SPECIAL DEVICES INC /DE - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: February 2, 2003
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to

Commission File Number: 333-75869

SPECIAL DEVICES, INCORPORATED
(Exact name of Registrant as specified in its charter)

Delaware

(State or other jurisdiction of
incorporation or organization)

95-3008754

(I.R.S. Employer Identification No.)

	14370 White Sage Road, Moorpark, California 93021 (Address of principal executive offices) (Zip Code)
	(805) 553-1200 (Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

As of March 14, 2003, the number of outstanding shares of the Registrant's common stock was 3,712,764.

SPECIAL DEVICES, INCORPORATED
INDEX TO QUARTERLY REPORT ON FORM 10-Q

			PAGE
PART I—FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	(a)	Consolidated Balance Sheets: February 2, 2003 and November 3, 2002	3
	(b)	Consolidated Statements of Operations: For the Three Months Ended February 2, 2003 and February 3, 2002	4
	(c)	Consolidated Statements of Cash Flows: For the Three Months Ended February 2, 2003 and February 3, 2002	5
	(d)	Notes to Consolidated Financial Statements	6
ITEM 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		12
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk		15
ITEM 4.	Controls and Procedures		15
PART II—OTHER INFORMATION
ITEM 1.	Legal Proceedings		16
ITEM 6.	Exhibits and Reports on Form 8-K		17
Signatures			20
Certifications			21

SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)

			February 2, 2003			November 3, 2002
ASSETS
Current assets:
	Cash and cash equivalents		$	1,831		$	4,852
	Accounts receivable, net of allowances of $212 at February 2, 2003 and $339 at November 3, 2002			12,532			12,700
	Inventories			9,097			7,461
	Prepaid expenses and other current assets			4,939			4,773
	Deferred tax assets			2,438			2,438

		Total current assets		30,837			32,224

Property, plant and equipment, at cost:
	Machinery and equipment			84,949			84,626
	Construction in progress			6,050			5,030
	Other			6,024			6,002

		Gross property, plant and equipment		97,023			95,658
		Less accumulated depreciation and amortization		(65,694	)		(63,502	)

		Net property, plant and equipment		31,329			32,156
Other assets, net of accumulated amortization				10,385			10,674

Total assets			$	72,551		$	75,054

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
	Accounts payable		$	11,688		$	7,756
	Accrued liabilities			6,309			10,355
	Accrued interest			1,129			3,255
	Current portion of long-term debt			1,000			1,000
	Revolving line of credit			1,058			—

		Total current liabilities		21,184			22,366
Other liabilities				5,318			5,318
Long-term debt, net of current portion				76,069			76,569

		Total liabilities		102,571			104,253

Commitments and contingencies (Note 10)
Redeemable preferred stock				4,000			4,000
Redeemable common stock				37,375			36,625
Stockholders' equity (deficit):
	Preferred stock, $.01 par value, 2,000,000 shares authorized; 4,000 shares issued and outstanding at February 2, 2003 and November 3, 2002			—			—
	Common stock, $.01 par value, 20,000,000 shares authorized; 3,712,764 shares issued and outstanding at February 2, 2003 and November 3, 2002			30			30
	Additional paid-in capital			63,352			64,102
	Retained earnings (deficit)			(134,777	)		(133,956	)

		Total stockholders' equity (deficit)		(71,395	)		(69,824	)

Total liabilities and stockholders' equity (deficit)			$	72,551		$	75,054

See accompanying notes to consolidated financial statements.

SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands)
(Unaudited)

			Three Months Ended
			February 2, 2003			February 3, 2002
Net sales			$	25,580		$	27,565
Cost of sales				21,584			23,775

		Gross profit		3,996			3,790
Operating expenses				2,533			3,649

		Income from operations		1,463			141

Other income (expense):
	Interest expense, net			(2,247	)		(2,218	)
	Gain on extinguishment of debt			—			521
	Equity in losses of SDI-Molan			(262	)		—

		Total other income (expense)		(2,509	)		(1,697	)

		Loss from continuing operations before income taxes		(1,046	)		(1,556	)
Income tax benefit				(221	)		(831	)

		Loss from continuing operations		(825	)		(725	)
Gain on sale of discontinued operations, net of tax expense of $28				—			41

		Net loss	$	(825	)	$	(684	)

See accompanying notes to consolidated financial statements.

SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

			Three Months Ended
			February 2, 2003			February 3, 2002
Cash Flows From Operating Activities:
	Net loss		$	(825	)	$	(684	)
	Gain on sale of discontinued operations			—			(41	)

	Loss from continuing operations			(825	)		(725	)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
		Depreciation and amortization		2,365			2,545
		Gain on extinguishment of debt		—			(521	)
		Equity in losses of SDI-Molan		262			—
	Changes in assets and liabilities:
		Accounts receivable and other assets		255			2,506
		Inventories		(1,636	)		2,101
		Accounts payable and other liabilities		(2,174	)		(5,878	)
		Income taxes payable		(66	)		(907	)
		Other		37			—

		Net cash used in continuing operations		(1,782	)		(879	)
		Net cash provided by discontinued operations		—			69

		Net cash used in operating activities		(1,782	)		(810	)

Cash Flows From Investing Activities:
	Purchases of property, plant and equipment			(1,398	)		(1,982	)
	Other			(399	)		51

	Net cash used in investing activities			(1,797	)		(1,931	)

Cash Flows From Financing Activities:
	Repurchase of long-term debt			—			(293	)
	Repayment of long-term debt			(500	)		(500	)
	Net borrowings under revolving line of credit			1,058			2,347

	Net cash provided by financing activities			558			1,554

Net decrease in cash and cash equivalents				(3,021	)		(1,187	)
Cash and cash equivalents at beginning of year				4,852			1,341

Cash and cash equivalents at end of period			$	1,831		$	154

Supplemental disclosure of cash flow information:
	Cash paid during the period for:
		Interest	$	4,324		$	4,420
		Income taxes		—			77

See accompanying notes to consolidated financial statements.

SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Company Operations

Special Devices, Incorporated, a Delaware corporation (the "Company" or "SDI"), is a leading designer and manufacturer of highly reliable precision engineered pyrotechnic devices. These devices are used predominantly in vehicle airbag and other automotive safety systems. The Company's primary products are initiators, which function like an "electrical match" to ignite the gas generating charge in an automotive airbag system. We believe we are the world's largest independent supplier of initiators sold to leading domestic and foreign automotive airbag system manufacturers. Those manufacturers use SDI's product in the assembly of integrated airbag safety systems, which they then sell to automobile original equipment manufacturers.

The Company formed a joint venture partnership, Special Devices-Molan GmbH & Co. KG ("SDI-Molan") in Germany in June 2001. The Company's 50% interest in SDI-Molan is held by SDI Germany GmbH ("SDI Germany"), a wholly owned German subsidiary. SDI Germany was established in 2001 for the purpose of holding the interest in the joint venture. SDI-Molan's business is the development, production, marketing, distribution and sale of air bag initiators, micro gas generators, and seat belt buckles and pyrotechnic pretensioners in Europe. SDI-Molan started operations in September 2002.

In June 2002 the Company incorporated Special Devices Japan Kabushiki Kaisha ("SDI Japan") in Japan and in October 2002 the Company incorporated Special Devices (Thailand) Co., Ltd. ("SDI Thailand"). SDI Japan and SDI Thailand are subsidiaries of SDI that were formed to create a direct business presence in these geographic markets. The Company previously distributed its products in Japan through an agent.

The divestiture of the Aerospace Division, which included the Company's subsidiary Scot, Incorporated ("Scot"), was completed in a series of transactions in 2000 and 2001. Scot was divested on September 21, 2000 and the net assets of the remaining Aerospace operations were sold on May 11, 2001.

As of February 2, 2003, the Company had net liabilities of $30.0 million. The Company's ability to pay the interest on, or to refinance debt, or to fund planned capital expenditures, will depend on generating cash flow from future operations. The Company had positive cash flow from continuing operations during the past two fiscal years.

2. Interim Financial Statements

The accompanying unaudited interim consolidated condensed financial statements of the Company include all adjustments (consisting of normal recurring entries) which management believes are necessary for a fair statement of the financial position and results of operations for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted. It is recommended that the accompanying consolidated condensed financial statements be read in conjunction with the Company's audited financial statements and footnotes as of and for the year ended November 3, 2002. Operating results for the three month period ended February 2, 2003 are not necessarily indicative of the operating results for the full year.

During 2002, the Company refined its allocation of overhead expenses to cost of sales. As a result of this change, cost of sales, gross profit and operating expenses have been reclassified for all prior periods presented. There was no impact on results of operations or financial position in any period. On November 4, 2002, the Company adopted Financial Accounting Standards Board ("FASB") Statement

of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Accordingly, gains on extinguishment of debt have been reclassified to income from continuing operations.

Certain other prior year amounts have been reclassified to conform to the current year's presentation.

3. Recent Accounting Pronouncements

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS 123". This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the estimate of the market value of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. The Company will adopt the annual disclosure provisions of SFAS No. 148 in its financial reports for the year ended November 2, 2003 and will adopt the interim disclosure provisions for its financial reports for the quarter ended May 4, 2003. As the adoption of this standard involves disclosures only, the Company does not expect a material impact on its results of operations, financial position or liquidity.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred, not when it is "planned". The Company is required to adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002 and does not expect the adoption to have a material impact on the Company's results of operations or financial position.

