UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: October 31, 2004
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)
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Delaware |
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95-3008754 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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14370 White Sage Road, Moorpark, California |
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93021 |
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(Address of principal executive offices) |
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(Zip Code) |
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(805) 553-1200 |
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(Registrant’s telephone number, including area code) |
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
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 x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes o No x
As of the last business day of the registrant’s most recently completed second fiscal quarter, none of the voting and non-voting common equity was held by non-affiliates.
The registrant’s common stock is not listed or traded on any exchange or market.
As of January 21, 2005, the number of outstanding shares of the registrant’s common stock was 3,712,764.
SPECIAL DEVICES, INCORPORATED
INDEX TO ANNUAL REPORT ON FORM 10-K
NOTE CONCERNING FORWARD-LOOKING INFORMATION
This report 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. For example, 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.
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In this report, the “Company,” “SDI”, “we,” “us” and “our” refer to Special Devices, Incorporated unless the context requires otherwise. We changed our fiscal year in 2002 from October 31 to the 52 or 53-week period ending the Sunday closest to the last day of October. Unless otherwise noted, all references to years, such as “during 2004”, mean our fiscal year.
We believe that we are 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. Our primary products are initiators, which function like an “electrical match” to ignite the gas generating charge in an automotive airbag system.
We believe our Automotive Products Division to be the world’s largest independent supplier of initiators sold to leading domestic and foreign automotive airbag system manufacturers. Those manufacturers use our product in the assembly of integrated airbag safety systems, which they then sell to automobile original equipment manufacturers (“OEMs”). Our Automotive Division accounted for virtually all of our consolidated net sales and assets as of and for the year ended October 31, 2004.
Following the expiration of certain noncompete agreements in select aerospace and military market segments, we have been developing internal capabilities for our emerging Aerospace Division to reenter these markets. During the third quarter of 2004 we began bidding on contracts in these markets and during the fourth quarter of 2004 shipped a small commercial order under $0.1 million to a customer in these markets. We expect to continue to pursue opportunities in this business.
We have been working on test units of a new product line called electronic ignition modules (“EIMs”) that will be sold to commercial mining and blasting customers worldwide. The initial shipments to customers are expected in 2005.
Our principal executive offices are located at 14370 White Sage Road, Moorpark, California 93021 and our phone number is (805) 553-1200.
Special Devices, Incorporated was founded in the late 1950s in Pacoima, California to manufacture pyrotechnics for motion picture special effects applications. In 1960, we constructed a new facility in Newhall, California for the production of military pyrotechnic devices.
During the 1980s, increased defense spending and a broadening of our product lines allowed us to become a leading manufacturer of high-reliability initiators for weapons systems and safe-and-arm and arm-fire devices. By the end of the 1980s, the decline of the Cold War and rising budget deficits were placing downward pressure on defense spending. At the same time Congress passed legislation mandating the increased use of airbags in passenger cars, and automotive OEMs were beginning to market the superior safety of cars equipped with airbags. As a result, we decided to maintain our aerospace business and aggressively penetrate the automotive market. In 1989, we signed a five-year contract to supply initiators to TRW, Inc., one of the leading manufacturers of automotive airbags. Through the 1990s, we gained additional airbag customers and established our position as a leading supplier of initiators and pyrotechnic devices to the world’s automotive and aerospace markets.
To accommodate our growth, we constructed a new, state-of-the-art facility in Moorpark, California during 1998 and 1999. We vacated our Newhall facility and relocated to Moorpark in 1999.
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In December 1998, we consummated a recapitalization (the “Recapitalization”) in which all shares of our 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. In connection with the Recapitalization, we delisted our Common Stock from the NASDAQ Stock Market, and accordingly filed for deregistration with the Securities and Exchange Commission (“SEC”).
In July 1999, we entered into a Contribution, License and Lease Agreement with McCormick Selph, Inc. (“MSI”), which at the time was an affiliate of our controlling stockholder, pursuant to which we received certain assets and licensed the intellectual property comprising the micro gas generator (“MGG”) automotive product line. MGG units are used by the automotive industry in seat belt pretensioner applications. The Contribution, License and Lease Agreement was amended and restated in September 2000 to convey all of MSI’s rights to the intellectual property to SDI. The MGG product line was moved to our Mesa, Arizona facility during the second half of 2000.
