EXHIBIT 13
FIVE-YEAR FINANCIAL SUMMARY
<Table>
<Caption>
(Dollars in millions, except per share amounts) 2002(1) 2001(2) 2000(3) 1999(4) 1998
---------- ---------- ---------- ---------- ----------
For years ended September 30:
Net sales $ 367.5 344.9 300.2 416.1 365.1
EBIT (Earnings Before Interest and Taxes) 34.9 27.4 25.1 70.0 24.0
Net earnings before accounting change (1999) 21.8 30.1 16.8 50.5 11.3
Net earnings 21.8 30.1 16.8 25.5 11.3
Earnings per share:
Earnings before accounting change (1999)
Basic 1.74 2.43 1.37 4.09 .94
Diluted 1.67 2.35 1.33 4.00 .90
Net earnings
Basic 1.74 2.43 1.37 2.06 .94
Diluted 1.67 2.35 1.33 2.02 .90
As of September 30:
Working capital 112.6 87.4 62.8 95.3 60.3
Total assets 407.7 375.6 331.1 378.4 409.3
Long-term debt 8.3 8.3 .6 41.9 50.1
Shareholders' equity 306.3 287.3 259.4 248.7 224.1
---------- ---------- ---------- ---------- ----------
</Table>
(1) Includes the acquisition of SRT. (See Footnote 3 of Notes to
Consolidated Financial Statements). Excludes goodwill
amortization in accordance with SFAS 142.
(2) Includes the acquisition of Bea. (See Footnote 3 of Notes to
Consolidated Financial Statements). Also, includes the
elimination of the net deferred tax valuation allowance of
approximately $12.7 million or $0.99 per share.
(3) Includes the acquisitions of Lindgren, Holaday, and Eaton
Space Products and the sale of the Rantec microwave antenna
business (See Footnote 3 of Notes to Consolidated Financial
Statements). Also, includes the after-tax gain on the sale of
the Riverhead, NY property of approximately $2.2 million or
$0.18 per share and the after-tax gain on the sale of the
Calabasas, CA property of approximately $0.5 million or $0.04
per share.
(4) Includes the gain on sale of Systems & Electronics Inc., the
accounting change (SOP 98-5) of $25 million,$5.1 million of
restructuring charges, and $3.9 million of other charges
related to cost of sales.
COMMON STOCK MARKET PRICE
The Company's common stock and associated preferred stock purchase
rights (subsequently referred to as common stock) are listed on the New
York Stock Exchange under the symbol "ESE." The following table
summarizes the high and low prices of the Company's common stock for
each quarter of fiscal 2002 and 2001.
<Table>
<Caption>
2002 2001
------------------------- -------------------------
Quarter HIGH LOW High Low
- ------- ---------- ---------- ---------- ----------
First $ 34.70 $ 22.20 $ 21.50 $ 16.38
Second 40.00 31.80 26.25 19.75
Third 41.15 27.90 32.67 23.67
Fourth 36.35 25.80 30.45 21.90
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
51
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto. The years
2002,2001 and 2000 represent the fiscal years ended September
30,2002,2001 and 2000,respectively,and are used throughout the
document.
- --------------------------------------------------------------------------------
INTRODUCTION
ESCO Technologies Inc. (ESCO, the Company) operates in four business
segments: Filtration/Fluid Flow, Communications, Test and Other. ESCO
develops, manufactures and markets a broad range of filtration products
used in the separation, purification and processing of liquids and
gases. The Company's engineered filtration products utilize membrane,
precision screen and other technologies to protect critical processes
and equipment from contaminants. Major applications include the removal
of contaminants in fuel, lubrication and hydraulic systems, various
health care applications, pharmaceutical and biopharmaceutical
applications, food and beverage processing, potable water,
semiconductor production processes and oil production. The Company's
Communications segment provides a well-proven power line based
communications system to the electric utility industry. The Two-Way
Automatic Communications System, known as the TWACS(R) system, is
currently used for automatic meter reading (AMR) and related advanced
metering functions, as well as its load management capabilities. ESCO
is a leading supplier of radio frequency (RF) shielding and EMC test
products. ESCO also supplies shielding to the growing Magnetic
Resonance Imaging (MRI) market. The Company's business segments are
comprised of the following primary operating entities:
-- Filtration/Fluid Flow: Filtertek Inc. (Filtertek) and PTI
Consolidated, which includes PTI Technologies Inc. (PTI), PTI
Advanced Filtration Inc. (PTA), PTI Technologies Limited
(PTL), PTI S.p.A., and VACCO Industries,
-- Communications: Distribution Control Systems, Inc. (DCSI) and
Comtrak Technologies, L.L.C. (Comtrak),
-- Test: EMC Group consisting of EMC Test Systems, L.P. (ETS) and
Lindgren RF Enclosures, Inc. (Lindgren),
-- Other: Rantec Power Systems Inc. (Rantec).
ESCO continues to operate with meaningful growth prospects in its
primary served markets, and with considerable financial flexibility.
The Company continues to focus on new products that incorporate
proprietary design and process technologies. Management is committed to
delivering shareholder value through internal growth, ongoing
performance improvement initiatives, and selective acquisitions.
- --------------------------------------------------------------------------------
HIGHLIGHTS OF 2002 OPERATIONS
The Company's 2002 highlights include:
o Firm order backlog increased by $113.1 million, or 62.8%, to
$293.2 million.
o The Communications segment received $192.4 million of new
orders, with the largest order from PPL Electric Utilities
Corporation (PPL) for $112 million. Net sales to PPL were
$31.5 million in 2002.
o Net sales increased $22.6 million, or 6.6%, to $367.5 million
from $344.9 million in 2001.
o Net sales in the Communications segment increased 60.1% to
$94.6 million.
o New products (defined as those introduced within the past
three years) were $81.4 million, or 22.1% of net sales.
o Gross profit margin increased to 32.4% in 2002 compared to
31.4% in the prior year.
o EBIT (defined as earnings before interest and taxes) increased
to 9.5% of net sales.
o Net earnings in 2002 were $21.8 million, or $1.67 per share.
The 2002 results were impacted by an after-tax charge of $0.4
million, or $0.04 per share, related to the previously
announced Management Transition Agreement (MTA) between the
Company and Dennis J. Moore, the Company's Chairman.
o The Company acquired the rights to the patent portfolio and
related intellectual property of North Carolina Separations
Research Technology Inc. and its affiliate (SRT), a
manufacturer of cross-flow filtration and separation modules
and equipment.
o The Company completed the consolidation of previous
acquisitions in the Test segment, including the former Holaday
Industries, Inc. (Holaday) and Lindgren facilities in
Minnesota and Florida, respectively, into the new
state-of-the-art facility in Cedar Park (Austin), TX.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
RECONCILIATION OF ADJUSTED NET EARNINGS
On October 1, 2001, the Company adopted Statement of Financial
Accounting Standards No.142 (SFAS 142), "Goodwill and Other Intangible
Assets, "which eliminated goodwill amortization in 2002.The following
table provides a reconciliation between the reported results of
operations for 2002, 2001 and 2000 and what the operating results would
have been after removing certain non-recurring items and goodwill
amortization, consistent with the 2002 adoption of SFAS 142. The table
is not intended to present net earnings as defined within accounting
principles generally accepted in the United States of America (GAAP),
and is presented for informational purposes only. Management believes
the estimated adjusted operating results provide a meaningful
presentation for purposes of comparing ESCO's historical financial
performance.
<Table>
<Caption>
2002 2001
---------------------------------------- --------------------------------------------
(Dollars in millions,
except per share amounts) REPORTED ADJ. ADJUSTED Reported Adj. Adjusted
---------- ---------- ---------- ---------- ---------- ----------
Net Sales $ 367.5 367.5 344.9 344.9
Cost and Expenses:
Cost of sales 248.5 248.5 236.6 236.6
SG&A 82.3 (0.7)(1) 81.6 71.5 71.5
Interest expense 0.3 0.3 0.1 0.1
Other expenses, net 1.8 1.8 9.4 (3.4)(2) 6.0
---------- ---------- ---------- ----------
Total costs and expenses 332.9 332.2 317.6 314.2
---------- ---------- ---------- ----------
Earnings before income taxes 34.6 35.3 27.3 30.7
Income taxes 12.8 0.3(1) 13.1 (2.8) 13.5(3) 10.7
---------- ---------- ---------- ---------- ---------- ----------
Net earnings $ 21.8 0.4 22.2 30.1 (10.1) 20.0
---------- ---------- ---------- ---------- ---------- ----------
Earnings per share:
Basic $ 1.74 1.78 2.43 1.62
---------- ---------- ---------- ----------
Diluted $ 1.67 1.71 2.35 1.56
---------- ---------- ---------- ----------
Average common shares O/S:
Basic 12,511 12,511 12,382 12,382
---------- ---------- ---------- ----------
Diluted 13,022 13,022 12,805 12,805
---------- ---------- ---------- ----------
<Caption>
2000
------------------------------------------
(Dollars in millions,
except per share amounts) Reported Adj. Adjusted
---------- ---------- ----------
Net Sales 300.2 300.2
Cost and Expenses:
Cost of sales 208.3 208.3
SG&A 61.8 61.8
Interest expense 0.4 0.4
Other expenses, net 5.0 0.4(4) 5.4
---------- ----------
Total costs and expenses 275.5 275.9
---------- ----------
Earnings before income taxes 24.7 24.3
Income taxes 7.9 0.3(5) 8.2
---------- ---------- ----------
Net earnings 16.8 (0.7) 16.1
---------- ---------- ----------
Earnings per share:
Basic 1.37 1.31
---------- ----------
Diluted 1.33 1.27
---------- ----------
Average common shares O/S:
Basic 12,307 12,307
---------- ----------
Diluted 12,668 12,668
---------- ----------
</Table>
(1) Excludes the cost and related tax impact of the Management Transition
Agreement between the Company and Dennis J. Moore.
(2) Excludes goodwill amortization of $3.4 million in 2001 in accordance
with the provisions of SFAS 142.
(3) Excludes the $12.7 million tax adjustment related to the elimination of
the deferred tax valuation allowance and $0.8 million of tax related to
the goodwill amortization noted in item (2) above.
(4) Excludes goodwill amortization of $2.6 million in 2000 in accordance
with the provisions of SFAS 142, offset by the elimination of $3.0
million of non-recurring gains from the sale of the Riverhead, NY
property ($2.2 million) and the sale of the Calabasas, CA property
($0.8 million).
(5) Excludes $0.6 million related to the tax impact of the goodwill
amortization noted in item (4) above, offset by $0.3 million related to
the tax impact from the sale of the properties noted in item (4)
above. The gain from the sale of the Riverhead, NY property was fully
sheltered by a capital loss carryforward.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
NET SALES
Net sales were $367.5 million, $344.9 million and $300.2 million in
2002, 2001 and 2000, respectively. Net sales in 2002 increased $22.6
million, or 6.6% from net sales of $344.9 million in 2001. Organic
sales growth accounted for $12.7 million of the sales increase in 2002,
with the balance coming from acquisitions. New products accounted for
$81.4 million, or 22.1%, of net sales in 2002 and $70.1 million, or
20.3%, of net sales in 2001, respectively.
FILTRATION/FLUID FLOW
Net sales of $192.5 million in 2002 were $4.3 million, or 2.3% higher
than net sales of $188.2 million in 2001. Net sales in 2002 increased
primarily as a result of the contribution from SRT, acquired in March
2002, and Bea Filtri S.p.A. (Bea), acquired in June 2001. Increased
sales from acquisitions, which accounted for $9.9 million of the sales
increase, were partially offset by declines in the commercial aerospace
and semiconductor markets.
Net sales of $188.2 million in 2001 were $6.5 million, or 3.6% higher
than net sales of $181.7 million in 2000. Net sales increased in the
health care and aerospace markets, partially offset by declines in the
semiconductor markets. The acquisition of Bea contributed $2.0 million
to the 2001 increase in net sales.
COMMUNICATIONS
Net sales were $94.6 million, $59.1 million and $42.7 million in 2002,
2001 and 2000, respectively. Net sales in 2002 were $35.5 million, or
60.1% higher than the $59.1 million of net sales in 2001. The increase
in net sales each year is the result of significantly higher shipments
of AMR equipment. Net sales to PPL were $31.5 million in 2002. In
addition, sales to various electric utility cooperatives (Co-ops) in
2002 increased in both dollar amount and number of utility customers as
compared to the prior year.
The Communications segment received $192.4 million and $104.0 million
of new orders for its TWACS systems and load control transponders in
2002 and 2001, respectively. The largest order in 2002 was from PPL for
$112 million. The Communications segment customer base includes
significant investor owned utilities (IOUs) and municipal utilities
such as PPL, Puerto Rico Electric Power Authority (PREPA), Wisconsin
Public Service Corporation (WPS), Florida Power & Light (FPL) as well
as numerous Co-ops throughout North America. During 2002, the Company
received $72.0 million of new orders from Co-ops.
In May 2002, in cooperation with the Public Service Commission of
Wisconsin and the Wisconsin Department of Agriculture, Trade and
Consumer Protection, WPS began voluntarily conducting tests involving
the Company's AMR equipment and the potential impact of stray voltage
on dairy farms. Test data previously collected by DCSI and WPS indicate
that stray voltage levels associated with the TWACS system are
inconsequential. Resolution of this issue is anticipated in the first
fiscal quarter of 2003.
TEST
Net sales were $69.0 million and $85.5 million in 2002 and
2001, respectively. The net sales decrease of $16.5 million in 2002 is
mainly due to the severe downturn in the overall electronics and
telecommunications markets and the prior year completion of the General
Motors test chamber complex. Sales of large EMC test chamber products
were
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
significantly impacted by the economic downturn in 2002. Net sales of
the Company's MRI shielding products increased by 10.3% in 2002 due to
the continued growth in the health care markets.
Net sales increased $22.5 million, or 35.7% to $85.5 million in 2001
compared to net sales of $63.0 million in 2000. The 2001 results
reflect the full year contributions from the fiscal 2000 Test
acquisitions. The General Motors contract contributed $4.6 million and
$13.2 million to net sales in 2001 and 2000, respectively.