4. Inventories

Inventories consist of the following components:

	February 2, 2003		November 3, 2002
	(In thousands)
Raw materials and components	$	3,253	$	2,867
Work in process		1,154		995
Finished goods		4,690		3,599

Total inventories	$	9,097	$	7,461

5. Long-Term Debt

The Company entered into a credit facility (the "Credit Facility") in June 2001 which consists of a $25.0 million five-year Revolving Credit Facility (the "Revolver") and a $5.0 million five-year Term Loan (the "Term Loan"). Available borrowings under the Revolver are based on a formula comprised

of eligible accounts receivable and inventory. The Credit Facility requires lockbox arrangements which provide for all receipts to be swept daily to reduce borrowings outstanding. The agreement governing the Credit Facility contains customary covenants, including restrictions on the incurrence of debt, the sale of assets, mergers, acquisitions and other business combinations, voluntary prepayment of other debt, transactions with affiliates, repurchase or redemption of equity securities, and financial covenants on tangible net worth. The Revolver and the Term Loan bear interest at the Bank's Base Rate or the LIBOR Rate plus applicable margins. The Company has the option of electing the LIBOR Rate on all or a portion of the amount outstanding under the Credit Facility prior to the start of each quarterly interest period. The Term Loan had a balance of $3.5 million and an effective interest rate of 4.75% per annum at February 2, 2003. At February 2, 2003, there were $1.1 million in borrowings outstanding under the Revolver with an effective interest rate of 4.50% per annum. Letters of credit outstanding and applied for under the Revolver reduce the amount of borrowings available. The Company had $2.5 million in letters of credit outstanding at February 2, 2003. The total amount available under the Revolver at February 2, 2003 was $8.9 million subject to compliance with certain financial and operating covenants which the Company must meet on a quarterly basis. The Company was in compliance with these covenants as of February 2, 2003. Substantially all of the Company's assets are pledged as collateral under the Credit Facility.

The Company has guaranteed bank loans made to SDI-Molan under agreements entered into in August 2002. The Company's guarantee is limited to fifty percent of the loans outstanding and is subject to a maximum of 3.2 million Euro or approximately $3.4 million at February 2, 2003. SDI-Molan had bank loans outstanding in the amount of 5.0 million Euro or approximately $5.4 million at February 2, 2003.

The following are the fair value and carrying amounts of long-term debt, including short-term borrowings:

	February 2, 2003		November 3, 2002
	(In thousands)
Fair value	$	54,025	$	45,188
Carrying amount		78,127		77,569

The Company's borrowings under its Term Loan and Revolver have variable rates that reflect currently available terms and conditions for similar debt. The carrying amount of this debt is a reasonable estimate of its fair value. The Senior Subordinated Notes (the "Notes") issued in 1999 bearing interest at 11³/8% per annum are traded occasionally in public markets.

6. Income Taxes

For the quarters ended February 2, 2003 and February 3, 2002, the Company had effective tax rates of 21% and 53%, respectively. The difference from the expected statutory rate results primarily from a valuation allowance provided against SDI Germany's losses in fiscal 2003 and a nontaxable gain on

extinguishment of debt in fiscal 2002. A reconciliation between the statutory federal income tax benefit and the Company's effective income tax benefit on losses from continuing operations is as follows:

	Three Months Ended
	February 2, 2003			February 3, 2002
	(In thousands)
Income tax benefit at federal statutory rates	$	(366	)	$	(545	)
State income taxes, net of federal income tax effect		(82	)		(135	)
Foreign source income taxed at other effective rates		24			—
Change in valuation allowance		163			—
Nontaxable gain on extinguishment of debt		—			(182	)
Other		40			31

	$	(221	)	$	(831	)

7. The Recapitalization

On December 15, 1998, the Company consummated a series of transactions accounted for as a recapitalization (the "Recapitalization") whereby affiliates of J.F. Lehman and Company ("J.F. Lehman") obtained a controlling interest in the Company. As a result of the Recapitalization, the Company delisted its Common Stock from the NASDAQ Stock Market, and accordingly filed for deregistration with the Securities and Exchange Commission (the "SEC"). The Company continues to file reports with the SEC pursuant to the terms governing the Notes, which were issued as part of the Recapitalization.

In connection with the Recapitalization all shares of the Company's Common Stock, other than those retained by certain members of management and certain other stockholders (the "Continuing Stockholders"), were converted into the right to receive $34 per share in cash. At the time of the Recapitalization, the Continuing Stockholders retained approximately 41.3% of the common equity of the Company while new investors acquired the balance of the equity interests in the Company. At February 2, 2003, the Continuing Stockholders own approximately 29.5% of the common equity of the Company.

