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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K405
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: OCTOBER 31, 1999
OR
/ / 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: 0-19330
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SPECIAL DEVICES, INCORPORATED
(Exact name of Registrant as specified in its charter)
DELAWARE 95-3008754
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
14370 WHITE SAGE ROAD, MOORPARK, CALIFORNIA 93021
(Address of principal executive offices) (Zip Code)
(805) 553-1200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
NONE
Securities registered pursuant to Section 12 (g) of the Act:
11 3/8% SENIOR SUBORDINATED NOTES DUE 2008
GUARANTEES OF 11 3/8% SENIOR SUBORDINATED NOTES DUE 2008
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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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
As of January 28, 2000, the number of outstanding shares of the Registrant's
common stock was 3,706,889.
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SPECIAL DEVICES, INCORPORATED
INDEX TO ANNUAL REPORT ON FORM 10-K
PAGE
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 11
Item 3. Legal Proceedings........................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5. Market for the Registrant's Common Equity and Related 13
Stockholder Matters.........................................
Item 6. Selected Consolidated Financial Data........................ 14
Item 7. Management's Discussion and Analysis of Financial Condition 15
and Results of Operations...................................
Item 7A. Quantitative and Qualitative Disclosures about Market 20
Risks.......................................................
Item 8. Financial Statements and Supplementary Data................. 20
Item 9. Changes in and Disagreements with Accountants on Accounting 20
and Financial Disclosure....................................
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 21
Item 11. Executive Compensation...................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and 30
Management..................................................
Item 13. Certain Relationships and Related Transactions.............. 32
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 34
8-K.........................................................
NOTE CONCERNING FORWARD-LOOKING INFORMATION
This report contains certain forward-looking statements and information
relating to our business that 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.
2
PART I
ITEM 1. BUSINESS
In this report, the "Company," "we," "us" and "our" refer to Special
Devices, Incorporated and its wholly owned subsidiary, unless the context
requires otherwise.
OVERVIEW
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 as well as in various aerospace
applications. Our primary products are initiators, which function like an
"electrical match" to ignite the gas generating charge in an automotive airbag
system or to provide precision ignitions in aerospace-related products. In
manufacturing our products, which utilize pyrotechnic materials, we ensure safe
handling and processing by following strict safety procedures that we have
developed for nearly 40 years.
We have two divisions: an Automotive Products Division and an Aerospace
Division.
- We believe that our Automotive Products Division is the world's largest
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 ("OEM's").
- Our Aerospace Division supplies initiators and other advanced
pyrotechnic products to aerospace companies. Those companies, in turn,
use our products in a variety of applications including tactical
missile systems, spacecraft launch vehicles and military aircraft crew
safety systems.
Our principal executive offices are located at 14370 White Sage Road,
Moorpark, California 93021 and our phone number is (805) 553-1200.
HISTORY
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-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 automotive and aerospace markets.
To accommodate our growth, we constructed during fiscal 1998 and fiscal 1999
a new, state-of-the-art facility in Moorpark, California. We vacated our Newhall
facility and relocated to Moorpark during the first nine months of fiscal 1999.
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.
The Continuing Stockholders retained approximately 41.3% of our common equity
while new investors acquired the balance of our equity interests.
3
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"), an affiliate of our controlling stockholder,
pursuant to which the Company 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.
AUTOMOTIVE PRODUCTS DIVISION
GENERAL
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.
The Automotive Products division accounted for 75%, 79%, and 80% of our net
sales during fiscal years 1999, 1998, and 1997, respectively.
INDUSTRY OVERVIEW
One of the major reasons for the establishment of the Automotive Products
Division was the adoption by the National Highway Traffic Safety Administration
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.
In 1994, these regulations were amended to require that airbags be the
automatic frontal crash protection system used for both the driver and front
passenger in at least 95% of passenger automobiles manufactured from
September 1996 to August 1997 for sale in the United States, and in 100% of
passenger automobiles manufactured on or after September 1997 for sale in the
United States. For light trucks and vans, the amended regulations require that
airbags be the automatic frontal crash protection system used for at least the
driver in no less than 80% of light trucks and vans manufactured from
September 1997 to August 1998 for sale in the United States, and for both the
driver and front passenger in 100% of light trucks and vans manufactured on or
after September 1998 for sale in the United States. In addition to these
requirements, automobile OEM's have recently introduced other safety restraint
devices, including side airbags, head protection airbags and seat belt
pretensioners.
In response to concerns over injuries caused by airbag deployment for out of
position occupants (primarily children and infants), research is ongoing to
develop "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. Research and development is currently in process for rear seat airbag
systems.
4
Automotive airbag systems consist of six basic components: sensors, a
diagnostic and firing module, an initiator (the product we manufacture), a
combustion chamber, 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 which burns very
rapidly, producing a gas which inflates the bag. The entire process takes
approximately 40 milliseconds. The diagnostic module also tests the initiator
each time the automobile is started.
PRODUCTS
We believe we are the world's largest supplier of airbag initiators and
micro gas generators. Initiators and micro gas generators are devices that
receive a low-energy electrical signal from an electronic firing module and
convert 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. Micro gas generators are
initiators used in seat belt pretensioning devices, which take dangerous slack
out of seat belts in the event of an accident.
The Automotive Products Division currently produces over 125 different
airbag initiators for foreign and domestic manufacturers of inflators. We also
began manufacturing micro gas generators in 1999 and have a variety of other
initiator products that are currently at various stages of the qualification
process. 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.
CUSTOMERS
Currently, the major domestic manufacturers of airbag inflators are Autoliv
ASP Incorporated, TRW, BAICO (owned by Atlantic Research Corporation), Inflation
Systems Incorporated (owned by Takata), and OEA, Inc., each of whom, except for
OEA, Inc., incorporates our initiators in certain of its airbag systems or
sub-systems. Breed Technologies also manufactures inflators but filed for
bankruptcy in the fall of 1999. This had a minimal effect on us as Breed's
demand for our products was nominal. Other companies have indicated that they
may enter the domestic 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. 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 are TRW (Europe), Autoliv
(Europe), Daicel Chemical Industries (Japan) and Takata (Japan). We sell our
products on a limited basis to these manufacturers.
Customers providing more than 10% of our consolidated sales for the fiscal
year ended October 31, 1999 include TRW (36.4%) and Autoliv (24.3%). The loss of
either of these two customers would have a material adverse effect on the
automotive segment of our business.
BACKLOG
The majority of sales for the Automotive Products Division are achieved
under long-term agreements specifying minimum customer requirements to be
supplied by us during the term of the agreements. Purchase order releases are
updated weekly by each customer and include "firm" shipping requirements for the
next 12 to 16 weeks. The Automotive Products Division does not reflect an order
in backlog until it has 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 receipt of the order, the amount of
"firm" backlog for the Automotive Products Division at any given time is not
indicative of sales levels expected to be achieved over the next 12-month
period.
5
COMPETITORS
There are two major suppliers of airbag initiators in the United States, the
Company and OEA. We believe we hold the largest share of the domestic 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. However, a new entrant would need to achieve high sales volumes of
relatively low-priced units in order to recover significant start up-costs,
including those relating to equipment outlays. In addition, each automotive
initiator platform must pass numerous tests established by automobile OEM's 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.
SALES AND MARKETING
The Automotive Products Division's 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 "smart" airbag systems.
For new programs, the Automotive Products Division generally receives a
request for quote from its customers. High volume production quotes are handled
by program management. Spot buys and prototype production quotes are handled by
contract management. 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 supplied
with specific performance parameters, performance data is also supplied to
customers.
AEROSPACE DIVISION
GENERAL
Our Aerospace Division has been designing and manufacturing products for the
aerospace industry for nearly 40 years. Its customers are primarily the United
States government and its prime contractors. The Aerospace Division's products
include state-of-the-art initiators and mechanical devices that incorporate
these initiators such as explosive bolts, cutters, actuators, valves, pin
pullers and safe and arm devices. Our wholly owned subsidiary,
Scot, Incorporated ("Scot"), designs and manufactures devices for launch
vehicles and aircraft egress applications as well as sophisticated test products
such as parachute release and oxygen mask testers.
The Aerospace Division accounted for 25%, 21%, and 20% of our net sales
during fiscal years 1999, 1998, and 1997, respectively.
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 Aerospace Division has focused its efforts primarily on the design and
manufacture of highly reliable ordnance and pyrotechnic products incorporated in
tactical missiles, launch vehicles and aircraft crew safety systems.
PRODUCTS
The Aerospace Division, like the Automotive Products Division, designs and
manufactures highly reliable initiators and other pyrotechnic devices. These
products are used to ignite larger pyrotechnic charges, such as rocket
propellant, or to activate mechanical devices. Missiles, other weapon systems
6
and aircraft incorporate initiators for several purposes, such as igniting the
fuel which propels the missile, releasing directional fins, triggering automatic
parachutes, ejecting crew members from military aircraft and opening or closing
valves.
Our products include state-of-the-art initiators and mechanical devices that
incorporate these initiators such as explosive bolts, cutters, actuators,
valves, pin pullers and arm-fire devices used in tactical missile systems and
cutters and gas generators used in military aircraft escape and safety systems
employed by the F-15, F-16, F-18, AV-8B, T-38, T-45, T-48 and B-2 aircraft,
automatic parachute releases, time delays, separation nuts, thrusters, valves,
actuators and retractors used to lock landing gear, jettison the manipulator arm
on the Space Shuttle, and deploy the drogue chute for the Space Shuttle upon
landing. In addition, during fiscal 1999, the Aerospace Division began delivery
of a portable oxygen flow/communications tester used by U.S. Air Force pilots,
completed production of a proprietary bomb ejector, developed a stage separation
system for launch vehicle applications and qualified numerous devices used in
tactical missiles.
Each of the devices manufactured by the 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.
Although we have few patents, there are practical barriers to entry for
potential new competitors. Each of our products is made to precise technical
specifications and must be thoroughly tested before being used in a customer's
products. Testing and approval is a costly and time-consuming process.
CUSTOMERS
The end user of the Aerospace Division's products is generally the United
States government. In most cases, we are a subcontractor to the non-governmental
prime contractor or other subcontractor of the project.
The current trend of the Aerospace Division's customers is to reduce their
supplier base to a few proven, reliable sources. During the past several years,
such determinations have been made based on historical performance, audits and
an analysis of the future viability of the supplier. We expect to continue as a
supplier to our current customers.
No program of the Aerospace Division accounted for more than 10% of our net
sales during any of the three fiscal years ended October 31, 1999.
BACKLOG
The Aerospace Division's backlog was $43.7 million at October 31, 1999,
compared to $34.5 million at October 31, 1998. Backlog includes the remaining
contract amount for units yet to be shipped for signed contracts (excluding
renewals or extensions which 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 Aerospace
Division backlog at October 31, 1999, we expect that approximately $8.1 million
will be delivered beyond fiscal 2000.
COMPETITORS
During the bid process for the initial contract for a program, the 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.
7
In recent years, the number of our competitors has decreased through both
attrition and acquisitions by the remaining companies. We have identified nine
competitors in the aerospace pyrotechnic market, and we do not believe that any
one company dominates the market.
SALES AND MARKETING
Marketing efforts for the 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 team of individuals whose duties include identifying and
pursuing new program opportunities, customers, potential teaming arrangements
and new business development strategies.
For new programs, the Aerospace Division generally receives a request for
bids 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.
Many contracts with respect to United States government programs involving
amounts in excess of $500,000 are subject to audit by the United States
government. Most of our contracts with respect to United States government
programs are subject to unilateral termination at the government's convenience.
GENERAL BUSINESS MATTERS
MANUFACTURING
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 chemicals. These
chemicals 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 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 Aerospace Division
manufactures primarily engineered-to-order products pursuant to custom
specifications. Lead times typically range between six to nine months in order
to satisfy the highly technical nature and intense product testing required
prior to product shipment. As a result, the Aerospace Division produces a wider
variety of products at significantly lower volumes than the Automotive Products
Division. However, these products typically generate higher gross margins.
8
QUALITY CONTROL. Each type of initiator manufactured by the Automotive
Products Division must qualify for use by passing numerous tests established by
the automobile 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 manufactured by the Aerospace Division also must meet rigorous
standards and specifications for workmanship, process, raw materials, procedures
and testing. Customers, and in some cases the United States government as the
end user, perform periodic quality audits of the manufacturing process. Certain
customers and the United States government maintain representatives at our
facilities to monitor quality assurance.
RISK MANAGEMENT AND INSURANCE
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 chemicals 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. Work stations
are designed to shield employees from any accidental explosion. Furthermore, our
machines are designed so that an accidental explosion will be contained in a
protective enclosure to minimize damage.
Transportation of pyrotechnic materials also involves certain risks and
potential liabilities. An accidental explosion which occurred in February 1999
in connection with the transportation of pyrotechnic materials at our former
Newhall facility is under investigation by the Occupational Safety and Health
Administration of the State of California. See "Legal Proceedings." The Company
has filed a claim with its insurance carriers for damage to personal property,
buildings, and business interruption resulting from the accident.
We maintain a liability insurance program covering a number of risks. Our
insurance program includes comprehensive general liability and products
liability coverage in the amount of $100 million for the Aerospace Division,
including Scot, and $102 million for the Automotive Products Division. 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 which could expose us to possible claims for
injury resulting from the failure of products sold by us, notably initiators for
airbag systems. We have received one product liability claim in fiscal 1999, but
have been indemnified by Daimler Chrysler, who also is named in the complaint.
Daimler Chrysler is vigorously defending the claim and is paying all costs
associated with the defense. We maintain product liability insurance coverage as
described above. However, there can be no assurance that other 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.
9
GOVERNMENT REGULATION
As a contractor and subcontractor of the United States 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 two
pending preliminary inquiries regarding compliance with government policies by
the Aerospace Division. At this point, given the limited information about the
government's investigations available to us, we are unable to predict or assess
the likelihood of an unfavorable outcome, or predict the amount of potential
liabilities. See "Legal Proceedings."
ENVIRONMENTAL REGULATION
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 or are in the process of obtaining necessary 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 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,
operator, or other responsible party was at fault for the presence of such
hazardous substances.
In connection with our relocation of operations from Newhall to Moorpark, we
may be required to conduct environmental investigations at the Newhall site. Due
to the site's history of industrial use by multiple parties, it is possible that
such investigations will reveal the presence of hazardous substances in soil
and/or groundwater, which could require remediation. We cannot determine whether
the remedial costs we may be required to incur at Newhall, if any, will be
material. Such costs that may be incurred in connection with the Newhall cleanup
may be shared with other responsible parties, although this cannot be
guaranteed.
To date, our efforts to ensure compliance with applicable environmental laws
have not had a material adverse effect on our financial condition, results of
operations or competitive position. Furthermore, although no assurances can be
given, we do not believe that future compliance with existing environmental laws
will have such a material adverse effect or require material expenditures in the
future. However, certain aspects of our past compliance with applicable
environmental regulations are under investigation, and there can be no assurance
that these matters will not have a material adverse effect upon us, our
operations, or our financial condition. See "Legal Proceedings."
EMPLOYEES
At October 31, 1999, we had approximately 622 full-time employees in
Moorpark, California, approximately 466 full-time employees in Mesa, Arizona,
approximately 77 full-time employees in Downers Grove, Illinois, approximately
48 full-time employees in Hollister, California and one full-time employee in
Ogden, Utah. None of our employees is represented by a collective bargaining
unit. We consider our relationship with our employees to be good.
10
INTELLECTUAL PROPERTY
In November 1990, we entered into the DBS License 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, "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 U.S.
Until December 31, 1998, DBS was required to pay royalties to us under the
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 not manufactured or distributed any products
under the DBS License Agreement. Significant competition from DBS in Europe or
the U.S. could have a material adverse effect on us.
ITEM 2. PROPERTIES
Our corporate headquarters are located in the City of Moorpark, located in
Ventura County, north of Los Angeles. The Moorpark facility, which was completed
during fiscal 1999 and is owned by us, consists of six buildings which cover
approximately 170,000 square feet. This facility is located on 280 acres of land
and is used by both the Automotive Products Division and the Aerospace Division.
We have an additional facility in Mesa, Arizona on approximately 21 acres of
land used for our Automotive Products Division. The Mesa facility is owned by us
and consists of several buildings aggregating approximately 60,000 square feet,
including a second blending facility and an approximately 12,000-square-foot
warehouse.
Scot's manufacturing facilities and principal offices are located in Downers
Grove, Illinois and consist of approximately 47,000 square feet of office and
manufacturing facilities located on three and one-half acres of land that are
owned by Scot. Scot also owns 29 acres of land in Ogden, Utah, on which Scot
tests various products.
In May 1997, we signed a seven year lease for an approximate 25,000 square
foot building in Moorpark, California, for the glass seal operation of the
Automotive Products Division. Monthly rental expense as of October 31, 1999 was
approximately $14,000, with annual increases equal to the change in the Consumer
Price Index.
In July 1999, we entered into a Contribution, License and Lease Agreement
with McCormick Selph, Inc., an affiliate of the Company's controlling
stockholder, in Hollister, California. We are leasing a portion of this building
at $14,000 per month.