OTHER
Net sales were $11.4 million in 2002, $12.1 million in 2001 and $12.8
million in 2000. The decrease in net sales in 2002 as compared to 2001
is due to the timing of orders received related to the power supply
business. The decrease in 2001 as compared to 2000 is due to the sale
of the Rantec microwave antenna business in February 2000.
ORDERS AND BACKLOG
Firm order backlog was $293.2 million at September 30, 2002,
representing an increase of $113.1 million (62.8%) from the beginning
of the year backlog of $180.1 million. New orders increased 26.6% to
$480.7 million in 2002 compared with $379.6 million in 2001. New orders
in 2002 included $4.1 million of backlog from acquisitions related to
the Filtration/Fluid Flow segment. In 2002, $202.1 million of new
orders related to Filtration/Fluid Flow products, $75.9 million related
to Test products, and $192.4 million related to Communications
products. In February 2002, the Company was awarded a $112 million
contract from PPL for an AMR system in Pennsylvania. The project is
currently scheduled for completion in November 2004.
GROSS PROFIT
The Company computes gross profit as net sales less cost of sales. The
gross profit margin is the gross profit divided by net sales, expressed
as a percentage.
The gross profit margin was 32.4%, 31.4% and 30.6% in 2002, 2001 and
2000, respectively. Gross profit margin increased in the comparable
periods presented due to ongoing operational improvements, including
favorable changes in sales mix and product pricing as well as
successful cost containment programs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses (SG&A) for 2002 were $82.3
million, or 22.4% of net sales, compared with $71.5 million, or 20.7%
of net sales for 2001. The increase in SG&A in 2002 is partly due to
the Bea and SRT acquisitions, which added $3.6 million of incremental
SG&A expenses in 2002. In addition, the Company is making significant
investments in research and development, engineering and marketing
within the Communications and Filtration/Fluid Flow segments related to
new product development and market expansion initiatives.
SG&A expenses in 2001 were $71.5 million, or 20.7% of net sales,
compared with $61.8 million, or 20.6% of net sales in 2000. The
increase in SG&A in 2001 is mainly due to the 2000 acquisitions being
included for the entire year in 2001, as well as additional investments
in research and development, engineering and marketing within the
Communications and Filtration/Fluid Flow segments.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
EARNINGS BEFORE INTEREST AND TAXES (EBIT)
The Company evaluates the performance of its operating segments based
on EBIT. On October 1, 2001, the Company adopted SFAS 142, which
eliminated goodwill amortization in 2002.
EBIT increased $7.5 million to $34.9 million (9.5% of net sales) in
2002 from $27.4 million (7.9% of net sales) in 2001. The prior year
period included goodwill amortization of $3.4 million. Excluding
goodwill amortization from the 2001 results, EBIT would have been $30.8
million (8.9% of net sales).
FILTRATION/FLUID FLOW
EBIT of $13.1 million (6.8% of net sales) in 2002 increased $1.6
million over EBIT of $11.5 million (6.1% of net sales) in 2001.
Goodwill amortization was $2.0 million in 2001. Excluding goodwill
amortization, EBIT would have been $13.5 million (7.2% of net sales) in
2001. The 2002 results were impacted by softness in the commercial
aerospace and semiconductor markets, and investments in new product
development and market expansion initiatives, primarily in
microfiltration.
EBIT was $11.5 million (6.1% of net sales) and $12.4 million (6.8% of
net sales) in 2001 and 2000, respectively. Fiscal 2001 was impacted by
non-recurring costs related to the consolidation of the previously
acquired Eaton space products business into existing Company owned
facilities and increases in other facility operating costs.
COMMUNICATIONS
EBIT of $21.0 million (22.2% of net sales) in 2002 was $9.1 million, or
76.5%, higher than the $11.9 million (20.1% of net sales) of EBIT in
2001. EBIT was $3.7 million, or 45.1%, higher than the $8.2 million
(19.1% of net sales) of EBIT in 2000. The increases in EBIT in the
comparable periods were the result of significantly higher shipments of
AMR equipment. The Company continues to increase its engineering and
new product development expenditures in the Communications segment in
order to continue its growth in the AMR markets, primarily involving
IOUs, and to further differentiate its technology from the competition.
TEST
EBIT was $3.6 million (5.4% of net sales) and $7.5 million (8.8% of net
sales) in 2002 and 2001, respectively. Goodwill amortization was $1.4
million in 2001. Excluding goodwill amortization, EBIT would have been
$8.9 million (10.4% of net sales) in 2001. The decline in EBIT in 2002
as compared to the prior year is mainly due to lower sales of large EMC
test chambers as a result of the severe downturn in the electronics and
telecommunications markets and the completion of the General Motors
test chamber complex in 2001.
EBIT was $7.5 million (8.8% of net sales) and $4.7 million (7.5% of net
sales) in 2001 and 2000, respectively. The increase in EBIT in 2001 as
compared to 2000 is mainly due to the full year contributions from the
Lindgren and Holaday acquisitions, which occurred in the second half of
fiscal 2000.
OTHER
Rantec's EBIT was $0.8 million, $1.2 million and ($0.2) million in
2002, 2001 and 2000, respectively. The decrease in EBIT in 2002 as
compared to the prior year is mainly due to lower sales, as well as
expenses incurred related to new product development programs. The
increase in EBIT in 2001 as compared to 2000 is due to the improved
operations of Rantec's business and the February 2000 sale of the
microwave antenna business. Unallocated corporate operating charges
were ($3.6) million and ($4.7) million in 2002 and 2001, respectively.
In 2000, unallocated corporate operating charges were ($2.0) million
offset by $2.0 million of other income primarily related to gains on
the sale of properties. The items included in unallocated corporate
operating charges are explained in Other Costs and Expenses, Net,
described on the following page.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
INTEREST EXPENSE
Interest expense increased to $0.3 million in 2002 from $0.1 million in
2001, primarily as a result of the foreign based borrowings incurred as
part of the Bea acquisition in June 2001. Interest expense decreased to
$0.1 million in 2001 from $0.4 million in 2000, primarily as a result
of lower outstanding average borrowings throughout 2001.
OTHER COSTS AND EXPENSES, NET
Other costs and expenses, net, were $1.8 million, $9.4 million and $8.0
million in 2002, 2001 and 2000, respectively. Other costs and expenses,
net, of $1.8 million in 2002 consisted primarily of the following
items: $1.6 million of amortization of identifiable intangible assets,
primarily patents and technology licenses; $0.3 million of exit costs
related to the Company's joint venture in India (Filtration/Fluid Flow
segment) which was terminated in the first quarter of 2002; $0.2
million of start-up costs for the Asian operations (Test segment); and
$0.2 million of litigation costs related to the Filtration/Fluid Flow
segment. These costs were offset by a $0.4 million gain from insurance
proceeds related to a former subsidiary and a $0.7 million gain from a
customer funded refurbishment of production test equipment within the
Filtration/Fluid Flow segment.
Other costs and expenses, net, of $9.4 million in 2001 consisted
primarily of the following items: goodwill amortization of $3.4
million; patent and other intangible asset amortization of $1.4
million; and approximately $2.1 million of net costs related to the
Filtration/Fluid Flow segment described below.
(1) $1.2 million of moving costs related to the consolidation of
PTI's filtration businesses into new facilities in Oxnard, CA.
The primary expenditures consisted of moving costs to pack and
ship manufacturing equipment, inventory and supplies. This
amount also included $0.5 million of certain vacant facility
costs and costs to restore the former facilities to their
original condition.
(2) $0.6 million of exit costs related to the consolidation of the
Stockton, CA manufacturing facility into the Huntley, IL
facility, which consisted of lease termination payments,
write-offs of abandoned leasehold improvements and employee
severance costs.
(3) $0.3 million of termination costs related to the Brazil
operation which were incurred as part of the Company's overall
facility rationalization and management reorganization. These
costs primarily included severance costs.
Other costs and expenses, net, of $8.0 million in 2000 consisted
primarily of the following items: goodwill amortization of $2.6
million; patent and other intangible asset amortization of $1.3
million; and approximately $2.0 million of net costs related to the
Filtration/Fluid Flow segment described below.
(1) $0.8 million of facility consolidation costs related to the
consolidation of PTI's filtration businesses into new
facilities in Oxnard, CA, primarily consisting of leasehold
improvement write-offs.
(2) $0.4 million of costs related to the planned upgrade of
production equipment to improve manufacturing efficiency at
Filtertek, primarily consisting of write-downs of the net book
value of equipment to be replaced.
(3) $0.8 million of costs related to a settlement with the former
owner of the microfiltration business.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
GAIN ON SALE OF PROPERTIES
Included in other current assets at September 30, 2002 is a note
receivable for $1.8 million related to the fiscal 2000 sale of the
Riverhead, NY property. The note receivable is currently due in
December 2002 with an option for the borrower to extend to February
2003. Through September 30, 2002, the Company received $1.3 million
related to the scheduled principal and interest payments on the note
receivable.
The gain on the sale of properties in 2000 represents $2.2 million from
the sale of the Riverhead, NY property and $0.8 million from the sale
of the Calabasas, CA property. These properties were related to
previously divested companies.
INCOME TAX EXPENSE (BENEFIT)
Income tax expense of $12.8 million for 2002 reflects current Federal
tax expense of $1.0 million, deferred Federal tax expense of $6.9
million, current state and local tax expense of $2.9 million, deferred
state and local tax benefit of ($0.2) million, current foreign tax
expense of $1.7 million, and deferred foreign tax expense of $0.5
million.
Income tax benefit of ($2.8) million for 2001 reflects current Federal
tax expense of $0.4 million, deferred Federal tax benefit of ($5.7)
million, current state and local tax expense of $1.2 million, current
foreign tax expense of $1.3 million, and deferred foreign tax benefit
of ($0.1) million.
Income tax expense of $7.9 million for 2000 reflects current Federal
tax expense of $0.3 million, deferred Federal tax expense of $6.3
million, current state and local tax expense of $0.8 million, and
current foreign tax expense of $0.6 million.
Based on the Company's historical pretax income, together with the
projection of future taxable income, Management believes it is more
likely than not that the Company will realize the benefits of the net
deferred tax asset of $49.7 million existing at September 30, 2002. In
order to realize this net deferred tax asset, the Company will need to
generate future taxable income of approximately $142 million, of which
$105 million is required to be realized prior to the expiration of the
net operating loss (NOL) carryforward, of which $12 million will expire
in 2009; $38 million will expire in 2010; $4 million will expire in
2011; $11 million will expire in 2018; and $40 million will expire in
2019. The net operating loss carryforward will be available to reduce
future Federal income tax cash payments.
During 2001, as the result of certain residual tax effects related to
the 2000 sale of the Rantec property in Calabasas, CA, the Company
utilized approximately $2 million of the remaining $33 million capital
loss carryforward available from the sale of its Hazeltine subsidiary
in 1996. The remaining capital loss carryforward of approximately $31
million expired on September 30, 2001. As a result, the valuation
reserve of $10.8 million maintained for the full value of the deferred
tax asset related to the capital loss carryforward was eliminated in
2001. There was no impact to the Company's results of operations in
2001 as a result of this event.
Also during 2001, the Company eliminated its remaining net deferred tax
valuation allowance of $12.7 million, which was the valuation allowance
representing the amount of the deferred tax asset associated with
temporary differences and NOLs which, prior to September 30, 2001,
Management believed would likely not be realized due to limitations on
future use. Management concluded in years prior to 2001, that the
valuation allowance set forth in prior period financial statements was
appropriate based on the following factors:
(1) The Company had a lengthy history of cumulative tax losses
(NOL carryforwards of $138 million at September 30, 2000),
including the addition of $11.6 million and $39.6 million of
NOLs in the then recent years ended September 30, 1998 and
1999, respectively;
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
(2) The Company's divestiture of Systems & Electronics Inc. on
September 30, 1999 transformed the Company from primarily a
defense-oriented business to primarily a commercial and
industrial manufacturing business, and the Company had not yet
established a record of positive tax earnings;
(3) The Company had not fully integrated the operations of its
three recent commercial acquisitions (Holaday, Lindgren and
Eaton space products) and could not reasonably project the tax
or earnings impact of these acquisitions with respect to its
newly transformed business base; and
(4) The Company was operating in commercial industries that, in
2000, were beginning to experience economic contraction in an
environment that was beginning to show signs of a slowdown.
Based on these factors, Management concluded that the valuation
allowance recorded in the September 30, 2000 (and earlier) financial
statements was appropriate, and supported Management's belief, at the
time, that it was more likely than not that the deferred tax asset may
not by realized.
At the end of 2001, Management concluded that it was more likely than
not that it would realize the benefits of the deferred tax assets
existing at September 30, 2001, and, therefore, eliminated the existing
deferred tax valuation allowance. Management concluded that the
elimination of the valuation allowance was appropriate based on the
following factors:
(1) The Company had completed its second year of operations as a
commercial and industrial manufacturer, and had successfully
integrated its prior year acquisitions into their respective
operating segments;
(2) The Company's financial projections, which incorporated the
current operating structure and acquisitions, provided
Management with reasonable assurance that taxable income in
future years would be sufficient to fully utilize the tax NOL
carryforwards prior to their expiration;
(3) The Company had two consecutive years of positive, and
increasing, taxable income, which provided Management with
assurance that a positive trend in taxable earnings was being
established, and that significant future tax operating losses
were unlikely; and
(4) During 2001, the Company experienced a substantial increase in
the operating contribution of its Communications segment
resulting from the rapidly expanding market for the Company's
AMR equipment.
Based on these factors, Management eliminated the $12.7 million
deferred tax asset valuation allowance at September 30, 2001 as a
credit to its 2001 income tax expense.
The effective tax rate in 2002 was 37.1% compared to (10.4%) in 2001.