The Recapitalization had the following effect on stockholders' equity (deficit) (dollars in thousands):

	Common Stock
	Common Stock					Additional Paid-in Capital			Retained Earnings (Deficit)			Total Stockholders' Equity (Deficit)
	Shares		Amount			Additional Paid-in Capital			Retained Earnings (Deficit)			Total Stockholders' Equity (Deficit)
Balances, October 31, 1998	7,809,801		$	78		$	51,364		$	45,838		$	97,280
Record recapitalization transaction	(3,367,618	)		(41	)		22,562			(163,727	)		(141,206	)
Record redeemable common stock	(735,294	)		(7	)		—			(24,993	)		(25,000	)
Contributed assets	—			—			3,286			—			3,286
Accreted put premium on redeemable common stock	—			—			(2,625	)		—			(2,625	)
Net loss	—			—			—			(20,266	)		(20,266	)

Balances, October 31, 1999	3,706,889		$	30		$	74,587		$	(163,148	)	$	(88,531	)

8. Related Party Transactions

The Company made a working capital loan to SDI-Molan in August 2002 for $0.7 million. The balance outstanding at February 2, 2003 was $0.7 million. In addition, the Company has a receivable from SDI-Molan for expenses in the amount of $0.5 million at February 2, 2003.

9. Gain on Extinguishment of Debt

In November 2001, the Company repurchased $0.8 million face value of Notes in the open market for $0.3 million resulting in a gain of $0.5 million.

10. Commitments and Contingencies

OSHA Investigations. On September 1, 2000, an accidental initiation incident occurred at the Company's Moorpark facility and two employees were injured. The State of California, Department of Industrial Relations, Division of Occupational Safety and Health ("Cal-OSHA") conducted a post-incident and process safety management inspection, which resulted in the issuance in February 2001 of citations for alleged safety violations and proposed fines aggregating approximately $168,000. The Company appealed the citations, and the appeal was settled pursuant to a Settlement Agreement under which the aggregate amount of fines was reduced to approximately $85,000, payable in quarterly installments commencing on December 5, 2002. Because the accident resulted in a serious injury, Cal-OSHA's Bureau of Investigation ("BOI") conducted its own investigation to determine whether to refer the matter to the District Attorney's Office for Ventura County. The Company believes that this investigation has concluded and no referral has been made. At this stage, it is not possible to predict or assess the amount of potential liabilities associated with the BOI investigation, which could result in criminal liabilities and penalties.

Qui Tam Suit. The Company is a defendant in a civil action entitled United States ex rel. Charles K. Holder v. Special Devices, Incorporated pending in the U.S. District Court for the Central District of California. The action, filed under seal in August 1999 and first served on the Company in December 2001, is a qui tam lawsuit in which a former employee of the Company is seeking, on behalf of the United States, an unspecified amount of money damages and civil penalties under the federal False Claims Act. The complaint alleges that the Company, when submitting invoices under unspecified government contracts prior to August 1999, falsely certified that it was in compliance with environmental laws. The Company is vigorously defending the action. At this stage, it is not possible to evaluate the likelihood of an unfavorable outcome or estimate the range of potential loss, if any.

CharTech Suit. A lawsuit alleging that the Company willfully infringed two patents held by CharTech Engineering, Inc. ("CharTech") was filed on July 14, 2000, in the U.S. District Court for the Central District of California. The Company answered the complaint, asserted counterclaims against CharTech, and filed a third party complaint against CharTech, its related company Iso Vac Engineering, Inc. ("IsoVac") and George Neff, a principal in both companies. The Company engaged in a mediation with CharTech, IsoVac and George Neff that resulted in a binding agreement setting forth key terms of the settlement of this dispute. Under these key terms, the Company will pay CharTech a fee of $1,250,000 for a non-exclusive license under the CharTech patent rights. The fee is payable in installments, with the last installment payable on December 31, 2007. The pending lawsuit is to be dismissed with prejudice as part of the terms. The parties are in the process of implementing the settlement agreement. The settlement does not have a material impact on the Company's results of operations, financial position or liquidity.

Hermetic Seal Suit. The Company is a defendant in a civil action entitled Hermetic Seal Corporation and HCC Industries, Inc. v. Special Devices, Inc. pending in the Superior Court of the State of

California for the County of Los Angeles. The complaint, filed in August 2002 by a former supplier, claims damages in excess of $2.3 million for breach of contract. The Company is vigorously defending the action. At this stage, it is not possible to evaluate the likelihood of an unfavorable outcome or estimate the range of potential loss, if any.