ITEM 3. LEGAL PROCEEDINGS
EPA MATTERS. In August 1999, representatives of the Department of Toxic
Substances Control of the California Environmental Protection Agency ("Cal EPA")
conducted an inspection of our former Newhall facility. Following the
inspection, Cal EPA issued a notice of violations ("NOV") indicating that there
had been unauthorized burning and treatment of hazardous waste at the facility.
Management immediately complied with the NOV requirements and directed that an
environmental audit of all of our facilities be undertaken. In September 1999, a
federal grand jury issued subpoenas requesting copies of documents relating to
the handling, generation, storage, and transportation of
11
hazardous waste and hazardous materials at our Newhall, Moorpark, and Mesa
facilities, as well as copies of documents related to other health and safety
issues.
We are cooperating fully with federal and state authorities in connection
with these matters. In light of their preliminary nature, however, and the fact
that our environmental audit is ongoing, we are unable to predict their outcome.
These matters have disrupted the conduct of our business and could result in
civil and/or criminal liabilities and penalties, including fines and remediation
costs. Accordingly, there can be no assurance that these matters will not have a
material adverse effect upon us, our operations, or our financial condition.
OSHA MATTERS. In February 1999, an accidental explosion occurred at our
Newhall facility, resulting in the death of one employee. A transport vehicle
was heavily damaged by the explosion, while nearby buildings sustained only
minor damage that was quickly repaired. We suspended all production at Newhall
for four days to conduct a thorough investigation of the accident along with the
Occupational Safety and Health Administration of the State of California
("OSHA"). We also suspended the blending of pyrotechnic powders for
approximately two weeks. We resumed full production at Newhall on March 4, 1999.
The Newhall facility was vacated upon completion of the move to the new Moorpark
facility in July 1999. OSHA's investigation of the accident was concluded during
the fiscal third quarter, resulting in the issuance on August 16, 1999, of
citations for alleged safety violations and fines aggregating approximately
$20,000. We appealed the citations as lacking in factual basis. The appeal is
pending. Because the accident resulted in a fatality, OSHA's Bureau of
Investigation is required to conduct its own investigation to determine whether
to refer the matter to the Distrct Attorney's Office for Los Angeles County. At
this point, given the limited information available regarding the Bureau of
Investigation's inquiry, it is impossible to predict or assess the likelihood of
an unfavorable outcome or predict the amount of potential liabilities.
STOCKHOLDER LITIGATION. Four purported stockholder class action lawsuits
were filed in the Delaware Court of Chancery challenging the Recapitalization.
On June 22, 1998, David Finkelstein filed a purported stockholder class action
lawsuit against J. Nelson Hoffman, Robert S. Ritchie, Jack B. Watson, Thomas F.
Treinen, Walter Neubauer, Samuel Levin, Donald A. Benedix, John M. Cuthbert, the
Company and J.F. Lehman & Company. Also on June 22, 1998, a purported
stockholder class action complaint was filed by Harbor Finance Partners against
Messrs. Treinen, Hoffman, Ritchie, Watson, Levin, Bendix, Cuthbert, as well as
the Company. Finally, on June 25, 1998, a purported stockholder class action
lawsuit was filed by Timothy Hawkins against Messrs. Hoffman, Watson, Treinen,
Levin, Bendix, Cuthbert, as well as the Company and J.F. Lehman & Company. Each
of these three lawsuits charges the individual defendants with breaching their
fiduciary duties to the public stockholders of the Company by allegedly failing
to obtain adequate consideration for the Recapitalization. The complaints
allege, among other things, that the terms of the Recapitalization are unfair,
that the defendants failed to consider other potential purchasers of the
Company, and that the individual defendants favored their own interest at the
expense of the stockholders. On August 21, 1998, David Finkelstein, the
plaintiff in one of the derivative lawsuits, filed an amended class action
complaint against the same defendants as the original complaint which charges
the individual defendants with failing to disclose material information in the
original proxy statements, including, among other things, the failure to
disclose third quarter financial statements, information concerning the
projections made available to bidders and the firm which rendered a fairness
opinion in connection with the Recapitalization, the interest of certain persons
in the equity of the continuing entity as well as breaching their fiduciary
duties to the public stockholders of the Company by allegedly failing to obtain
adequate consideration for the Recapitalization.
On November 30, 1998, a fourth purported stockholder class action lawsuit
was filed in the Delaware Court of Chancery challenging the Recapitalization.
The lawsuit, filed by Paul Packer, purportedly on behalf of himself and other
stockholders of the Company as of October 15, 1998, was brought against J.
Nelson Hoffman, Jack B. Watson, Thomas F. Treinen, Samuel Levin, Donald A.
12
Bendix, John M. Cuthbert, Robert S. Ritchie and the Company. The lawsuit
essentially charges the individual defendants with breaching their fiduciary
duties to the public stockholders of the Company by allegedly failing to obtain
adequate consideration for the Recapitalization. The complaint alleges, among
other things, that the terms of the Recapitalization were unfair, that the
consideration paid to the public stockholders of the Company was unfair,
inadequate and substantially below the fair market value of the Company, that
the individual defendants failed to take steps to enhance the Company's value,
that they failed to effectively expose the Company in the marketplace, and that
they favored their own interests at the expense of the public stockholders.
The plaintiffs and defendants agreed in the first three purported class
actions to enter into a memorandum of understanding, evidencing the parties'
agreement on the material terms of a settlement of the litigation before the
fourth lawsuit was filed. Since then, we and our counsel have had discussions
with counsel for the plaintiffs in all of these actions and it is possible that
the actions will still be settled. Any settlement will be subject to approval by
the Delaware Court of Chancery. No trial date has been set for any of the four
lawsuits and the defendants have not yet filed responsive pleadings. Management
disputes all of the plaintiffs' material allegations and believes that this
litigation is without merit. At this preliminary stage, we are not in a position
to evaluate the likely outcome of this litigation nor the terms of any possible
settlement.
There has been little activity in any of these stockholder lawsuits during
the past year.
DEPARTMENT OF DEFENSE. Our Aerospace Division is under investigation by the
Defense Criminal Investigative Service ("DCIS") of the Office of the Inspector
General, Department of Defense. The DCIS is currently investigating allegations
that involve deviating from contractual requirements relating to the use of
organic sealants. We dispute the government's interpretation of the contracts as
precluding the use of such sealants. This matter has been under investigation
for approximately two years with little change in status. If the matter is
referred to the U.S. Attorney's Office for a prospective opinion, one potential
consequence of criminal charges being filed is the possibility that our defense
operations would be suspended or debarred from military or government sales. At
this point, given the limited information about the government's investigation
available to counsel, it is not possible to predict or assess the likelihood of
an unfavorable outcome or predict the amount of potential liabilities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 27, 1999, by written consent, holders of 58.7% of the issued and
outstanding shares of the Company's common stock voted to remove
Messrs. Cuthbert, Treinen, and Watson as directors.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
As a result of the Recapitalization, our common equity is no longer traded
publicly on the NASDAQ. See public filing form 15-12G dated January 19, 1999.
13
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data of the Company as of
and for each of the five fiscal years ended October 31, 1999. The financial data
for the fiscal year ended October 31, 1999 is derived from the Consolidated
Financial Statements of the Company, which consolidated statements have been
audited by PricewaterhouseCoopers LLP, independent accountants. The financial
data for the four fiscal years ended October 31, 1998 is also derived from the
Consolidated Financial Statements of the Company, which consolidated statements
have been audited by KPMG LLP, independent accountants. The data set forth below
should be read in conjunction with the Financial Statements and related Notes
thereto appearing elsewhere herein and Item 7--Management's Discussion and
Analysis of Financial Condition and Results of Operations.
FOR THE YEARS ENDED OCTOBER 31
----------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(IN THOUSANDS)
Income statement data:
Net sales:
Automotive................................ $71,253 $80,235 $111,930 $135,235 $124,552
Aerospace................................. 29,339 24,247 28,572 35,303 41,947
------- ------- -------- -------- --------
Total................................... 100,592 104,482 140,502 170,538 166,499
Cost of sales:
Automotive................................ 63,241 68,513 93,159 110,284 110,555
Aerospace................................. 19,730 15,815 19,394 21,326 25,169
------- ------- -------- -------- --------
Total................................... 82,971 84,328 112,553 131,610 135,724
Gross profit:
Automotive................................ 8,012 11,722 18,771 24,951 13,998
Aerospace................................. 9,609 8,432 9,178 13,977 16,777
------- ------- -------- -------- --------
Total................................... 17,621 20,154 27,949 38,928 30,775
Operating expenses:
Automotive................................ 3,412 3,477 5,123 6,460 9,971
Aerospace................................. 4,270 4,633 5,599 6,564 6,992
Environmental and other investigation
costs................................... -- -- -- -- 11,117
------- ------- -------- -------- --------
Total................................... 7,682 8,110 10,722 13,024 28,079
Earnings (loss) from operations:
Automotive................................ 4,600 8,245 13,648 18,492 4,028
Aerospace................................. 5,339 3,799 3,579 7,413 9,785
Corporate................................. -- -- -- -- (11,117)
------- ------- -------- -------- --------
Total................................... 9,939 12,044 17,227 25,905 2,696
Other income (expense), net................. (639) 129 111 (48) (33,570)
------- ------- -------- -------- --------
Earnings (loss) before income taxes......... 9,300 12,173 17,338 25,857 (30,874)
Income tax provision (benefit).............. 3,720 4,725 6,660 10,410 (10,608)
------- ------- -------- -------- --------
Net earnings (loss)......................... $ 5,580 $ 7,448 $ 10,678 $ 15,447 $(20,266)
======= ======= ======== ======== ========
14
OCTOBER 31
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
Balance Sheet Data:
Current assets............................................ $43,407 $ 39,179 $ 55,274
Total assets.............................................. $99,824 $124,619 $155,652
Current liabilities....................................... $13,271 $ 23,508 $ 45,072
Long-term debt, less current portion...................... $ 2,057 $ 416 $168,600
Stockholders' equity (deficit)............................ $81,357 $ 97,280 $(88,531)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and our consolidated financial statements
and the notes thereto included elsewhere in this report.
RESULTS OF OPERATIONS
The following table is derived from the Company's statements of operations
data and sets forth, for the periods indicated, certain statement of operations
data as a percentage of net sales.
FOR THE YEARS ENDED
OCTOBER 31
------------------------------
1997 1998 1999
-------- -------- --------
Automotive Products Division
Net sales................................................. 100.0% 100.0% 100.0%
Cost of sales............................................. 83.2 81.6 88.8
----- ----- -----
Gross profit.............................................. 16.8 18.5 11.2
Operating expenses........................................ 4.6 4.8 8.0
----- ----- -----
Earnings from operations.................................. 12.2% 13.7% 3.2%
===== ===== =====
Aerospace Division
Net sales................................................. 100.0% 100.0% 100.0%
Cost of sales............................................. 67.9 60.4 60.0
----- ----- -----
Gross profit.............................................. 32.1 39.6 40.0
Operating expenses........................................ 19.6 18.6 16.7
----- ----- -----
Earnings from operations.................................. 12.5% 21.0% 23.3%
===== ===== =====
FISCAL 1999 COMPARED TO FISCAL 1998
NET SALES
Consolidated net sales for fiscal 1999 were $166.5 million, compared to net
sales of $170.5 million for fiscal 1998. Net sales for the Automotive Products
Division in fiscal 1999 decreased 7.9% to $124.6 million from $135.2 million in
fiscal 1998 primarily due to contractual price decreases, and the inability to
offset these price decreases with increased initiator unit production due to the
disruptions caused by moving certain manufacturing operations from Newhall to
Moorpark. Net sales for the Aerospace Division in fiscal 1999 increased 18.8% to
$41.9 million from $35.3 million in fiscal 1998 primarily due to increased
shipments of products used on several missile programs and deliveries related to
bomb ejector programs.
15
GROSS PROFIT
Consolidated gross profit for fiscal 1999 was $30.8 million, compared with
consolidated gross profit for fiscal 1998 of $38.9 million, a decrease of
$8.1 million or 20.9%. Gross profit for the Automotive Products Division for
fiscal 1999 was $14.0 million, or 11.2% of division net sales, compared with
gross profit for fiscal 1998 of $25.0 million, or 18.5% of division net sales.
The decrease in gross profit for the Automotive Products Division was due to
unit price concessions made to the Company's leading automotive customers, the
inefficiencies inherent during the six months required to move certain
manufacturing operations from Newhall to Moorpark, approximately $2.3 million in
adjustments to inventory and certain receivables, and the disruptions associated
with the internal investigation and compliance audit in connection with the Cal
EPA and other investigations in the fourth quarter of fiscal 1999. See "Legal
Proceedings."
Gross profit for the Aerospace Division for fiscal 1999 was $16.8 million,
or 40.0% of division net sales, compared with gross profit for fiscal 1998 of
$14.0 million, or 39.6% of division net sales. The increase in gross profit of
$2.8 million was due to increased net sales during fiscal 1999, while the
increase in gross profit as a percentage of division sales was due to changes in
product mix.
OPERATING EXPENSES
Consolidated operating expense for fiscal 1999 (excluding expenses related
to environmental and other investigations) was $17.0 million, compared with
consolidated operating expense for fiscal 1998 of $13.0 million, an increase of
$4.0 million or 30.2%. Operating expenses for the Automotive Products Division
for fiscal 1999 were $10.0 million, or 8.0% of division net sales, compared with
operating expenses for fiscal 1998 of $6.5 million, or 4.8% of division net
sales. The increase in operating expenses for the Automotive Products Division
on both an absolute and percentage basis was due to redundant costs incurred
during the Moorpark move as well as increased marketing and general and
administrative costs related to staffing additions.
Operating expenses for the Aerospace Division for fiscal 1999 were
$7.0 million, or 16.7% of division net sales, compared with operating expenses
for fiscal 1998 of $6.6 million, or 18.6% of division net sales. The increase in
operating expenses of $0.4 million was due primarily to increases in performance
bonuses, although operating expenses as a percentage of division net sales
decreased due to the absorption of relatively stable general and administrative
expenses over greater net sales.
EXPENSES RELATED TO GOVERNMENT INVESTIGATIONS
Expenses related to the Cal EPA and other investigations aggregated
$11.1 million in fiscal 1999, while no such expenses were incurred in fiscal
1998. The $11.1 million represents legal, consulting and other related costs
incurred during the fourth quarter of fiscal 1999 as well as an allowance for
estimated costs in connection with this matter. See "Legal Proceedings."
OTHER INCOME AND EXPENSE
Interest expense for fiscal 1999 was $16.6 million, compared with fiscal
1998 interest expense of $0.2 million. The increase was the result of increased
debt outstanding resulting from the Recapitalization. Other expenses of
$17.0 million in fiscal 1999 were due to certain costs and management fees
incurred in connection with the Recapitalization.
FISCAL 1998 COMPARED TO FISCAL 1997
NET SALES
Consolidated net sales for fiscal 1998 were $170.5 million, compared to net
sales of $140.5 million in fiscal 1997. Net sales for the Automotive Products
Division in fiscal 1998 increased 20.8% to
16
$135.2 million from $111.9 million in fiscal 1997 primarily due to a 43.9%
increase in units shipped during fiscal 1998. The increase in units shipped
resulted primarily from increased shipments to Autoliv under terms of a supplier
agreement partially offset by the UAW strike at General Motors and continued
weaknesses in the Asian market. Net sales for the Aerospace Division in fiscal
1998 increased 23.6% to $35.3 million from $28.6 million in fiscal 1997. The
increase was primarily attributed to a contract for production of a proprietary
bomb ejector, which began in fiscal 1998, and also due to increased demand for
products used in commercial satellite launch vehicles.
GROSS PROFIT
Consolidated gross profit for fiscal 1998 was $38.9 million, compared with
consolidated gross profit for fiscal 1997 of $27.9 million, an increase of
$11.0 million or 39.4%. Gross profit for the Automotive Products Division for
fiscal 1998 was $25.0 million, or 18.4% of division net sales, compared with
gross profit for fiscal 1997 of $18.8 million, or 16.8% of division net sales.
The increase in gross profit for the Automotive Products Division was due to
efficiencies related to volume increases, improvements in automated machine
yields and other manufacturing efficiencies.
Gross profit for the Aerospace Division for fiscal 1998 was $14.0 million,
or 39.6% of division net sales, compared with gross profit for fiscal 1997 of
$9.2 million, or 32.1% of division net sales. The increase in gross profit for
the Aerospace Division was due to changes in the mix of products shipped
compared to fiscal 1997 and the absorption of relatively stable overhead
expenses over greater net sales in fiscal 1998.
OPERATING EXPENSES
Consolidated operating expense for fiscal 1998 was $13.0 million, compared
to $10.7 million in fiscal 1997. Operating expenses for the Automotive Products
Division were $6.5 million, compared to $5.1 million in fiscal 1997. The
increase of 26.1% is primarily attributable to higher labor costs, and, to a
lesser extent, increases in the corporate allocation. Operating expenses for the
Aerospace Division were $6.6 million, compared to $5.6 million in fiscal 1997.
