E S C O TE Ch nOlOg iE S inC. 2 0 0 7 A n n u
Al REpO R T
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
C o m m u n i C at i o n S
F i lt r at i o n
r F S h i e l d i n g & t e S t
Contents
Letter To Shareholders
23 Financial Statements
1
3
4
6
Company Overview
Communications
Filtration
8 RF Shielding & Test
10 Commitment To Communities
11 Financial Section
12 Management’s Discussion
and Analysis
28 Notes to Consolidated
Financial Statements
43 Accountability Reports
46 Five-Year Financial Summary
47 Market Performance
48 Shareholders’ Summary
49 Management and Directors
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
To Our Shareholders
Fiscal 2007 was a challenging year for ESCO and included
events. On the positive side, our operating performance
many positive developments along with a few negative
was strong across all three business segments, and we real-
ized sales growth of 10 percent or more in five of our eight
operating units. Hexagram clearly was our biggest success, as
we more than doubled their sales to nearly $50 million and ex-
panded our product offering with the successful launch of our
fixed-network RF AMI electric solution. At DCSI, sales to COOP
customers which represent the core strength of our business
base increased 15 percent to nearly $95 million. Additionally,
we are pleased with the continued strength of our aerospace-
related businesses (PTI and VACCO) which combined for nearly
15 percent top line growth along with a meaningful operat-
ing margin expansion. While more expensive and longer in
development than originally planned, we are pleased with
the current operational status of our next generation AMI
software, TWACS NG.
On the negative side, PG&E’s decision to reevaluate the
electric AMI requirements, along with a slower than originally
Victor L. Richey, Alyson S. Barclay, and Gar y E. Muenster
planned deployment, certainly was the biggest disappointment
My perspective on the current position and outlook for the
in 2007. Additionally, while progress on the TWACS NG software
individual segments of our business is as follows:
development continues going well, the delayed delivery and
In the Communications segment, 2007 was a solid year for us
resulting revenue deferral was disappointing. Lastly, the 2007
in terms of positioning ESCO for significant growth. This segment
arbitration loss in the Test segment related to a long completed
continues to offer the best opportunity to deliver meaningful
government project negatively impacted that segment’s operat-
increases in shareholder value over the next few years.
ing performance.
In September, we announced the strategic integration of the
Summarizing 2007, despite the challenges we faced, ESCO
Communications segment to take full advantage of our broad
showed resiliency and delivered year-over-year improvement both
range of product offerings. This action allows ESCO to present
at the top and bottom line, and most importantly, positioned our-
customers with a more focused customer-facing organization
selves for substantial growth in 2008 and beyond. Additionally,
that will bring together a comprehensive suite of unique products
the November 2007 sale of a portion of Filtertek along with the
and services providing proven technologies and industry leader-
acquisition of Doble has allowed us to strategically reposition
ship while offering seamless, integrated solutions that have not
ourselves by adding a high margin growth business, which is
previously existed in the marketplace. Customer reaction to this
complementary to our Communications segment, while exiting a
integration and the rollout of our “hybrid” solution which offers
lower margin slower growth business. The cash proceeds from the
a mix of power-line based and RF based AMI technologies has
divestiture will be used to partially fund the Doble acquisition.
been very favorable.
The investments we continue to make in new products, software,
Today, we have the most capable, proven AMI technologies
and acquisition partners, have positioned us for significantly
available in the market which can be deployed to satisfy even the
improved financial performance. This growth will provide the
largest IOU customer’s requirements, whether used for electric,
opportunity to increase long-term shareholder value, which is
gas or water utility applications. With that said, we will never
our primary mission.
stand still when it comes to new product development, evidenced
1
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
To Our Shareholders
I believe we have the financial
strength and flexibility, as well as
the right products and technolo-
gies, to effectively achieve our
growth plans in 2008 and beyond.
new testing standards continues at an unprecedented level.
Our expanding international presence is a primary source of our
growth as electronics manufacturers continue establishing new
product development centers in the Far East, and therefore, we
will continue to expand our presence near these customers to
capture this growing demand. My confidence in our ability to cap-
ture a majority of this growth is based on our leadership position,
expanding international presence, and superior technology.