Selleck Suit. The Company is a defendant in a civil action entitled Daniel F. Selleck v. Special Devices, Incorporated pending in the Superior Court of the State of California for the County of Ventura. A complaint, served in September 2002, alleged breach of contract, fraud and deceit, negligent misrepresentation, and injunctive and declaratory relief, and seeks damages in excess of $1 million relating to the Plaintiff's purchase from the Company of certain real estate located in Moorpark, California. An amended complaint served in January 2003 withdrew the allegations of fraud and deceit and the claim for injunctive relief, and added allegations of negligent interference with prospective economic advantage. The Company is vigorously defending the action. At this stage, it is not possible to evaluate the likelihood of an unfavorable outcome or estimate the range of potential loss, if any.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and the related Notes thereto included elsewhere in this report. During 2002, we refined our allocation of overhead expenses to cost of sales. As a result of this change, cost of sales, gross profit and operating expenses have been reclassified for all prior periods presented. There was no impact on net income (loss) in any period.

Results of Operations

The following table is derived from our Consolidated Statements of Operations and sets forth, for the periods indicated, certain statement of operations data as a percentage of net sales.

	Three Months Ended
	February 2, 2003		February 3, 2002
Net sales	100.0	%	100.0	%
Cost of sales	84.4	%	86.3	%

Gross profit	15.6	%	13.7	%
Operating expenses	9.9	%	13.2	%

Income from operations	5.7	%	0.5	%

Comparison of the Three Months Ended February 2, 2003 to the Three Months Ended February 3, 2002

Net Sales

Consolidated net sales for the first quarter of 2003 were $25.6 million, compared to consolidated net sales of $27.6 million for the first quarter of 2002. While total units shipped increased by 11%, the decrease in net sales was primarily due to lower unit sales and prices on high value-added lead wire products. Leadwire products differ from standard products in that SDI adds a length of electrical wire, an electrical harness connector and, in some cases, a machined retainer. Any combination of these value-added features, depending on the customer need, differentiates a leadwire or value-added product from a standard product.

Gross Profit

Consolidated gross profit for the first quarter of 2003 was $4.0 million or 15.6% of consolidated net sales, compared to consolidated gross profit of $3.8 million or 13.7% of consolidated net sales for the first quarter of 2002. The improvement in gross margin is primarily due to productivity gains achieved through operating efficiencies.

Operating Expenses

Consolidated operating expenses for the first quarter of 2003 were $2.5 million or 9.9% of consolidated net sales, compared with consolidated operating expenses of $3.6 million or 13.2% of consolidated net sales for the first quarter of 2002. The decrease was primarily due to reduced legal expenses related to the CharTech Litigation (see Note 10 to the Consolidated Financial Statements in Part 1).

Other Income (Expense)

There were no gains on extinguishment of debt in the first quarter of 2003 compared to a gain of $0.5 million in the first quarter of 2002 when we repurchased $0.8 million face value of Senior

Subordinated Notes (the "Notes") issued in 1999 bearing interest of 11³/8% per annum in the open market for $0.3 million.

We recorded $0.3 million in the first quarter of 2003 for our share of the losses of our joint venture in Germany, SDI-Molan. SDI-Molan started operations in September 2002 and we anticipate net losses from its operations during the current fiscal year.

Liquidity and Capital Resources

Our principal sources of liquidity are cash flow from operations and borrowings under our credit facilities. Our principal uses of cash are debt service requirements, capital expenditures and working capital.

We entered into a five-year credit facility (the "Credit Facility") in June 2001 which consists of a $25.0 million Revolving Credit Facility (the "Revolver") and a $5.0 million five-year Term Loan (the "Term Loan"). Available borrowings under the Revolver are based on a formula comprised of our eligible accounts receivable and inventory. The Credit Facility requires lockbox arrangements which provide for all receipts to be swept daily to reduce borrowings outstanding.

The agreement governing the Credit Facility contains customary covenants, including restrictions on the incurrence of debt, the sale of assets, mergers, acquisitions and other business combinations, voluntary prepayment of other debt, transactions with affiliates, repurchase or redemption of equity securities, and financial covenants on tangible net worth. Substantially all of our assets are pledged as collateral under the Credit Facility.

As of February 2, 2003, we had $1.1 million in borrowings and $2.5 million in letters of credit outstanding under the Revolver. The total amount available under the Revolver at February 2, 2003 was $8.9 million subject to compliance with certain financial and operating covenants which we must meet on a quarterly basis. As of February 2, 2003, we were in compliance with all such covenants.

We have guaranteed bank loans made to SDI-Molan under agreements entered into in August 2002. Our guarantee is limited to fifty percent of the loans outstanding and is subject to a maximum of 3.2 million Euro or approximately $3.4 million at February 2, 2003. SDI-Molan had bank loans outstanding in the amount of 5.0 million Euro or $5.4 million at February 2, 2003. SDI-Molan started operations in September 2002. We anticipate net losses from its operations for the current year.

Continuing operations used cash of $(1.8) million and $(0.9) million in the three months ended February 2, 2003 and February 3, 2002, respectively. The decrease in cash flow was primarily due to higher incentive bonus payments. Capital expenditures, primarily for manufacturing equipment, were $1.4 million in the first quarter of 2003 compared to $2.0 million in the first quarter of 2002. We expect to spend approximately $5.0 to $6.0 million on capital expenditures, primarily for manufacturing equipment, during 2003, comparable to the $6.0 million spent in 2002. We will make the next semi-annual interest payment of $4.2 million on our Notes in June 2003. We expect to make the aforementioned payments with cash from operations and borrowings under the Revolver.