The increase of 17.2% was primarily attributable to increases in performance
bonuses and corporate allocations.
OTHER INCOME AND EXPENSE
Interest income was $0.1 million for fiscal 1998, compared to $0.4 million
in fiscal 1997. The decrease is primarily attributable to lower average amounts
invested in interest-bearing securities during the year. Interest expense was
$0.2 million in fiscal 1998, compared to $0.3 million in fiscal 1997. The
decrease is attributable to lower average debt balances resulting from scheduled
monthly principal payments, and to the assumption by the buyer of debt relating
to the sale of an airplane which we previously owned.
LIQUIDITY AND CAPITAL RESOURCES
The Recapitalization had a substantial impact on the Company's capital
structure. The recapitalized Company is significantly more highly leveraged and,
accordingly, the Recapitalization resulted in substantial changes to the
Company's debt-to-equity ratio and its debt service requirements.
As part of the Recapitalization, the Company entered into a credit facility
(the "New Credit Facility") with a syndicate of banks (the "Banks") which
consists of a $25.0 million revolving credit facility (the "Revolving Credit
Facility") and a $70.0 million senior term loan (the "Senior Term Loan"). The
Senior Term Loan was fully drawn at the closing date of the Recapitalization. In
addition, as part of the Recapitalization, the Company issued $100.0 million of
11 3/8% Senior Subordinated Notes due 2008 (the "Notes").
17
The Revolving Credit Facility bears interest at the Banks Base Rate plus an
applicable margin (an effective rate of 10.00% at October 31, 1999). The Company
has the option of converting all or a portion of the balance outstanding under
the Revolving Credit Facility to a Eurodollar Loan, for one, two, three or six
month periods, to bear interest at the Eurodollar Rate plus an applicable margin
(an effective rate of 8.1% at October 31, 1999). The Senior Term Loan is a seven
year loan which bears interest at the Eurodollar Rate plus an applicable margin
(an effective rate of 9.5% at October 31, 1999).
The Company's principal sources of liquidity are cash flow from operations
and borrowings under the Revolving Credit Facility. The Company's principal uses
of cash are debt service requirements, capital expenditures, research and
development and working capital.
Working capital requirements increased in fiscal 1999 compared to fiscal
1998 to service the Company's new long-term debt incurred in connection with the
Recapitalization, to support increases in accounts receivable and inventories,
and to finance the investment in new production equipment which is expected to
be installed in fiscal 2000. As of October 31, 1999, the Company had
$5.9 million outstanding under the Revolving Credit Facility together with $2.3
million in outstanding letters of credit; accordingly $11.8 million was
available under the Revolving Credit Facility at October 31, 1999. The Company
believes that it can meet its expected working capital requirements for the
foreseeable future from cash from operations and borrowings under the Revolving
Credit Facility.
The agreement governing the New 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 of the Company, transactions with affiliates, repurchase or
redemption of stock from stockholders, and various financial covenants,
including covenants requiring the maintenance of minimum interest coverage,
maximum debt to earnings before interest, taxes, depreciation and amortization
(EBITDA) ratios, and minimum consolidated EBITDA.
On July 14, 1999, the Company and the Banks entered into the First Amendment
to the New Credit Facility pursuant to which the Company increased the Maximum
Swingline Amount (as defined therein) to $3.0 million from $1.0 million while
not increasing the total amount of borrowings available under the Revolving
Credit Facility. The Swingline requires no notification to the Banks with
respect to either borrowings or repayments.
On August 20, 1999, the Company notified the Banks of the Company's
potential noncompliance with certain environmental covenants in connection with
the Cal EPA investigation (the "Environmental Noncompliance"). See "Legal
Proceedings." On September 14, 1999, the Company and the Banks entered into a
Waiver and Modification to the New Credit Facility pursuant to which the Banks
waived any Default or Event of Default arising from such Environmental
Noncompliance until such time as the Banks or the Company determine that the
Environmental Noncompliance has had, or could reasonably be expected to have, a
materially adverse effect on the Company. The Waiver and Modification to the New
Credit Facility has also temporarily limited the maximum borrowings under the
Revolving Credit Facility to $20.0 million.
As of October 31, 1999, the Company was not in compliance with certain
financial covenants contained in the New Credit Facility. On January 26, 2000,
the Company entered into a Second Amendment and Waiver to the New Credit
Facility pursuant to which, among other things, certain financial covenants were
amended, and the Company received a waiver for past noncompliance with its
financial covenants.
Substantially all of the Company's assets are pledged as collateral under
the New Credit Facility. As required under the terms of the New Credit Facility,
effective March 16, 1999, the Company entered into an interest rate protection
agreement. The terms of the agreement relate to the notional amount of
$35.0 million of the total $70.0 million original principal amount. This
agreement set the
18
rate at 5.42% plus 175 basis points, requiring quarterly interest payments
starting June 17, 1999 through March 17, 2001.
Our ability to make scheduled payments of principal of, or to pay the
interest on, or to refinance, our debt, or to fund planned capital expenditures
and research and development expense, will depend on our future performance,
which, to a certain extent, is subject to general economic, financial,
competitive, legislative, regulatory and other factors that are beyond our
control. While management believes that we will be able to meet our liquidity
needs, there can be no assurance that our business will generate sufficient cash
flow from operations or that future borrowings will be available under the
Revolving Credit Facility in an amount sufficient to enable us to service our
debt, or to fund our other liquidity needs.
CAPITAL CALL AGREEMENT
In connection with amending the New Credit Facility on January 26, 2000, the
Company and its controlling stockholder entered into a capital call agreement
(the "Capital Call Agreement") with the Banks. The Capital Call Agreement
requires the controlling stockholder to make a capital contribution to the
Company upon the occurrence of certain events, including the failure to comply
with certain financial covenants contained in the New Credit Facility. Upon
receipt of any such contribution, the Company is obligated to repay outstanding
term loans under the New Credit Facility.
SEASONALITY
The airbag manufacturers' requirements for the Company's initiators are
dependent on the requirements of automobile manufacturers. The Company believes
that the airbag initiator market in the United States has become, and will for
the foreseeable future remain, closely tied with the seasonal 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.
The Aerospace Division recognizes sales upon the shipment of units or
completion of a task. While there is no identifiable seasonality to the
aerospace business, there can be quarter-to-quarter changes in shipment volume
that result from customer requirements or other factors beyond the Company's
control. Historically, during the past several years, customer shipments have
been greater in the second half of the Company's fiscal year.
YEAR 2000 COMPLIANCE
During fiscal 1999, the Company established and implemented a comprehensive
Y2K transition plan. To-date, we have not experienced any material disruptions
to business operations.
COMPREHENSIVE INCOME
On November 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," issued by the
Financial Accounting Standards Board (the "FASB"). SFAS No. 130 establishes
standards for reporting and presentation of comprehensive income and its
components in a full set of financial statements. The statement requires only
additional disclosures in the financial statements; it does not affect the
Company's financial position or results of operations. There is no difference
between the net loss and comprehensive income for the Company for the year ended
October 31, 1999.
19
STARTUP ACTIVITIES
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting on the Cost of Startup
Activities." This SOP requires that costs incurred during start-up activities,
including organization costs, be expensed as incurred. SOP 98-5 is effective for
financial statements for fiscal years beginning after December 15, 1998. Initial
application of the SOP should be as of the beginning of the fiscal year in which
the SOP is first adopted and should be reported as a cumulative effect of a
change in accounting principle. We believe that the adoption of SOP 98-5 will
not have a material impact on our consolidated financial statements.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 modifies the accounting for
derivative and hedging activities and is effective for fiscal years beginning
after December 15, 1999. We believe that the adoption of SFAS No. 133 will not
have a material impact on our financial reporting.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company has only limited involvement in derivative financial instruments
and does not hold or issue them for trading purposes. Certain amounts borrowed
under the Company's New Credit Facility are at variable rates and the Company is
thus subject to market risk resulting from interest rate fluctuations. The
Company has entered into an interest rate swap arrangement to alter interest
rate exposure, as described below. This arrangement allows the Company to raise
long-term borrowings at floating rates and effectively swap them into fixed
rates that are lower than those available to the Company if fixed rate
borrowings were made directly. Under interest rate swaps, the Company agrees
with another party to exchange, at specified intervals, the difference between
fixed-rate and floating-rate amounts calculated by reference to an agreed
notional principal amount.
In March 1999, as required under the New Credit Facility, the Company
entered into an interest rate swap agreement with the agent under the New Credit
Facility. Under the swap agreement, which is in the notional principal amount of
$35 million, the Company is required to pay a fixed rate of 5.42% to the agent
on each March 17, June 17, September 17 and December 17, commencing on June 17,
1999. On those same dates, the Company will receive a floating-rate payment from
the agent based on the three-month LIBOR rate. The swap agreement terminates on
March 7, 2001.
The Company also is exposed to market risks related to fluctuations in
interest rates on the Notes 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. The Company does not have an obligation to repay the Notes prior to
maturity in December 2008 and, as a result, interest-rate risk and changes in
fair value should not have a significant impact on the Company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements required in response to this Item are
listed under Item 14(a) of Part IV of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As reported in a Form 8-K filed on September 3, 1999, upon recommendation of
the Audit Committee, the Board of Directors engaged PricewaterhouseCoopers LLP
as independent accountants in place of KPMG LLP.
20
KPMG LLP's reports on the financial statements for the two most recent
fiscal years ended October 31, 1997 and 1998 did not contain an adverse opinion,
disclaimer of opinion, or qualification or modification as to audit scope or
accounting principles. Furthermore, during the two most recent fiscal years and
through August 27, 1999 (the date of dismissal), there have been no
disagreements with KPMG LLP on any matter of accounting principles or practices,
financial statement disclosure or auditing scope and procedures, which
disagreements, if not resolved to the satisfaction of KPMG LLP, would have
caused that firm to make reference to the subject matter of such disagreements
in connection with their reports.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the name, age and position of each of our
directors and executive officers. All of our officers are elected annually and
serve at the discretion of the Board of Directors.
NAME AGE POSITIONS
- ---- -------- ------------------------------------------------------------
Dr. John F. Lehman............. 56 Chairman of the Board of Directors
Thomas W. Cresante............. 52 Director, President and Chief Executive Officer
Joseph A. Stroud............... 44 Director, Executive Vice President, Chief Financial Officer,
Assistant Secretary
George A. Sawyer............... 67 Director, Secretary
Oliver C. Boileau, Jr.......... 71 Director
Donald Glickman................ 65 Director
William Paul................... 62 Director
Thomas G. Pownall.............. 76 Director
Gary A. Binning................ 40 Director
Randy H. Brinkley.............. 56 Director
Keith E. Oster................. 37 Director
Sabra Bennett.................. 49 Vice President - Human Resources
Andrew G. Bonas................ 39 Vice President - Aerospace Division
Thomas R. Cessario............. 45 Vice President - Environmental, Health and Safety
Herbert G. Chick............... 56 Vice President - Finance
Gary T. Smith.................. 41 Vice President - Automotive Products Division
John J. Walsh.................. 41 Vice President - Strategic Marketing and Programs
Patrick Carroll................ 56 Vice President - General Manager, Hollister
Alan S. Fabian................. 49 Vice President - General Manager, Mesa
Robert McSweeney............... 37 Vice President - General Manager, Moorpark
James O. Moore................. 57 Vice President - General Manager, Scot
DR. JOHN F. LEHMAN, who became a director of the Company upon consummation
of the Recapitalization and Chairman of the Company in June 1999, is a Managing
General Partner of J.F. Lehman and Company. Prior to founding J.F. Lehman &
Company, Dr. Lehman was an investment banker with PaineWebber Incorporated and
served as a Managing Director in Corporate Finance. Dr. Lehman served for six
years as Secretary of the Navy, was a member of the National Security Council
Staff, served as a delegate to the Mutual Balanced Force Reductions negotiations
and was the Deputy Director of the Arms Control and Disarmament Agency.
Dr. Lehman served as Chairman of the Board of Directors of Sperry Marine, Inc.,
and is a member of the Board of Directors of Elgar Holdings, Inc., Ball
Corporation, ISO Inc., McCormick Selph Holdings, Inc. and Burke
Industries, Inc. and is Chairman of the Princess Grace Foundation, a director of
OpSail Foundation and a Trustee of LaSalle College High School.
THOMAS W. CRESANTE became a director, President and Chief Executive Officer
of the Company in October 1999. Prior to joining the Company, Mr. Cresante was
general manager with ITT Hancock
21
Hardware Division from 1984 thru 1987, at which time he was named Vice President
of Manufacturing for its Hardware and Seating Division. Mr. Cresante joined TRW
Inflatable Restraints Division in 1990 as the Vice President of Operations.
During his tenure with TRW, two of his startup facilities were named as "10 Best
Plants in the U.S." by Industry Week Magazine. In early 1996, Mr. Cresante
joined Allied Signal Aerospace as the Vice President of Operations and later
that year was named President of Allied Signal Safety Restraints Systems.
Mr. Cresante returned to Arizona in 1997 as the Executive Vice President and
Chief Operating Officer for Safety Components International, Inc.
JOSEPH A. STROUD, who became a director of the Company upon consummation of
the Recapitalization and Executive Vice President and Chief Financial Officer in
June 1999, is a General Partner of J.F. Lehman & Company. Mr. Stroud has been
affiliated with J.F. Lehman & Company since 1992 and formally joined the firm in
1996. Prior to joining J.F. Lehman & Company, Mr. Stroud was the Chief Financial
Officer of Sperry Marine Inc. from 1993 until the company was purchased by
Litton Industries, Inc. in 1996. From 1989 to 1993, Mr. Stroud was Chief
Financial Officer of the Accudyne and Kilgore Corporations. Mr. Stroud is
currently a director of Elgar Holdings, Inc., Burke Industries, Inc. and
McCormick Selph Holdings, Inc.
GEORGE A. SAWYER is currently a director and Secretary of the Company and
also served as Chairman of the Board from December 1998 to May 1999 and interim
Chief Executive Officer from May 1999 to October 1999. Mr. Sawyer is also a
co-founder and Managing General Partner of J.F. Lehman & Company. From 1993 to
1995, Mr. Sawyer served as the President and Chief Executive Officer of Sperry
Marine Inc. Prior thereto, Mr. Sawyer held a number of prominent positions in
private industry and in the United States government, including serving as the
President of John J. McMullen Associates, the President and Chief Operating
Officer of TRE Corporation, Executive Vice President and Director of General
Dynamics Corporation, the Vice President of International Operations for Bechtel
Corporation and the Assistant Secretary of the Navy for Shipbuilding and
Logistics under Dr. Lehman. Mr. Sawyer is currently Chairman of Burke
Industries, Inc. and a director of Elgar Holdings, Inc. and McCormick Selph
Holdings, Inc. He also serves on the Board of Trustees of Webb Institute and is
on the Board of Managers of the American Bureau of Shipping.
OLIVER C. BOILEAU, JR. became a director of the Company upon consummation of
the Recapitalization. He joined The Boeing Company in 1953 as a research
engineer and progressed through several technical and management positions and
was named Vice President in 1968 and then President of Boeing Aerospace in 1973.
In 1980, he joined General Dynamics Corporation as President and a member of the
Board of Directors. In January 1988, Mr. Boileau was promoted to Vice Chairman.
He retired in May 1988. Mr. Boileau joined Northrop Grumman Corporation in
December 1989 as President and General Manager of the B-2 Division. He also
served as President and Chief Operating Officer of the Grumman Corporation, a
subsidiary of Northrop Grumman, and as a member of the Board of Directors of
Northrop Grumman. Mr. Boileau retired from Northrop Grumman in 1995. He is an
Honorary Fellow of the American Institute of Aeronautics and Astronautics, a
member of the National Academy of Engineering, the Board of Trustees of St.
Louis University and the Massachusetts Institute of Technology--Lincoln
Laboratory Advisory Board. Mr. Boileau is also director of Burke
Industries, Inc. and Elgar Holdings, Inc.
DONALD GLICKMAN, who became a director of the Company upon consummation of
the Recapitalization, is a Managing General Partner of J.F. Lehman & Company.
Prior to joining J.F. Lehman & Company, Mr. Glickman was a principal of the
Peter J. Solomon Company, a Managing Director of Shearson Lehman Brothers
Merchant Banking Group and Senior Vice President and Regional Head of The First
National Bank of Chicago. Mr. Glickman served as an armored calvary officer in
the Seventh U.S. Army. Mr. Glickman is currently Chairman of Elgar
Holdings, Inc. and a director of the MacNeal-Schwendler Corporation, General
Aluminum Corporation, Monroe Muffler Brake, Inc., McCormick Selph
Holdings, Inc. and Burke Industries, Inc. He is also a trustee of MassMutual
Corporate Investors, MassMutual Participation Investors and Wolf Trap Foundation
for the Performing Arts.
