall not be a violation of this Agreement for Employee to (i) serve on corporate, civic or charitable boards or committees or (ii) manage passive personal investments, in either case so long as any such activities do not interfere with the performance of his responsibilities as an employee of the Company in accordance with this Agreement or adversely affect or negatively reflect upon the Company.

(c)           The Company shall indemnify and hold harmless the Employee for all actions taken in the course of his employment which are taken in accordance with paragraph 3 above.

(a)           The Company shall pay to Employee a base salary (the “Base Salary”) at a rate of $150,000 per annum, payable in accordance with the Company’s payroll practices for its executive employees.  The Board will review the Base Salary for possible increase not less than annually during the Term, but the Employee shall be entitled to receive at least the amount of any cost-of-living increases granted to the Company’s employees in general.

(b)           Employee will be granted stock options, share appreciation rights or bonuses under plans adopted by the Board for the benefit of the executives and key management personnel of the Company.  The employee will be granted stock options in an amount and under terms specified in the attached letter (Exhibit A).  In the event that the Employee does not receive such stock options according to the terms of the attached letter, prior to March 1, 2006, this agreement will be null and void.

(c)           In addition to the Base Salary, the Employee shall be entitled to payment of the following annual bonus compensation, paid after the final closing of each fiscal year during the Term and verification of the financial results for such fiscal year by the Board of Directors of the Company:

i.      If the Company achieves at least 85% but less than 100% of its budgeted EBITDA, the amount of such bonus shall be 4.5% of the Employee’s Base Salary.  If the Company achieves at least 100% but less than 120% of its budgeted EBITDA, the amount of such bonus shall be 9.0% of the Employee’s Base Salary.

ii.     If the Company achieves at least 120% of its budgeted EBITDA, the amount of such bonus shall be 13.5% of the Employee’s Base Salary.

iii.    If the Company achieves percentages of its budgeted EBITDA between those levels listed above, the bonus amount will be adjusted proportionately.

(d)           In addition to a base salary, the Employee shall also be entitled to payment of the following annual bonus compensation based on the Company’s Worldwide Government & Safety Division performance, paid after the final closing of the fiscal year and verification of the financial results by the Board:

i.      If the Worldwide Government & Safety Division achieves at least 85% but less than 100% of its budgeted EBITDA, the amount of such bonus shall be 10.5% of the Employee’s Base Salary.

ii.     If the Worldwide Government & Safety Division achieves at least 100% but less than 120% of its budgeted EBITDA, the amount of such bonus shall be 21.0% of the Employee’s Base Salary.

iii.    If the Worldwide Government & Safety Division achieves at least 120% of its budgeted EBITDA, the amount of such bonus shall be 13.5% of the Employee’s Base Salary.

iv.    If the Worldwide Government & Safety Division achieves percentages of its budgeted EBITDA between those levels listed above, the bonus amount will be adjusted proportionately.

For purposes of this Agreement, “EBITDA” shall mean for each applicable fiscal year, (a) the net income of the Company (as a whole) or the Company’s military/government segment, as applicable; plus, (b) in each case, to the extent deducted in determining net income for such period, the Company’s, or the military/government segment’s portion of the Company’s (i) taxes, (ii) interest expenses and (iii) amortization and depreciation, as calculated by the Company’s Chief Financial Officer based on the amounts as set forth in the Company’s annual audited consolidated financial statements prepared by the Company’s independent certified public accountants.

(e)           Employee shall be entitled to participate in or receive benefits under any pension plan, health, dental, long term disability, and accident plan or any other employee benefit plan or arrangement made available now to the senior managers of the Company or in the future as determined by the Board.  In the event that the Employee elects not to participate in the Company health plan, the Company will reimburse the Employee for the cost of a similar plan from another source, provided that such reimbursement does not exceed the cost which the Company would have paid for similar coverage had the Employee remained in the Company health plan.