The difference in the tax rates results from the favorable tax
adjustment in 2001.On an operational basis, Management estimated the
2001 effective tax rate would have been 36.1%, excluding this tax
adjustment. An analysis of the effective tax rates for 2002, 2001 and
2000 is included in the Notes to the Consolidated Financial Statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
CAPITAL RESOURCES & LIQUIDITY
Working capital increased to $112.6 million at September 30, 2002 from
$87.4 million at September 30, 2001. During 2002, cash and cash
equivalents increased by $10.4 million. Accounts receivable increased
$8.1 million and inventories increased $4.4 million primarily due to
the sales growth in the Company's Communications segment related to the
PPL contract.
Net cash provided by operating activities was $35.0 million, $33.0
million and $20.0 million in 2002, 2001 and 2000, respectively. The
increase in 2001 as compared to 2000 was primarily due to the Company's
additional earnings and improved working capital resulting from asset
management initiatives.
Capital expenditures were $13.2 million, $11.9 million and $10.4
million, in 2002, 2001 and 2000, respectively, and primarily included
manufacturing equipment. There were no commitments outstanding that
were considered material for capital expenditures at September 30,
2002.
At September 30, 2002, the Company had an available NOL carryforward
for tax purposes of approximately $105 million. This NOL will expire
beginning in 2009 and ending in 2019, and will be available to reduce
future Federal income tax cash payments.
At September 30, 2002, accounts receivable included $1.0 million of
reimbursable costs incurred to replace certain filtration elements
resulting from the receipt of nonconforming material obtained from a
supplier. The supplier has acknowledged responsibility for this matter,
has appropriate insurance coverage, and has committed to reimburse the
Company.
Other current assets included $0.9 million of deferred legal costs that
have been incurred in the defense of certain revenue generating patents
used by Filtertek Inc. In the Filtration/Fluid Flow segment. The
Company believes it is probable it will prevail in this litigation. The
Company's position is supported by internal and third-party legal
opinions and favorable developments in the course of the litigation.
The recovery of amounts equal to or greater than the legal costs, while
probable, is subject to the inherent risks of litigation.
Other current assets also included $1.4 million of deferred legal costs
incurred to defend a customer product liability lawsuit related to the
Company's Test business. These costs are covered by and will be
reimbursed through insurance. Subsequent to September 30, 2002, the
Company received $0.8 million from its insurance carrier related to
this matter. The balance is expected to be received by December 31,
2002.
SYNTHETIC LEASE OBLIGATION
The Company has a $31.5 million obligation under a synthetic lease
facility arranged by Bank of America. For GAAP purposes, this is
accounted for as an operating lease. This obligation is secured by
three manufacturing locations, two of which are located in Oxnard, CA
and the other in Cedar Park, TX, as well as a $10.6 million letter of
credit issued under the Company's $70 million credit facility. The
leases expire on December 29, 2005 at which time the Company will be
required to extend the leases on terms to be negotiated, purchase the
properties for $31.5 million, or refinance the obligation. The
Financial Accounting Standards Board (FASB) has issued an exposure
draft on the accounting treatment related to synthetic lease
arrangements. If this exposure draft is adopted as written, the Company
would record the net assets and obligations under the synthetic lease
facility as property, plant and equipment and debt.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
ACQUISITIONS/DIVESTITURES
On March 11, 2002, the Company acquired the exclusive rights to the
patent portfolio and related intellectual property of North Carolina
Separations Research Technology Inc. and its affiliate (SRT), a
manufacturer of cross-flow filtration and separation modules and
equipment. The Company also acquired certain production assets and
inventory of SRT. The purchase price was $11.5 million of which the
Company paid $9.5 million at closing and will pay future consideration
of $1 million in March 2003 and $1 million in March 2004. Additionally,
the Company will be obligated to pay consideration, primarily in the
form of royalties, based on certain future product sales and/or the
grant of sublicenses generated as a result of the acquired rights in
the patent portfolio. SRT sales of products utilizing the technologies
acquired were approximately $3 million in calendar 2001. Since the date
of acquisition, sales for SRT were $1.1 million in fiscal 2002. The
intellectual property rights and related assets of SRT are included
within the Filtration/Fluid Flow segment. The intellectual property is
being amortized over a period of fifteen years, consistent with the
remaining life of the patent portfolio and related intellectual
property.
On June 8, 2001, the Company acquired all of the outstanding common
stock of Bea Filtri S.p.A. (Bea) for approximately $13.5 million in
cash and debt. Bea, headquartered in Milan, Italy, is a supplier of
filtration products to the pharmaceutical, food and beverage,
healthcare, and petrochemical markets. Bea broadens the Company's
microfiltration product offering and increases the Company's
penetration in European markets. Bea assets and liabilities and related
operating results since the date of acquisition are included within the
Filtration/Fluid Flow segment.
On June 2, 2000, the Company purchased all of the outstanding common
stock of Holaday for approximately $4 million in cash. Holaday is a
leading supplier of specialty measurement probes to the EMC test,
health and safety, and microwave markets. The operating results for
Holaday since the date of acquisition are included within the Test
segment. During 2002, the Company consolidated the operations of
Holaday into its new Test facility in Cedar Park, TX.
On April 9, 2000, the Company acquired all of the outstanding common
stock of Lindgren RF Enclosures, Inc. (formerly known as The Curran
Company) and Lindgren, Inc. (doing business through its subsidiary,
Rayproof Ltd.) (collectively Lindgren) for approximately $22 million in
cash. Lindgren is a leading supplier of RF shielding products and
components used by manufacturers of medical equipment, communications
systems and electronic products. The operating results for Lindgren
since the date of acquisition are included within the Test segment.
On March 31, 2000, the Company acquired the assets of the Eaton space
products business (Eaton), formerly located in El Segundo, CA, for
approximately $6 million in cash. Eaton manufactures specialty valves
and other fluid flow components for satellite launch vehicles and
aircraft applications and has been integrated into the Filtration/Fluid
Flow segment.
All of the Company's acquisitions have been accounted for using the
purchase method of accounting. The goodwill recorded as a result of the
above transactions has been tested for impairment in 2002 and no
adjustments were required.
In February 2000, the Company completed the sale of its microwave
antenna product line, which had historically operated as part of Rantec
Microwave & Electronics, Inc. The Company transferred the contract
order backlog and operating assets of the microwave antenna business
for $2.1 million in cash, and in September 2000, sold the related land
and buildings in Calabasas, CA for approximately $6 million.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
BANK CREDIT FACILITY
Effective April 5, 2002, the Company amended its existing $75 million
revolving credit facility changing the previously scheduled reductions
and extending the $25 million increase option through April 11, 2004.
The amendment calls for $5 million annual reductions to the credit
facility beginning in April 2002 with the balance due upon maturity and
expiration on April 11, 2005. As of September 30, 2002, the Company had
not exercised the $25 million increase option and the revolving line of
credit was $70 million.
The credit facility is available for direct borrowings and/or the
issuance of letters of credit, and is provided by a group of five
banks, led by Bank of America as agent. The maturity of the credit
facility is April 11, 2005. At September 30, 2002, the Company had
approximately $49.7 million available to borrow under the credit
facility in addition to $24.9 million cash on hand. Against the $70
million available under the revolving credit facility at September 30,
2002, the Company had $7.7 million of outstanding long-term foreign
borrowings related to the Bea acquisition and outstanding letters of
credit of $12.5 million related to the Company's synthetic lease
arrangement and performance guarantees.
The credit facility requires, as determined by certain financial
ratios, a commitment fee ranging from 20-30 basis points per annum on
the unused portion. The terms of the facility provide that interest on
borrowings may be calculated at a spread over the London Interbank
Offered Rate (LIBOR) or based on the prime rate, at the Company's
election. Substantially all of the assets of the Company are pledged
under the credit facility. The financial covenants of the credit
facility include limitations on leverage and minimum consolidated
EBITDA. As of September 30, 2002, the Company was in compliance with
all bank covenants.
Cash flow from operations and borrowings under the bank credit facility
are expected to provide adequate resources to meet the Company's
capital requirements and operational needs for the foreseeable future.
SHARE REPURCHASE
In February 2001, the Company authorized an open market repurchase
program of up to 1.3 million shares, which is subject to market
conditions and other factors and covers the period ending September 29,
2003. The Company repurchased 127,100, 76,700 and 516,368 shares in
2002, 2001 and 2000, respectively. In June 2000, the Company initiated
an odd lot share repurchase program which extended through September
2000 whereby the Company repurchased 24,968 shares, which are included
in the 516,368 of shares repurchased in 2000, above.
MANAGEMENT TRANSITION AGREEMENT
On August 5, 2002, the Company entered into a Management Transition
Agreement (MTA) with Dennis J. Moore, the Company's Chairman, which
provided for Mr. Moore to receive certain compensation in conjunction
with his planned retirement in April 2003 and for consulting services
after such retirement. During the fourth quarter of fiscal 2002,
approximately $0.7 million of the total cost noted below was expensed
in SG&A. The costs associated with and described in the MTA are
quantified below:
<Table>
<Caption>
(Dollars in millions)
New Restricted Shares $ 1.2(1)
Previously Awarded Restricted Shares and
Performance Shares for which vesting have been accelerated $ 1.0(1)(2)
Consulting Agreement $ 0.3(3)
------
Total $ 2.5
======
</Table>
(1) The costs of these arrangements will be recognized over the eight month
transition (i.e. service) period, from August 2002 through March 2003.
(2) These items were subject to remeasurement based on FASB Interpretation
(FIN) No. 44, "Accounting for Certain Transactions Involving Stock
Compensation (an Interpretation of APB Opinion No. 25)." The
remeasurement was based on the closing stock price on August 5, 2002,
the date on which the vesting of the shares was accelerated.
(3) The cost of the consulting agreement will be expensed over the twelve
month period from April 2003 through March 2004, consistent with the
period of service.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
20
MANAGEMENT'S DISCUSSION AND ANALYSIS
OTHER
Management believes that, for the periods presented, inflation has not
had a material effect on the Company's results of operations.
The Company is currently involved in various stages of investigation
and remediation relating to environmental matters. Based on current
information available, Management does not believe the aggregate costs
involved in the resolution of these matters will have a material
adverse effect on the Company's operating results, capital expenditures
or competitive position.
The Company continues to explore consolidation opportunities within its
existing businesses that could improve future operating earnings and
enhance the Company's competitive position. In addition, the Company
continues to explore possible divestitures of certain of its non-core
businesses.
- --------------------------------------------------------------------------------
MARKET RISK ANALYSIS
MARKET RISK EXPOSURE
Market risks relating to the Company's operations result primarily from
changes in interest rates and changes in foreign currency exchange
rates. The Company had interest rate exposure relating to floating rate
lease obligations and, accordingly, the Company entered into interest
rate swaps covering approximately $32 million to mitigate this
exposure. These interest rate swaps relate to operating lease
obligations under the Company's synthetic lease facility, and have been
arranged by Bank of America and Wells Fargo Bank. The interest rate
swaps effectively fix the interest rates on the underlying lease
obligations at a weighted average rate of 6.47%. These lease
obligations and their related interest rate swaps expire on December
29, 2005. In addition, the Company had interest rate exposure of
approximately $8.4 million relating to floating rate obligations
denominated in Euros. Therefore, the Company entered into an interest
rate swap of approximately $4.6 million to mitigate this exposure which
effectively fixed the interest rate on these floating rate obligations
at 4.89%. These Euro obligations consist of borrowings under the
Company's $70 million credit facility and mature on April 11, 2005
along with the related interest rate swap. These swaps are accounted
for as cash flow hedges under the provisions of SFAS 133, "Accounting
for Derivative Instruments and Hedging Activities, as amended by SFAS
138." For the year ended September 30, 2002, accumulated other
comprehensive loss included an after tax decrease in fair value of
approximately $1.0 million related to the interest rate swaps.
The following table provides further detail about the Company's
interest rate swaps outstanding at September 30, 2002:
<Table>
<Caption>
Amounts scheduled for maturity Estimated fair value at
as of December 29, 2005 September 30, 2002
------------------------------- ------------------------
Interest Rate Swaps (related to
synthetic lease facility)
Variable to fixed:
Notional value (in millions) $ 31.5 $ (2.8)
Average pay rate (excludes spread) 5.4%
==================== ====================
</Table>
<Table>
<Caption>
Amounts scheduled for maturity Estimated fair value at
as of April 11, 2005 September 30, 2002
------------------------------- ------------------------
Interest Rate Swaps
(related to Euro debt)
Variable to fixed:
Notional value (in millions) $ 4.6 $ (0.1)
Average pay rate (excludes spread) 4.1%
==================== ====================
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
21
MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company is also subject to foreign currency exchange rate risk
inherent in its sales commitments, anticipated sales, anticipated
purchases and assets and liabilities denominated in currencies other
than the U.S. dollar. The currency most significant to the Company's
operations is the Euro. The Company hedges certain foreign currency
commitments by purchasing foreign currency forward contracts. The
estimated fair value of open forward contracts at September 30, 2002 is
not material.
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP
requires Management to make estimates and assumptions in certain
circumstances that affect amounts reported in the accompanying
consolidated financial statements. In preparing these financial
statements, Management has made its best estimates and judgments of
certain amounts included in the financial statements, giving due
consideration to materiality. The Company does not believe there is a
great likelihood that materially different amounts would be reported
under different conditions or using different assumptions related to
the accounting policies described below. However, application of these
accounting policies involves the exercise of judgment and use of
assumptions as to future uncertainties and, as a result, actual results
could differ from these estimates. The Company's senior Management
discusses the critical accounting policies described below with the
Audit Committee of the Company's Board of Directors on an annual basis.
The following discussion of critical accounting policies is intended to
bring to the attention of readers those accounting policies which
Management believes are critical to the Consolidated Financial
Statements and other financial disclosure. It is not intended to be a
comprehensive list of all significant accounting policies that are more
fully described in Note 1 of Notes to Consolidated Financial
Statements.
REVENUE RECOGNITION
The majority of the Company's revenues are recognized when products are
shipped to or when services are performed for unaffiliated customers.