22
WILLIAM PAUL became a director of the Company upon consummation of the
Recapitalization. Mr. Paul began his career with United Technologies Corporation
("UTC") at its Sikorsky Aircraft division in 1955. Mr. Paul progressed through a
succession of several technical and managerial positions while at Sikorsky
Aircraft, including Vice President of Engineering and Programs and Executive
Vice President and Chief Operating Officer, and in 1983 was named President and
Chief Executive Officer of Sikorsky Aircraft. In 1994, Mr. Paul was appointed
the Executive Vice President of UTC, Chairman of UTC's international operations
and became a member of UTC's Management Executive Committee. Mr. Paul retired
from these positions in 1997 but remains a consultant to UTC. Mr. Paul is a
Fellow of the American Institute of Aeronautics and a Fellow of the Royal
Aeronautical Society. Mr. Paul is also a director of Elgar Holdings, Inc.
THOMAS G. POWNALL, who became a director of the Company upon consummation of
the Recapitalization, is a member of the investment advisory board of
J.F. Lehman & Company. Mr. Pownall was Chairman of the Board of Directors from
1983 until 1992 and Chief Executive Officer of Martin Marietta Corporation
("Martin Marietta") from 1982 until 1988. Mr. Pownall joined Martin Marietta in
1963 as Vice President of its Aerospace Advanced Planning Unit, became President
of Aerospace Operations and, in succession, Vice President, then President and
Chief Operating Officer of Martin Marietta. Mr. Pownall is also a director of
The Titan Corporation, Burke Industries, Inc., Elgar Holdings, Inc., Director
Emeritus of Sundstrand Corporation and serves on the advisory board of Ferris,
Baker Watts Incorporated. He is also a director of the U.S. Naval Academy
Foundation and the Naval Academy Endowment Trust and a trustee of Salem-Teikyo
University.
GARY A. BINNING became a director of the Company in September 1999.
Mr. Binning is currently the Managing Partner of Paribas Principal Partners, the
U.S. private equity arm of Banque Paribas ("Paribas"), which he co-founded in
1997. Prior to his current position at Paribas, Mr. Binning was a Managing
Director in the merchant banking group of Banque Paribas specializing in
financing and investing in leveraged buyouts for five years. Mr. Binning
currently serves on the Board of Directors of Atlantic Coast Fire
Protection, Inc., Collins and Aikman Floorcoverings, Inc., Key Plastics, Inc.,
Polaris Pool Systems, Inc., Stauber Performance Ingredients, Inc. and Transport
Labor Contract Leasing, Inc.
RANDY H. BRINKLEY became a director of the Company in September 1999.
Currently, Mr. Brinkley serves as a Senior Vice President of Programs for Hughes
Space and Communications Company ("HSC"), the world's largest manufacturer of
commercial communication satellites. Before joining HSC in 1999, Mr. Brinkley
spent seven years as a senior executive at the National Aeronautics and Space
Administration, including positions as Program Manager for the International
Space Station and Mission Director of the Hubble Space Telescope repair mission.
From 1990 to 1992, Mr. Brinkley managed research and development activities for
advanced aircraft systems and technologies at the McDonnell Douglas Corporation.
Prior thereto, Mr. Brinkley served in the U.S. Marine Corps for 25 years before
retiring as a Colonel.
KEITH E. OSTER, who became a director of the Company upon consummation of
the Recapitalization, is a General Partner of J.F. Lehman & Company. Prior to
joining J.F. Lehman & Company in 1992, Mr. Oster was with the Carlyle Group,
where he was responsible for analyzing acquisition opportunities and arranging
debt financing, and was a Senior Financial Analyst with Prudential-Bache Capital
Funding, working in the Mergers, Acquisitions and Leveraged Buyouts Department.
Mr. Oster is currently a director of Burke Industries, Inc., McCormick Selph
Holdings Inc. and Elgar Holdings, Inc.
SABRA BENNETT, Vice President - Human Resources, is responsible for the
overall human resource functions at the Company. Ms. Bennett joined the Company
in 1995 as the Director of Human Resources. In 1998, Ms. Bennett was promoted to
her current position. Prior to joining the Company, Ms. Bennett worked as a
Human Resources Manager, Personnel Representative and Staffing Representative
from 1972 to 1995 for GTE Corporation. Ms. Bennett has a degree in Business
Administration from the University of Redlands.
23
ANDREW G. BONAS, Vice President - Aerospace Division, is responsible for
managing the day-to-day operations of the Company's Aerospace Division.
Mr. Bonas joined the Company in April 1999 in his current position. Prior to
joining the Company, Mr. Bonas worked in product design for TRW's Vehicle Safety
Systems. Starting with TRW in 1988, Mr. Bonas worked as a New Product Team
Leader, a Product Design and Development Engineering Manager and a Senior
Engineer. From 1983 to 1988, Mr. Bonas worked in various engineering roles with
two different manufacturing companies producing pyrotechnic devices. Mr. Bonas
holds a degree in Mechanical Engineering from Pennsylvania State University and
a Master of Business Administration from the University of Phoenix.
THOMAS R. CESSARIO, Vice President - Environment, Health and Safety, is
responsible for all matters regarding environmental, health and safety issues at
the Company. Mr. Cessario joined the Company in November 1999 in his current
position. Prior to joining the Company, Mr. Cessario was the Corporate Director
of Safety, Health and Environment from 1997 to 1999 for Irex Construction
Engineering Corporation. From 1992 to 1997, Mr. Cessario worked in a similar
position with Rollins Environmental, Inc. Mr. Cessario worked as a Division
Manager of Safety, Health and Environment from 1983 to 1992 for Thiokol
Corporation. Mr. Cessario has Bachelor of Science from West Virginia University
as well as a Master of Safety and Industrial Hygiene and a Master of Operations
from Wilmington College.
HERBERT G. CHICK, Vice President - Finance, is responsible for managing the
day-to-day financial operations of the Company. Mr. Chick joined the Company in
August 1999 in his current position. Prior to joining the Company, Mr. Chick was
the Senior Vice President and Chief Financial Officer for the Passenger Systems
division of Rockwell International Corporation from 1996 to 1999. Prior thereto,
Mr. Chick worked as a self-employed consultant from 1993 to 1996. From 1986 to
1993, Mr. Chick held a variety of positions, including Chief Financial Officer,
at a number of manufacturing firms. Mr. Chick has a degree in Aerospace
Engineering from the Georgia Institute of Technology and a Master of Business
Administration from University of California, Los Angeles.
GARY T. SMITH, Vice President - Automotive Products Division, is responsible
for managing the day-to-day operations of the Company's Automotive Products
Division. Mr. Smith joined the Company in January 1995 as a Senior Project
Engineer. Mr. Smith was promoted in 1996 to Engineering Supervisor, in 1997 to
Manufacturing Manager, in 1998 to General Manager and in 1999 to his current
position. Prior to joining the Company, Mr. Smith worked from 1984 to 1995 for
Barry Controls Aerospace in a variety of positions, including Senior Project
Leader, Business Unit Leader and a Project Engineer. Mr. Smith holds a degree in
Mechanical Engineering and studied Applied Mechanics in graduate school at
California State University at Northridge.
JOHN J. WALSH, Vice President - Strategic Marketing and Programs, is
responsible for overall marketing and program management functions at the
Company. Mr. Walsh joined the Company in May 1999 in his current position. Prior
to joining the Company, Mr. Walsh was the Director of Sales and Marketing,
Aerospace from 1996 to 1999 and the Director of Aerospace, Defense and Specialty
Products from 1994 to 1996 for The Ensign-Bickford Company. Mr. Walsh worked as
a Product Section Manager and a Business Development Manager from 1986 to 1993
for Thiokol Corporation. From 1977 to 1986, Mr. Walsh worked in various
engineering roles for two different aerospace manufacturing firms. Mr. Walsh has
a degree in Guidance and Control Engineering from Purdue University and a Master
of Business Administration from St. Joseph's University.
PATRICK CARROLL, Vice President - General Manager, Hollister, is responsible
for the day-to-day facility operations and general management of the Company's
Hollister, California facility. Mr. Carroll joined the Company in 1999 when the
Company acquired the Micro Gas Generator product line. Prior to the acquisition,
Mr. Carroll worked for two years as the General Manager of Commercial Operations
for McCormick Selph Ordnance Products, a business unit of Teledyne Ryan
Aeronautical. Prior thereto, Mr. Carroll worked for FMC Corporation from 1970 to
1997, most recently as General Manager of the Corporate Technology Center and
Director of Corporate Research and Development.
24
Mr. Carroll has a degree in Mechanical Engineering and Master of Mechanical
Engineering from Pennsylvania State University and an Executive Master of
Business Administration from Stanford University.
ALAN S. FABIAN, Vice President - General Manager, Mesa, is responsible for
the day-to-day facilities operations and general management of the Company's
Mesa, Arizona facility. Mr. Fabian joined the Company as a plant manager in
1995. Mr. Fabian was promoted to General Manager in 1997 and to Vice President
in 1999. Prior to joining the Company, Mr. Fabian was the Vice President of
Operations from 1990 to 1995 for Power Convertibles Corporation. Mr. Fabian has
a degree in Engineering from Oakland University and a Master of Industrial
Engineering from Wayne State University.
ROBERT MCSWEENEY, Vice President - General Manager, Moorpark, is responsible
for the day-to-day facility operations and general management of the Company's
Moorpark, California facility. Mr. McSweeney joined the Company in 1995 as a
Supervisor and Project Engineer. Mr. McSweeney was promoted to Manufacturing
Engineer Manager in 1996, Plant Manger in 1998 and Vice President in 1999. Prior
to joining the Company, Mr. McSweeney worked as a Manufacturing Engineering
Supervisor from 1992 to 1995 for the Fluid Controls Division of BW/IP
International. Mr. McSweeney has a degree in Mechanical Engineering from the
University of Santa Clara and a Master of Business Administration from Loyola
Marymount University.
JAMES O. MOORE, Vice President - General Manager, Scot, Inc., is responsible
for the day-to-day facilities operations and general management of Scot, Inc., a
subsidiary of the Company. Mr. Moore joined the Company in 1998 in his current
position. Prior to joining the Company, Mr. Moore worked as the Director of
Pressure Control Equipment from 1996 to 1998 for Hydril Company. From 1989 to
1996, Mr. Moore was a General Manager for Grimes Aerospace Company. Mr. Moore
worked for General Electric Corporation from 1966 to 1989, most recently as a
Facilities Manager. Mr. Moore has a degree in Mechanical Engineering from Purdue
University.
COMMITTEES OF THE BOARD OF DIRECTORS
EXECUTIVE COMMITTEE. The Executive Committee of the Board of Directors is
comprised of Messrs. Lehman, Sawyer, Glickman, Paul and Cresante. The Executive
Committee's main function is to expedite the decision-making process on certain
matters.
AUDIT COMMITTEE. The Audit Committee of the Board of Directors is comprised
of Messrs. Paul, Glickman, Oster, Binning and Boileau. The Audit Committee makes
recommendations concerning the engagement of independent public accountants,
reviews with the independent public accountants the scope and results of the
audit engagement, approves professional services provided by the independent
public accountants, reviews the independence of the independent public
accountants, considers the range of audit and non-audit fees and reviews the
adequacy of the Company's internal accounting controls.
COMPENSATION COMMITTEE. The Compensation Committee of the Board of
Directors is comprised of Messrs. Lehman, Sawyer, Glickman, Stroud, Pownall and
Cresante. The Compensation Committee makes recommendations concerning the
salaries and incentive compensation of employees and consultants to the Company,
and oversees and administers certain of the Company's stock option plans.
STOCK OPTION COMMITTEE. The Stock Option Committee of the Board of
Directors is comprised of Messrs. Lehman, Sawyer, Glickman, Stroud, and Pownall.
The Stock Option Committee is responsible for the administration of the
Company's 1999 Stock Option Plan.
25
ITEM 11. EXECUTIVE COMPENSATION
Compensation. Set forth below is information concerning the annual and
long-term compensation for services in all capacities to the Company for fiscal
1999, 1998 and 1997, of those persons (collectively, the "Named Executive
Officers") who were, during fiscal 1999, (i) the Chief Executive Officer and
(ii) the other most highly compensated executive officers receiving compensation
of $100,000 or more from the Company or one of its subsidiaries.
LONG-TERM
ANNUAL COMPENSATION
COMPENSATION ------------
------------------- SECURITIES ALL OTHER
SALARY BONUS UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) OPTIONS ($)
- --------------------------- -------- -------- -------- ------------ ------------
Thomas W. Cresante........................ 1999 $ 32,934 -- 111,200(1) --
President and Chief Executive 1998 -- -- -- --
Officer (October 1999 to date) 1997 -- -- -- --
George A. Sawyer.......................... 1999 57,982 -- -- 14,000(2)
President and Chief Executive Officer 1998 -- -- -- --
(June 1999--September 1999) 1997 -- -- -- --
John M. Cuthbert.......................... 1999 217,679 35,000 -- 1,741,524(2)(6)
President and Chief Executive Officer 1998 211,598 34,660 -- 2,917(2)
(December 1998--June 1999) 1997 177,162 13,158 150,000(3) 2,656(2)
Thomas F. Treinen......................... 1999 30,962 27,000 -- 464(2)
President and Chief Executive Officer 1998 225,680 72,542 -- 3,449(2)
(1976--December 1998) 1997 221,667 27,465 -- 3,353(2)
Samuel Levin (7).......................... 1999 215,208 167,820 -- 205,160(2)(6)
President--Scot, Incorporated 1998 206,766 437,901 -- 4,000(2)
(1992--December 1999) 1997 187,500 105,019 10,000(4) 9,918(2)
Alan S. Fabian............................ 1999 144,776 30,000 18,000(5) 112,500(2)(6)
Vice President--General Manager, Mesa 1998 122,281 13,141 -- --
1997 119,238 4,315 -- --
Gary T. Smith............................. 1999 156,928 30,000 20,000(5) 97,475(2)(6)
Vice President--Automotive Products 1998 93,938 17,889 -- --
Division 1997 87,844 8,978 -- --
Thomas J. Treinen (8)..................... 1999 123,307 24,036 -- 528,864(2)(6)
Vice President--Administration/Business 1998 109,828 18,740 -- 2,678(2)
Systems 1997 103,248 8,491 -- 2,560(2)
John T. Vinke............................. 1999 167,137 -- -- 684,299(2)(6)
Executive Vice President and Chief 1998 131,304 29,096 -- 772(2)
Financial Officer 1997 118,938 12,149 25,000(3) 716(2)
(April 1994--June 1999)
Robert S. Ritchie......................... 1999 120,797 40,000 -- 552,000(2)(6)
Vice President--Aerospace Division 1998 149,365 58,642 -- 2,062(2)
(1990--July 1999) 1997 138,263 13,365 30,000(3) 2,200(2)
- ------------------------
(1) Options granted pursuant to the 1999 Stock Option Plan adopted by the Board
of Directors on June 3, 1999, as authorized by the Stock Option Committee of
the Board of Directors on October 12, 1999.
(2) Consists of matching contributions by the Company under its 401(k) plan,
which was adopted in Fiscal 1994, or its non-qualified deferred compensation
plan, which was adopted in Fiscal 1995, certain life insurance premiums as
well as certain directors fees.
26
(3) Options granted by the Compensation Committee of the Board of Directors on
December 30, 1996 and ratified by the stockholders at the Company's 1997
annual meeting. All grants were at the market price of the Common Stock
($17.00) on the date of grant.
(4) Granted pursuant to the Company's Amended and Restated 1991 Stock Incentive
Plan at the market price of the Common Stock on the date of grant.
(5) Options granted pursuant to the 1999 Stock Option Plan adopted by the Board
of Directors on June 3, 1999, as authorized by the Stock Option Committee of
the Board of Directors on June 21, 1999.
(6) Includes the compensation component of the consideration paid for certain
stock options in connection with the Recapitalization.
(7) Mr. Levin retired from his position in December 1999 and is now a consultant
to the Company. (See "Employment and Consulting Agreements.")
(8) Mr. Treinen was terminated from his position in December 1999.