On May 11, 2001, we completed the sale of the net assets comprising the remaining operations of our Aerospace Division (the “Aerospace Sale”), which had designed and manufactured products for the aerospace industry for nearly 40 years. Its customers were primarily the U.S. Department of Defense and its prime contractors and subcontractors. The Aerospace Division’s products included initiators and devices that incorporated these initiators such as explosive bolts, cutters, actuators, valves, pin pullers and safe-and-arm and arm-fire devices. Our subsidiary Scot, Incorporated (“Scot”), which was sold on September 21, 2000, designed and manufactured devices for launch vehicles and aircraft egress applications as well as sophisticated test products such as parachute release and oxygen mask testers.
In June 2001, we completed the sale and leaseback of our facilities in Moorpark, California and Mesa, Arizona (the “Real Estate Transaction”).
We formed a joint venture partnership, SDI-Molan GmbH & Co. KG (“SDI-Molan”) in Germany in June 2001. Our 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, MGGs, and seat belt buckles and pyrotechnic pretensioners in Europe. SDI-Molan began operations in 2002 with its MGG production line. Commercial production commenced on its Global Standard Initiator (“GSI”) lines in 2004.
In June 2002, we incorporated Special Devices Japan Kabushiki Kaisha (“SDI Japan”) in Japan and SDI Japan began operations as a sales office in 2003. We previously distributed our products in Japan through an agent. In November 2002, we formed Special Devices (Thailand) Co., Ltd (“SD Thailand”) in Thailand. SD Thailand is leasing a production ready facility in Thailand. Commercial production is expected to scale up in 2005.
Our Automotive Products Division was created in 1989 after the United States government adopted regulations requiring the installation of airbags and other crash protection systems in all new passenger automobiles. Since that time, demand for our initiators has grown rapidly. We attribute this growth in large part to the continuing evolution of automotive safety standards and increased customer preferences for airbag-related safety options. We expect continued growth in the demand for our products as the number of airbag-equipped vehicles increases, the number of airbags per vehicle grows, and our customers implement new technologies. These new technologies include seat belt pretensioners and “smart” airbag systems, both of which we expect will require new types of initiators and sometimes more than one initiator per product.
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One of the major reasons for the establishment of the Automotive Products Division was the adoption by the National Highway Traffic Safety Administration (“NHTSA”) of regulations that initially required all passenger automobiles manufactured on or after 1989 for sale in the United States to have automatic frontal crash protection systems for the driver and front passenger. Beginning in 1994 similar requirements for light trucks and vans went into effect. Airbags and automatic seat belts were the two initial means of compliance with these regulations.
Automotive airbag systems consist of six basic components: sensors, a diagnostic and firing module, an initiator (the product we manufacture), a combustion chamber, a gas generator and a specially treated fabric bag. Once the sensors detect an impact of sufficient severity, the diagnostic and firing module transmits an electrical charge to the initiator. The initiator then fires, igniting the gas generator in the combustion chamber that burns very rapidly, producing a gas that inflates the bag. The entire process takes approximately 40 milliseconds. The diagnostic module also tests the initiator each time the automobile is started.
In 1994, the NHTSA regulations were amended to require that airbags be the automatic frontal crash protection system used for both the driver and front passenger in 100% of passenger automobiles, light trucks and vans manufactured on or after September 1998 for sale in the United States. In addition to these requirements, automobile OEMs have recently introduced other safety restraint devices, including side airbags, head protection airbags and seat belt pretensioners. Research and development is currently in process for rear seat airbag systems.
In response to concerns over injuries caused by airbag deployment for out-of-position occupants (primarily children and infants), research is ongoing to develop advanced or “smart” airbag systems. The first generation of these systems, which deploys an airbag at lower forces, has been introduced. The next generation systems will have the ability to detect weight and position of the occupant. Most of these new systems have “dual chambers,” each of which requires an initiator. The NHTSA Reauthorization Act of 1998 mandates the issuance of a final rule for advanced airbags. The advanced airbags were required in some new passenger cars and light trucks beginning in September 2002 and will be required in all new cars and light trucks beginning in September 2005. Additional published and proposed regulations over the last ten years have required more airbags.