Other revenue recognition methods the Company uses include the
following: revenue on production contracts is recorded when specific
contract terms are fulfilled, usually by delivery or acceptance;
revenue from cost reimbursement contracts is recorded as costs are
incurred, plus fees earned; revenue under long-term contracts, for
which delivery is an inappropriate measure of performance, is
recognized on the percentage-of-completion method based upon incurred
costs compared to total estimated costs under the contract; and revenue
under engineering contracts is generally recognized as milestones are
attained. The SEC's Staff Accounting Bulletin (SAB) No. 101, "Revenue
Recognition" provides guidance on the application of generally accepted
accounting principles to selected revenue recognition issues.
Management believes the Company's revenue recognition policy is in
accordance with GAAP and SAB No. 101.
ACCOUNTS RECEIVABLE
Accounts receivable have been reduced by an allowance for amounts that
may become uncollectible in the future. This estimated allowance is
based primarily on Management's evaluation of the financial condition
of the customer and historical bad debt experience.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
22
MANAGEMENT'S DISCUSSION AND ANALYSIS
INVENTORY
Inventories are valued at the lower of cost (first-in, first-out) or
market value and have been reduced by an allowance for excess,
slow-moving and obsolete inventories. The estimated allowance is based
on Management's review of inventories on hand compared to historical
usage and estimated future usage and sales. Inventories under long-term
contracts reflect accumulated production costs, factory overhead,
initial tooling and other related costs less the portion of such costs
charged to cost of sales and any unliquidated progress payments. In
accordance with industry practice, costs incurred on contracts in
progress include amounts relating to programs having production cycles
longer than one year, and a portion thereof may not be realized within
one year.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities 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. Deferred tax assets may be reduced by a valuation allowance
if it is more likely than not that some portion of all of the deferred
tax assets will not be realized. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. The Company regularly reviews
its deferred tax assets for recoverability and establishes a valuation
allowance when Management believes it is more likely than not such
assets will not be recovered, taking into consideration historical
operating results, expectations of future earnings, tax planning
strategies, and the expected timing of the reversals of existing
temporary differences.
GOODWILL AND OTHER LONG-LIVED ASSETS
The Company adopted the provisions of SFAS 142 effective October 1,
2001. Goodwill and other long-lived assets with indefinite useful lives
are reviewed by Management for impairment annually or whenever events
or changes in circumstances indicate the carrying amount may not be
recoverable. If indicators of impairment are present, the determination
of the amount of impairment is based on Management's judgment as to the
future operating cash flows to be generated from these assets
throughout their estimated useful lives. SFAS 142 also requires that
intangible assets with estimable useful lives be amortized over their
respective estimated useful lives to their estimated residual values,
and reviewed for impairment in accordance with SFAS 121.
PENSION PLANS AND OTHER POSTRETIREMENT BENEFIT PLANS
The measurement of liabilities related to pension plans and other
post-retirement benefit plans is based on Management's assumptions
related to future events including interest rates, return on pension
plan assets, rate of compensation increases, and health care cost trend
rates. Actual pension plan asset performance will either decrease or
increase unamortized pension losses which will affect net earnings in
future years.
CONTINGENCIES
As a normal incident of the businesses in which the Company is engaged,
various claims, charges and litigation are asserted or commenced
against the Company. In the opinion of Management, final judgments, if
any, which might be rendered against the Company in current litigation
are adequately reserved, covered by insurance, or would not have a
material adverse effect on its financial statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS 143, "Accounting for Asset
Retirement Obligations, "which addresses the financial accounting and
reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. In August
2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets, "which addresses the financial
accounting and reporting for the impairment or disposal of long-lived
assets and the reporting of discontinued operations. The Company does
not believe adoption of these Standards will have a material impact on
the Company's financial statements.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement requires
that a liability for costs associated with an exit or disposal activity
be recognized and measured initially at fair value only when the
liability is incurred. The provisions of this Statement are effective
for exit or disposal activities that are initiated after December 31,
2002.
FORWARD - LOOKING INFORMATION
The statements contained in the Letter to Shareholders (pgs. 1-2), the
business summaries (pgs. 3-9), and Management's Discussion and Analysis
contain forward-looking statements regarding future events and the
Company's future results that are based on current expectations,
estimates, forecasts, and projections about the industries in which the
Company operates and the beliefs and assumptions of Management. Words
such as expects, anticipates, targets, goals, projects, intends, plans,
believes, estimates, variations of such words, and similar expressions
are intended to identify such forward-looking statements. Investors are
cautioned that such statements are only predictions, and speak only as
of the date of this report. The Company's actual results in the future
may differ materially from those projected in the forward-looking
statements due to risks and uncertainties that exist in the Company's
operations and business environment including, but not limited to:
further weakening of economic conditions in served markets; changes in
customer demands or customer insolvencies; competition; intellectual
property rights; consolidation of internal operations; integration of
recently acquired businesses; delivery delays or defaults by customers;
performance issues with key suppliers and subcontractors; collective
bargaining and labor disputes; changes in laws and regulations;
litigation uncertainty; and the Company's successful execution of
internal operating plans.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
24
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
Years ended September 30,
(Dollars in thousands, except per share amounts) 2002 2001 2000
---------- ---------- ----------
Net sales $ 367,525 344,904 300,157
Costs and expenses:
Cost of sales 248,512 236,526 208,263
Selling, general and administrative expenses 82,329 71,537 61,819
Interest expense, net 293 130 359
Other, net 1,762 9,438 7,969
Gain on sale of properties -- -- (2,989)
---------- ---------- ----------
Total costs and expenses 332,896 317,631 275,421
---------- ---------- ----------
Earnings before income tax 34,629 27,273 24,736
Income tax expense (benefit) 12,848 (2,834) 7,917
---------- ---------- ----------
Net earnings $ 21,781 30,107 16,819
========== ========== ==========
Earnings per share:
Net earnings:
Basic $ 1.74 2.43 1.37
Diluted 1.67 2.35 1.33
---------- ---------- ----------
Average common shares outstanding (in thousands):
Basic 12,511 12,382 12,307
Diluted 13,022 12,805 12,668
========== ========== ==========
</Table>
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
25
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
As of September 30,
(Dollars in thousands) 2002 2001
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 24,930 14,506
Accounts receivable, less allowance for doubtful accounts of $1,100
and $1,382 in 2002 and 2001,respectively 69,496 61,351
Costs and estimated earnings on long-term contracts, less progress
billings of $4,541 and $21,913 in 2002 and 2001,respectively 2,951 6,637
Inventories 52,579 48,167
Current portion of deferred tax assets 22,782 15,278
Other current assets 8,650 5,491
---------- ----------
Total current assets 181,388 151,430
---------- ----------
PROPERTY, PLANT AND EQUIPMENT:
Land and land improvements 2,570 2,561
Buildings and leasehold improvements 31,085 29,470
Machinery and equipment 82,466 71,289
Construction in progress 4,984 4,620
---------- ----------
121,105 107,940
Less accumulated depreciation and amortization 52,583 42,902
---------- ----------
Net property, plant and equipment 68,522 65,038
Goodwill 103,283 102,163
Deferred tax assets 26,950 38,573
Other assets 27,545 18,373
---------- ----------
$ 407,688 375,577
========== ==========
</Table>
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
26
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
As of September 30,
(Dollars in thousands) 2002 2001
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current maturities of long-term debt $ 121 122
Accounts payable 39,051 35,180
Advance payments on long-term contracts, less costs incurred
of $3,794 and $809 in 2002 and 2001,respectively 2,770 1,534
Accrued expenses 26,845 27,233
---------- ----------
Total current liabilities 68,787 64,069
---------- ----------
Other liabilities 24,313 15,890
Long-term debt 8,277 8,338
---------- ----------
Total liabilities 101,377 88,297
---------- ----------
Commitments and contingencies -- --
SHAREHOLDERS' EQUITY:
Preferred stock, par value $.01 per share, authorized 10,000,000 shares -- --
Common stock, par value $.01 per share, authorized 50,000,000 shares;
Issued 13,601,095 and 13,409,934 shares in 2002 and 2001,respectively 136 134
Additional paid-in capital 209,402 206,282
Retained earnings since elimination of deficit at September 30,1993 121,430 99,649
Accumulated other comprehensive loss (9,473) (6,518)
---------- ----------
321,495 299,547
Less treasury stock, at cost (1,067,046 and 985,469 common shares in
2002 and 2001,respectively) (15,184) (12,267)
---------- ----------
Total shareholders' equity 306,311 287,280
---------- ----------
$ 407,688 375,577
========== ==========
</Table>
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
27
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<Table>
<Caption>
Accumulated
Years ended September 30, Common Stock Additional Other
(Dollars in thousands, -------------------------- Paid-In Retained Comprehensive
except per share amounts) Shares Amount Capital Earnings Income (Loss)
------------ ------------ ------------ ------------ ------------
Balance, September 30,1999 12,783 $ 128 201,719 52,723 (1,870)
Comprehensive income:
Net earnings -- -- -- 16,819 --
Translation adjustments -- -- -- -- (2,896)
Comprehensive income -- -- -- -- --
Stock options and stock
compensation plans 442 4 3,795 -- --
Purchases into treasury -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balance, September 30,2000 13,225 132 205,514 69,542 (4,766)
Comprehensive income:
Net earnings -- -- -- 30,107 --
Translation adjustments -- -- -- -- (209)
Minimum pension liability, net -- -- -- -- (639)
Interest rate swap adjustment, net -- -- -- -- (904)
Comprehensive income -- -- -- -- --
Stock options and stock
compensation plans 185 2 768 -- --
Purchases into treasury -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balance, September 30,2001 13,410 134 206,282 99,649 (6,518)
Comprehensive income:
Net earnings -- -- -- 21,781 --
Translation adjustments -- -- -- -- 782
Minimum pension liability, net -- -- -- -- (2,745)
Interest rate swap adjustment, net -- -- -- -- (992)
Comprehensive income -- -- -- -- --
Stock options and stock
compensation plans 191 2 3,120 -- --
Purchases into treasury -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balance, September 30,2002 13,601 $ 136 209,402 121,430 (9,473)
============ ============ ============ ============ ============
<Caption>
Years ended September 30,
(Dollars in thousands, Treasury
except per share amounts) Stock Total
------------ ------------
Balance, September 30,1999 (4,011) 248,689
Comprehensive income:
Net earnings -- 16,819
Translation adjustments -- (2,896)
Comprehensive income -- 13,923
------------
Stock options and stock
compensation plans 59 3,858
Purchases into treasury (7,048) (7,048)
------------ ------------
Balance, September 30,2000 (11,000) 259,422
------------
Comprehensive income:
Net earnings -- 30,107
Translation adjustments -- (209)
Minimum pension liability, net -- (639)
Interest rate swap adjustment, net -- (904)
------------
Comprehensive income -- 28,355
------------
Stock options and stock
compensation plans 414 1,184
Purchases into treasury (1,681) (1,681)
------------ ------------
Balance, September 30,2001 (12,267) 287,280
------------
Comprehensive income:
Net earnings -- 21,781
Translation adjustments -- 782
Minimum pension liability, net -- (2,745)
Interest rate swap adjustment, net -- (992)
------------
Comprehensive income -- 18,826
------------
Stock options and stock
compensation plans 521 3,643
Purchases into treasury (3,438) (3,438)
------------ ------------
Balance, September 30,2002 (15,184) 306,311
============ ============
</Table>
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
28
CONSOLIDATED STATEMENTS OF CASH FLOW
<Table>
<Caption>
Years ended September 30,
(Dollars in thousands, except per share amounts) 2002 2001 2000
------------ ------------ ------------
Cash flows from operating activities:
Net earnings $ 21,781 30,107 16,819
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 12,377 15,100 14,185
Changes in operating working capital (8,311) (9,441) (20,532)
Effect of deferred taxes on tax provision 7,238 (5,774) 6,270
Other 1,931 2,994 3,259
------------ ------------ ------------
Net cash provided by operating activities 35,016 32,986 20,001
------------ ------------ ------------
Cash flows from investing activities:
Capital expenditures (13,179) (11,881) (10,363)
Acquisition of businesses and technology rights (9,546) (13,559) (29,996)
------------ ------------ ------------
Net cash used by investing activities (22,725) (25,440) (40,359)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from long-term debt 453 7,356 80
Principal payments on long-term debt (505) (740) (49,322)
Net decrease in short-term borrowings (12) (3,988) (8,506)
Purchases of common stock into treasury (3,438) (1,681) (6,215)
Other, including exercise of stock options 1,635 393 2,232
------------ ------------ ------------
Net cash (used) provided by financing activities (1,867) 1,340 (61,731)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 10,424 8,886 (82,089)
Cash and cash equivalents at beginning of year 14,506 5,620 87,709
------------ ------------ ------------
Cash and cash equivalents at end of year $ 24,930 14,506 5,620
============ ============ ============
Changes in operating working capital:
Accounts receivable, net $ (8,145) 1,632 (10,907)
Costs and estimated earnings on long-term contracts, net 3,686 (497) (2,122)
Inventories (4,412) (1,650) 1,553
Other current assets and current portion of deferred tax assets (3,159) (10,665) 859
Accounts payable 3,871 1,174 (704)
Advance payments on long-term contracts, net 1,236 (1,369) 2,221
Accrued expenses (1,388) 1,934 (11,432)
------------ ------------ ------------
$ (8,311) (9,441) (20,532)
============ ============ ============
Supplemental cash flow information:
Interest paid $ 521 425 867
Income taxes paid (including state, foreign & AMT) 4,076 4,106 1,132
============ ============ ============
</Table>
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1 o SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of ESCO
Technologies Inc. (ESCO) and its wholly owned subsidiaries (the
Company). All significant intercompany transactions and accounts have
been eliminated in consolidation. Certain prior year amounts have been
reclassified to conform with the 2002 presentation. Effective July
10,2000, the Company changed its name from ESCO Electronics Corporation
to ESCO Technologies Inc.