OPTIONS GRANTED IN FISCAL 1999
The following table summarizes options granted in fiscal 1999 to the Named
Executive Officers:
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS
OPTIONS GRANTED TO EXERCISE
GRANTED EMPLOYEES PRICE PER EXPIRATION
NAME (#) IN FISCAL 1999 SHARE DATE
---- ---------- -------------- --------- ----------
Thomas W. Cresante................................. 111,200 30.6% $50.00 10/11/09
George A. Sawyer................................... 0 0.0% $50.00 --
John M. Cuthbert................................... 0 0.0% $50.00 --
Thomas F. Treinen.................................. 0 0.0% $50.00 --
Samuel Levin....................................... 0 0.0% $50.00 --
Alan S. Fabian..................................... 18,000 5.0% $50.00 6/22/09
Gary T. Smith...................................... 20,000 5.5% $50.00 6/22/09
Thomas J. Treinen.................................. 5,000 1.4% $50.00 1/12/00
John T. Vinke...................................... 0 0.0% $50.00 --
Robert S. Ritchie.................................. 0 0.0% $50.00 --
27
AGGREGATE OPTION PURCHASES IN FISCAL 1999 AND FISCAL 1999 YEAR END OPTION VALUES
The following table summarizes information with respect to all options held
by the Named Executive Officers exercisable within 60 days of October 31, 1999:
NUMBER OF
SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT FISCAL
SHARES AT FISCAL YEAR END YEAR END ($)
ACQUIRED ON (#) EXERCISABLE/ EXERCISABLE/
NAME EXERCISE VALUE REALIZED UNEXERCISABLE UNEXERCISABLE(1)
---- ----------- -------------- ------------------- --------------------
Thomas W. Cresante................ 0 $ 0 0/111,200 $0/$0
George A. Sawyer.................. 0 $ 0 0/0 $0/$0
John M. Cuthbert.................. 102,400 $1,739,000 50,000/0 $850,000/$0
Thomas F. Treinen................. 0 $ 0 0/0 $0/$0
Samuel Levin...................... 11,250 $ 187,500 2,250/1,500 $38,250/$25,500
Alan S. Fabian.................... 10,000 $ 112,500 4,500/13,500 $0/$0
Gary T. Smith..................... 8,000 $ 95,000 5,000/15,000 $0/$0
Thomas J. Treinen................. 28,000 $ 527,500 5,750/6,750 $76,500/$51,000
John T. Vinke..................... 34,000 $ 683,750 7,500/0 $127,500/$0
Robert S. Ritchie................. 30,500 $ 551,250 4,500/3,000 $76,500/$51,000
(1) There is no public market for our Common Stock. The Company estimates the
market value for its common stock is approximately $34.00 per share.
BONUS AND INCENTIVE PLANS
Since March 1998, the Company has maintained two short-term incentive plans
for the benefit of all regular, full time employees of the Automotive Products
Division and the Aerospace Division, respectively (collectively, the "Bonus
Plans"), and a Management Incentive Plan for certain members of management from
both divisions (the "Management Plan"). The Bonus Plans permit the Company to
pay employees quarterly bonuses based on employment level, the attainment of
certain pre-established financial performance criteria, and the attainment of
certain pre-established individual goals. The Management Plan bonuses are paid
annually, based upon the attainment of certain pre-established Company and
division financial performance criteria. The Bonus Plans and the Management Plan
are administered by a committee of the Board of Directors, which has full power
and authority to determine the terms and conditions of awards under the Bonus
Plans and the Management Plan.
BENEFIT PLANS
The Company also maintains various qualified and non-qualified benefit plans
for its employees, including a 401(k) profit sharing plan and an insured
deferred compensation plan for certain highly compensated employees. The Company
reserves the right to add, amend, change, tie off and/or terminate any or all
qualified or nonqualified benefit plans at any time and to alter, amend, add to
and/or restrict employee participation to the extent permitted by applicable
federal or state law or regulation.
COMPENSATION OF DIRECTORS
None of the directors of the Company who are employees of the Company
receive any compensation directly for their service on the Board of Directors.
All other directors receive $2,000 per meeting and $20,000 per annum for their
services.
28
EMPLOYMENT AND CONSULTING AGREEMENTS
THOMAS W. CRESANTE. On October 1, 1999, the Company entered into an
employment agreement with Mr. Cresante. The employment agreement has an initial
term of two years and provides for an automatic one-year renewal at the end of
the initial term and each renewal term until terminated upon written notice. The
Company will pay Mr. Cresante a base salary of $342,500 per year, subject to
annual review by the Company's Board of Directors. In addition, Mr. Cresante is
eligible to receive at least 60% of his annual base salary in bonus compensation
based upon set performance standards. Pursuant to the employment agreement, Mr.
Cresante is eligible to receive options to purchase up to 3% of the Company's
common stock at an exercise price of $50.00 per share. Mr. Cresante is also
required by the employment agreement to purchase 5,875 shares of the Company's
common stock at a price of $34.00 per share no later than January 31, 2000. The
employment agreement provides that the Company may terminate Mr. Cresante's
employment for cause (as defined in the employment agreement). If the Company
terminates Mr. Cresante's employment other than for cause or disability,
Mr. Cresante will be entitled to receive an amount equal to the balance payable
under the employment agreement or twelve months salary, depending on when the
agreement is terminated.
SAMUEL LEVIN. Mr. Levin's employment agreement, pursuant to which he
retired as President of Scot, Incorporated on December 31, 1999, provides for a
consulting term beginning on January 1, 2000 and ending on December 31, 2000,
during which period Mr. Levin will receive a payment of $50,000, payable in
equal monthly installments. In the event Mr. Levin provides more than eight
hours of service in any month during this period, he shall be paid at the rate
of $1,000 a day. During fiscal 1999, Scot entered into a Noncompetition
Agreement with Mr. Levin, pursuant to which Mr. Levin has agreed not to compete
with Scot or the Company until November 30, 2001. In consideration of
Mr. Levin's agreement not to compete with Scot or the Company, Scot has agreed
to pay an aggregate of $890,000 to Mr. Levin, of which $570,000 was paid on
November 30, 1999, $185,000 will be paid on November 30, 2000, and $135,000 will
be paid on November 30, 2001.
29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of October 31, 1999, ownership of the
Company's common stock by (i) the stockholders known to us to be the beneficial
owners of more than five percent of the outstanding shares of common stock,
(ii) each director, (iii) each named executive officer and (iv) all directors
and executive officers as a group:
NUMBER OF SHARES
BENEFICIALLY PERCENT OF CLASS
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OWNED(2) OUTSTANDING(3)
- --------------------------------------- ---------------- ----------------
JFL Co-Invest Partners I, L.P............................... 1,173,499(4) 31.7%
2001 Jefferson Davis Highway, Suite 607
Arlington, Virginia 22202
J.F. Lehman & Company....................................... 735,294(4)(5) 19.8%
450 Park Avenue
New York, New York 10022
J.F. Lehman Equity Investors I, L.P......................... 679,442(4) 18.3%
2001 Jefferson Davis Highway, Suite 607
Arlington, Virginia 22202
Neubauer Family Trust....................................... 1,096,522(6) 29.6%
Ordnance Products, Inc.
16207 Carmenita Rd.
Cerritos, CA 90703
Paribas Principal Inc....................................... 323,529 8.7%
787 Fifth Avenue
New York, New York 10019
Treinen Family Trust........................................ 433,897(7) 11.7%
10457 Laramie Ave.
Chatsworth, CA 91311
Oliver C. Boileau, Jr....................................... --(8) --
Gary A. Binning............................................. 323,529(9) 8.7%
John F. Lehman.............................................. 2,588,235(4)(10) 69.8%
Donald Glickman............................................. 2,588,235(4)(10) 69.8%
George A. Sawyer............................................ 2,588,235(4)(10) 69.8%
Joseph A. Stroud............................................ 2,588,235(4)(10) 69.8%
Keith E. Oster.............................................. 2,588,235(4)(10) 69.8%
William Paul................................................ --(11) --
Thomas G. Pownall........................................... --(12) --
Thomas W. Cresante.......................................... --(13) --
Alan S. Fabian.............................................. 4,500(13) *
Thomas J. Treinen........................................... 5,750(13) *
Gary T. Smith............................................... 5,000(13) *
John M. Cuthbert............................................ 50,000(13) 1.3%
Robert S. Ritchie........................................... 4,500(13) *
Samuel Levin................................................ 2,250(13) *
John T. Vinke............................................... 7,500(13) *
Directors and Executive Officers as a Group................. 2,991,264 79.0%
- ------------------------
* Indicates ownership of less than one percent of outstanding shares.
(1) Unless indicated otherwise, the address of the beneficial owner listed
above is c/o Special Devices, Incorporated, 14370 White Sage Road,
Moorpark, California 93021.
30
(2) As used in this table, beneficial ownership means the sole or shared power
to vote, or to direct the voting of a security, or the sole or shared power
to dispose, or direct the disposition of, a security. However, under
California law, personal property owned by a married person may be
community property that either spouse may manage and control. The Company
has no information as to whether any shares shown in this table are subject
to California community property law.
(3) Computed based upon the total number of shares of Common Stock outstanding
and the number of shares of Common Stock underlying options or warrants
held by that person exercisable within 60 days of October 31, 1999. In
accordance with Rule 13(d)-3 of the Exchange Act, any Common Stock that
will not be outstanding within 60 days of October 31, 1999 that is subject
to options or warrants exercisable within 60 days of October 31, 1999 is
deemed to be outstanding for the purpose of computing the percentage of
outstanding shares of the Common Stock owned by the person holding such
options or warrants, but is not deemed to be outstanding for the purpose of
computing the percentage of outstanding shares of the Common Stock owned by
any other person.
(4) JFL Co-Invest Partners I, L.P. is a Delaware limited liability company that
is an affiliate of J.F. Lehman Equity Investors I, L.P. and J.F. Lehman &
Company. Each of Messrs. Lehman, Glickman, Sawyer, Oster, and Stroud,
either directly (whether through ownership interest or position) or through
one or more intermediaries, may be deemed to control JFL Co-Invest
Partners I, L.P., J.F. Lehman Equity Investors I, L.P. and J.F. Lehman &
Company. J.F. Lehman Investors I, L.P. and J.F. Lehman & Company may be
deemed to control the voting and disposition of the shares of the Common
Stock owned by JFL Co-Invest Partners I, L.P. Accordingly, for certain
purposes, Messrs. Lehman, Glickman, Sawyer, Oster and Stroud may be deemed
to be beneficial owners of the shares of Common Stock owned by JFL
Co-Invest Partners I, L.P.
(5) Represents 735,294 shares owned by the Neubauer and Treinen Family Trusts
that J.F. Lehman & Company has the right to vote under an irrevocable
voting power and has the right to acquire at any time prior to
December 15, 2002.
(6) Includes 367,647 shares as to which Mr. Neubauer has granted
J.F. Lehman & Company an irrevocable voting proxy and which J.F. Lehman &
Company has the right to acquire at any time prior to December 15, 2002.
(7) All of such shares are owned by the Treinen Family Trust dated December 2,
1981, as restated on November 3, 1986, under which Mr. Treinen is the sole
trustee and has sole voting and investment power. Includes 367,647 shares
as to which Mr. Treinen has granted J.F. Lehman & Company an irrevocable
voting proxy and which J.F. Lehman & Company has the right to acquire at
any time prior to December 15, 2002.
(8) Mr. Boileau is a member of a limited partnership of J.F. Lehman Equity
Investors I, L.P. The address for Mr. Boileau is 202 North Brentwood
Boulevard, Apt. 3A, St. Louis, Missouri 63105.
(9) As an affiliate of Paribas, Mr. Binning may be deemed to control the shares
of Common Stock owned by Paribas Principal, Inc. Accordingly, Mr. Binning
may be deemed to be beneficial owner of the shares of Common Stock owned by
Paribas Principal, Inc. reflected above. The address for Mr. Binning is c/o
Paribas Principal, Inc., 787 Fifth Avenue, New York, New York 10019.
(10) The address of Messrs. Lehman, Glickman, Sawyer, Oster and Stroud is 2001
Jefferson Davis Highway, Suite 607, Arlington, Virginia 22202.
(11) Mr. Paul is a member of a limited partnership of J.F. Lehman Equity
Investors I, L.P. The address for Mr. Paul is 21 Springwood Drive,
Trumbull, Connecticut 06611.
31
(12) Mr. Pownall is a member of a limited partnership of J.F. Lehman Equity
Investors I, L.P. and is on the investment advisory board of
J.F. Lehman & Company. The address for Mr. Pownall is 1800 K Street, N.W.,
Suite 724, Washington, D.C. 20006.
(13) Includes options exercisable within 60 days of October 31, 1999 for
50,000, 2,250, 4,500, 5,000, 5,750, 7,500 and 4,500 shares for
Messrs. Cuthbert, Levin, Fabian, Smith, Thomas J. Treinen, Vinke and
Ritchie, respectively.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
STOCKHOLDERS AGREEMENT
Upon consummation of the Recapitalization, the Company entered into a
Stockholders Agreement with JFL Equity Investors I, L.P., JFL Co-Invest
Partners I, L.P., Paribas Principal, Inc., the Treinen Family Trust and the
Neubauer Family Trust (collectively, the "Stockholders") and J.F. Lehman &
Company. Among other things, the Stockholders Agreement provides that each
Stockholder will vote all of its Common Stock to elect as directors the 11
persons designated as directors by JFL Equity Investors I, L.P. and the one
person designated as a director by Paribus Principal Inc. The Stockholders
Agreement contains customary restrictions on transfer, rights of first offer,
preemptive rights, tag-along and drag-along rights. The Stockholders Agreement
will terminate upon the earlier of:
- the tenth anniversary of the Stockholders Agreement,
- the date when all Stockholders and their transferees cease to hold any
Securities (as defined under the Stockholders Agreement),
- the date when all Securities have been sold in a registered public
offering or distributed to the public pursuant to Rule 144 under the
Securities Act, or
- the date when Securities at an aggregate offering price of at least
$20,000,000 are sold in a registered public offering.
The Stockholders Agreement will terminate with respect to any Stockholder
once that Stockholder ceases to hold any Securities. The Stockholders Agreement
will terminate with respect to any Securities once those Securities have been
sold in a registered public offering or distributed to the public pursuant to
Rule 144 under the Securities Act.
ROLLOVER STOCKHOLDERS AGREEMENT
Upon consummation of the Recapitalization, the Company entered into a
Rollover Stockholders Agreement with J.F. Lehman & Company, and the Treinen and
Neubauer family trusts. The Rollover Stockholders Agreement provides that the
Neubauer and Treinen family trusts and their respective transferees will have
the right under certain circumstances to require the Company to purchase all or
any portion of the Additional Rollover Shares (as defined in the Rollover
Stockholders Agreement) at the Call Price (as defined in the Rollover
Stockholders Agreement). The Rollover Stockholders Agreement also provides that
J.F. Lehman & Company will have the right for a specified period to purchase any
or all of the Additional Rollover Shares held by the Neubauer and Treinen family
trusts at the Call Price. J.F. Lehman & Company has an irrevocable proxy to vote
all of the Additional Rollover Shares it has a right to acquire.
REGISTRATION RIGHTS AGREEMENT
Pursuant to the Registration Rights Agreement entered into upon consummation
of the Recapitalization, J.F. Lehman Equity Investors I, L.P., JFL Co-Invest
Partners I, L.P., Paribas Principal, Inc., the Treinen Family Trust and the
Neubauer Family Trust and any of their direct or indirect
32
transferees have certain demand and piggyback registration rights, on customary
terms, with respect to the Common Stock held by such entities and persons.
MGG CONTRIBUTION, LICENSE AND LEASE
In July 1999, the Company entered into a Contribution, License and Lease
Agreement with McCormick Selph, Inc. ("MSI"), an affiliate of our controlling
stockholder, pursuant to which the Company 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
pretentioner applications. Under the terms of the agreement, MSI licensed to the
Company on a perpetual, non-exclusive basis, the intellectual property rights to
produce MGG units, and leased to the Company the portion of the premises in
Hollister, California where the tangible MGG assets are located. The Company is
obligated to pay MSI $14,000 per month for the leased premises. As consideration
for the licensed intellectual property, the Company is obligated to pay a
royalty of $0.25 per MGG unit produced and sold by the Company. The Company's
obligation to pay the royalty will arise once it has commenced production of MGG
units at one of its facilities (which is expected to occur by September 30,
2000) and will terminate no later than July 16, 2003. Finally, during the term
of the lease, MSI has agreed to provide the Company with certain materials and
manpower resources to enable the Company to produce MGG units at the Hollister
facility. In exchange for such materials and services, the Company has agreed to
pay MSI $36,000 per month.
33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
PAGE
--------
(a)(1) FINANCIAL STATEMENTS
Report of Independent Accountants........................... F-1
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets at October 31, 1998 and 1999.... F-3
Consolidated Statements of Operations for each of the three
years ended October 31, 1999.............................. F-4
Consolidated Statements of Stockholders' Equity for each of
the three years ended October 31, 1999.................... F-5
Consolidated Statements of Cash Flows for each of the three
years ended October 31, 1999.............................. F-6
Notes to Consolidated Financial Statements.................. F-7
(a)(2) FINANCIAL STATEMENT SCHEDULES
All other financial statement schedules have been omitted as
they are not applicable, not material or the required
information is included in the Consolidated Financial
Statement or Notes thereto.
(a)(3) EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
1.1(k) Purchase Agreement, dated as of December 11, 1998, among SDI
Acquisition Corp. and BT Alex. Brown Incorporated and
Paribas Corporation.
2.1(a) Amended and Restated Agreement and Plan of Merger, dated as
of June 19, 1998, between the Company and SDI Acquisition
Corp.
2.2(b) Amendment No. 1, dated as of October 27, 1998, to the
Amended and Restated Agreement and Plan of Merger between
the Company and SDI Acquisition Corp.
2.3(c) Guaranty Agreement, dated as of June 19, 1998, between J.F.