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 legacy lead wire products. See “Products” for a discussion of these products. The retail automotive market remains very competitive as the OEMs compete for market share. Automobile manufacturers continue to offer an array of incentives in an effort to sustain sales. In recent years, our automotive sales volume has been subject to the outcome of various make-or-buy decisions from a major customer who has the capability to manufacture select initiator products. We expect this trend to continue in the future. While we have been able to offset these decreases in volume with gains from other customers, there can be no assurance that we can continue to do so in the future.
We believe we are the world’s largest independent supplier of airbag initiators and MGGs. Initiators and MGGs are devices that receive a low-energy electrical signal from an electronic firing module and convert
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that signal to a high-energy output by a thermal reaction of compacted pyrotechnic materials. In the event of an automobile accident, airbag initiators activate inflators, which in turn inflate an airbag. MGGs are initiators used in seat belt pretensioning devices, which take dangerous slack out of seat belts in the event of an accident.
We currently produce three primary families of pyrotechnics for automotive safety systems delivered to both domestic and foreign manufacturers of airbag inflators and seat belt pretensioners: standard (“squib”), leadwire and MGG type. Within these families a wide variety of configurations are offered with more than thirty-six different propellant options with multiple physical configurations to meet specific customer requirements. In the North American market, leadwire products are legacy programs in declining demand. Leadwire product differs from standard product 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. We have a variety of other initiator products that are currently in the qualification process including the Global Gas Generator (“G4”). In order to maintain our leadership position in the industry, we are in the process of developing “smart” initiator technologies that will be used in new, integrated occupant protection systems.
The airbag manufacturers’ requirements for our initiators are dependent on the requirements of automobile manufacturers. We believe that the airbag initiator market in the United States has become, and will for the foreseeable future remain, closely tied with the cyclical fluctuations of the automotive market. This trend may be offset partially as new applications for airbags and initiators, such as airbags for side-impact protection and seat belt pretensioners, are installed by automobile manufacturers.
Currently, the major North American manufacturers of airbag inflators are Autoliv ASP Incorporated (“Autoliv”), TRW, BAICO (owned by Atlantic Research Corporation (“ARC”)), Key Safety Systems (formerly Breed Technologies) and Inflation Systems Incorporated (“ISI”) (owned by Takata), each of whom incorporates our initiators in certain of its airbag systems or sub-systems. Other companies have indicated that they may enter the North American automotive airbag market and reportedly are working on the development of airbag systems. None of the current manufacturers produces all of the components of an airbag system although Autoliv and Takata have pursued a vertical integration strategy. Most components of the system are purchased from suppliers like us, and the manufacturers concentrate on the design, assembly, testing and qualification of the airbag systems.
The major non-U.S. manufacturers of inflators to whom we sell our products to are TRW (Europe), Autoliv (Europe), Takata-Petri (Europe), Daicel Chemical Industries (Japan), Autoliv Nichiyu (Japan), NSK (Japan) (owned by Autoliv) and Takata (Japan).
Customers providing more than 10% of our net sales for the year ended October 31, 2004 include Autoliv (26.1%), TRW (22.7%), ISI (19.5%) and ARC (17.5%). The loss of any of these customers would have a material adverse effect on our results of operations, financial position and liquidity.
The majority of the sales in our Automotive Division are achieved under blanket orders specifying customer requirements to be supplied by us. All of our blanket orders include a clause under which either party can request modifications due to market conditions. Purchase order releases are updated weekly by each customer and include “firm” shipping requirements for the next 8 to 16 weeks. We do not reflect an order in backlog until we have received a purchase order from a customer that specifies the quantity ordered and the delivery dates required. Since these orders are generally shipped within 12 to 16 weeks of
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receipt of the order, the amount of “firm” backlog at any given time is not indicative of sales levels expected to be achieved over the next twelve-month period.
There are three suppliers of airbag initiators currently operating in the United States, SDI, Autoliv (formerly OEA, Inc. ) and LifeSparc (owned by Nippon Kayaku). Both Autoliv and LifeSparc compete with us based on price, delivery reliability and quality. We believe we hold the largest share of the North American airbag initiator market. In addition, we have identified four major suppliers of airbag initiators in Europe and one major supplier of initiators in Japan.