(b) BASIS OF PRESENTATION
Effective September 30,1993,the Company implemented an accounting
readjustment in accordance with the accounting provisions applicable to
a "quasireorganization" which restated assets and liabilities to fair
values and eliminated the deficit in retained earnings.
Fair values of the Company's financial instruments are estimated by
reference to quoted prices from market sources and financial
institutions, as well as other valuation techniques. The estimated fair
value of each class of financial instruments approximated the related
carrying value at September 30,2002 and 2001.
(c) NATURE OF OPERATIONS
The Company is a leading supplier of engineered filtration products to
the process, health care and transportation markets worldwide. The
Company's filtration products include depth filters, membrane based
microfiltration products and precision screen filters. The balance of
the Company's sales is derived primarily from special purpose
communication systems including automatic meter reading, where the
Company is well positioned in niche markets based on proprietary
products, and radio frequency (RF) shielding and EMC test products.
The Company operates in four industry segments: Filtration/Fluid Flow,
Communications, Test and Other.
(d) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America (GAAP)
requires management to make estimates and assumptions, including
estimates of anticipated contract costs and revenues utilized in the
earnings process, that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
(e) REVENUE RECOGNITION
The majority of the Company's revenues are recognized when products are
shipped to or when services are performed for unaffiliated customers.
Other revenue recognition methods the Company uses include the
following: revenue on production contracts is recorded when specific
contract terms are fulfilled, usually by delivery or acceptance;
revenue from cost reimbursement contracts is recorded as costs are
incurred, plus fees earned; revenue under long-term contracts, for
which delivery is an inappropriate measure of performance, is
recognized on the percentage-of-completion method based upon incurred
costs compared to total estimated costs under the contract; and revenue
under engineering contracts is generally recognized as milestones are
attained. The SEC's Staff Accounting Bulletin (SAB) No. 101,"Revenue
Recognition" provides guidance on the application of generally accepted
accounting principles to selected revenue recognition issues.
Management believes the Company's revenue recognition policy is in
accordance with GAAP and SAB No. 101.
(f) CASH AND CASH EQUIVALENTS
Cash equivalents include temporary investments that are readily
convertible into cash, such as Euro dollars, commercial paper and
treasury bills with original maturities of three months or less.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(g) ACCOUNTS RECEIVABLE
Accounts receivable have been reduced by an allowance for amounts that
may become uncollectible in the future. This estimated allowance is
based primarily on Management's evaluation of the financial condition
of the customer and historical bad debt experience.
(h) COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS
Costs and estimated earnings on long-term contracts represent unbilled
revenues, including accrued profits, accounted for under the
percentage-of-completion method, net of progress billings.
(i) INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or
market value and have been reduced by an allowance for excess,
slow-moving and obsolete inventories. This estimated allowance is based
on Management's review of inventories on hand compared to historical
usage and estimated future usage and sales. Inventories under long-term
contracts reflect accumulated production costs, factory overhead,
initial tooling and other related costs less the portion of such costs
charged to cost of sales and any unliquidated progress payments. In
accordance with industry practice, costs incurred on contracts in
progress include amounts relating to programs having production cycles
longer than one year, and a portion thereof will not be realized within
one year.
(j) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation and
amortization are computed primarily on a straight-line basis over the
estimated useful lives of the assets: buildings, 10-40 years; machinery
and equipment, 5-10 years; and office furniture and equipment, 5-10
years. Leasehold improvements are amortized over the remaining term of
the applicable lease or their estimated useful lives, whichever is
shorter.
(k) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of purchase costs over the fair value of
net identifiable assets acquired in business acquisitions. The Company
accounts for goodwill as required by Statement of Financial Accounting
Standards (SFAS) 142, "Goodwill and Other Intangible Assets." Under
SFAS 142, purchased goodwill and other intangible assets with
indefinite useful lives are no longer amortized, and are reviewed by
Management for impairment annually or whenever events or changes in
circumstances indicate the carrying amount may not be recoverable. If
indicators of impairment are present, the determination of the amount
of impairment is based on Management's judgment of the discounted
future operating cash flows to be generated from these assets
throughout their estimated useful lives. On October 1, 2001, the date
SFAS 142 was adopted, the Company performed impairment tests of its
goodwill and other intangible assets and determined that no impairment
existed. Prior to fiscal 2002,goodwill was amortized over periods
ranging in periods from 20-30 years. Other intangible assets represent
costs allocated to identifiable intangible assets, principally patents
and technology rights. See Note 2 below regarding goodwill and other
intangible assets activity.
(l) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE
DISPOSED OF
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net discounted
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 exceeds 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 dispose.
(m) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities 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. Deferred tax assets may be reduced by a valuation allowance
if it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The effect on deferred tax assets and
liabilities of a change
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in tax rates is recognized in income in the period that includes the
enactment date. The Company regularly reviews its deferred tax assets
for recoverability and establishes a valuation allowance when
Management believes it is more likely than not such assets will not be
recovered, taking into consideration historical operating results,
expectations of future earnings, tax planning strategies, and the
expected timing of the reversals of existing temporary differences.
(n) RESEARCH AND DEVELOPMENT COSTS
Company-sponsored research and development costs include research and
development and bid and proposal efforts related to the Company's
products and services. Company-sponsored product development costs are
charged to expense when incurred. Customer-sponsored research and
development costs incurred pursuant to contracts are accounted for
similar to other program costs. Customer-sponsored research and
development costs refer to certain situations whereby customers provide
funding to support specific contractually defined research and
development costs. As the Company incurs costs under these specific
funding contracts, the costs are "inventoried" until billed to the
customer for reimbursement, consistent with other program costs. Once
billed/invoiced, these costs are transferred to accounts receivable
until the cash is received from the customer. All research and
development costs incurred in excess of the contractual funding amount,
or costs incurred outside the scope of the contractual research and
development project, are expensed as incurred.
(o) FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign operations are
translated into U.S. dollars in accordance with SFAS 52 "Foreign
Currency Translation" (SFAS 52). The resulting translation adjustments
are recorded as a separate component of accumulated other comprehensive
income.
(p) EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted average
number of common shares outstanding during the period. Diluted earnings
per share is calculated using the weighted average number of common
shares outstanding during the period plus shares issuable upon the
assumed exercise of dilutive common share options and vesting of
performance shares by using the treasury stock method.
The number of shares used in the calculation of earnings per share for
each year presented is as follows:
<Table>
<Caption>
(In thousands) 2002 2001 2000
------------ ------------ ------------
Weighted Average Shares Outstanding--Basic 12,511 12,382 12,307
Dilutive Options and Performance Shares 511 423 361
------------ ------------ ------------
Adjusted Shares--Diluted 13,022 12,805 12,668
============ ============ ============
</Table>
Options to purchase 34,000 shares (at a per share price of $35.93),
12,500 shares (at per share prices of $25.18 - $27.28) and 95,500
shares (at per share prices of $15.72 - $19.22) were outstanding during
the years ended September 30, 2002, 2001 and 2000, respectively, but
were not included in the respective computations of diluted EPS because
the options' exercise price was greater than the average market price
of the common shares. These options expire in various periods through
2012. Approximately 91,000, 181,000 and zero performance shares were
outstanding but unearned at September 30, 2002, 2001 and 2000,
respectively, and, therefore, were not included in the respective
years' computations of diluted EPS.
(q) STOCK-BASED COMPENSATION
The Company measures its compensation cost of equity instruments issued
under employee compensation plans under the provisions of Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued
to Employees," and related Interpretations.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(r) COMPREHENSIVE INCOME (LOSS)
SFAS 130, "Reporting Comprehensive Income" requires the Company to
report separately the translation adjustments of SFAS 52 defined above,
changes to the minimum pension liability, and changes in fair value of
the Company's interest rate swaps designated as a cash flow hedge, as
components of comprehensive income or loss. Management has chosen to
disclose the requirements of this Statement within the Consolidated
Statements of Shareholders' Equity.
(s) ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended by SFAS 138 requires that all derivative
instruments be recorded on the balance sheet at their fair value. The
accounting treatment of changes in fair value is dependent upon whether
or not a derivative instrument is designated as a hedge and if so, the
type of hedge. For derivatives designated as a fair value hedge, the
changes in fair value are recognized in other comprehensive income
until the hedged item is settled and recognized in earnings. The
Company has interest rate exposure relating to floating rate lease
obligations and, accordingly, during 2002 and 2001, entered into
interest rate swaps totaling approximately $8 million and $23 million
to mitigate this exposure, respectively. In addition, the Company has
interest rate exposure relating to floating rate obligations
denominated in Euros, therefore, as of September 30, 2002, $4.6 million
of this debt is hedged by a fixed interest rate swap entered into
during fiscal 2001. These interest rate swaps are accounted for as cash
flow hedges under the provisions of SFAS 133 as of and for the year
ended September 30, 2002. At September 30, 2002, other comprehensive
income included an after-tax decline in fair value of approximately
$1.0 million.
(t) NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS 143, "Accounting for Asset Retirement Obligations," which
addresses the financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. In August 2001, the FASB issued SFAS
144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
which addresses the financial accounting and reporting for the
impairment or disposal of long-lived assets and the reporting of
discontinued operations. The Company does not believe adoption of these
Standards will have a material impact on the Company's financial
statements.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement requires
that a liability for a cost associated with an exit or disposal
activity be recognized and measured initially at fair value only when
the liability is incurred. The provisions of this Statement are
effective for exit or disposal activities that are initiated after
December 31, 2002.
2 o GOODWILL AND OTHER INTANGIBLE ASSETS
Management adopted the provisions of SFAS 142, "Goodwill and Other
Intangible Assets" effective October 1, 2001, the beginning of the
Company's fiscal year 2002. SFAS 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized,
but instead tested for impairment at least annually in accordance with
the provisions of SFAS 142. SFAS 142 also requires that intangible
assets with definite useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed
for impairment in accordance with SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of." In addition, to the extent an intangible asset is
identified as having an indefinite useful life, the Company is required
to test the intangible asset for impairment in accordance with the
provisions of SFAS 142. No impairment loss was recorded upon adoption
of SFAS 142.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Included on the Company's Consolidated Balance Sheet at September 30,
2002 and 2001 are the following intangible assets gross carrying
amounts and accumulated amortization:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Goodwill:
Gross carrying amount $ 116.0 114.9
Less: accumulated amortization 12.7 12.7
---------- ----------
Net 103.3 102.2
---------- ----------
Intangible assets with determinable lives: (included in Other Assets)
Patents
Gross carrying amount 16.2 15.7
Less: accumulated amortization 10.1 9.1
---------- ----------
Net 6.1 6.6
---------- ----------
Other (including acquired technology rights)
Gross carrying amount 14.9 2.7
Less: accumulated amortization 1.3 0.7
---------- ----------
Net $ 13.6 2.0
========== ==========
</Table>
At September 30, 2002, the net goodwill balance of $103.3 million is
comprised of $75.6 million and $27.7 million related to the
Filtration/Fluid Flow and Test segments, respectively.
Technology rights, net, of $10.9 million, included in Other assets,
consist of the acquired intellectual property from SRT in 2002 which is
being amortized over 15 years, consistent with the remaining life of
the patent portfolio and related intellectual property.
Amortization expense related to intangible assets with determinable
lives was $1.6 million and $1.4 million in 2002 and 2001, respectively.
Estimated intangible assets amortization for each of the subsequent
five fiscal years is estimated at $1.6 million per year.
The following table presents a reconciliation of net earnings for the
fiscal years ended September 30, 2001 and 2000, to reflect the removal
of goodwill amortization in accordance with SFAS 142, to be used for
comparison purposes with the fiscal year ended September 30, 2002:
<Table>
<Caption>
(Dollars in thousands, except per share amounts) 2002 2001 2000
------------------------------------------------ ---------- ---------- ----------
Reported net earnings $ 21,781 30,107 16,819
Add back: Goodwill amortization, net of tax -- 2,584 1,986
---------- ---------- ----------
Adjusted net earnings $ 21,781 32,691 18,805
---------- ---------- ----------
Earnings per share--Basic:
As Reported $ 1.74 2.43 1.37
Goodwill amortization -- 0.21 0.16
---------- ---------- ----------
Adjusted $ 1.74 2.64 1.53
---------- ---------- ----------
Earnings per share--Diluted:
As Reported $ 1.67 2.35 1.33
Goodwill amortization -- 0.20 0.15
---------- ---------- ----------
Adjusted $ 1.67 2.55 1.48
========== ========== ==========
</Table>
Note: 2001 includes the tax gain related to the elimination of the
valuation allowance of $12.7 million, or $0.99 per share. 2000 includes
the after-tax gains on the sale of properties of $2.7 million or $0.22
per share.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3 o ACQUISITIONS/DIVESTITURES
In March 2002, the Company acquired the exclusive rights to the patent
portfolio and related intellectual property of North Carolina
Separations Research Technology Inc. and its affiliate (SRT), a
manufacturer of cross-flow filtration and separation modules and
equipment. The Company also acquired certain production assets and
inventory of SRT. The purchase price was $11.5 million of which the
Company paid $9.5 million at closing and will pay future consideration
of $1 million in March 2003 and $1 million in March 2004. Additionally,
the Company will be obligated to pay consideration, primarily in the
form of royalties, based on certain future product sales and the grant
of sublicenses generated as a result of the acquired rights in the
patent portfolio. SRT sales of products utilizing the technologies
acquired were approximately $3 million in calendar 2001. Since the date
of acquisition, sales for SRT were $1.1 million in fiscal 2002. The
intellectual property rights and related assets of SRT are included
within the Company's Filtration/Fluid Flow segment. The intellectual
property is being amortized over a period of fifteen years, consistent
with the remaining life of the patent portfolio and related
intellectual property.
On June 8, 2001, the Company acquired all of the outstanding common
stock of Bea Filtri S.p.A. (Bea) for approximately $13.5 million in
cash and debt. Bea, headquartered in Milan, Italy, is a supplier of
filtration products to the pharmaceutical, food and beverage,
healthcare, and petrochemical markets. Bea broadens the Company's
microfiltration product offering and increases the Company's
penetration in European markets. Bea's assets and liabilities and
related operating results since the date of acquisition are included
within the Company's Filtration/Fluid Flow segment.