Lehman Equity Investors I, L.P. and the Company
3.1(k) Certificate of Incorporation of the Company
3.2(k) Bylaws of the Company
3.3(k) Certificate of Incorporation of Scot, Incorporated
3.4(k) By laws of Scot, Incorporated
4.1(k) Indenture, dated as of December 15, 1998, among SDI
Acquisition Corp., the Guarantors named therein and United
States Trust Company of New York, as Trustee.
4.2(k) First Supplemental Indenture, dated as of December 15, 1998,
among the Company, the Guarantors named therein and the
United States Trust Company of New York, as Trustee.
4.3(k) Form of 11 3/8% Senior Subordinated Note due 2008, Series A
(see Exhibit A of the First Supplemental Indenture in
Exhibit 4.2).
4.4(k) Form of 11 3/8% Senior Subordinated Note due 2008, Series B
(see Exhibit B of the First Supplemental Indenture in
Exhibit 4.2).
4.5(k) Registration Rights Agreement, dated as of December 15,
1998, among SDI Acquisition Corp., as Issuer and BT Alex.
Brown Incorporated and Paribas Corporation as Initial
Purchasers.
34
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.1(k) Assumption Agreement, dated as of December 15, 1998, by the
Company and Scot, Incorporated, assuming, among other
things, the obligations of SDI Acquisition Corp. under the
Purchase Agreement and the Registration Rights Agreement
10.2(k) Credit Agreement, dated as of December 15, 1998, among the
Company, various banks and Bankers Trust Company, as Lead
Arranger and Administrative Agent.
10.3(k) Security Agreement, dated as of December 15, 1998, by the
Company and Scot, Incorporated in favor of Bankers Trust
Company.
10.4(k) Pledge Agreement, dated as of December 15, 1998, by the
Company and Scot, Incorporated in favor of Bankers Trust
Company.
10.5(k) Subsidiaries Guarantee, dated as of December 15, 1998, by
Scot, Incorporated in favor of Bankers Trust Company.
10.6(k) Management Agreement, dated as of December 15, 1998, between
the Company and J.F. Lehman & Company
10.7(k) Management Services Agreement, dated as of December 15,
1998, between the Company and J.F. Lehman & Company
10.8(k) Subscription Agreement, dated as of September 7, 1998, among
the Company, Paribas Principal Inc., J.F. Lehman Equity
Investors I, L.P. and JFL Co-Invest Partners I, L.P.
10.9(k) Amendment No. 1 to Subscription Agreement, dated as of
December 3, 1998, among the Company, Paribas Principal Inc.,
J.F. Lehman Equity Investors I, L.P. and JFL Co-Invest
Partners I, L.P.
10.10(k) Amendment No. 2 to Subscription Agreement, dated as of
December 15, 1998, among the Company, Paribas Principal
Inc., J.F. Lehman Equity Investors I, L.P. and JFL Co-
Invest Partners I, L.P.
10.11(k) Stockholders Agreement, dated as of December 15, 1998, among
the Company, J.F. Lehman & Co., J.F. Lehman Equity Investors
I, L.P., JFL Co-Invest Partners I, L.P., the Neubauer Family
Trust, by Walter Neubauer trustee, and the Treinen Family
Trust, by Thomas F. Treinen trustee.
10.12(k) Pledge Agreement, dated as of December 15, 1998, between the
Neubauer Family Trust, by Walter Neubauer, trustee and J.F.
Lehman & Company.
10.13(k) Rollover Stockholders Agreement, dated as of December 15,
1998, among the Company, J.F. Lehman & Co., the Neubauer
Family Trust, by Walter Neubauer trustee, and the Treinen
Family Trust, by Thomas F. Treinen trustee.
10.14(k) Pledge Agreement, dated as of December 15, 1998, between
Thomas Treinen Family Trust, by Thomas F. Treinen, trustee
and J.F. Lehman & Company.
10.15(k) Registration Rights Agreement, dated as of December 15,
1998, among the Company, J.F. Lehman Equity Investors I,
L.P., JFL Co-Invest Partners I, L.P., Paribas Principal
Inc., the Neubauer Family Trust, by Walter Neubauer trustee,
and the Treinen Family Trust, by Thomas F. Treinen trustee.
10.16(d) Lease dated May 1, 1991 between the Company and Placerita
Land and Farming Company.
10.17(d) Letter Agreement dated June 8, 1990 between the Company and
Hermetic Seal Corporation.
10.18(d) Master Purchase Agreement, dated May 15, 1990, between the
Company and TRW Inc. (confidential treatment granted as to
part).
10.19(d) Technology License Agreement dated November 7, 1990 between
the Company and Davey Bickford Smith.
10.20(e) Amended and Restated 1991 Stock Incentive Plan of the
Company
10.21(d) Special Devices, Incorporated 401(k) Plan.
10.22(e) First Amendment to Master Purchase Agreement, dated February
25, 1993, between the Company and TRW, Inc. (confidential
treatment granted as to part).
35
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.23(f) Letter Agreement, dated November 30, 1994 between the
Company and Hermetic Seal Corporation (confidential
treatment granted as to part).
10.24(f) Employment Agreement dated September 7, 1994, between the
Company, Scot, Incorporated and Samuel Levin.
10.25(g) Second Amendment to Master Purchase Agreement, dated March
8, 1995, between the Company and TRW, Inc. (confidential
treatment granted as to part).
10.26(h) Supply Agreement dated as of November 14, 1995 between the
Company and Autoliv International, Inc. (confidential
treatment requested as to part).
10.27(i) Development Agreement, dated August 28, 1996, between
Company and the City of Moorpark.
10.28(j) Purchase Agreement, dated September 30, 1997, between the
Company and Hermetic Seal Corporation (confidential
treatment requested as to part).
10.29 Employment Agreement dated October 1, 1999 between the
Company and Thomas W. Cresante.
10.30 Non-competition Agreement, dated July 29, 1999, between
Scot, Incorporated and Samuel Levin.
10.31 1999 Stock Option Plan dated June 23, 1999.
10.32 Contribution, License, and Lease Agreement between McCormick
Selph, Inc. and the Company dated May 17, 1999.
10.33 Capital Call Agreement dated January 26, 2000 among the
Company, various banks, and Bankers Trust Company as
Administrative Agent.
10.34 Second Amendment to Credit Agreement, dated January 26, 2000
among the Company, various banks, and Bankers Trust Company,
as Lead Arranger or Administrative Agent.
12.1(k) Statement of Computation of Ratios of Earnings to Fixed
Charges
21.1(k) Subsidiaries of the Company
25.1(k) Form T-1 Statement of Eligibility of United States Trust
Company of New York to act as trustee under the Indenture
27 Financial Data Schedules
- ------------------------
(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 by
reference herein.
(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 by
reference herein.
(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 by reference
herein.
(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 Amendment No. 1 on Form 10-K/A for the
fiscal year ended October 31, 1994 and incorporated herein by reference.
(g) Previously filed as an exhibit to Registration Statement on Form S-1 (File
No. 33-89902) and incorporated herein by reference.
(h) Previously filed as an exhibit to Annual Report on Form 10-K for the fiscal
year ended October 31, 1995 and incorporated herein by reference.
(i) Previously filed as an exhibit to Annual Report on Form 10-K for the fiscal
year ended October 31, 1996 and incorporated herein by reference.
(j) Previously filed as an exhibit to Annual Report on Form 10-K for the fiscal
year ended October 31, 1997 and incorporated herein by reference.
(k) Previously filed as an exhibit to Registration Statement on Form S-4 (File
No. 333-75869) and incorporated herein by reference.
36
(b) REPORTS ON FORM 8-K
On August 27, 1999, Special Devices, Incorporated (the "Company") dismissed
KPMG LLP as its independent accountants and appointed PricewaterhouseCoopers LLP
as auditors for the Company as of August 27, 1999. The Audit Committee of the
Company's Board of Directors recommended the change in independent accountants
and the change was approved by the Board of Directors. See Form 8-K filed
September 3, 1999.
Effective October 1, 1999, Thomas W. Cresante became the new Chief Executive
Officer of Special Devices, Incorporated, replacing George A. Sawyer, a director
of the Company who served as President and Chief Executive Officer on an interim
basis. Mr. Cresante has entered into a two-year employment agreement with the
Company. Mr. Sawyer, who stepped down as President and Chief Executive Officer
of the Company on October 1, 1999, will remain on the Board of Directors. See
Form 8-K filed September 22, 1999.
37
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders
Special Devices, Incorporated:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, stockholders' equity, and cash flows
present fairly, in all material respects, the financial position of Special
Devices, Incorporated and its subsidiary at October 31, 1999, and the results of
their operations and their cash flows for the fiscal year then ended in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for the opinion expressed above.
PricewaterhouseCoopers LLP
Los Angeles, California
January 26, 2000
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Special Devices, Incorporated:
We have audited the accompanying consolidated balance sheet of Special
Devices, Incorporated and subsidiary as of October 31, 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the two-year period ended October 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principals used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Special
Devices, Incorporated and subsidiary as of October 31, 1998, and the results of
their operations and their cash flows for each of the years in the two-year
period ended October 31, 1998, in conformity with generally accepted accounting
principles.
KPMG LLP
Los Angeles, California
December 9, 1998
F-2
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
OCTOBER 31
-------------------
1998 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,248 $ 448
Accounts receivable, net of allowance for doubtful
accounts of $385 in 1998 and $352 in 1999............... 19,410 26,675
Inventories............................................... 16,609 17,833
Deferred tax assets....................................... 1,366 4,883
Prepaid expenses and other current assets................. 546 1,171
Income taxes receivable................................... -- 4,264
-------- --------
Total current assets.................................. 39,179 55,274
-------- --------
Property, plant and equipment, at cost......................
Land...................................................... 1,611 4,227
Building and improvements................................. 9,332 36,923
Furniture, fixtures and computer equipment................ 3,338 5,815
Machinery and equipment................................... 59,483 79,209
Transportation equipment.................................. 331 484
Leasehold improvements.................................... 3,929 237
Construction in progress (includes land and related costs
of $25,562 in 1998 and $468 in 1999).................... 38,236 4,203
-------- --------
Gross property, plant, and equipment.................. 116,260 131,098
Less accumulated depreciation & amortization.......... (31,489) (41,016)
-------- --------
Net property, plant and equipment..................... 84,771 90,082
Other assets, net of accumulated amortization............... 669 10,296
-------- --------
$124,619 $155,652
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 9,360 $ 16,574
Accounts payable to related parties....................... 270 --
Accrued liabilities....................................... 7,178 12,281
Accrued environmental and other investigation costs....... -- 9,617
Income taxes payable...................................... 4,590 --
Current portion of long-term debt......................... 2,110 6,600
-------- --------
Total current liabilities............................... 23,508 45,072
Deferred income taxes....................................... 3,415 2,331
Long-term debt, net of current portion...................... 416 168,600
Other long-term liability................................... -- 555
-------- --------
Total liabilities....................................... 27,339 216,558
-------- --------
Redeemable common stock..................................... -- 27,625
Stockholder's equity (deficit):
Preferred stock $.01 par value, 2,000,000 shares
authorized; no shares issued and outstanding in 1998 and
1999.................................................... -- --
Common stock, $.01 par value, 20,000,000 shares
authorized; 7,809,881 and 3,706,889 shares issued and
outstanding in 1998 and 1999, respectively.............. 78 30
Additional paid-in capital................................ 51,364 74,587
Retained earnings (deficit)............................... 45,838 (163,148)
-------- --------
Total stockholders' equity (deficit).................... 97,280 (88,531)
-------- --------
$124,619 $155,652
======== ========
See accompanying notes to consolidated financial statements.
F-3
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED OCTOBER 31
---------------------------------
1997 1998 1999
--------- --------- ---------
Net sales................................................... $ 140,502 $ 170,538 $ 166,499
Cost of sales............................................... 112,553 131,610 135,724
--------- --------- ---------
Gross profit............................................ 27,949 38,928 30,775
--------- --------- ---------
Operating expenses.......................................... 10,722 13,023 16,962
Environmental and other investigation costs................. -- -- 11,117
--------- --------- ---------
Total operating expenses.................................... 10,722 13,023 28,079
--------- --------- ---------
Earnings from operations................................ 17,227 25,905 2,696
--------- --------- ---------
Other (expense) income:
Interest expense.......................................... (258) (156) (16,605)
Interest income........................................... 369 108 3
Management fees........................................... -- -- (788)
Recapitalization costs.................................... -- -- (16,180)
--------- --------- ---------
Total other (expense) income............................ 111 (48) (33,570)
--------- --------- ---------
Earnings (loss) before income taxes..................... 17,338 25,857 (30,874)
Income tax provision (benefit).............................. 6,660 10,410 (10,608)
--------- --------- ---------
Net earnings (loss)....................................... $ 10,678 $ 15,447 $ (20,266)
========= ========= =========
See accompanying notes to consolidated financial statements.
F-4
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)
COMMON STOCK ADDITIONAL RETAINED TOTAL
--------------------- PAID-IN EARNINGS STOCKHOLDERS'
SHARES AMOUNT CAPITAL (DEFICIT) EQUITY (DEFICIT)
---------- -------- ----------- --------- -----------------
Balance, October 31, 1996.............. 7,675,535 $ 77 $ 49,911 $ 19,713 $ 69,701
Issuance of common stock on exercise of
stock options........................ 95,632 1 977 -- 978
Net earnings........................... -- -- -- 10,678 10,678
---------- -------- -------- --------- ---------
Balance, October 31, 1997.............. 7,771,167 78 50,888 30,391 81,357
Issuance of common stock on exercise of
stock options........................ 38,634 -- 476 -- 476
Net earnings........................... -- -- -- 15,447 15,447
---------- -------- -------- --------- ---------
Balance, October 31, 1998.............. 7,809,801 78 51,364 45,838 97,280
Record acquisition transaction......... (3,367,618) (41) 22,562 (163,727) (141,206)
Record redeemable common stock......... (735,294) (7) (24,993) (25,000)
Contributed assets..................... -- -- 3,286 -- 3,286
Accreted put premium on redeemable
common stock......................... -- -- (2,625) -- (2,625)
Net loss............................... -- -- -- (20,266) (20,266)
---------- -------- -------- --------- ---------
Balance, October 31, 1999.............. 3,706,889 $ 30 $ 74,587 $(163,148) $ (88,531)
========== ======== ======== ========= =========
See accompanying notes to consolidated financial statements.
F-5
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED OCTOBER 31
-------------------------------
1997 1998 1999
-------- -------- ---------
Cash Flows From Operating Activities:
Net earnings (loss)....................................... $ 10,678 $ 15,447 $ (20,266)
Adjustments to reconcile net earnings (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization........................... 6,377 8,520 15,110
Deferred income taxes................................... 50 (100) (4,601)
Changes in assets and liabilities:
Accounts receivable..................................... (5,530) (1,218) (7,324)
Inventories............................................. 3,744 (2,054) (1,578)
Prepaid expenses and other current assets and income
taxes receivable...................................... (102) (42) (4,889)
Other assets............................................ 53 (520) (1,548)
Accounts payable, accounts payable to related parties
and accrued liabilities............................... 3,987 5,740 21,664
Other long-term liability............................... -- -- 555
Income taxes payable.................................... (733) 3,332 (4,590)
-------- -------- ---------
Net cash provided by (used in) operating activities..... 18,524 29,105 (7,467)
-------- -------- ---------
Cash Flows From Investing Activities:
Purchases of property, plant and equipment.............. (22,544) (38,523) (16,046)
Sales of marketable securities.......................... 3,950 6,750 --
-------- -------- ---------
Net cash used in investing activities................... (18,594) (31,773) (16,046)
-------- -------- ---------
Cash Flows From Financing Activities:
Proceeds from issuance of common stock.................. 978 476 --
Proceeds from issuance of long-term debt................ -- -- 170,000
Repurchase of common stock.............................. -- -- (41)
Recapitalization costs.................................. -- -- (141,165)
Payment of deferred financing fees...................... -- -- (8,815)
Net borrowings under revolving line of credit........... 750 1,300 5,900
Repayment of long-term debt............................. (1,835) (275) (3,166)
-------- -------- ---------
Net cash provided by (used in) financing activities..... (107) 1,501 22,713
-------- -------- ---------
Net decrease in cash........................................ (177) (1,167) (800)
Cash at beginning of year................................... 2,592 2,415 1,248
-------- -------- ---------
Cash at end of year......................................... $ 2,415 $ 1,248 $ 448
======== ======== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest (net of amounts capitalized in 1997 and
1998)................................................. $ 269 $ 156 $ 11,181
Income taxes............................................ 7,200 7,178 5,349
Non-cash financing activities:
Assignment of note payable.............................. $ 530 -- --
Long-term debt assumed by buyer on sale of aircraft..... -- $ 1,500 --
Issuance of redeemable common stock..................... -- -- $ 27,625
See accompanying notes to consolidated financial statements.