As of February 2, 2003, we had net liabilities of $30.0 million. Our ability to pay the interest on, or to refinance our debt, or to fund planned capital expenditures, will depend on generating cash flow from future operations. We have had positive cash flow from continuing operations during the past two fiscal years.

Critical Accounting Policies

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. This requires us to make estimates and assumptions that affect reported

amounts and related disclosures. Actual results could differ from those estimates. From time to time, we may have the following allowances and/or accruals among others:

1.: Allowances for accounts receivable including a sales allowance and an allowance for bad debts;
2.: Allowances for inventory including allowances for obsolescence and shrinkage;
3.: Valuation allowances for deferred taxes;
4.: Accruals for cleanup at former sites; and
5.: Other expense accruals such as for litigation.

At February 2, 2003, these allowances and/or accruals were not material to our results of operations or our financial position.

General Business and Economic Conditions

Our business and earnings are sensitive to general business and economic conditions. These conditions include automotive vehicle sales, short-term interest rates and consumer confidence levels about the economy. If any of these conditions worsen, our business and earnings could be adversely affected. For example, if consumer confidence erodes and short term interest rates rise to a point where purchases of automobiles are deferred, our production of initiators, our principal revenue producing product, would be adversely affected. We are subject to price pressure from our customers which reduces our revenues through lower standard unit pricing. We also are affected by the trend towards increased unit sales of lower cost standard products as replacements for higher cost prior generation lead wire products. The retail automotive market remains very competitive as the OEMs compete for market share. During calendar year 2002 and early 2003, automobile manufacturers have offered an array of incentives in an effort to sustain sales.

Accounting Developments

In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS 123". This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We have chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the estimate of the market value of our stock at the date of the grant over the amount an employee must pay to acquire the stock. We will adopt the annual disclosure provisions of SFAS No. 148 in our financial reports for the year ended November 2, 2003 and we will adopt the interim disclosure provisions for financial reports for the quarter ended May 4, 2003. As the adoption of this standard involves disclosures only, we do not expect a material impact on our results of operations, financial position or liquidity.

with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred, not when it is "planned". We are required to adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002 and do not expect the adoption to have a material impact on our results of operations, financial position or liquidity.

Forward-Looking Information

The Management's Discussion and Analysis of Financial Condition and Results of Operations section in this report on Form 10-Q contains certain forward-looking statements and information within the meaning of the Private Litigation Reform Act of 1995. These forward-looking statements and information relating to our business are based on the beliefs of management as well as assumptions made by and information currently available to management. The words "anticipates," "believes," "estimates," "expects," "plans," "intends," and similar expressions, as they relate to our operations, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed in any forward-looking statement. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. We do not intend to update these forward-looking statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

We have only limited involvement in derivative financial instruments and do not hold or issue them for trading purposes. We are exposed to market risk related to changes in foreign exchange rates on transactions denominated in foreign currencies and we selectively use foreign currency forward exchange contracts to manage those risks. At February 2, 2003 we had no open contracts. Certain amounts borrowed under our Credit Facility are at variable rates and we are thus subject to market risk resulting from interest rate fluctuations. A change of 1% in the interest rates on these borrowings would have no material impact on our financial position, results of operations or liquidity.

We also are exposed to market risks related to fluctuations in interest rates on the Notes we issued in December 1998. For fixed rate debt such as the Notes, changes in interest rates generally affect the fair value of the debt instrument. However, we do not have an obligation to repay the Notes prior to maturity in December 2008.

ITEM 4. CONTROLS AND PROCEDURES

The Chief Executive Officer and the Vice President Finance of Special Devices, Incorporated (its principal executive officer and principal financial and accounting officer, respectively) have concluded, based on their evaluation as of a date within 90 days prior to the date of the filing of this report, that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including the Chief Executive Officer and Vice President Finance, as appropriate to allow timely decisions regarding required disclosure.

There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Defense Criminal Investigative Service Investigation. Our former Aerospace Division remains the subject of an investigation commenced in 1999 by the Defense Criminal Investigative Service ("DCIS") of the Office of the Inspector General, Department of Defense, into allegations that SDI deviated from contractual requirements relating to the use of organic sealants. We responded to a subpoena in 1999, and, since that time, we have not been advised formally of any action against SDI arising out of the investigation. However, the government recently has requested a meeting in connection with the investigation. We dispute the government's interpretation of the contracts as precluding the use of such sealants in the manner in which they were used. One potential consequence of civil proceedings or criminal charges, if filed, is the possibility that we would be suspended from future military and federal government sales, and if convicted, debarred from such sales for a period of time. This would not be expected to materially affect our financial condition, results of operations or liquidity given the divestiture of our Aerospace Division, which was completed in 2001. At this point, it is not possible to predict or assess the likelihood of an unfavorable outcome or predict the amount of potential liabilities.