On June 2, 2000, the Company purchased all of the outstanding common
stock of Holaday Industries, Inc. (Holaday) for approximately $4
million in cash. Holaday is a leading supplier of specialty measurement
probes to the EMC test, health and safety, and microwave markets. The
operating results for Holaday since the date of acquisition are
included within the Company's Test segment. During 2002, the Company
consolidated the operations of Holaday into its new Test facility in
Cedar Park, TX.
On April 9, 2000, the Company acquired all of the outstanding common
stock of Lindgren RF Enclosures, Inc. (formerly known as The Curran
Company) and Lindgren, Inc. (doing business through its subsidiary,
Rayproof Ltd.) (collectively Lindgren) for approximately $22 million in
cash. Lindgren is a leading supplier of radio frequency (RF) shielding
products and components used by manufacturers of medical equipment,
communications systems and electronic products. The operating results
for Lindgren since the date of acquisition are included within the
Company's Test segment.
On March 31, 2000, the Company acquired the assets of the Eaton space
products business (Eaton), formerly located in El Segundo, CA, for
approximately $6 million in cash. Eaton manufactures specialty valves
and other fluid flow components for satellite launch vehicles and
aircraft applications and has been integrated into the Company's
Filtration/Fluid Flow segment.
In February 2000, the Company completed the sale of its microwave
antenna business, which had historically operated as part of Rantec
Microwave & Electronics, Inc. The Company transferred the contract
order backlog and operating assets of the microwave antenna business
for $2.1 million in cash, and in September 2000, sold the related land
and buildings in Calabasas, CA for approximately $6 million.
Assuming the acquisitions of Holaday, Lindgren and Eaton had occurred
on October 1, 1999, (the beginning of fiscal 2000 which includes
goodwill amortization and non-recurring gains mentioned earlier), pro
forma unaudited net sales, net earnings and diluted EPS for the year
ended September 30, 2000 would have been approximately $327 million,
$17.3 million and $1.37 per share, respectively. These unaudited pro
forma amounts are not necessarily indicative of the results of
operations that would have occurred had these actions been completed on
October 1, 1999, or of future results of operations.
All of the Company's acquisitions have been accounted for using the
purchase method of accounting and accordingly, the respective purchase
prices were allocated to the assets (including intangible assets)
acquired and liabilities assumed based on estimated fair values at the
date of acquisition. The financial results from these acquisitions have
been included in the Company's financial statements from the date of
acquisition.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4 o ACCOUNTS RECEIVABLE
Accounts receivable consist of the following at September 30, 2002 and
2001:
<Table>
<Caption>
(Dollars in thousands) 2002 2001
---------------------- ---------- ----------
Commercial $ 65,939 57,513
U. S. Government and prime contractors 3,557 3,838
---------- ----------
Total $ 69,496 61,351
========== ==========
</Table>
The increase in accounts receivable at September 30, 2002 of
approximately $8.1 million is primarily due to a $7.6 million increase
in the Communications segment as a result of the contract received from
PPL Electric Utilities Corporation (PPL). Approximately $1.0 million of
accounts receivable at September 30, 2002 represents amounts due under
long-term contracts related to retainage provisions, which are due
after one year.
5 o INVENTORIES
Inventories consist of the following at September 30, 2002 and 2001:
<Table>
<Caption>
(Dollars in thousands) 2002 2001
---------------------- ---------- ----------
Finished goods $ 12,232 12,065
Work in process -- including long-term contracts 13,439 13,935
Raw materials 26,908 22,167
---------- ----------
Total $ 52,579 48,167
========== ==========
</Table>
The increase in raw materials inventories at September 30, 2002 of
approximately $4.7 million is mainly due to a $2.8 million increase in
the Communications segment inventories which is related to the ramp-up
of the PPL contract.
6 o PROPERTY, PLANT AND EQUIPMENT
Depreciation expense of property, plant and equipment for the years
ended September 30, 2002, 2001 and 2000 was $10.8 million, $10.3
million and $10.3 million, respectively.
The Company has a $31.5 million obligation under a synthetic lease
facility arranged by Bank of America. For GAAP purposes, this is
accounted for as an operating lease. This obligation is secured by
three manufacturing locations, two of which are located in Oxnard, CA
and the other in Cedar Park, TX, as well as a $10.6 million letter of
credit issued under the Company's $70 million credit facility. The
leases expire on December 29, 2005 at which time the Company will be
required to extend the leases on terms to be negotiated, purchase the
properties for $31.5 million, or refinance the obligation.
The Company leases certain real property, equipment and machinery under
noncancelable operating leases, which include the synthetic lease
facility. Rental expense under these operating leases for the years
ended September 30, 2002, 2001 and 2000 was $7.1 million, $6.8 million
and $5.0 million, respectively. Future aggregate minimum lease
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
payments under operating leases that have initial or remaining
noncancelable lease terms in excess of one year as of September 30,
2002 are:
<Table>
<Caption>
(Dollars in thousands) Years ending September 30:
-------------------------------------------------
2003 $ 6,303
2004 6,405
2005 5,554
2006 4,279
2007 and thereafter 5,457
-------
Total $27,998
=======
</Table>
7 o INCOME TAX EXPENSE
For the year ended September 30, 2002, pre-tax earnings related to
United States (U.S.) and foreign tax jurisdictions were $27.2 million
and $7.4 million, respectively. For the year ended September 30, 2001,
pre-tax earnings related to U.S. and foreign tax jurisdictions were
$21.7 million and $5.6 million, respectively. Fiscal 2000 pre-tax
earnings related to foreign tax jurisdictions were not material. The
principal components of income tax expense for the years ended
September 30, 2002, 2001 and 2000 consist of:
<Table>
<Caption>
(Dollars in thousands) 2002 2001 2000
---------------------- ---------- ---------- ----------
Federal:
Current (including Alternative Minimum Tax) $ 1,038 413 275
Deferred (including elimination of valuation allowance in 2001) 6,895 (5,669) 6,270
State and local:
Current 2,872 1,229 788
Deferred (153) -- --
Foreign:
Current 1,700 1,298 584
Deferred 496 (105) --
---------- ---------- ----------
Total $ 12,848 (2,834) 7,917
========== ========== ==========
</Table>
The actual income tax expense for the years ended September 30, 2002,
2001 and 2000 differs from the expected tax expense for those years
(computed by applying the U.S. Federal corporate statutory rate) as
follows:
<Table>
<Caption>
2002 2001 2000
---------- ---------- ----------
Federal corporate statutory rate 35.0% 35.0% 35.0%
Change in tax valuation allowance:
Utilization of capital loss carryforward -- (2.5) (4.3)
Elimination of valuation allowance -- (46.5) --
Other -- -- (3.2)
State and local, net of Federal benefits 3.7 4.2 2.0
Foreign (3.3) (2.8) .5
Other, net 1.7 2.2 2.0
---------- ---------- ----------
Effective income tax rate 37.1% (10.4)% 32.0%
========== ========== ==========
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at September 30,
2002 and 2001 are presented below:
<Table>
<Caption>
(Dollars in thousands) 2002 2001
---------------------- ---------- ----------
Deferred tax assets:
Inventories, long-term contract accounting,
contract cost reserves and others $ 7,163 4,243
Pension and other postretirement benefits 5,031 3,535
Net operating loss carryforward 36,813 45,361
Other compensation-related costs and other cost accruals 7,992 5,801
---------- ----------
Total deferred tax assets 56,999 58,940
Deferred tax liabilities:
Plant and equipment, depreciation methods,
acquisition asset allocations, and other (7,267) (5,089)
---------- ----------
Net deferred tax asset before valuation allowance 49,732 53,851
Less valuation allowance -- --
---------- ----------
Net deferred tax assets $ 49,732 53,851
========== ==========
</Table>
Net deferred tax assets are classified in the Consolidated Balance
Sheets as follows:
<Table>
<Caption>
(Dollars in thousands) 2002 2001
---------------------- ---------- ----------
Current portion of deferred tax assets $ 22,782 15,278
Deferred tax assets (non-current) 26,950 38,573
---------- ----------
$ 49,732 53,851
========== ==========
</Table>
Based on the Company's historical pretax income, together with the
projection of future taxable income, Management believes it is more
likely than not that the Company will realize the benefits of the net
deferred tax asset existing at September 30, 2002. In order to realize
this net deferred tax asset, the Company will need to generate future
taxable income of approximately $142 million, of which $105 million is
required to be realized prior to the expiration of the NOL
carryforward, of which $12 million will expire in 2009; $38 million
will expire in 2010; $4 million will expire in 2011; $11 million will
expire in 2018; and $40 million will expire in 2019. The NOL
carryforward may be used to reduce future Federal income tax cash
payments.
During 2001, as the result of certain residual tax effects related to
the fiscal 2000 sale of the property in Calabasas, CA, the Company
utilized approximately $2 million of the remaining $33 million capital
loss carryforward available from the sale of its Hazeltine subsidiary
in 1996. The remaining capital loss carryforward of approximately $31
million expired on September 30, 2001. As a result, the valuation
reserve of $10.8 million maintained for the full value of the deferred
tax asset related to the capital loss carryforward was eliminated in
2001. There was no impact to the Company's results of operations in
2001 as a result of this event.
Also during 2001,the Company eliminated its remaining net deferred tax
valuation allowance of $12.7 million, which was the valuation allowance
representing the amount of the deferred tax asset associated with
temporary differences and NOLs which, prior to September 30, 2001,
Management believed would likely not be realized due to limitations on
future use. Management concluded in years prior to 2001, that the
valuation allowance set forth in prior period financial statements was
appropriate based on the following factors:
(1) The Company had a lengthy history of cumulative tax losses
(NOL carryforwards of $138 million at September 30, 2000),
including the addition of $11.6 million and $39.6 million of
NOLs in the then recent fiscal years ended September 30, 1998
and 1999, respectively;
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) The Company's divestiture of Systems & Electronics Inc. on
September 30, 1999 transformed the Company from primarily a
defense-oriented business to primarily a commercial and
industrial manufacturing business, and the Company had not yet
established a record of positive tax earnings;
(3) The Company had not fully integrated the operations of its
three recent commercial acquisitions (Holaday, Lindgren, and
Eaton space products) and could not reasonably project the tax
or earnings impact of these acquisitions with respect to its
newly transformed business base; and
(4) The Company was operating in commercial industries that, in
2000, were beginning to experience economic contraction in an
environment that was beginning to show signs of a slowdown.
Based on these factors, Management concluded that the valuation
allowance recorded in the September 30, 2000 (and earlier) financial
statement was appropriate, and supported Management's belief, at the
time, that it was more likely than not that the deferred tax asset may
not be realized.
At the end of 2001, Management concluded that it was more likely than
not that it would realize the benefits of the deferred tax assets
existing at September 30, 2001, and therefore, eliminated the existing
deferred tax valuation allowance. Management concluded that the
elimination of the valuation allowance was appropriate based on the
following factors:
(1) The Company had completed its second year of operations as a
commercial and industrial manufacturer, and had successfully
integrated its prior year acquisitions into their respective
operating segments;
(2) The Company's financial projections, which incorporated the
current operating structure and acquisitions, provided
Management with reasonable assurance that taxable income in
future years would be sufficient to fully utilize the tax NOL
carryforwards prior to their expiration;
(3) The Company had two consecutive years of positive, and
increasing, taxable income, which provided Management with
assurance that a positive trend in taxable earnings was being
established, and that significant future tax operating losses
were unlikely; and
(4) During 2001, the Company experienced a substantial increase in
the operating contribution of its Communications segment
resulting from the rapidly expanding market for the Company's
AMR equipment.
Based on these factors, Management eliminated the $12.7 million
deferred tax asset valuation allowance at September 30, 2001 as a
credit to its 2001 income tax expense.
8 o DEBT
Long-term debt consists of the following at September 30, 2002 and
2001:
<Table>
<Caption>
(Dollars in thousands) 2002 2001
---------------------- ---------- ----------
Long-term borrowings under the revolving credit facility $ 7,739 7,249
Other debt 659 1,200
Less current maturities of long-term debt (121) (111)
---------- ----------
Long-term debt $ 8,277 8,338
========== ==========
</Table>
Effective April 5, 2002, the Company amended its existing $75 million
revolving credit facility changing the previously scheduled reductions
and extending the $25 million increase option through April 11, 2004.
The amendment calls for $5 million annual reductions to the credit
facility beginning in April 2002 with the balance due upon maturity and
expiration, April 11, 2005. As of September 30, 2002, the Company had
not exercised the $25 million increase option and the revolving line of
credit was $70 million. The credit facility is available for direct
borrowings and/or the issuance of letters of credit, and is provided by
a group of five banks, led by Bank of America as agent. The maturity of
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the bank credit facility is April 11, 2005. At September 30, 2002, the
Company had approximately $49.7 million available to borrow under the
credit facility in addition to its $24.9 million cash on hand. Against
the $70 million available under the revolving credit facility at
September 30, 2002, the Company had $7.7 million of outstanding
long-term borrowings related to the Bea acquisition and outstanding
letters of credit of $12.5 million, related to the Company's synthetic
lease arrangement and performance guarantees.
The credit facility requires, as determined by certain financial
ratios, a commitment fee ranging from 20-30 basis points per annum on
the unused portion. The terms of the facility provide that interest on
borrowings may be calculated at a spread over the London Interbank
Offered Rate (LIBOR) or based on the prime rate, at the Company's
election. Substantially all of the assets of the Company are pledged
under the credit facility. The financial covenants of the credit
facility include limitations on leverage and minimum consolidated
EBITDA. As of September 30, 2002, the Company was in compliance with
all bank covenants.
Long-term borrowings under the revolving credit facility were $7.7
million and $7.2 million at September 30, 2002 and 2001, respectively.