Additionally, we remain committed to managing our cost struc-
by the continued investments we made in 2007. We increased
ture in this segment to better leverage our growth as evidenced
our Company-wide spending on research and development to
by the consolidation of our acoustics business in Austin, Texas,
$33 million compared to $26 million in 2006, with AMI related
resulting in a 40,000 square foot reduction in floor space.
product solutions leading the way.
In Filtration, we expect continued solid financial performance
In Communications, our new product development has been
in our aerospace related businesses although our growth outlook
focused on meeting customer needs and includes several prod-
remains somewhat modest compared to our 2007 growth. This
ucts that will provide functionality “behind the meter.” These
segment continues to provide a solid foundation for our business
new products include interfaces with smart thermostats and
while generating a significant amount of cash. Our favorable
multiple-function in-home displays which will allow utilities
cost structure allows us to earn above average returns which
and their customers to better manage how and when energy is
supports our commitment to invest in this segment via drop-in
used. Our full suite of products provide the information neces-
acquisitions such as Wintec.
sary to allow the utilities to gain greater insight into and better
The divestiture of Filtertek makes us a more strategically
control over the management of their energy resources, which
focused higher margin business with a much improved growth
is the core tenet of AMI.
profile. Additionally, this divestiture fully supports our stated
Additionally, we expect to continue our market-leading posi-
strategy of continuing to concentrate our investments in our
tion with COOP and Municipal customers that have provided a
fastest growing, highest margin Communications segment.
stable revenue platform for the last few years. On the interna-
Overall, I believe we have the financial strength and flexibil-
tional front, we expanded our focus by adding senior business
ity, as well as the right products and technologies, to effectively
development staff to address the fast moving dynamics currently
achieve our growth plans in 2008 and beyond. I am grateful that
being seen in numerous countries outside of North America. The
we have solid management teams in place across the Company
international AMR / AMI opportunities are substantial, and we
who understand our mission and are fully committed to deliver-
feel we have the appropriate resources and product offerings in
ing exceptional results.
place to capitalize on these.
In closing, I want to thank our customers for the opportunity
Lastly, we are excited about the addition of Doble Engineering
to serve them, our employees for their effort and dedication, our
Company. Doble will allow us to further penetrate the electric
Board of Directors for their leadership and guidance, and our
utility market by leveraging its strong brand recognition and
shareholders for their support and confidence.
superior customer service. Along with the additional resources
that ESCO will provide to grow this business, Doble is expected to
capture more than its fair share of the electric utilities’ substan-
tial investments in the areas of grid management, grid reliability,
and optimal asset utilization.
Victor L. Richey
Moving to the Test segment, we continue to see solid growth
Chairman, Chief Executive Officer, and President
prospects as the introduction of new electronic products and
November 29, 2007
2
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Company Overview
ESCO Technologies Inc. is a worldwide manufacturer of highly engineered products operating in three business segments:
Communications The primary
companies of the Communications
segment, DCSi, hexagram and
nexus Energy Software, provide
market and technology leadership,
employing the highest caliber,
proven Two-Way Fixed Network
Advanced Metering Communication
Systems (TWACS by DCSi® and
hexagram Star®), with enter-
prise software that stands apart
in its ability to optimize what
smart meter data can accomplish
for utilities and their customers
(nexus MDMS™). Our SecurVision®
product line provides digital video
surveillance and security functions
for large commercial enterprises
and alarm monitoring companies.
Electric, Gas, and Water Utilities,
Security Industry
Filtration/Fluid Flow The com-
panies in this segment design and
manufacture specialty filtration
products ranging from high volume
medical components to unique
filter mechanisms used in micro-
propulsion devices for satellites.
RF Shielding & Test The com-
panies in the RF Shielding & Test
segment are industry leaders in
providing their customers with the
ability to identify, measure and
contain magnetic, electromagnetic
and acoustic energy.