For other legal proceedings, see our Annual Report on Form 10-K for the year ended November 3, 2002.

ITEM 2 THROUGH 5.

Omitted as not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a): EXHIBITS

Exhibit No.		Description
1.1(g)		Purchase Agreement, dated as of December 11, 1998, among SDI Acquisition Corp. and BT Alex. Brown Incorporated and Paribas Corporation.
2.1(a)		Amended and Restated Agreement and Plan of Merger, dated as of June 19, 1998, between the Company and SDI Acquisition Corp.
2.2(b)		Amendment No. 1, dated as of October 27, 1998, to the Amended and Restated Agreement and Plan of Merger between the Company and SDI Acquisition Corp.
2.3(c)		Guaranty Agreement, dated as of June 19, 1998, between J.F. Lehman Equity Investors I, LP and the Company.
3.1(g)		Certificate of Incorporation of the Company.
3.2(g)		Bylaws of the Company.
4.1(g)		Indenture, dated as of December 15, 1998, among SDI Acquisition Corp., the Guarantors named therein and United States Trust Company of New York, as Trustee.
4.2(g)		First Supplemental Indenture, dated as of December 15, 1998, among the Company, the Guarantors named therein and the United States Trust Company of New York, as Trustee.
4.3(g)		Form of 11³/8% Senior Subordinated Note due 2008, Series A (see Exhibit A of the First Supplemental Indenture in Exhibit 4.2).
4.4(g)		Form of 11³/8% Senior Subordinated Note due 2008, Series B (see Exhibit B of the First Supplemental Indenture in Exhibit 4.2).
4.5(g)		Registration Rights Agreement, dated as of December 15, 1998, among SDI Acquisition Corp., as Issuer and BT Alex. Brown Incorporated and Paribas Corporation as Initial Purchasers.
4.6(k)		Certificate of Designation of Preferences and Relative Participating, Optional and Other Special Rights of Series A 6% Cumulative Convertible Preferred Stock of Special Devices, Incorporated dated as of February 28, 2001.
10.6(g)		Management Agreement, dated as of December 15, 1998, between the Company and J.F. Lehman & Company.
10.7(g)		Management Services Agreement, dated as of December 15, 1998, between the Company and J.F. Lehman & Company.
10.8(g)		Subscription Agreement, dated as of September 7, 1998, among the Company, Paribas Principal Incorporated, J.F. Lehman Equity Investors I, LP and JFL Co-Invest Partners I, LP.
10.9(g)		Amendment No. 1 to Subscription Agreement, dated as of December 3, 1998, among the Company, Paribas Principal Incorporated, J.F. Lehman Equity Investors I, LP and JFL Co-Invest Partners I, LP.
10.10(g)		Amendment No. 2 to Subscription Agreement, dated as of December 15, 1998, among the Company, Paribas Principal Incorporated, J.F. Lehman Equity Investors I, LP and JFL Co-Invest Partners I, LP.
10.11(g)		Stockholders Agreement, dated as of December 15, 1998, among the Company, J.F. Lehman & Co., J.F. Lehman Equity Investors I, LP, JFL Co-Invest Partners I, LP, the Neubauer Family Trust, by Walter Neubauer trustee, and the Treinen Family Trust, by Thomas F. Treinen trustee.
10.12(g)		Pledge Agreement, dated as of December 15, 1998, between the Neubauer Family Trust, by Walter Neubauer, trustee and J.F. Lehman & Company.
10.13(g)		Rollover Stockholders Agreement, dated as of December 15, 1998, among the Company, J.F. Lehman & Co., the Neubauer Family Trust, by Walter Neubauer trustee, and the Treinen Family Trust, by Thomas F. Treinen trustee.