The $7.7 million of long-term borrowings are due on April 11,
2005. There were no short-term borrowings under the credit facility as
of September 30, 2002 and 2001, respectively. During 2002 and 2001, the
maximum aggregate short-term borrowings at any month-end were $0.6
million and $5.5 million, respectively; the average aggregate
short-term borrowings outstanding based on month-end balances were $0.1
million and $1.7 million, respectively; and the weighted average
interest rates were 4.8% in 2002, 6.4% in 2001 and 7.5% in 2000. The
letters of credit issued and outstanding under the credit facility
totaled $12.5 million and $6.1 million at September 30, 2002 and 2001,
respectively.
9 o CAPITAL STOCK
The 13,601,095 and 13,409,934 common shares as presented in the
accompanying Consolidated Balance Sheets at September 30, 2002 and 2001
represent the actual number of shares issued at the respective dates.
The Company held 1,067,046 and 985,469 common shares in treasury at
September 30, 2002 and 2001, respectively.
The Company has various stock option plans which permit the Company to
grant key Management employees (1) options to purchase shares of the
Company's common stock or (2) stock appreciation rights with respect to
all or any part of the number of shares covered by the options. All
outstanding options were granted at prices equal to fair market value
at the date of grant.
Information regarding stock options awarded under the option plans is
as follows:
<Table>
<Caption>
FY 2002 FY 2001 FY 2000
-------------------------- -------------------------- --------------------------
ESTIMATED Estimated Estimated
SHARES AVG. PRICE Shares Avg. Price Shares Avg. Price
---------- ---------- ---------- ---------- ---------- ----------
October 1, 796,648 $ 12.60 792,699 $ 10.62 1,437,442 $ 9.35
Granted 437,500 $ 28.64 175,250 $ 18.65 99,250 $ 12.90
Exercised (191,608) $ 11.20 (151,298) $ 9.18 (558,738) $ 7.37
Cancelled (3,002) $ 22.89 (20,003) $ 12.91 (185,255) $ 12.16
---------- ---------- ---------- ---------- ---------- ----------
September 30, 1,039,538 $ 19.58 796,648 $ 12.60 792,699 $ 10.62
At September 30,
Reserved for future grant 111,014 342,063 405,566
Exercisable 366,406 $ 11.89 370,854 $ 10.72 393,647 $ 10.65
========== ========== ========== ========== ========== ==========
</Table>
The weighted-average fair value of stock options granted in 2002, 2001,
and 2000 was $14.02, $8.37, and $5.27, respectively.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summary information regarding stock options outstanding at September
30, 2002 is presented below:
<Table>
<Caption>
OPTIONS OUTSTANDING
----------------------------------------------------------
NUMBER WEIGHTED-AVERAGE WEIGHTED
Range of OUTSTANDING AT REMAINING AVERAGE
Exercise Prices SEPTEMBER 30, 2002 CONTRACTUAL LIFE EXERCISE PRICE
--------------- ------------------ ---------------- ---------------
$6.08 - $7.37 70,102 4.0 years $ 6.47
$9.14 - $12.91 316,085 6.2 years $ 10.97
$14.19 - $19.22 176,828 7.4 years $ 17.04
$21.44 - $27.28 190,773 8.9 years $ 24.81
$29.04 - $35.93 285,750 9.9 years $ 30.42
--------------- --------------- ---------------
1,039,538 7.8 years $ 19.58
=============== =============== ===============
</Table>
<Table>
<Caption>
EXERCISABLE OPTIONS OUTSTANDING
--------------------------------------------
Range of NUMBER EXERCISABLE AT WEIGHTED AVERAGE
Exercise Prices SEPTEMBER 30, 2002 EXERCISE PRICE
--------------- --------------------- ------------------
$6.08 - $7.37 70,102 $ 6.47
$9.14 - $12.91 204,444 $ 11.00
$14.19 - $19.22 79,874 $ 17.22
$21.44 - $27.28 11,986 $ 23.21
------------------ ------------------
366,406 $ 11.89
================== ==================
</Table>
The options have a ten year contractual life from date of issuance,
expiring in various periods through 2012, excluding 60,000 options
granted as part of the Management Transition Agreement (MTA) which have
a five year contractual life. The increase in exercised shares and
cancelled shares in 2000 is mainly due to options held by former
employees of previously divested entities.
In February 2001, the Company authorized a stock repurchase program to
purchase up to 1.3 million shares of its common stock in the open
market, subject to market conditions and other factors, through
September 30, 2003. The Company repurchased 127,100, 76,700 and 516,368
shares in 2002, 2001 and 2000, respectively.
During 2001, the Board of Directors authorized and the shareholders
approved, the 2001 Stock Incentive Plan, which states, in part, that on
February 8, 2001 and on each October 1 thereafter, through October 1,
2004, there shall be added to the authorized shares allocated the
lesser of (i) 1% of the total outstanding shares as of each such date,
or (ii) 125,000 shares which may be used for the grant of stock
options, stock appreciation rights, performance share awards or
restricted stock. In addition, the Company may, in its discretion, use
shares held in the Treasury in lieu of authorized but unissued shares.
During 2001, the Board of Directors authorized, and the shareholders
approved, the Performance Share Plan. The maximum number of shares
available for issue was 532,814 shares. As of September 30, 2002,
428,133 have been awarded and 180,636 shares have been earned.
Compensation expense related to these awards was $2.4 million and $1.7
million in 2002 and 2001, respectively. These shares vest over five
years with accelerated vesting over three years if certain performance
targets are achieved. During fiscal 2002, 40,000 shares of restricted
stock were issued as part of the MTA, for a total of 80,000 shares of
restricted stock outstanding at September 30, 2002.
In February 2000, the Company amended and restated the Preferred Stock
Purchase Rights Plan such that each Right entitles the holder to
purchase one one-hundredth of a share of preferred stock at an initial
purchase price of $60. The Rights remain in existence until February 3,
2010, unless renewed, redeemed earlier (at one cent per Right),
exercised or exchanged under the terms of the plan. Under certain
conditions involving the acquisition of, or an offer for, 20% or more
of the Company's common stock, all holders of Rights, except an
acquiring entity, would be entitled (1) to
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
purchase, at a defined price, common stock of the Company or an
acquiring entity at a value twice the defined price, or (2) at the
option of the Board, to exchange each Right for one share of common
stock.
The Company adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation." Under APB 25, no
compensation cost was recognized for the Company's stock option plans.
Had compensation cost for the Company's stock option plans and
performance share plans been determined based on the fair value at the
grant date for awards outstanding during 2002, 2001 and 2000 consistent
with the provisions of this Statement, the Company's net earnings and
net earnings per share would have been as shown in the table below:
<Table>
<Caption>
Pro forma (Unaudited)
(Dollars in thousands, except per share amounts) 2002 2001 2000
------------------------------------------------ ---------- ---------- ----------
Net earnings $ 19,305 29,405 16,214
Net earnings per share:
Basic 1.54 2.37 1.32
Diluted 1.48 2.30 1.28
========== ========== ==========
</Table>
As shown in the table above, diluted net earnings per share in 2002
would have been $1.48 as compared to actual 2002 diluted net earnings
per share of $1.67 for a difference of $0.19 per share. Fiscal 2002 was
impacted by the MTA ($0.06 per share) and the timing of annual stock
options granted ($0.08 per share). The impact to diluted net earnings
per share was $0.05 in 2001 and 2000. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions
used for grants in 2002, 2001 and 2000, respectively: expected dividend
yield of 0% in all periods; expected volatility of 31.2%, 37.5% and
29.2%, risk-free interest rate of 3.6%, 4.6% and 5.8%, and expected
life based on historical exercise periods of 4.25 years, 4.21 years and
4.06 years.
The 2002 Performance Share award grants were valued at the stock price
on the date of grant. No adjustments were made for the probability that
performance thresholds would not be met. In 2001 and 2000, to determine
the fair value of grants under the Performance Share Plans, the
probability that performance thresholds would be met was applied to the
ESCO stock price on the date of grant. This probability was based on an
estimated average annual growth rate of 10.0% and an annualized
volatility of 37.9% and 38.3% in 2001 and 2000, respectively.
10 o RETIREMENT AND OTHER BENEFIT PLANS
Substantially all employees are covered by defined benefit or defined
contribution pension plans maintained by the Company for the benefit of
its employees. Benefits are provided to employees under defined benefit
pay-related and flat-dollar plans, which are noncontributory. The
annual contributions to retirement plans equal or exceed the minimum
funding requirements of the Employee Retirement Income Security Act or
applicable local regulations.
Net periodic benefit cost for the years ended September 30, 2002, 2001
and 2000 is comprised of the following:
<Table>
<Caption>
(Dollars in millions) 2002 2001 2000
--------------------- ---------- ---------- ----------
Defined benefit plans:
Service cost $ 1.7 1.4 1.4
Interest cost 2.7 2.5 2.1
Expected return on plan assets (3.0) (3.0) (2.8)
Amortization of service costs .1 .1 .1
Net actuarial gain (.1) (.5) (.5)
Curtailment gain -- -- (.7)
---------- ---------- ----------
Net periodic benefit cost 1.4 .5 (.4)
Defined contribution plans .6 .7 .6
---------- ---------- ----------
Total $ 2.0 1.2 .2
========== ========== ==========
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company recognized a curtailment gain in 2000 as a result of the
sale of the Rantec microwave business in February 2000.
The projected benefit obligation, accumulated benefit obligation, and
fair value of plan assets for defined benefit pension plans with
accumulated benefit obligations in excess of plan assets were $42.9
million, $35.3 million and $26.9 million, respectively, as of September
30, 2002. The projected benefit obligation, accumulated benefit
obligation, and fair value of plan assets for defined benefit pension
plans with accumulated benefit obligations in excess of plan assets
were $5.1 million, $4.7 million and $2.6 million, respectively, as of
September 30, 2001.
The net benefit obligation of the Company's defined benefit pension
plans as of September 30, 2002 and 2001 is shown below:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Change in benefit obligation--
Net benefit obligation at beginning of year $ 36.5 29.6
Service cost 1.7 1.4
Interest cost 2.7 2.5
Plan amendments -- .1
Actuarial loss 3.0 3.9
Gross benefits paid (1.0) (1.0)
---------- ----------
Net benefit obligation at end of year $ 42.9 36.5
========== ==========
</Table>
The plan assets of the Company's defined benefit pension plans at
September 30, 2002 and 2001 are shown below:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Change in plan assets:
Fair value of plan assets at beginning of year $ 28.1 35.9
Actual return on plan assets (2.6) (6.8)
Employer contributions 2.4 --
Gross benefits paid (1.0) (1.0)
---------- ----------
Fair value of plan assets at end of year $ 26.9 28.1
========== ==========
</Table>
Pension plan assets consist principally of marketable securities
including common stocks, bonds, and interest-bearing deposits.
The Company's defined benefit pension plans recognized the following
net amounts at September 30, 2002 and 2001:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Funded status at end of year $ (16.0) (8.4)
Unrecognized prior service cost .4 .5
Unrecognized net actuarial loss 12.7 4.1
---------- ----------
Accrued benefit cost $ (2.9) (3.8)
---------- ----------
Amounts recognized in the Balance Sheet consist of:
Prepaid benefit cost $ .1 .2
Accrued benefit cost (3.0) (4.0)
Additional minimum liability (5.6) (.8)
Intangible asset .4 .2
Accumulated other comprehensive income (before tax
effect) 5.2 .6
---------- ----------
Accrued benefit liability (Included in
Other liabilities) $ (2.9) (3.8)
========== ==========
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The benefit obligations of the defined benefit plans as of September
30, 2002 and 2001 were based on discount rates of 6.75% and 7.25%,
respectively, and an assumed rate of increase in compensation levels of
4.5% in 2002 and 2001.
The 2002, 2001 and 2000 pension expense for the defined benefit plans
was based on a 7.25%, 7.75% and 7.75% discount rate, respectively, a
4.5% increase in compensation levels in all three years, and a 9.0%,
9.5% and 9.5% expected long-term rate of return on plan assets,
respectively.
In addition to providing retirement income benefits, the Company
provides unfunded postretirement health and life insurance benefits to
certain retirees. To qualify, an employee must retire at age 55 or
later and the employee's age plus service must equal or exceed
75. Retiree contributions are defined as a percentage of medical
premiums. Consequently, retiree contributions increase with increases
in the medical premiums. The life insurance plans are noncontributory
and provide coverage of a flat dollar amount for qualifying retired
employees.
Net periodic postretirement benefit cost is comprised of the following:
<Table>
<Caption>
(Dollars in millions) 2002 2001 2000
--------------------- ---------- ---------- ----------
Service cost $ -- -- .1
Interest cost .1 .1 .1
Net amortization and deferral (.2) (.2) (.3)
Curtailment gain recognized -- -- (.3)
---------- ---------- ----------
Net periodic postretirement benefit cost $ (.1) (.1) (.4)
========== ========== ==========
</Table>
The Company recognized a curtailment gain in 2000 as a result of the
sale of the Rantec microwave business in February 2000.
The net benefit obligation for postretirement benefits at September 30,
2002 and 2001 is shown below:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Net benefit obligation at beginning of year $ 1.7 1.2
Service cost -- --
Interest cost .1 .1
Actuarial (gain) loss (.4) .5
Gross benefits paid (.1) (.1)
---------- ----------
Net benefit obligation at end of year $ 1.3 1.7
========== ==========
</Table>
The plan assets for postretirement benefits at September 30, 2002 and
2001 are shown below:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Fair value of plan assets at beginning of year $ -- --
Employer contributions .1 .1
Gross benefits paid (.1) (.1)
---------- ----------
Fair value of plan assets at end of year $ -- --
========== ==========
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company recognized the following accrued benefit liabilities for
postretirement benefits at September 30, 2002 and 2001:
<Table>
<Caption>
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Funded status at end of year $ (1.3) (1.7)
Unrecognized prior service cost -- --
Unrecognized net actuarial (gain) loss (3.2) (3.1)
---------- ----------
Accrued benefit costs $ (4.5) (4.8)
---------- ----------
Amounts recognized in the Balance Sheet consist of --
Accrued benefit liability (Included in Other liabilities) $ (4.5) (4.8)
========== ==========
</Table>
The net benefit obligations of the postretirement benefit plans as of
September 30, 2002 and 2001 were based on discount rates of 6.75% and
7.25%, respectively. The September 30, 2002 net benefit obligation was
based on a health care cost trend of 11.0% for fiscal 2002, decreasing
1% per year to 5% in fiscal 2008. The September 30, 2001 net benefit
obligation was based on a health care cost trend of 5.5% for fiscal
2001. A 1% increase in the health care cost trend rate for each year
would increase the September 30, 2002 net benefit obligation by
approximately $6,000, while a 1% decrease in the health care cost trend
rate for each year would decrease the September 30, 2002 net benefit
obligation by approximately $7,000.