Healthcare, Aviation, Space, Trans-
portation, Consumer Appliance
Healthcare, Electronics,
Transportation
north America
Cedar Park, TX
Cleveland, OH
Durant, OK
Glendale Heights, IL
Hebron, IL
Huntley, IL
Juarez, Mexico
Minocqua, WI
Oxnard, CA
South El Monte, CA
St. Louis, MO
Wellesley, MA
Europe
Eura, Finland
Newcastle West, Ireland
Plailly, France
Stevenage, England
ESCO Operations
Markets Served
South America
São Paulo, Brazil
Asia
Beijing, China
Tokyo, Japan
3
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Automated Metering Infrastructure
and Meter Data Management for Electric,
Gas and Water Utilities Worldwide
C
ustomers of ESCO’s Communications segment get proven results with
industry-leading advanced metering solutions that are innovative,
fully customizable, and built using advanced RF- and PLC-based fixed-
network technologies and leading meter data management software.
A deep-rooted culture of improvement in the Communications segment
companies drives them to exceed customer expectations. The segment’s
three primary companies — DCSI, Hexagram, and Nexus Energy Software —
work closely with municipal and investor-owned utilities worldwide
through a unique integrated sales, marketing, and customer-service
organization that allow them to respond quickly and effectively with
cutting-edge solutions that meet the most exacting requirements.
e n d u S e r S B e n e F i t
▲
Increase awareness of energy
pricing and conservation
▲
Stabilize energy costs
▲
Improve interaction with
utility companies
▲
Enable customer prepayment
4
e l e C t r i C
PoWer utilitieS ProFit From
reliaBle and ComPlete adVanCed
metering inFraStruCture. ESCO’s
Communications segment offers proven
power line and radio frequency com-
munication systems with full two-way
access to and from the meter, providing
useful information to utilities. With
features such as load control, demand
response, interval data, time-of-use,
and critical peak pricing, customers of
ESCO’s Communications segment benefit
from reduced resource requirements,
efficient and reliable meter data man-
agement, reduced costs, and enabled
innovation in business processes.
B u s i n e s s s e g m e n t
The versatile TWACS®
IHD (In-Home Display),
above left, from DCSI
provides utilities with
valuable end-customer
information and supports
applications from
rate-change messaging
to individual account
monitoring. The device
works via the existing
TWACS infrastructure —
an important market
differentiator — and is
an easy addition to exist-
ing utility deployments.
Nexus Energy Software
provides utility and
energy companies with
value-added software
solutions that unlock
the power of advanced
metering and energy
information. Nexus’
applications are in use
at more than 100 energy
companies worldwide
and help reduce capital,
operating and resource
costs and increase
customer satisfaction,
while supporting millions
of customers, interac-
tions, and transactions
each year.
V iSiOn
> E n g i nE E Ri n g
> i M A g i nA TiOn
ga S
Wat e r
gaS utilitieS relY on FiXed-netWorK
Water utilitieS dePend on adVanCed
teChnologY For reliaBle data
meter reading and leaK deteCtion
ColleCtion. Flexible advanced-metering
solutions from Hexagram, Inc. provide gas
utilities with the decision-making infor-
mation that they need to serve customers.
Transmitters, designed to supplement
nearly all gas meters, automatically
collect readings on a customer-defined
schedule and transfer the incremental
data regularly to the utility. The informa-
tion then is used by utili-
ties to balance distribution
records or to track individual
consumption, leading to high-
er customer satisfaction.
teChnologieS. Water utilities use
innovative metering technologies from
Hexagram to improve customer service
and enhance water-conservation efforts.
Fixed-network solutions allow utilities
to collect meter readings automatically
and analyze them quickly to pinpoint
in-home leaks as well as tamper or
backflow conditions. Hexagram’s partner-
ship with Gutermann International will
take leak detection to the next level by
helping utilities acquire and correlate
acoustic readings to identify leak loca-
tions on the water main.