F-6
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. COMPANY OPERATIONS
Special Devices, Incorporated, a Delaware corporation, and its wholly owned
subsidiary, Scot, Incorporated ("Scot"), collectively referred to as "the
Company," 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 as well as in various aerospace
applications. Our primary products are initiators, which function like an
"electrical match" to ignite the gas generating charge in an automotive airbag
system or to provide precision ignitions in aerospace-related products. In
manufacturing our products, which utilize pyrotechnic materials, we ensure safe
handling and processing by following strict safety procedures that we have
developed for nearly 40 years.
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.
In connection with the Recapitalization all shares of the Company's Common
Stock, other than those retained by certain members of management and certain
other stockholders (the "Continuing Stockholders"), were converted into the
right to receive $34 per share in cash. 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.
The Company has the right with respect to certain of the outstanding shares
of common stock held by the Continuing Stockholders (additional rollover shares)
to acquire all or any portion of such shares prior to December 31, 2002. The
owners of the additional rollover shares under certain conditions have the right
to require the Company to purchase all or a portion of the additional rollover
shares at a price per share equal to the call price. Accordingly, the additional
rollover shares have been recorded as redeemable common stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company.
All material intercompany accounts and transactions have been eliminated.
F-7
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company has two operating divisions. The Automotive Products Division,
organized in 1989, manufactures products, to customer specifications, under
standard purchase orders. Sales are primarily recognized when products are
shipped. The Aerospace Division manufactures products under fixed price,
long-term contracts directly for the U.S. Department of Defense, their prime
contractors and commercial companies. The contracts vary in length, but
generally are completed within 12 to 24 months. Sales under long-term production
contracts are recognized as units are shipped or, in some cases, when accepted
by the customer; sales under significant engineering contracts are recognized
under the percentage of completion method.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's cash, trade accounts receivable and
all current liabilities (excluding short-term borrowings) approximate the fair
values due to the relatively short maturities of these instruments.
At October 31, 1999, the Company estimated the fair value of its total debt,
including short-term borrowings, to be approximately $145,200,000.
INVENTORIES
Inventories, other than inventoried costs relating to long-term contracts,
are stated at the lower of cost (principally first-in, first-out) or market.
Inventoried costs relating to long-term contracts and programs are stated at the
actual production cost, including overhead incurred to date reduced by amounts
identified with revenue recognized on units delivered. Inventoried costs
relating to long-term contracts are further reduced by any amounts in excess of
estimated realizable value. The costs attributed to units delivered under
long-term contracts are based on the estimated average cost of all units
expected to be produced under existing contracts.
In accordance with industry practice, inventories are classified as current
assets although inventories may include amounts relating to contracts and
programs having production cycles longer than one year.
F-8
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. The cost of maintenance and
repairs is charged against results of operations as incurred. Depreciation is
charged against results of operations using the straight-line method over the
estimated service lives of the related assets. The following are the lives used
in determining depreciation rates of various assets:
Buildings and improvements.................................. 25-39 years
Machinery and equipment..................................... 8 years
Furniture, fixtures and computer equipment.................. 5 years
Transportation equipment.................................... 4 years
Leasehold improvements are amortized over the lesser of 10 years or the
remaining life of the lease. Upon sale or retirement of the depreciable
property, the related cost and accumulated depreciation are eliminated from the
accounts and gains or losses are reflected in the statement of operations.
Interest costs incurred during the period of construction of plant and
equipment are capitalized. The interest costs capitalized were $101,000,
$112,600 and $0 in 1997, 1998 and 1999, respectively.
INCOME TAXES
The Company accounts for income taxes under the asset and liability method
of accounting for income taxes whereby deferred income taxes are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date.
IMPAIRMENT OF LONG-LIVED ASSETS
On November 1, 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of." SFAS No. 121 establishes
accounting standards for the impairment of long-lived assets, certain
identifiable intangibles and goodwill related to those assets to be held and
used and for long-lived assets and certain identifiable intangibles to be
disposed of. SFAS No. 121 requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. Adoption of SFAS No. 121 did not have a material impact on the Company's
financial position, results of operations, or liquidity.
F-9
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
On November 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
presentation of comprehensive income and its components in a full set of
financial statements. The statement requires only additional disclosures in the
financial statements; it does not affect the Company's financial position or
results of operations. There is no difference between the net loss and
comprehensive income for the Company for the year ended October 31, 1999.
STOCK-BASED COMPENSATION
On November 1, 1997, the Company adopted 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 has chosen to continue to
account for stock-based compensation using the intrinsic value method prescribed
in Accounting Principles Board 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS No. 133 is effective for all fiscal years
beginning after December 15, 1999. Management believes that the adoption of SFAS
No. 133 will not have a material impact on the Company's financial reporting.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting on the Cost of Startup
Activities." This SOP requires that costs incurred during start-up activities,
including organization costs, be expensed as incurred. SOP 98-5 is effective for
financial statements for fiscal years beginning after December 15, 1998. Initial
application of the SOP should be as of the beginning of the fiscal year in which
the SOP is first adopted and should be reported as a cumulative effect of a
change in accounting principle. The Company will adopt SOP 98-5 in the first
quarter of Fiscal 2000. The Company believes that the adoption of SOP 98-5 will
not have a material impact on its consolidated financial statements.
NON-COMPETE AGREEMENTS
In July 1999, we entered into non-compete agreements with three former
officers of Scot, Incorporated (two of whom retired in December 1999) totaling
$1,825,000. The non-compete agreements expire November 30, 2001, and are being
amortized on the straight-line method.
F-10
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER
Certain items in prior year and quarterly financial statements have been
reclassified to conform to the 1999 presentation.
3. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following components:
OCTOBER 31
-------------------------
1998 1999
----------- -----------
(IN THOUSANDS)
Commercial customers............................... $ 13,591 $ 17,872
U.S. Government.................................... 2,273 3,018
U.S. Government subcontractors..................... 3,931 6,137
----------- -----------
19,795 27,027
Less allowance for doubtful accounts............... 385 352
----------- -----------
$ 19,410 $ 26,675
=========== ===========
The following is activity relating to the allowance for doubtful accounts
(in thousands):
Balance at October 31, 1996................................. $156
Additions charged to expense................................ 208
Write-offs.................................................. (320)
----
Balance at October 31, 1997................................. 44
Additions charged to expense................................ 510
Write-offs.................................................. (169)
----
Balance at October 31, 1998................................. 385
Additions charged to expense................................ 360
Write-offs.................................................. (393)
----
Balance at October 31, 1999................................. $352
====
F-11
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVENTORIES
Inventories and inventoried costs relating to long-term contracts consist of
the following components:
OCTOBER 31
-------------------------
1998 1999
----------- -----------
(IN THOUSANDS)
Raw materials and component parts.................. $ 6,294 $ 6,695
Work in process.................................... 3,678 4,126
Finished goods..................................... 1,651 916
Inventoried costs relating to long term contracts,
net of amounts attributed to revenues recognized
to date.......................................... 6,810 6,598
----------- -----------
18,433 18,335
Less progress payments related to long-term
contracts........................................ 1,824 502
----------- -----------
$ 16,609 $ 17,833
=========== ===========
Inventoried costs relate to costs of products currently in progress. There
are no significant inventoried costs relating to the production costs of
delivered units over the estimated average cost of all units expected to be
produced.
5. LONG-TERM DEBT
Long-term debt consists of the following components:
OCTOBER 31
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
Senior term loan........................................... $ 476 $ 69,300
Bank revolver.............................................. 2,050 5,900
Senior subordinated notes.................................. -- 100,000
----- --------
2,526 175,200
Less current portion....................................... 2,110 6,600
----- --------
$ 416 $168,600
===== ========
As part of the Recapitalization, the Company issued $100,000,000 of Senior
Subordinated Notes. The Notes are due in December 2008, and bear interest at
11 3/8%. Interest is payable semi-annually in June and December.
The Notes are noncollateralized obligations of the Company and are
subordinate to its obligations under the New Credit Facility. The Notes are
fully and unconditionally guaranteed, jointly and severally, on an
noncollateralized, senior subordinated basis by Scot (the "Subsidiary
Guarantor").
F-12
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LONG-TERM DEBT (CONTINUED)
As part of the Recapitalization, the Company entered into a new credit
facility (the "New Credit Facility") with a syndicate of banks ("the Banks"),
which consists of a $25,000,000 Revolving Credit Facility ("the Revolver") and a
$70,000,000 Senior Term Loan.
The Revolver bears interest at the Banks Base Rate plus an applicable margin
(an effective rate of 10.0% at October 31, 1999). The Company has the option of
converting all or a portion of the balance outstanding under the Revolver to a
Eurodollar Loan, for one, two, three or six month periods, to bear interest at
the Eurodollar Rate plus an applicable margin (an effective rate of 8.1% at
October 31, 1999). At October 31, 1999, $5,900,000 was outstanding under the
Revolver and this amount has been classified as current. Also at October 31,
1999, the Company had $2,321,000 of letters of credit outstanding under the
Revolver, which reduces the amount of additional borrowings available. The total
amount available under the Revolver at October 31, 1999 was $11,779,000. The
Senior Term Loan is a seven year loan which bears interest at the Eurodollar
Rate plus an applicable margin (an effective rate of 9.5% at October 31, 1999).
The New Credit Facility contains several financial and operating covenants which
the Company must meet on a quarterly basis.
On July 14, 1999, the Company and the Banks entered into the First Amendment
to the New Credit Facility pursuant to which the Company increased the Maximum
Swingline Amount (as defined) to $3,000,000 from $1,000,000 while not increasing
the total amount of borrowings available under the Revolver.
On August 20, 1999, the Company notified the Banks of the Company's
potential noncompliance with certain environmental covenants in connection with
an investigation by the California Environmental Protection Agency (the
"Environmental Noncompliance"). On September 14, 1999, the Company and the Banks
entered into a Waiver and Modification to the New Credit Facility pursuant to
which the Banks waived any Default or Event of Default (as defined) arising from
such Environmental Noncompliance until such time as the Banks or the Company
determine that the Environmental Noncompliance has had, or could reasonably be
expected to have, a materially adverse effect on the Company. The Waiver and
Modification to the New Credit Facility also temporarily limited the maximum
borrowings under the Revolver to $20,000,000.
As of October 31, 1999, the Company was not in compliance with certain
financial covenants contained in the New Credit Facility. On January 26, 2000,
the Company entered into a Second Amendment and Waiver to the New Credit
Facility pursuant to which, among other things, certain financial covenants were
amended, and the Company received a waiver for past noncompliance with its
financial covenants. In connection with amending the New Credit Facility on
January 26, 2000, the Company and its controlling stockholder entered into a
capital call agreement (the "Capital Call Agreement") with the Banks. The
Capital Call Agreement requires the controlling stockholder to make a capital
contribution to the Company upon the occurrence of certain events, including the
failure to comply with certain financial covenants contained in the New Credit
Facility. Upon receipt of any such contribution, the Company is obligated to
repay outstanding term loans under the New Credit Facility.
F-13
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT (CONTINUED)
Substantially all of the Company's assets are pledged as collateral under
the New Credit Facility. As required under the terms of the New Credit Facility,
effective March 16, 1999, the Company entered into an interest rate protection
agreement. The terms of the agreement relate to the notional amount of
$35,000,000 of the total $70,000,000 original principal amount. This agreement
set the rate at 5.42% plus 175 basis points, requiring quarterly interest
payments starting June 17, 1999 through March 17, 2001.
The following are the remaining principal payments under the Senior Term
Loan:
FOR THE YEARS ENDING OCTOBER 31 AMOUNT
- ------------------------------- --------------
(IN THOUSANDS)
2000........................................................ $ 700
2001........................................................ 700
2002........................................................ 10,000
2003........................................................ 16,700
2004........................................................ 18,000
Thereafter.................................................. 23,200
-------
$69,300
=======
At October 31, 1998, $2,050,000, was outstanding under a credit agreement,
which was paid in full on December 15, 1998 in connection with the
Recapitalization. This credit agreement was then terminated. In addition, at
October 31, 1998, the Company had outstanding approximately $3,518,000 of
performance bonds collateralized by standby letters of credit.
Also at October 31, 1998, Scot had a term loan with a bank, collateralized
by certain real property of Scot. The principal balance outstanding at
October 31, 1998, was $475,687. The loan was repaid in full on December 15,
1998.
F-14
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
The income tax provision (benefit) consists of the following components:
FOR THE YEARS ENDED OCTOBER 31
---------------------------------
1997 1998 1999
--------- --------- ---------
(IN THOUSANDS)
Current:
Federal................................................... $5,343 $ 8,492 $ (6,007)
State..................................................... 1,267 2,018 --
------ -------- --------
$6,610 $ 10,510 $ (6,007)
------ -------- --------
Deferred:
Federal................................................... $ 77 $ (96) $ (3,446)
State..................................................... (27) (4) (1,155)
------ -------- --------
$ 50 $ (100) $ (4,601)
------ -------- --------
Total:
Federal................................................... $5,420 $ 8,396 $ (9,453)
State..................................................... 1,240 2,014 (1,155)
------ -------- --------
$6,660 $ 10,410 $(10,608)
====== ======== ========
The following are temporary differences which give rise to deferred tax
assets and liabilities:
OCTOBER 31
---------------------
1998 1999
--------- ---------
(IN THOUSANDS)
Noncurrent deferred tax assets (liabilities):
Depreciation......................................... $(3,415) $ (3,309)
State net operating losses........................... -- 666
Alternative minimum tax credit....................... -- 312
------- ---------
(3,415) (2,331)
------- ---------
Current deferred tax assets:
Allowance for doubtful accounts...................... 117 156
Inventories.......................................... 472 508
Vacation............................................. 451 527
State income taxes................................... 326 --
Other accruals....................................... -- 3,692
------- ---------
1,366 4,883
------- ---------
Net deferred tax asset (liability)..................... $(2,049) $ 2,552
======= =========
Management believes that it is more likely than not that future operations
will generate sufficient taxable income to realize the net deferred tax assets.
F-15
SPECIAL DEVICES, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES (CONTINUED)
The following are the reasons the income tax provision (benefit) differs
from the amount that would have resulted by applying the Federal statutory rates
during such periods to the earnings (loss) before income taxes:
FOR THE YEARS ENDED OCTOBER 31
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
Income tax provision (benefit) at Federal
statutory rates................................ $5,522 $ 9,050 $(10,497)
State income taxes............................... 806 1,312 (1,155)
Recapitalization costs not deductible for tax
purposes....................................... -- -- 2,075
Decrease in tax reserves......................... -- -- (1,000)
Other............................................ 332 48 (31)
------ ------- --------
$6,660 $10,410 $(10,608)
====== ======= ========
Of the total recapitalization costs of $16,180,000, approximately $6,100,000
consists of certain fees related to the Recapitalization that may not be
deductible for income tax purposes.
The state net operating losses begin to expire in 2005. The alternative
minimum tax credit carries forward indefinitely.
F-16
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue 2,000,000 shares of Preferred Stock, $.01
par value. Shares of Preferred Stock may be issued from time to time in one or
more series and the Board of Directors, without further stockholder approval, is
authorized to fix the rights and terms, including dividends and liquidation
preferences and any other rights to each such series of Preferred Stock. At
October 31, 1998 and 1999, no shares of Preferred Stock were issued or
outstanding.
STOCK OPTIONS AND GRANTS
The Company's Amended and Restated 1991 Stock Incentive Plan (the "1991
Plan") is administered by a committee of the Board of Directors which determines
the amount, type, terms and conditions of the awards made pursuant to the Plan.
The Plan provides for issuance of restricted stock, grants of incentive and
non-qualified stock options, stock appreciation rights and performance share
awards. There are 560,000 shares of Common Stock reserved for issuance under the
1991 Plan.
Pursuant to the 1991 Plan, no option may be granted that is exercisable in
less than six months or more than ten years from the grant date. Certain events,
including a change in control of the Company, may accelerate exercise dates,
cause forfeiture of all shares of any restricted stock and terminate all
conditions relating to the realization of any performance awards.
In December 1996, the Company's Stock Option Committee authorized stock
option grants to certain employees via a special grant which is not part of the
1991 Stock Option Plan. Under terms of this authorization, options to purchase
130,000 shares were granted which vest ratably over 5 years from the grant date,
and options to purchase 312,000 shares vest ratably over a period ranging from 5
to 8 years from the grant date. The grants for the latter options contain
vesting acceleration clauses during the first 36 months of the option; the
acceleration clauses are contingent upon the price of the Company's Common Stock
attaining a certain level, and upon the Company attaining certain earnings
levels. The options were granted at the fair market value of the stock on the
grant date, which was $17.00 per share.
In June, 1999, the Company adopted the 1999 Stock Option Plan (the "Plan"),
which provides for the issuance of up to 370,000 shares of common stock pursuant
to awards granted under the Plan. All options have been granted at an exercise
price of $50.00 per share. Options vest ratably over four years and expire on
the tenth anniversary of the date of grant.