The fiscal 2002, 2001 and 2000 net periodic benefit costs were based on
discount rates of 7.25%, 7.75% and 7.75%, respectively. The net
periodic benefit cost was based on an assumed health care cost trend of
11.0% for fiscal 2002 decreasing 1% per year to 5% in fiscal 2008, 5.5%
for 2001 and 6.5% for 2000 gradually grading down to 5.5% by fiscal
year 2002. A 1% increase in the health care cost trend rate for each
year would increase the aggregate of the service cost and interest cost
components of the fiscal 2002 net periodic benefit cost by
approximately $400, while a 1% decrease in the health care cost trend
rate for each year would decrease the aggregate of the service cost and
interest cost components of the fiscal 2002 net periodic benefit cost
by approximately $600.
11 o OTHER FINANCIAL DATA
Items charged to operations during the years ended September 30, 2002,
2001 and 2000 included the following:
<Table>
<Caption>
(Dollars in thousands) 2002 2001 2000
---------------------- ---------- ---------- ----------
Maintenance and repairs $ 4,579 4,952 4,870
Salaries and wages (including fringes) 97,252 91,649 78,206
---------- ---------- ----------
Research and development (R&D) costs:
Company-sponsored $ 14,901 9,749 6,135
Customer-sponsored 6,183 5,231 3,961
---------- ---------- ----------
Total R&D $ 21,084 14,980 10,096
Other engineering costs 7,827 10,518 8,391
---------- ---------- ----------
Total R&D and other engineering costs $ 28,911 25,498 18,487
As a % of net sales 7.9% 7.4% 6.2%
========== ========== ==========
</Table>
The increase in salaries and wages in 2002 compared to 2001 and 2000 is
mainly due to the Company's acquisition activities and the addition of
personnel within the Communications segment. The increase in research
and development costs is due to the Company's acquisition activities
and increased spending in the Communications segment related to product
enhancements and additional product offerings.
Accrued expenses included accrued employee compensation of $10.8
million and $9.1 million at September 30, 2002 and 2001, respectively.
Other liabilities include accrued benefit liabilities related to the
Company's defined benefit
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pension plans, accrued benefit liabilities related to the Company's
postretirement benefits, miscellaneous tax liabilities, and liabilities
related to the Company's cash flow hedges, discussed earlier.
12 o BUSINESS SEGMENT INFORMATION
The Company is organized based on the products and services that it
offers. Under this organizational structure, the Company operates in
four segments: Filtration/Fluid Flow, Communications, Test and Other.
Filtration/Fluid Flow operations consist of: Filtertek Inc. (Filtertek)
and PTI Consolidated, which includes PTI Technologies Inc. (PTI), PTI
Advanced Filtration Inc. (PTA), PTI Technologies Limited (PTL), PTI
S.p.A., and VACCO Industries. Filtertek develops and manufactures a
broad range of high-volume, original equipment manufacturer (OEM)
filtration products at its facilities in North America, South America
and Europe. PTI Consolidated develops and manufactures a wide range of
filtration products and is a leading supplier of filters to the
commercial aerospace market and microfiltration market. Communications
operations consist of Distribution Control Systems, Inc. (DCSI) which
is principally involved in providing two-way power line communication
systems for the utility industry. These systems provide the electric
utilities with a patented communication technology for demand-side
management, distribution automation and automatic meter reading
capabilities. Communications also includes the operations of Comtrak
Technologies, L.L.C., a provider of video security systems. Test
segment operations represent the EMC Group, consisting of EMC Test
Systems, L.P. (ETS) and Lindgren RF Enclosures, Inc. (Lindgren). The
EMC Group is principally involved in the design and manufacture of EMC
test equipment, test chambers, and electromagnetic absorption
materials. The EMC Group also manufactures radio frequency (RF)
shielding products and components used by manufacturers of medical
equipment, communications systems, electronic products, and shielded
rooms for high security data processing and secure communication. The
Other segment is comprised of Rantec Power Systems Inc. (Rantec) and
unallocated corporate operating charges. Rantec produces power supplies
widely used in high performance displays, such as cockpit
instrumentation, engineering workstations and medical imaging.
Accounting policies of the segments are the same as those described in
the summary of significant accounting policies in Note 1 to the
Consolidated Financial Statements.
In accordance with SFAS 131, the Company evaluates the performance of
its operating segments based on EBIT, which is defined as: Earnings
Before Interest and Taxes. Intersegment sales and transfers are not
significant. Segment assets consist primarily of customer receivables,
inventories and fixed assets directly associated with the production
processes of the segment. Segment assets also include goodwill. Segment
depreciation and amortization is based upon the direct assets listed
above.
<Table>
<Caption>
NET SALES
Year ended September 30,
(Dollars in millions) 2002 2001 2000
------------------------ ---------- ---------- ----------
Filtration/Fluid Flow $ 192.5 188.2 181.7
Communications 94.6 59.1 42.7
Test 69.0 85.5 63.0
Other 11.4 12.1 12.8
---------- ---------- ----------
Consolidated totals $ 367.5 344.9 300.2
========== ========== ==========
</Table>
<Table>
<Caption>
EBIT
Year ended September 30,
(Dollars in millions) 2002 2001 2000
------------------------ ---------- ---------- ----------
Filtration/Fluid Flow $ 13.1 11.5 12.4
Communications 21.0 11.9 8.2
Test 3.6 7.5 4.7
Other .8 1.2 (.2)
Reconciliation to consolidated totals (Corporate) (3.6) (4.7) --
---------- ---------- ----------
Consolidated totals $ 34.9 27.4 25.1
========== ========== ==========
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill amortization was $3.4 million and $2.6 million in 2001 and
2000, respectively. Goodwill amortization is excluded from the 2002
results in accordance with the adoption of SFAS 142.
The Company is also presenting EBITDA by segment for informational
purposes only. EBITDA is defined as earnings before interest, taxes,
depreciation and amortization. EBITDA in 2001 has been adjusted to
remove the $3.4 million of goodwill amortization, (consisting of $2.0
million related to the Filtration/Fluid Flow segment and $1.4 million
related to the Test segment).
<Table>
<Caption>
2002 2001
EBITDA -------------------------------------------- --------------------------------------------
Year ended September 30, DEPRECIATION/ Depreciation/
(Dollars in millions) EBIT AMORTIZATION EBITDA EBIT Amortization EBITDA
------------------------ ----------- ------------- ----------- ----------- ------------- -----------
Filtration/Fluid Flow $ 13.1 9.6 22.7 13.5 8.8 22.3
Communications 21.0 1.2 22.2 11.9 1.2 13.1
Test 3.6 1.2 4.8 8.9 1.1 10.0
Other (Rantec & Corporate) (2.8) .4 (2.4) (3.5) .6 (2.9)
----------- ----------- ----------- ----------- ----------- -----------
Consolidated totals $ 34.9 12.4 47.3 30.8 11.7 42.5
=========== =========== =========== =========== =========== ===========
</Table>
<Table>
<Caption>
IDENTIFIABLE ASSETS
As of September 30,
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
Filtration/Fluid Flow $ 233.6 213.4
Communications 31.2 22.4
Test 59.6 62.3
Other 7.2 7.5
Reconciliation to consolidated totals (Corporate assets) 76.1 70.0
---------- ----------
Consolidated totals $ 407.7 375.6
========== ==========
</Table>
Corporate assets consist primarily of deferred taxes and cash balances.
<Table>
<Caption>
CAPITAL EXPENDITURES
Year ended September 30,
(Dollars in millions) 2002 2001 2000
------------------------ ---------- ---------- ----------
Filtration/Fluid Flow $ 11.1 9.4 9.0
Communications .8 .9 .5
Test .7 1.1 .3
Other .6 .5 .6
---------- ---------- ----------
Consolidated totals $ 13.2 11.9 10.4
========== ========== ==========
</Table>
Depreciation and amortization is included in the EBITDA table, noted
previously.
<Table>
<Caption>
GEOGRAPHIC INFORMATION
Net sales to customers
(Dollars in millions) 2002 2001 2000
---------------------- ---------- ---------- ----------
North America $ 274.9 276.3 234.6
Europe 60.5 43.4 46.1
Far East 16.2 15.0 9.5
Other 15.9 10.2 10.0
---------- ---------- ----------
Consolidated totals $ 367.5 344.9 300.2
========== ========== ==========
</Table>
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
LONG-LIVED ASSETS
(Dollars in millions) 2002 2001
--------------------- ---------- ----------
North America $ 54.3 53.8
Europe 14.2 11.2
---------- ----------
Consolidated totals $ 68.5 65.0
========== ==========
</Table>
Net sales are attributed to countries based on location of customer.
Long-lived assets are attributed to countries based on location of the
asset.
13 o COMMITMENTS AND CONTINGENCIES
At September 30, 2002, the Company had $12.5 million in letters of
credit outstanding related to the synthetic lease arrangement mentioned
earlier and as guarantees of contract performance.
As a normal incidence of the businesses in which the Company is
engaged, various claims, charges and litigation are asserted or
commenced against the Company. In connection with the Filtertek
lawsuit, the Company believes it is probable it will prevail as
supported by internal and third-party legal opinions and favorable
developments to date in the course of the litigation. With respect to
other claims and litigation asserted or commenced against the Company,
it is the opinion of Management, that final judgments, if any, which
might be rendered against the Company in current litigation are
adequately reserved, covered by insurance, or would not have a material
adverse effect on its financial statements.
14 o QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<Table>
<Caption>
(Dollars in thousands, FIRST SECOND THIRD FOURTH FISCAL
except per share amounts) QUARTER QUARTER QUARTER QUARTER YEAR
------------------------- ---------- ---------- ---------- ---------- ----------
2002
Net sales $ 84,336 88,224 94,701 100,264 367,525
Gross profit 26,879 29,125 31,092 31,917 119,013
EBIT 7,811 8,360 9,297 9,454 34,922
Net earnings 4,772 5,193 5,738 6,078 21,781
Earnings per share:
Basic .38 .42 .46 .48 1.74
Diluted .37 .40 .44 .47 1.67
========== ========== ========== ========== ==========
2001
Net sales $ 82,871 86,905 87,862 87,266 344,904
Gross profit 25,245 27,230 28,015 27,888 108,378
EBIT 6,569 6,993 7,413 6,428 27,403
Net earnings 3,978 4,287 4,557 17,285 30,107
Earnings per share:
Basic .32 .35 .37 1.39 2.43
Diluted .31 .34 .35 1.33 2.35
========== ========== ========== ========== ==========
</Table>
The Company adopted SFAS 142 on October 1, 2001. Therefore, the 2001
amounts above include goodwill amortization and the 2002 amounts
exclude goodwill amortization. For 2001, goodwill amortization was
approximately $0.9 million per quarter.
The 2001 fourth quarter reflects the elimination of the net deferred
tax valuation allowance of approximately $12.7 million or $0.97 per
share, during the fourth quarter. The full year impact of this
adjustment was $0.99 per share in 2001.
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
48
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
ESCO TECHNOLOGIES INC.:
We have audited the accompanying consolidated balance sheets of ESCO
Technologies Inc. and subsidiaries as of September 30, 2002 and 2001,
and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period
ended September 30, 2002. 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 auditing standards generally
accepted in the United States of America. 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 principles 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
ESCO Technologies Inc. and subsidiaries as of September 30, 2002 and
2001, and the results of their operations and their cash flows for each
of the years in the three-year period ended September 30, 2002, in
conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 2 to the consolidated financial statements, in
fiscal year 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
/s/ KPMG LLP
St. Louis, Missouri
November 13, 2002
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
50
SHAREHOLDERS' SUMMARY
SHAREHOLDERS' ANNUAL MEETING
The Annual Meeting of the shareholders of ESCO Technologies Inc. will
be held at 10 a.m. Thursday, February 6, 2003, at the Hilton St. Louis
Frontenac Hotel, 1335 South Lindbergh Boulevard, St. Louis County,
Missouri 63131. Notice of the meeting and a proxy statement were sent
to shareholders with this Annual Report.
10-K REPORT
A copy of the Company's 2002 Annual Report on Form 10-K filed with the
Securities and Exchange Commission is available to shareholders without
charge. Direct your written request to the Investor Relations
Department, ESCO Technologies Inc., 8888 Ladue Road, Suite 200, St.
Louis, Missouri 63124.
INVESTOR RELATIONS
Additional investor-related information may be obtained by contacting
the Director of Investor Relations at (314) 213-7277 or toll free at
(888) 622-3726. Information is also available through the Company's
website at www.escotechnologies.com or by e-mail at
pmoore@escotechnologies.com.
TRANSFER AGENT AND REGISTRAR
Shareholder inquiries concerning lost certificates, transfer of shares
or address changes should be directed to:
Transfer Agent/Registrar
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016-3572
1 (800) 368-5948
E-mail: info@rtco.com
CAPITAL STOCK INFORMATION
ESCO Technologies Inc. common stock shares (symbol ESE) are listed on
the New York Stock Exchange. There were approximately 4,100 holders of
record of shares of common stock at September 30, 2002.
INDEPENDENT AUDITORS
KPMG LLP
10 South Broadway, Suite 900
St. Louis, Missouri 63102
ESCO TECHNOLOGIES 2002 ANNUAL REPORT
53