Other companies may choose to enter the automotive initiator market in the future. There are significant barriers to entry into this market. New entrants would need to achieve high sales volumes of relatively low-priced units in order to recover significant startup costs, including those relating to equipment outlays. In addition, each automotive initiator platform must pass numerous tests established by automobile OEMs and airbag system manufacturers. These testing phases typically take approximately 12 to 18 months to complete and are very expensive. We believe a new entrant would require many years and significant up-front expenditures to replicate the qualification and testing required to successfully market the mix of products that we offer.
Our management, engineers and personnel maintain close contact with each customer and monitor developments in the automotive industry and safety restraint markets. Recent efforts have focused on the status of products such as side and rear seat airbag systems, seat belt pretensioners and other emerging inflation technologies.
As a result of the close relationship with our customers, we generally receive a request for quote for new programs. Our program management handles high volume production quotes, spot buys and prototype production quotes. We respond to customer inquiries with price quotes, configuration confirmation and prospective shipping dates. Lot acceptance testing results are available upon request for confirmed orders. When customers supply specific performance parameters, performance data are also supplied to customers.
AEROSPACE DIVISION
General
In 2001, we completed the sale of the net assets comprising the remaining operations of our Aerospace Division, which had designed and manufactured products for the aerospace industry for nearly 40 years. Following the expiration of certain noncompete agreements in select aerospace and military market segments, we have been developing internal capabilities to reenter these markets. During the third quarter of 2004 we began bidding on contracts in these markets and during the fourth quarter of 2004 shipped a small commercial order under $0.1 million to a customer in these markets.
Industry Overview
The aerospace market is comprised of a large number of companies that manufacture a wide variety of products and provide a diverse group of services. The new Aerospace Division is focusing its efforts primarily on the design, development and manufacture of highly reliable ordnance and pyrotechnic products incorporated in tactical missiles, weapons and launch vehicles.
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Each of the devices manufactured by the new Aerospace Division is a component in a larger product of its customer. As a result, we and our competitors must respond to specification requirements by devoting significant engineering, development and testing resources.
The new Aerospace Division’s products are expected to include initiators and devices that incorporate these initiators such as explosive bolts, cutters, actuators, valves, pin pullers and safe-and-arm and arm-fire devices.
Backlog and Customers
The new Aerospace Division had a total backlog of $1.2 million at October 31, 2004. Our current and prospective customers are primarily the U.S. Department of Defense and its prime contractors and subcontractors. All open contracts were firm fixed price contracts. Backlog includes the remaining contract amount for units yet to be shipped for signed contracts (excluding renewals or extensions that are at the discretion of the customer) or contract award notifications with firm delivery dates and prices. Backlog is calculated without regard to possible adjustments for scope change or potential cancellations until such changes or cancellations occur. Of the total new Aerospace Division backlog at October 31, 2004, we expect that all of it will be delivered in fiscal 2005.
Contract Risks
Some of our contracts contain pricing provisions that require the payment of a set fee by the customer for our services regardless of the costs we incur in performing these services, or provide for penalties in the event we fail to achieve certain contract standards. In such situations, we are exposed to the risk that we will incur significant unforeseen costs or such penalties in performing the contract.
Competitors
During the bid process for the initial contract for a program, the new Aerospace Division competes with several firms, some with greater financial resources than we have. Once the initial contract is awarded, contracts for additional quantities are generally entered into on a negotiated price basis and are not competitively bid.
In recent years, the number of our competitors has decreased through both attrition and acquisitions by the remaining companies. Not withstanding the foregoing, we have identified multiple competitors in the aerospace pyrotechnic market including Pacific Scientific, a division of Danaher Corporation, Goodrich Corporation and Hi-Shear Corporation.
Sales and Marketing
Marketing efforts for the new Aerospace Division are focused on identifying emerging new programs that have long-term production potential and the prime contractors or subcontractors who are likely to receive contracts for such programs. We have a marketing team whose duties include identifying and pursuing new program opportunities, customers, potential teaming arrangements and new business development strategies.
For new programs, the new Aerospace Division generally receives a request for quotation from its customer. We respond to customer inquiries with quotations and extensive cost, technical and management proposals. In some cases, we will provide prototype hardware for the customer’s evaluation prior to source selection. We believe that customers award contracts based upon the technical proposals submitted, which include design innovation, analysis and compliance with specifications, in addition to pricing.