(f)           The Company shall promptly pay to Employee the approved reasonable expenses incurred by him in the performance of his duties hereunder in accordance with the Company’s policies in effect from time to time, including, without limitation, those incurred in connection with business related travel or entertainment, or if such expenses are paid directly by Employee, shall promptly reimburse him for such payment, provided that Employee provides proper documentation thereof in accordance with the Company’s policy.

(g)           Employee shall be entitled to paid vacation days in each calendar year determined by the Company from time to time, but not less than twenty (20) days in any calendar year, subject to the Company’s vacation policies for its key management personnel.  Vacation shall be prorated in any calendar year of the Term during which Employee is employed hereunder for less than an entire year in accordance with the number of days in such year during which he is so employed.  Employee shall also be entitled to carry over unused vacation for a maximum accrual of 20 days.  Employee is also entitled to all paid holidays given by the Company to its key management employees.

(h)           The Company may, at its discretion, subscribe for and maintain, on behalf of the Company, life insurance, key-man insurance and long-term disability insurance with respect to Employee, in such amount and upon such terms or conditions as the Company may deem reasonable.  Employee shall cooperate with the Company in connection with the obtaining of any such policies, including the submission to physical examination and blood testing.

Employee’s employment hereunder shall be terminated upon Employee’s death or Disability or Employee’s voluntarily leaving the employ of the Company, and may be terminated by the Company as follows:

(a)            For Cause.   The Company shall have the right to terminate Employee’s employment for “Cause.”  A termination for “Cause” is a termination evidenced by a resolution adopted by the Board finding that Employee has:

i.      breached or failed to comply with any of the material terms of this Agreement, including, without limitation, Sections 3, 7, 8, 9 or 12 of this Agreement;

ii.     failed to perform his duties under this Agreement, including refusing to carry out the instructions of the Board or its designees, or disregarding the lawful instructions from the Board or its designees, in any case which instructions are consistent with the responsibilities and duties of Employee contemplated by this Agreement;

iii.    engaged in gross negligence or gross misconduct in connection with or arising out of the performance of his duties hereunder;

iv.    been under the influence of drugs (other than prescription medicine or other medically-related drugs to the extent that they are taken in accordance with their directions) or alcohol during the performance of his duties under this Agreement, or while under the influence of drugs or alcohol, engages in inappropriate conduct during the conduct of business.

v.     engaged in behavior that would constitute grounds for liability for sexual harassment (as proscribed by the U.S. Equal Employment Opportunity Commission Guidelines, the Massachusetts Commission Against Discrimination and/or any other applicable state regulatory body) or, in the reasonable opinion of the Board, other egregious conduct violative of laws governing the workplace; or

vi.    committed any act of fraud, larceny, misappropriation of funds or embezzlement or been convicted of a felony or a crime of moral depravity;

provided, however , that any act or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by Employee in good faith and in the best interests of the Company.

(b)            For Disability.   The Company shall have the right to terminate Employee’s employment as a result of Employee’s “Disability.”  For purposes of this Agreement, a termination for “Disability” shall occur:

i.      immediately after the Board has provided a written termination notice to Employee supported by a written statement from a reputable independent physician selected by the Company to the effect that Employee shall have become so incapacitated as to be unable to resume, within 90 days, his employment hereunder by reason of physical or mental illness or injury, or

ii.     upon rendering of a written termination notice by the Company after Employee has been unable to substantially perform his duties hereunder for 90 consecutive days or for 90 days in any 360 day period by reason of any physical or mental illness or injury.

(c)           Employee agrees to make himself available and to cooperate in any reasonable examination by a reputable independent physician selected by the Company for the purpose of determining disability pursuant to Section 5(b)(i).

(a)            Death or Disability.   In the event of the termination of Employee’s employment as a result of his death or Disability, the Company shall:

i.      pay to Employee or his estate, as the case may be, the Base Salary plus accrued and unpaid bonus, if any, in accordance with Section 4(b) through the date of his death or Disability (pro rated for any partial month);

ii.     assign rights to Employee or his estate, as the case may be, to all of Employee’s vested stock options; and

iii.    reimburse Employee, or his estate, as the case may be, for any expenses pursuant to Section 4(d) (the amounts payable pursuant to the