Back to GetFilings.com

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

FORM 10-Q

For the quarterly period ended: August 1, 2004

OR

For the Transition Period from                               to                              

Commission File Number: 333-75869

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o    No ý

As of September 10, 2004, 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

2

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

See accompanying notes to consolidated financial statements.

3

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

See accompanying notes to consolidated financial statements.

4

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

See accompanying notes to consolidated financial statements.

5

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. The Company believes it is 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 ("MGG"), 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, the Company incorporated Special Devices Japan Kabushiki Kaisha ("SDI Japan") in Japan and SDI Japan began operations as a sales office in 2003. The Company previously distributed its products in Japan through an agent. In November 2002, the Company formed Special Devices (Thailand) Co., Ltd ("SD Thailand") in Thailand. SD Thailand is leasing a production ready facility in Thailand and shipped qualifying products in the second half of 2003. Commercial production is expected to scale up in 2005.

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 2, 2003. Operating results for the three and nine month periods ended August 1, 2004 are not necessarily indicative of the operating results for the full year.

The consolidated financial statements include the accounts of the Company and its subsidiaries, SDI Germany, SDI Japan and SD Thailand. All material intercompany accounts and transactions have been eliminated. The Company accounts for its 50% ownership interest in SDI-Molan under the equity method of accounting.

The Company follows Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," which encourages, but does not require, companies to record as compensation expense over the vesting period the fair value of all stock-based awards on the date of grant. The Company adopted the disclosure requirements of SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of SFAS No. 123" effective for the second quarter of fiscal 2003.

6

At August 1, 2004, the Company has two stock-based employee compensation plans. The Company accounts for those plans 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 the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. No stock-based employee compensation cost is reflected in net income (loss), as all options granted under those plans had an exercise price equal to the estimated market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net loss if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

3. Recent Accounting Pronouncements

 In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments With Characteristics of both Liabilities and Equity". The statement changes the accounting for certain financial instruments that, under previous guidance, could be classified as equity or "mezzanine" equity, by now requiring those instruments to be classified as liabilities (or assets in some circumstances). The Company is required to adopt the provisions of SFAS No. 150 for financial instruments entered into or modified after May 31, 2003 and otherwise as of July 7, 2003, except for mandatorily redeemable financial instruments for which the adoption date is February 1, 2004. The Company's "mezzanine" equity does not meet the requirements of this statement and, therefore, the Company's adoption of this standard did not have a material impact on the Company's consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). This interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," addresses consolidation by business enterprises of variable interest entities. Under current practice, two enterprises generally have been included in consolidated financial statements because one enterprise controls the other through voting interests. FIN 46 defines the concept of "variable interests" and requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among the parties involved. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. In December 2003, the

7

FASB issued FIN 46R, which among other things, revised the implementation dates applicable to a nonpublic entity such as SDI. The Company is required to immediately apply FIN 46 and FIN 46R ("the Interpretation") to any entity that is subject to the Interpretation and that is created after December 31, 2003. SDI is also required to apply the Interpretation to any entity subject to the Interpretation that was created before December 31, 2003 by the beginning of the first annual period beginning after December 15, 2004. The Company is currently evaluating the potential impact of the adoption of FIN 46 and FIN 46R on the financial reporting of its interest in SDI-Molan.

4. Inventories

 Inventories consist of the following components:

5. Investment in SDI-Molan

 The Company accounts for its 50% ownership interest in SDI-Molan under the equity method of accounting.

Summarized financial information for SDI-Molan is as follows:

8

The Company made two working capital loans to SDI-Molan each in the amount of 0.8 million Euro in October 2003 and in August 2002 or approximately $1.8 million in total at August 1, 2004. The loans are denominated in Euros and carry an interest rate of prime plus 2.5% per annum with interest due monthly and principal due in 2006 and 2008, respectively. The Company also made a short term loan of $0.3 million in June 2004 which was repayable in full by August 2004. At August 1, 2004, $0.1 million was outstanding. In addition, the Company has a receivable for expenses from SDI-Molan in the amount of $0.8 million at August 1, 2004. In October 2003, the Company also made a loan to its partners in SDI-Molan in the amount of 0.8 million Euro or approximately $0.9 million at August 1, 2004. The loan carries an interest rate of prime plus 2.5% per annum with principal and interest due in Euros at maturity in 2006.

The Company has guaranteed bank loans made to SDI-Molan under agreements entered into in August 2002 concurrent with the commencement of operations. SDI-Molan had bank loans outstanding in the amount of 3.6 million Euro or approximately $4.3 million at August 1, 2004. 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 $3.8 million at August 1, 2004.