In accordance with APB Opinion No. 25, no compensation expense has been
charged to earnings in any of the three years ended October 31, 1999. Had
compensation expense for the Company's stock-based compensation plans been
determined consistent with SFAS No. 123, the Company's net earnings (loss) would
have been adjusted to the pro forma amounts indicated below:
FOR THE YEARS ENDED OCTOBER 31
---------------------------------
1997 1998 1999
--------- --------- ---------
(IN THOUSANDS)
Net earnings (loss)............... As reported $10,678 $ 15,447 $(20,266)
Pro forma 9,415 14,548 (21,976)
F-17
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (CONTINUED)
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1997, 1998, and 1999, respectively: risk-free interest rates of
6.12%, 5.68% and 6.02%; dividend yields of 0% for all three years; and a
weighted-average expected life of the option of 9.2 years for all three years.
The following table summarizes stock option activity for the three years
ended October 31, 1999:
WEIGHTED WEIGHTED WEIGHTED
1991 STOCK AVERAGE 1996 AVERAGE 1999 STOCK AVERAGE
OPTION PLAN EXERCISE PRICE SPECIAL GRANT EXERCISE PRICE OPTION PLAN EXERCISE PRICE
----------- -------------- ------------- -------------- ----------- --------------
Shares authorized......... 560,000 442,000 370,000
======= ======= =======
Shares under option:
Outstanding at October 31,
1996.................... 319,710 -- --
Granted................. 33,000 $17.07 442,000 $17.00 -- --
Exercised............... 95,632 $10.85 -- -- -- --
Forfeited............... 10,672 $12.54 -- -- -- --
------- ------- -------
Shares under option:
Outstanding at October 31,
1997.................... 246,406 442,000 --
Granted................. 25,500 $23.80 -- -- -- --
Exercised............... 38,634 $12.30 -- -- -- --
Forfeited............... 1,200 $17.75 -- -- -- --
------- ------- -------
Shares under option:
Outstanding at October 31,
1998.................... 232,072 442,000 --
Granted................. -- -- -- -- 363,200 $50.00
Exercised............... 228,072 $17.75 344,425 $17.00 -- --
Forfeited............... -- -- -- $ -- 7,000 $50.00
------- ------- -------
Outstanding at October 31,
1999.................... 4,000 97,575 356,200
======= ======= =======
Weighted average fair
value of options granted
during the year:........
1997.................... $ 9.19 $ 9.16 --
1998.................... $12.32 -- --
1999.................... -- -- $ 4.80
Options exercisable:
At October 31, 1997..... 129,209 58,000 --
At October 31, 1998..... 119,212 338,000 --
At October 31, 1999..... 4,000 73,530 --
F-18
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about stock options outstanding
at October 31, 1999:
OPTIONS OUTSTANDING
-----------------------------------------
WEIGHTED AVERAGE OPTIONS EXERCISABLE
--------------------- ------------------------------------
AVERAGE EXERCISABLE NUMBER NUMBER WEIGHTED
AT RANGE OF OUTSTANDING AT REMAINING EXERCISE EXERCISABLE AT AVERAGE EXERCISE
EXERCISE PRICE OCTOBER 31, 1999 LIFE PRICE OCTOBER 31, 1999 PRICE
- ------------------- ----------------- ---------- -------- ----------------- ----------------
$17.00-$17.75...... 101,575 7.2 $17.51 77,530 $17.04
$50.00............. 356,200 9.8 50.00 -- --
------- ------ ------- ------
457,775 9.2 $42.74 77,530 $17.04
======= ====== ======= ======
REGISTRATION RIGHTS AGREEMENT
Pursuant to the Registration Rights Agreement entered into upon consummation
of the Recapitalization, J.F. Lehman Equity Investors I, L.P., JFL Co-Invest
Partners I, L.P., Paribas Principal, Inc., the Treinen Family Trust and the
Neubauer Family Trust and any of their direct or indirect transferees have
certain demand and piggyback registration rights, on customary terms, with
respect to the Common Stock held by such entities and persons.
8. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan that provides eligible employees the
opportunity to make tax deferred contributions to a retirement trust account in
amounts up to 20% of their gross wages. The Company can elect to make matching
contributions in amounts that can change from year to year. During the last
three fiscal years the Company matched 30% of an employee's deferral up to the
first 5% of each participating employee's deferral. Employees vest immediately
in the Company's matching contributions. The Company's matching contributions
aggregated approximately $242,000, $244,000 and $332,000 in 1997, 1998 and 1999,
respectively.
9. RELATED PARTY TRANSACTIONS
MANAGEMENT AGREEMENTS WITH J.F. LEHMAN
Pursuant to the terms of a ten-year Management Agreement and a ten-year
Management Services Agreement (together, the "Management Agreements") we entered
into with J.F. Lehman upon consummation of the Recapitalization, we paid
J.F. Lehman a transaction fee of $3,000,000 for its efforts in connection with
the Recapitalization. In addition, we agreed to pay J.F. Lehman an annual
management fee equal to $900,000, payable in advance on a quarterly basis.
COMPONENT PURCHASES
The Company purchased materials from two corporations owned by one of its
stockholders. During the years ended October 31, 1997, 1998 and 1999,
$3,460,000, $720,000 and $4,498,000, respectively, of materials were purchased
from such stockholder's corporations. At October 31, 1998 and 1999, $270,000 and
$203,000, respectively, were owed to the corporations owned by this stockholder.
F-19
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. RELATED PARTY TRANSACTIONS (CONTINUED)
MGG CONTRIBUTION, LICENSE AND LEASE AGREEMENT
In July 1999, the Company entered into a Contribution, License and Lease
Agreement with McCormick Selph, Inc. ("MSI"), an affiliate of the Company's
controlling stockholder, pursuant to which the Company 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 pretentioner applications. Under the terms of the agreement, MSI
licensed to the Company on a perpetual, non-exclusive basis, the intellectual
property rights to produce MGG units, and leased to the Company the portion of
the premises in Hollister, California where the tangible MGG assets are located.
The Company is obligated to pay MSI $14,000 per month for the leased premises.
As consideration for the licensed intellectual property, the Company is
obligated to pay a royalty of $0.25 per MGG unit produced and sold by the
Company. The Company's obligation to pay the royalty will arise once it has
commenced production of MGG units at one of its facilities (which is expected to
occur by September 30, 2000) and will terminate no later than July 16, 2003.
Finally, during the term of the lease, MSI has agreed to provide the Company
with certain materials and manpower resources to enable the Company to produce
MGG units at the Hollister facility. In exchange for such materials and
services, the Company has agreed to pay MSI $36,000 per month.
10. MAJOR CUSTOMERS
The following are accounts receivable from, and sales to, customers which
exceeded 10% of total accounts receivable and net sales:
OCTOBER 31
-----------------------------------------
1998 1999
------------------- -------------------
$ % $ %
-------- -------- -------- --------
(IN THOUSANDS)
Accounts Receivable:
TRW, Incorporated............................. $3,847 19.4% -- --
Autoliv....................................... 5,710 28.9% $2,673 9.9%
Atlantic Research Corporation................. -- -- 8,796 32.5%
FOR THE YEARS ENDED OCTOBER 31
---------------------------------------------------------------
1997 1998 1999
------------------- ------------------- -------------------
$ % $ % $ %
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Sales:
TRW, Incorporated............ $68,987 49.1% $67,704 39.7% $60,606 36.4%
Autoliv...................... 28,943 20.6% 42,464 24.9% 40,459 24.3%
Atlantic Research
Corporation................ -- -- 19,271 11.3% -- --
F-20
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
for 1998 and 1999:
1998 QUARTER ENDED
---------------------------------------------------------
FEBRUARY 1 MAY 3 AUGUST 2 OCTOBER 31 FULL YEAR
---------- -------- -------- ---------- ---------
(IN THOUSANDS)
Net sales......................................... $40,732 $45,114 $43,400 $41,292 $170,538
Gross profit...................................... 8,209 10,146 10,503 10,070 38,928
Earnings from operations.......................... 5,546 6,944 7,305 6,110 25,905
Net earnings...................................... 3,387 4,048 4,394 3,618 15,447
1999 QUARTER ENDED
---------------------------------------------------------
JANUARY 31 MAY 2 AUGUST 1 OCTOBER 31 FULL YEAR
---------- -------- -------- ---------- ---------
(IN THOUSANDS)
Net sales......................................... $ 37,716 $42,442 $42,775 $43,566 $166,499
Gross profit...................................... 6,992 7,217 9,811 6,755 30,775
Earnings (loss) from operations................... (11,222) 2,958 6,213 4,747 2,696
Net earnings (loss)............................... (10,379) (1,861) 1,143 (9,169) (20,266)
12. INDUSTRY SEGMENT INFORMATION
The Company operates primarily in two industry segments--aerospace and
automotive. In the aerospace industry, the Company produces pyrotechnic devices
under long-term contracts for the U.S. Department of Defense and their prime
contractors. In the automotive industry, the Company produces airbag initiators
under trade terms for commercial companies.
Each division is allocated administrative operating expenses incurred by the
Company (which are not attributable to a particular division) on an equitable
basis (e.g., sales and headcount) to fairly reflect the benefit received by each
operating division. In 1997 the allocation was made at 35% to the Aerospace
Division and 65% to the Automotive Products Division. In 1998 the allocation was
made at 40% to the Aerospace Division and 60% to the Automotive Products
Division. In 1999 the allocation was made at 21% to the Aerospace Division and
79% to the Automotive Products Division. Administrative operating expenses
amounted to approximately $3,874,000, $3,928,000 and $6,858,000 in 1997, 1998
and 1999, respectively.
The Company operates entirely within the United States and has no
intersegment sales. Corporate assets are primarily cash, prepaid expenses and
other assets.
F-21
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. INDUSTRY SEGMENT INFORMATION (CONTINUED)
Financial information for these segments is summarized in the table below:
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
Net sales:
Automotive Products....................................... $111,930 $135,235 $124,552
Aerospace................................................. 28,572 35,303 41,947
-------- -------- --------
Total net sales......................................... $140,502 $170,538 $166,499
======== ======== ========
Earnings (losses) from operations:
Automotive Products....................................... $ 13,648 $ 18,492 $ 4,028
Aerospace................................................. 3,579 7,413 9,785
Corporate................................................. -- -- (11,117)
-------- -------- --------
Total earnings (losses) from operations................. $ 17,227 $ 25,905 $ 2,696
======== ======== ========
Depreciation and amortization:
Automotive Products....................................... $ 5,593 $ 7,601 $ 12,626
Aerospace................................................. 518 592 1,393
Corporate................................................. 266 327 1,091
-------- -------- --------
Total depreciation and amortization..................... $ 6,377 $ 8,520 $ 15,110
======== ======== ========
Capital expenditures:
Automotive Products....................................... $ 10,911 $ 21,204 $ 12,969
Aerospace................................................. 681 1,270 320
Corporate................................................. 10,952 16,049 2,757
-------- -------- --------
Total capital expenditures.............................. $ 22,544 $ 38,523 $ 16,046
======== ======== ========
Identifiable assets:
Automotive Products....................................... $ 53,997 $ 69,295 $ 78,674
Aerospace................................................. 18,422 21,737 27,667
Corporate................................................. 27,405 33,587 49,311
-------- -------- --------
Total identifiable assets............................... $ 99,824 $124,619 $155,652
======== ======== ========
F-22
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. SCOT, INCORPORATED
Sections 13 and 15(d) of the Securities Exchange Act of 1934 require
presentation of the following audited summarized financial information of the
Subsidiary Guarantor. The Company has elected not to present separate financial
statements and other disclosures concerning the Subsidiary Guarantor because
management believes such information is not material to investors. There are no
significant contractual restrictions on distributions from the Subsidiary
Guarantor to the Company.
FOR THE YEAR ENDED OCTOBER 31
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
INCOME STATEMENT
Net sales................................................... $11,658 $17,272 $23,722
Gross profit................................................ 4,961 8,930 11,838
Income from continuing operations........................... 2,259 4,704 7,085
Net earnings................................................ 1,391 2,801 6,820
OCTOBER 31
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
BALANCE SHEET
Current assets.............................................. $ 6,688 $ 6,749 $ 6,979
Non-current assets.......................................... 2,998 3,414 4,722
Current liabilities......................................... 1,312 3,125 4,415
Non-current liabilities..................................... 475 416 555
14. COMMITMENTS AND CONTINGENCIES
LEASES
LAND AND BUILDINGS
In 1997, the Company signed a 7-year lease for an approximate 25,000 square
foot building in Moorpark, California, for its glass-sealing division. Monthly
rental expense as of October 31, 1999 was approximately $14,000 per month with
annual increases equal to the change in the Consumer Price Index.
OTHER OPERATING LEASES
Rental expense for non-cancelable operating leases for each of the fiscal
years ended October 31, 1997, 1998, and 1999 were approximately $286,000,
$236,000 and $252,000 respectively.
F-23
SPECIAL DEVICES, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The following are future minimum lease payments under non-cancelable
operating leases:
AMOUNT
--------------
(IN THOUSANDS)
For The Years Ending October 31
2000...................................................... $ 270
2001...................................................... 259
2002...................................................... 242
2003...................................................... 183
2004...................................................... 110
-------
Total minimum lease payments.............................. $ 1,064
=======
OTHER MATTERS
EPA MATTERS. In August 1999, representatives of the Department of Toxic
Substances Control of the California Environmental Protection Agency ("Cal EPA")
conducted an inspection of the Company's former Newhall facility. Following the
inspection, Cal EPA issued a notice of violations ("NOV") indicating that there
had been unauthorized burning and treatment of hazardous waste at the facility.
Management immediately complied with the NOV requirements and directed that an
environmental audit of all facilities be undertaken. In September 1999, a
federal grand jury issued subpoenas requesting copies of documents relating to
the handling, generation, storage, and transportation of hazardous waste and
hazardous materials at our Newhall, Moorpark, and Mesa facilities, as well as
copies of documents related to other health and safety issues.
The Company is cooperating fully with federal and state authorities in
connection with these matters. In light of their preliminary nature, however,
and the fact that the Company's environmental audit is ongoing, the Company is
unable to predict their outcome. These matters have disrupted the conduct of the
Company's business and could result in civil and/or criminal liabilities and
penalties, including fines and remediation costs. Accordingly, there can be no
assurance that these matters will not have a material adverse effect upon the
Company's financial condition or results of operations.
OSHA MATTERS. In February 1999, an accidental explosion occurred at the
Company's Newhall facility, resulting in the death of one employee. A transport
vehicle was heavily damaged by the explosion, while nearby buildings sustained
only minor damage that was quickly repaired. The Company suspended all
production at Newhall for four days to conduct a thorough investigation of the
accident along with the Occupational Safety and Health Administration of the
State of California ("OSHA"). The Company also suspended the blending of
pyrotechnic powders for approximately two weeks. We resumed full production at
Newhall on March 4, 1999. The Newhall facility was vacated upon completion of
the move to the new Moorpark facility in July 1999. OSHA's investigation of the
accident was concluded during the fiscal third quarter, resulting in the
issuance on August 16, 1999, of citations for alleged safety violations and
fines aggregating approximately $20,000. The Company appealed the citations as
lacking in factual basis. The appeal is pending. Because the accident resulted
in a fatality, OSHA's Bureau of Investigation is required to conduct its own
investigation to determine whether to refer the matter to the Distrct Attorney's
Office for Los Angeles County. At this point, given the limited information
available regarding the Bureau of Investigation's inquiry, it is impossible to
predict or assess the likelihood of an unfavorable outcome or predict the amount
of potential liabilities.
F-24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Moorpark, State of California, on the 28th day of January 2000.
SPECIAL DEVICES, INCORPORATED
By: /s/ THOMAS W. CRESANTE
-----------------------------------------
Thomas W. Cresante
PRESIDENT AND CHIEF EXECUTIVE OFFICER
SIGNATURE TITLE DATE
--------- ----- ----
/s/ THOMAS W. CRESANTE
------------------------------------------- Director, President and Chief January 28, 2000
Thomas W. Cresante Executive Officer
/s/ DR. JOHN F. LEHMAN
------------------------------------------- Chairman of the Board of January 28, 2000
Dr. John F. Lehman Directors
Director, Executive Vice
/s/ JOSEPH STROUD President and Chief
------------------------------------------- Financial Officer, January 28, 2000
Joseph Stroud Assistant Secretary
/s/ GEORGE SAWYER
------------------------------------------- Director and Secretary January 28, 2000
George Sawyer
/s/ OLIVER C. BOILEAU, JR.
------------------------------------------- Director January 28, 2000
Oliver C. Boileau, Jr.
/s/ DONALD GLICKMAN
------------------------------------------- Director January 28, 2000
Donald Glickman
/s/ WILLIAM PAUL
------------------------------------------- Director January 28, 2000
William Paul
/s/ THOMAS G. POWNALL
------------------------------------------- Director January 28, 2000
Thomas G. Pownall
/s/ GARY BINNING
------------------------------------------- Director January 28, 2000
Gary Binning
/s/ RANDY BRINKLEY
------------------------------------------- Director January 28, 2000
Randy Brinkley
/s/ KEITH OSTER
------------------------------------------- Director January 28, 2000
Keith Oster