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Many contracts with respect to the U.S. Department of Defense programs involving amounts in excess of $500,000 are subject to audit by the United States government. Most of our contracts with respect to the U.S. Department of Defense programs are subject to termination at the government’s convenience.
General. Our production process consists of fabricating and assembling hardware components and separately preparing the pyrotechnic charge. Production of the electro-mechanical assemblies involves the purchase of machined components, seals and other materials, the mechanical assembly of the components and the testing of the completed units. Throughout the entire process, strict quality assurance controls are maintained in order to obtain the lowest possible theoretical failure rates. After assembly, the products are functionally tested on a sample basis as required by each customer or the applicable contract.
We manufacture the pyrotechnic charge from raw generic materials. These materials are readily available from a variety of suppliers, and we have handled and processed these fuels and oxidizers for nearly 40 years. Some of the pyrotechnic fuels are delivered to us in bulk in a wet and non-volatile form. We dry the pyrotechnic fuels before use. These fuels are then mixed with oxidizers and pressed in small quantities into the metal housings of the specific product being made. Handling and processing pyrotechnic materials requires extensive experience and expertise as well as the proper equipment and facilities.
While both the Automotive Products Division and the new Aerospace Division manufacture similar pyrotechnic products, each division’s manufacturing process is unique. Because the Automotive Products Division must produce large quantities of highly reliable products at high speeds, automation and process engineering are as important to us as product design. We have a staff of highly trained automation engineers, technicians and operators whose goal is to maximize yield and product quality. In contrast, the new Aerospace Division will manufacture primarily engineered-to-order products pursuant to custom specifications. Lead times are expected to typically range between six to nine months in order to satisfy the highly technical and intense product testing required prior to product shipment. As a result, the new Aerospace Division is expected to produce a wider variety of products at significantly lower volumes than the Automotive Products Division. We have implemented Six Sigma and Lean Manufacturing methodologies. Six Sigma is a methodology designed to improve the quality of our products, manufacturing processes and administration. Lean Manufacturing is a systematic approach to the identification and elimination of waste and non-value added activities through continuous improvement in all products and processes.
Quality Control. Each product manufactured by the Automotive Products Division must qualify for use by passing numerous tests established by the automobile OEM and airbag system manufacturers. The initial test phase is design validation, which is intended to demonstrate that the design of the initiator is capable of performing the required function within the stated specifications. The second test phase is product validation, which is intended to demonstrate that we have the management, personnel, equipment and facilities to manufacture the initiator in production quantities to design specifications. The design validation and product validation qualification phases must be repeated for each new initiator design. The product validation qualification phase must also be repeated for each facility at which initiators are produced. These initial qualification procedures are very costly and time consuming. The product validation qualification phase, for example, requires a supplier to have in place its management, personnel, equipment and facilities prior to the time they would otherwise be required for production.
Products to be manufactured by the new Aerospace Division will be required to meet rigorous standards and specifications for workmanship, process, raw materials, procedures and testing. Customers, and in some cases the U.S. Department of Defense as the end user, may perform periodic quality audits of the
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manufacturing process. Some customers and the U.S. Department of Defense may in the future place representatives at our facilities to monitor quality assurance.
The drying, sifting, mixing and processing of pyrotechnic materials involves certain risks and potential liabilities. Our safety and health programs provide specialized training to employees working with pyrotechnic materials. Pyrotechnic materials generally are delivered to us and are stored in a non-volatile form. The pyrotechnic materials are then dried, sifted and blended in a separate building specially designed for these operations. Workstations are designed to shield employees from any accidental initiation incidents. Furthermore, our machines are designed so that an accidental initiation incident will be contained in a protective enclosure to minimize damage. Transportation of pyrotechnic materials also involves certain risks and potential liabilities. See Note 17 to the Consolidated Financial Statements.
We maintain a liability insurance program covering a number of risks. Our insurance program includes commercial general liability and products liability coverage for approximately $77 million. We also have casualty and fire insurance with various coverage limits for damage to personal property and buildings, business interruption, earthquakes, boilers and machinery and automobile liability. Pollution liability is excluded from our comprehensive general liability insurance policy.
We are engaged in a business that could expose us to possible claims for injury resulting from the failure of products sold by us, notably initiators for airbag systems. We maintain product liability insurance coverage as described above. However, there can be no assurance that claims will not arise in the future and that the proceeds of our insurance policies will be sufficient to pay future claims or that we will be able to maintain the same level of insurance.