6. Accrued Liabilities

 Accrued liabilities consist of the following components:

7. Long-Term Debt

 Long-term debt consists of the following components:

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 that

9

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. On July 30, 2004, the Company elected the LIBOR Rate option for $2.0 million of the Term Loan for a contract term and rate of 3 months and 4.18% per annum, respectively. At August 1, 2004, there were no borrowings outstanding under the Revolver. Letters of credit outstanding and applied for under the Revolver reduce the amount of borrowings available. The Company had $1.8 million in letters of credit outstanding at August 1, 2004. The total amount available under the Revolver at August 1, 2004 was $10.8 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 August 1, 2004. Substantially all of the Company's assets are pledged as collateral under the Credit Facility.

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

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.

8. Income Taxes

 The effective tax benefit rate is lower than the statutory tax rate primarily as a result of the valuation allowance provided against the deferred tax asset arising from the Company's share of losses, under the equity method of accounting, from its investment in SDI-Molan.

9. Recapitalization Transaction

 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

10

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 August 1, 2004, the Continuing Stockholders owned approximately 29.5% of the common equity of the Company. The following table shows the effect the Recapitalization had on stockholders' equity (deficit) in 1999 (dollars in thousands):

10. Commitments and Contingencies

Defense Criminal Investigative Service Investigation.    The Company's 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, U.S. Department of Defense, into allegations that SDI deviated from contractual requirements relating to the use of organic sealants. The Company responded to a subpoena in 1999, and has met with the government regarding the status of the investigation. The government initially indicated that it no longer was focusing on the organic sealant issue, but believed SDI may have deviated from contractual requirements regarding other organic epoxy. The Company disputed the government's interpretation of the contracts as precluding the use of the epoxy in question and submitted an expert report to that effect. The government responded by reasserting the sealant issue, this time asserting that the sealant may have inhibited the curing of the epoxy, an allegation not previously raised. The Company is responding to the latest allegation but has preliminarily concluded that certain assumptions underlying the allegation as presented are erroneous. One potential consequence of civil proceedings, if filed, is the possibility that the Company would be suspended from future military and federal government sales, and if found liable, debarred from such sales for a period of time. This would not be expected to materially affect the Company's financial condition, results of operations or liquidity given the divestiture of the Aerospace Division, which was completed in 2001. It could, however, affect the Company's ability to reenter 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.

Qui Tam Suit.    On July 28, 2004, the Company entered into a Stipulation Re Dismissal in the 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 SDI in December 2001, was a qui tam lawsuit in which a former employee of SDI

11

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. The settlement was recognized as an operating expense in the quarter ended August 1, 2004.

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. SDI also successfully challenged the negligent interference claim, which was withdrawn in a further amended complaint filed in July 2003. 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.

Newhall Property.    The Company learned in May 2003 that it held record title to approximately 156 acres in Newhall, California, including the property on which it conducted its operations prior to relocating to Moorpark in 1999. It had been management's understanding that title to the property was held by an entity affiliated with the Company's former owner, from which the Company leased the property from 1978 until 1999. The Company investigated the status of ownership of the property and the potential effects, if any, of such status on the Company and its financial statements. As a result of its investigation, the Company has transferred title to the property to its former landlord, in exchange for its agreement to pay certain expenses related to the investigation, and has concluded that the transaction will not have a material adverse impact on the Company and its financial statements.

11. Subsequent Event

 In late August 2004, the Company reached a decision to reduce its U.S. workforce by approximately 20%. 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 the Company's profitability during 2005. One-time termination benefits of severance and health insurance of approximately $0.4 million are expected to be accrued in the fourth quarter of fiscal 2004 and paid during the first quarter of fiscal 2005.

12

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

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 priced standard products as replacements for higher priced legacy 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. 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.

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 we began bidding on contracts 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 ("EIM's") that will be sold to commercial mining and blasting customers worldwide. The initial shipments to customers are expected in 2005.

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.

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.

Comparison of the Three Months Ended August 1, 2004 to the Three Months Ended August 3, 2003

Net Sales

Consolidated net sales for the third quarter of 2004 were $25.3 million, compared to consolidated net sales of $27.0 million for the third quarter of 2003. The decrease in net sales was primarily due to

13

lower unit prices and a decrease in shipments of high value-added lead wire products. Also, one of our European customers substituted an SDI-Molan product for a product manufactured by SDI in the U.S., which reduced SDI's consolidated net sales during the third quarter of 2004. SDI-Molan is accounted for on the equity method of accounting and therefore its sales of $3.7 million and $1.0 million in the third quarter of 2004 and 2003, respectively, are not included in consolidated net sales.

Gross Profit

Consolidated gross profit for the third quarter of 2004 was $4.5 million or 17.8% of consolidated net sales, compared to consolidated gross profit of $5.2 million or 19.1% of consolidated net sales for the third quarter of 2003. The decrease in gross profit was due to lower unit prices for standard products as well as reduced shipment levels of high value-added lead wire products.