10.15(g)		Registration Rights Agreement, dated as of December 15, 1998, among the Company, J.F. Lehman Equity Investors I, LP, JFL Co-Invest Partners I, LP, Paribas Principal Incorporated, the Neubauer Family Trust, by Walter Neubauer trustee, and the Treinen Family Trust, by Thomas F. Treinen trustee.
10.19(d)		Technology License Agreement dated November 7, 1990 between the Company and Davey Bickford Smith.
10.20(e)		Amended and Restated 1991 Stock Incentive Plan of the Company.
10.27(f)		Development Agreement, dated August 28, 1996, between Company and the City of Moorpark.
10.29(h)		Employment Agreement dated October 1, 1999 between the Company and Thomas W. Cresante.
10.31(h)		1999 Stock Option Plan dated June 23, 1999.
10.41(l)		Partnership Agreement, dated as of June 26, 2001, among SDI Germany GmbH, Klaus-Jurgen Dittrich and Frank Dittrich.
10.42(l)		Side Agreement, dated as of June 26, 2001, among the Company, Anhaltinische Chemische Fabriken ACF GmbH, Molan-Werk Dittrich Gessellschaft mit beschrankter Haftung & Co. Komman-ditgesellschaft, SDI Germany GmbH, Klaus-Jurgen Dittrich and Frank Dittrich.
10.43(l)		Loan and Security Agreement, dated as of June 27, 2001, among the Company and Foothill Capital Corporation.
10.44(n)		Amended and Restated 1999 Stock Option Plan of the Company.
12.1(g)		Statement of Computation of Ratios of Earnings to Fixed Charges.
21.1(o)		Subsidiaries of the Company.
25.1(g)		Form T-1 Statement of Eligibility of United States Trust Company of New York to act as trustee under the Indenture.
99.1(i)		Special Devices, Incorporated Press Release dated September 22, 2000.
99.2(i)		Agreement and Plan of Merger between the Company and Wind Point Partners IV, LP dated August 18, 2000.
99.3(j)		Special Devices, Incorporated Press Release dated May 14, 2001.
99.4(j)		Asset Purchase Agreement, dated as of March 27, 2001, among the Company, PS/EMC West LLC and Pacific Scientific Company (solely with respect to Section 7.2 thereof).
99.5(j)		Amendment No. 1 to Asset Purchase Agreement dated as of May 11, 2001.
99.6(k)		Lease Agreement, dated as of June 4, 2001, among the Company, Autosafe Airbag 14 (CA) LP and Autosafe Airbag 12 (CA) LP.
99.79(m)		Amendment No. 2 to Asset Purchase Agreement dated as of July 30, 2001.

(a): Previously filed as Appendix A to the Company's Proxy Statement on Schedule 14A filed with the Commission on August 18, 1998 and incorporated herein by reference.
(b): Previously filed as Appendix B to the Company's Proxy Statement on Schedule 14A filed with the Commission on December 10, 1998 and incorporated herein by reference.
(c): Previously filed as Exhibit 2.3 to the Company's Current Report on Form 8-K filed with the Commission on July 10, 1998 and incorporated herein by reference.
(d): Previously filed as an exhibit to Registration Statement on Form S-1 (File No. 33-40903) and incorporated herein by reference.
(e): Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1994 and incorporated herein by reference.
(f): Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1996 and incorporated herein by reference.

(g): Previously filed as an exhibit to Registration Statement on Form S-4 (File No. 333-75869) and incorporated herein by reference.
(h): Previously filed as an exhibit to the Company's Annual Report on Form 10-K405 for the fiscal year ended October 31, 1999 and incorporated herein by reference.
(i): Previously filed as an exhibit to the Company's Current Report on Form 8-K filed with the Commission on October 6, 2000 and incorporated herein by reference.
(j): Previously filed as an exhibit to the Company's Current Report on Form 8-K filed with the Commission on May 25, 2001 and incorporated herein by reference.
(k): Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended April 29, 2001 and incorporated herein by reference.
(l): Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended July 29, 2001 and incorporated herein by reference.
(m): Previously filed as an exhibit to the Company's Annual Report on Form 10-K405 for the fiscal year ended October 31, 2001 and incorporated herein by reference.
(n): Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended May 5, 2002 and incorporated herein by reference.
(o): Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended November 3, 2002 and incorporated herein by reference.
(b): REPORTS ON FORM 8-K

None.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		SPECIAL DEVICES, INCORPORATED
Dated: March 18, 2003		/s/ THOMAS W. CRESANTE Director, President and Chief Executive Officer (Principal Executive Officer)
Dated: March 18, 2003		/s/ JAMES E. REEDER Vice President Finance (Principal Financial and Accounting Officer)

CERTIFICATIONS

I, Thomas W. Cresante, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Special Devices, Incorporated;

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: March 18, 2003		/s/ THOMAS W. CRESANTE Director, President and Chief Executive Officer (Principal Executive Officer)

CERTIFICATIONS

I, James E. Reeder, certify that:

1.

I have reviewed this quarterly report on Form 10-K of Special Devices, Incorporated;

2.

3.

4.

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: March 18, 2003		/s/ JAMES E. REEDER Vice President Finance (Principal Financial and Accounting Officer)

QuickLinks

SPECIAL DEVICES, INCORPORATED INDEX TO QUARTERLY REPORT ON FORM 10-Q
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) (Unaudited)
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands) (Unaudited)
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited)
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

ITEM 4. CONTROLS AND PROCEDURES

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 2 THROUGH 5.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

SIGNATURES
CERTIFICATIONS
CERTIFICATIONS