As a contractor and subcontractor of the U.S. Government, we are subject to various laws and regulations more restrictive than those applicable to non-government contractors. We are subject to periodic audits to confirm compliance with these laws. Violations can result in civil and/or criminal liability as well as suspension or debarment from eligibility for awards of new government contracts or contract renewals. As of the date hereof, we know of one pending inquiry regarding compliance with laws pertaining to government contracts held by our former Aerospace Division. See “Item 3. Legal Proceedings.”
We use various hazardous materials in our manufacturing processes, including organic solvents and pyrotechnic materials. Our operations are subject to numerous federal, state and local laws, regulations and permit requirements relating to the handling, storage and disposal of those substances, including the Clean Water Act, the Clean Air Act, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), and the Occupational Safety and Health Act. We believe that we are in substantial compliance with applicable laws and regulations and that we have obtained all material permits. While compliance with such laws and regulations has the effect of increasing costs of operations, these costs must also be incurred by our competitors and, therefore, they do not materially adversely affect our competitive position. Under certain environmental laws, a current or previous owner, lessee or operator of real property and parties that generate or transport hazardous substances that are disposed of at real property, may be liable for the costs of investigating and remediating such substances on or under the property. CERCLA and similar state laws impose liability on a joint and several basis, regardless of whether the owner, lessee, operator or other responsible party was at fault for the presence of such hazardous substances.
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In connection with our relocation of operations from Newhall to Moorpark and pursuant to a stipulation and order entered into with the California Department of Toxic Substances Control and other responsible parties, we have been and could in the future be required to conduct environmental investigations of the Newhall property. These investigations have disclosed the presence of some hazardous substances in soil that may require remediation, and that could have a potential impact on groundwater conditions. We cannot determine whether the remedial costs we may be required to incur at Newhall, if any, will be material. Any costs that may be incurred in connection with the Newhall cleanup may be shared with other responsible parties due to the site’s history of industrial use by multiple parties, although this cannot be guaranteed.
At October 31, 2004, we had approximately 294 full-time employees in Moorpark, California and approximately 276 full-time employees in Mesa, Arizona. None of our employees are represented by a collective bargaining unit. We consider our relationship with our employees to be good.
In October 2004, we reached a decision to reduce our workforce by approximately 10%. The reductions are expected to be completed by the end of the first quarter of 2005. The action is the result of improvements to SDI’s manufacturing productivity and is designed to reduce costs and improve our profitability during 2005.
Financial Information About Geographic Areas
See Note 15 to the Consolidated Financial Statements for financial information about the geographic areas in which we operate.
In November 1990, we entered into the DBS License Agreement (“DBS Agreement”) pursuant to which we granted Davey Bickford Smith (“DBS”) a license to:
· use all patented and non-patented technical information, know-how, data, systems, programs and specifications (collectively, the “Technology”) used in the manufacture of initiators or incorporated in initiators (whether such Technology is owned by us or developed by us subsequently); and
· distribute initiators using the Technology worldwide, provided that DBS may not sell such initiators to TRW or its affiliates in the United States.
Until December 31, 1998, DBS was required to pay royalties to us under the DBS Agreement. From and after January 1, 1999, DBS is no longer obligated to pay royalties to us, and DBS is entitled to continue using the Technology perpetually on a royalty-free basis. As DBS failed to meet certain distribution requirements by December 31, 1998, we have the right to license the Technology to third parties. To date, DBS has neither manufactured nor distributed any products under the DBS Agreement. Significant competition from DBS in Europe or the United States could have a material adverse effect on us.
See “Item 1. Business—History” for a discussion of our intellectual property rights in connection with the MGG product line.
Patents
SDI holds patents covering key design and processing features of its existing and future products. In total, we have 9 U.S. patents granted.
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Seven patents, five of which expire in 2020 and two of which expire in 2022, cover improvements in pyrotechnic initiators.
One patent, which expires in 2019, covers an effective pyrotechnic system.
One patent, which expires in 2023, covers an electronic blasting system.
Our research and development department’s expense was $1.3 million, $1.1 million and $2.1 million in 2004, 2003 and 2002, respectively.