Operating Expenses

Consolidated operating expenses for the third quarter of 2004 were $3.6 million or 14.0% of consolidated net sales, compared with consolidated operating expenses of $3.3 million or 12.4% of consolidated net sales for the third quarter of 2003. The increase in 2004 was primarily due to the settlement of the Qui Tam suit during the third quarter of 2004. Excluding the settlement, operating expenses declined by $0.1 million.

Equity in Net Earnings (Losses) of SDI-Molan

Our share of the income of SDI-Molan was $0.1 million for the third quarter of 2004 compared with a loss of $0.4 million for the third quarter of 2003. SDI-Molan, our joint venture in Germany, commenced commercial production of Global Standard Initiators ("GSI") in 2004. During the third quarter of 2004, SDI-Molan shipped GSI to one of our European customers in substitution for a U.S. manufactured product. The increase in shipments led to a profit for the third quarter of 2004.

Comparison of the Nine Months Ended August 1, 2004 to the Nine Months Ended August 3, 2003

Net Sales

Consolidated net sales for the first nine months of 2004 were $79.4 million, compared to consolidated net sales of $82.8 million for the first nine months of 2003. The decrease in net sales was primarily due to lower unit prices and a decrease in shipments of high value-added lead wire products. Also, one of our European customers substituted an SDI-Molan product for a product manufactured by SDI in the U.S., which reduced SDI's consolidated net sales in 2004. SDI-Molan is accounted for on the equity method of accounting and therefore its sales of $7.7 million and $1.5 million for the nine months ended August 1, 2004 and August 3, 2003, respectively, are not included in consolidated net sales.

Gross Profit

Consolidated gross profit for the first nine months of 2004 was $14.8 million or 18.6% of consolidated net sales, compared to consolidated gross profit of $15.7 million or 19.0% of consolidated net sales for the first nine months of 2003. The decrease in gross profit was due to lower unit prices and a decrease in shipments of high value-added lead wire products.

Operating Expenses

Consolidated operating expenses for the first nine months of 2004 were $9.4 million or 11.8% of consolidated net sales, compared with consolidated operating expenses of $8.5 million or 10.3% of consolidated net sales for the first nine months of 2003. The increase in 2004 was due to increased legal expenses and the settlement of the Qui Tam suit during the third quarter of 2004.

14

Equity in Net Earnings (Losses) of SDI-Molan

Our share of the losses of SDI-Molan was $0.5 million for the first nine months of 2004 compared with $0.9 million for the first nine months of 2003. SDI-Molan, our joint venture in Germany, commenced commercial production of GSI in 2004. During the third quarter of 2004, SDI-Molan shipped GSI to one of our European customers in substitution for a U.S. manufactured product. We expect to reduce the loss in 2004 as shipments to customers increase. However, increased customer shipments may be sensitive to the Euro/U.S. dollar exchange rate and production start-up issues.

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 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 that 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.

On July 30, 2004, we elected the LIBOR Rate option on $2.0 million of the Term Loan for a contract term and rate of 3 months and 4.187% per annum, respectively. As of August 1, 2004, we had no borrowings and had $1.8 million in letters of credit outstanding under the Revolver. The total amount available under the Revolver at August 1, 2004 was $10.8 million subject to compliance with certain financial and operating covenants which we must meet on a quarterly basis. As of August 1, 2004, we were in compliance with all such covenants.

Operating activities provided cash of $1.9 million and $1.5 million in the nine months ended August 1, 2004 and August 3, 2003, respectively. Capital expenditures, primarily for manufacturing equipment, were $2.9 million in the nine months ended August 1, 2004 compared to $4.8 million in the nine months ended August 3, 2003. We expect to spend a total of approximately $4.0 to $5.0 million on capital expenditures, primarily for manufacturing equipment, during 2004. We will make the next semi-annual interest payment of $4.2 million on our Notes in December 2004. We have made or expect to make the aforementioned payments with cash from operations and borrowings under the Revolver.

As of August 1, 2004, we had net liabilities of $29.6 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 years ended November 2, 2003.

Off-Balance Sheet Arrangements

We have guaranteed bank loans made to SDI-Molan, our German joint venture, under agreements entered into in August 2002 concurrent with the commencement of operations. SDI-Molan had bank loans outstanding in the amount of 3.6 million Euro or $4.3 million at August 1, 2004. Our guarantee is limited to fifty percent of the loans outstanding and is subject to a maximum of 3.2 million Euro or approximately $3.8 million at August 1, 2004. See Note 5 to the Consolidated Financial Statements.

15

Critical Accounting Policies

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported therein, including the financial information reported in Management's Discussion and Analysis of Financial Condition and Results of Operations. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent form other sources. Actual results reported in future periods may be based upon amounts that differ from those estimates. The following represent what we believe are the critical accounting policies most affected by significant management estimates and judgments:

Allowance for Doubtful Accounts

We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that have been identified. Accounts receivable are reported net of the allowance for amounts that may become uncollectible in the future. Such allowances can be either specific to a particular customer or general to all customers. The Company believes the level of the allowance for bad debts is reasonable based on past experience. However, the credit loss rate can be impacted by adverse changes in the automotive industry, or changes in the liquidity or financial position of our customers which would affect the collectability of our accounts receivable and our future operating results. If credit losses exceed established allowances, our results of operations and financial condition may be adversely affected.

Inventory Reserves

We review our inventory for specific usage and future utility. Estimates for impairment of inventory are recorded as reserves to reduce the items to the lower of cost or market.

Contingencies

We account for contingencies in accordance with Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies." SFAS No. 5 requires that we record an estimated loss from a loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. Accounting for contingencies such as legal matters requires significant judgment. Many of these legal matters can take years to resolve. Generally, as the time period increases over which the uncertainties are resolved, the likelihood of changes to the estimate of the ultimate outcome increases. Management believes that the accruals for loss contingencies are adequate.

Environmental Expenditures

Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be estimated. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties. Subsequent adjustments to estimates, which may be significant, may be made as more information becomes available or as circumstances change.

16

Revenue Recognition

We manufacture products to customer specifications under standard purchase orders. Sales are primarily recognized when products are shipped.

Income Taxes

Deferred income taxes are determined using the liability method. A deferred tax asset or liability is determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is the result of changes in the deferred tax asset or liability. If necessary, valuation allowances are established to reduce deferred tax assets to their expected realizable values.

Accounting Developments

In May 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments With Characteristics of both Liabilities and Equity". The statement changes the accounting for certain financial instruments that, under previous guidance, could be classified as equity or "mezzanine" equity, by now requiring those instruments to be classified as liabilities (or assets in some circumstances). We were required to adopt the provisions of SFAS No. 150 for financial instruments entered into or modified after May 31, 2003 and otherwise as of July 7, 2003, except for mandatorily redeemable financial instruments for which the adoption date is February 1, 2004. Our "mezzanine" equity does not meet the requirements of this statement and, therefore, our adoption of this standard did not have a material impact on the our consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). This interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," addresses consolidation by business enterprises of variable interest entities. Under current practice, two enterprises generally have been included in consolidated financial statements because one enterprise controls the other through voting interests. FIN 46 defines the concept of "variable interests" and requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among the parties involved. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. In December 2003, the FASB issued FIN 46R, which among other things, revised the implementation dates applicable to a nonpublic entity such as SDI. We are required to immediately apply FIN 46 and FIN 46R ("the Interpretation") to any entity that is subject to the Interpretation and that is created after December 31, 2003. SDI is also required to apply the Interpretation to any entity subject to the Interpretation that was created before December 31, 2003 by the beginning of the first annual period beginning after December 15, 2004. We are currently evaluating the potential impact of the adoption of FIN 46 and FIN 46R on the financial reporting of our interest in SDI-Molan.

Subsequent Event

In late August 2004, we reached a decision to reduce our U.S. workforce by approximately 20%. The reductions are expected to be completed by the end of the first quarter of 2005. The action is the result of improvements to our manufacturing productivity and is designed to reduce costs and improve our profitability during 2005. One-time termination benefits of severance and health insurance of approximately $0.4 million are expected to be accrued in the fourth quarter of fiscal 2004 and paid during the first quarter of fiscal 2005.

17

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 the 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 August 1, 2004 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 officer, respectively) have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were effective in reaching a reasonable level of assurance that management is timely alerted to material information relating to us during the period when our periodic reports are being prepared.

During the quarter ended August 1, 2004, there has not occurred any change in our internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f), that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within SDI have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

18

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Qui Tam Suit.    On July 28, 2004, we entered into a Stipulation Re Dismissal in the 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 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.

For other legal proceedings, see Note 10 to the Consolidated Financial Statements and our Annual Report on Form 10-K for the year ended November 2, 2003.

ITEM 2 THROUGH 5

Omitted as not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

EXHIBITS

19

20

(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.

21

(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.



(p)

Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended August 3, 2003 and incorporated herein by reference.



(q)

Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended August 3, 2003 and incorporated herein by reference.



(r)

Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended November 2, 2003 and incorporated herein by reference.



(s)

Previously filed as an exhibit to the Company's Annual Report on Form 10-K/A for the fiscal year ended November 2, 2003 and incorporated herein by reference.

(b)

REPORTS ON FORM 8-K

        None.

22

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.

23

QuickLinks

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

ITEM 1. LEGAL PROCEEDINGS
ITEM 2 THROUGH 5
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K