Our corporate headquarters are located in the City of Moorpark, in Ventura County, north of Los Angeles. The Moorpark facility, which was completed during 1999, consists of six buildings that cover approximately 170,000 square feet. This facility is located on approximately 220 acres of land. We have an additional facility in Mesa, Arizona on approximately 21 acres of land. The Mesa facility consists of eight buildings aggregating approximately 60,000 square feet including two warehouses aggregating approximately 12,000 square feet.
In June 2001, we completed the sale and leaseback of our facilities in Moorpark, California and Mesa, Arizona. The lease provides for an initial term of twenty years with options to extend for two ten-year terms and initial annual rent of $3.9 million with yearly rent escalations beginning in 2003 based on the Consumer Price Index.
SD Thailand leases a manufacturing facility located in Saraburi Province, Thailand. The facility consists of approximately 5,000 square feet and has an initial lease term of 5 years beginning July 2003 and ending July 2008 with renewal options in 5 year increments.
SDI Japan leases a sales office in Tokyo, Japan on a month to month basis.
Defense Criminal Investigative Service Investigation. Our former Aerospace Division remains the subject of an investigation commenced in 1999 by the Defense Criminal Investigative Service of the Office of the Inspector General, U.S. 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 have met with the government regarding the status of the investigation. In addition, we have responded to and disputed the Government’s allegations that SDI may have deviated from various contractual requirements. Although one potential consequence of the Government instituting civil proceedings is that we could be suspended from future military and federal government sales pending the conclusion of the civil proceedings, we do not believe this is likely to occur. A suspension 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. It would, however, impact our reentry into the aerospace market. At this point, it is not possible to predict or assess the likelihood of an unfavorable outcome or predict the amount of potential liabilities.
Selleck Suit. We are 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 alleges breach of contract, fraud and deceit and negligent misrepresentation, claims injunctive and declaratory relief, and seeks damages in excess of $1.0 million relating to the Plaintiff’s purchase from SDI of certain real estate located in Moorpark, California. An amended complaint served 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. We also successfully challenged
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the negligent claim, which was withdrawn in a further amended complaint filed in July 2003. We are 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.
Qui Tam Suit. On July 28, 2004, we entered into a Stipulation Re Dismissal in the civil action entitled Unites 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 SDI in December 2001, was a qui tam lawsuit in which a former employee of SDI sought, on behalf of the United States, an unspecified amount of money damages and civil penalties under the federal False Claims Act. Pursuant to the Stipulation, on July 30, 2004 the lawsuit was dismissed with prejudice with respect to the relator and without prejudice with respect to the federal government. Concurrently, the parties entered into a Settlement Agreement pursuant to which the relator released all claims against SDI in exchange for payment by SDI in the amount of $412,500.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
As a result of the Recapitalization, our common equity is no longer publicly traded. There are five stockholders of our common equity as of January 21, 2005. No cash dividends have been declared on our common equity in 2004 or 2003.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected financial data as of and for each of the five years in the period ended October 31, 2004. The financial data is derived from our consolidated financial statements which have been audited by PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm. The data set forth below should be read in conjunction with the consolidated financial statements and related notes thereto appearing elsewhere herein and Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
We sold our wholly owned subsidiary, Scot, on September 21, 2000 and the net assets comprising our remaining aerospace operations on May 11, 2001. The results of operations, the gain on sale of Scot and the net assets of the former Aerospace Division have been reclassified to Discontinued Operations for all prior periods presented. Activity related to our reentry into this market was not significant in 2004.
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For the Years Ended |
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October 31 |
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November 2 |
|
November 3 |
|
October 31 |
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|
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
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|
|
(In thousands) |
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Statement of Operations Data: |
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|
|
|
|
|
|
|
|
|
|
|
|
|
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Net sales |
|
$ |
105,452 |
|
|
$ |
112,908 |
|
|
|
$ |
120,254 |
|
|
$ |
122,917 |
|
$ |
131,970 |
|
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Gross profit |
|
19,036 |
|
|
21,385 |
|
|
|
21,472 |
|
|
13,191 |
|
12,143 |
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Operating expenses |
|
12,654 |
|
|
11,426 |
|
|
|
13,893 |
|
|
14,394 |
|
9,210 |
|
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Environmental and other investigation costs |
|
— |
|
|
— |
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