Hexagram’s STAR®
Network AMI/AMR
system delivers the right
data in the right format
to municipal and privately
held gas, water, and
electric utilities.
u t i l i t i e S B e n e F i t
▲
Know and understand
consumption patterns
▲
Implement demand-
response programs
▲
Recapture lost revenues
▲
Improve customer service
and communications
5
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Engineered Filtration and Fluid Flow
Products for the Aerospace, Medical, and
Automotive Markets Worldwide
E SCO’s Filtration and Fluid Flow segment, comprised of Filtertek,
PTI Technologies and VACCO Industries, serves a diverse group
of technically demanding markets such as automotive, air transport,
medical and satellite communications. The applied level of innovation
and commercial success into these markets is testament to their ability
to turn vision into engineered solutions. Through the incorporation of
cutting-edge technology they continue to stimulate imagination and
shape the path forward. The success of the Filtration group has been
historically demonstrated and will continue to be defined through the
successful exploitation of new ideas, products and services.
B u s i n e s s s e g m e n t
e n d u S e r S B e n e F i t
▲
Reliability in aircraft, automo-
tive and recreational vehicles
▲
Variety of entertainment
provided by satellites
▲
Healthier lives through cleaner
and safer water
6
ae r o S PaC e
Filtration and Fluid FloW
ProduCtS For SPaCe and airCraFt
marKetS. Innovation as the corner-
stone for success is best exhibited
with the VACCO automated refueling
mechanism aboard the Orbital Express
mission. The VACCO solution provides
the first ever U.S. on-orbit demonstra-
tion of automated fuel transfer between
two satellites. Closer to earth, similar
successes can be found at PTI with the
development of a wide range of products
supporting the next generation of
manned and unmanned aircraft from
the Global Hawk to the Joint Strike
Fighter to the Boeing 787.
Life’s challenges often
require unique solutions.
The ability to rise to
these challenges defines
the Filtration group.
Universally, Filtertek,
PTI and VACCO are recog-
nized globally as sources
for the custom develop-
ment of engineered
solutions. Through their
own efforts or through
collaborative devel-
opment with
the OEM, they
push the limits
continually.
With a com-
mitment to
cutting-edge projects
and technologies; it
is engineering that
truly invents the future.
Whether the goal is for
greater operational
efficiency as demanded
by the automotive
industry, the quality
assurances essential
to sustain life or the
reliability required to
sustain non-stop flight,
the Filtration group
prides itself on its ability
to leverage its design
experience and manufac-
turing expertise to take
invention to innovation.
V iSiOn
> E n g i nE E Ri n g
> i M A g i nA TiOn
m e d iC a l
au t o m o t iV e
mediCal, PharmaCeutiCal and Bio-
CuStom Filtration For automotiVe
PharmaCeutiCal Filtration. Critical
medical applications require the highest
level of product engineering and manu-
facturing expertise. Whether it’s an at-
home drug delivery device or an extracor-
poreal circuit particulate filter supporting
open heart surgery, patients and practi-
tioners need the most advanced products
possible. Recognizing this need, Filtertek
remains at the forefront of emerging
medical technologies, materials and
manufacturing practices, and works to
incorporate the most innova-
tive ones in a broad spectrum
of medical applications.
manuFaCturerS and diStriButorS.
Coming off the production line, each auto-
mobile houses numerous filters designed
to protect its fluid systems and keep them
operating reliably. Automakers continue
to promote longer vehicle life with lengthy
warranty periods, bringing filtration to
the forefront as a central design issue in
new vehicle development. Understand-
ing the vanguard of emerging automotive
technologies such as alternative fuels,
gas mileage improvements, and advanced
power train development, allows Filtertek
to support its automotive customers with
continued ingenuity and flexibility.
Filtertek has manufactured
custom-engineered filters
for major automobile
manufacturers since the
company was founded in
1965. Pioneering the all-
plastic transmission filter,
the company remains at
the forefront of transmis-
sion filter technology.
i n d u S t r i e S B e n e F i t
▲
Innovative engineered
filtration solutions
▲
Reliability of a proven
product track record
▲
World-class quality
control systems
▲
Value through
operational efficiency
7
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Detect, Measure and Manage Magnetic,
Electromagnetic and Acoustic Energy for
Customers in a Broad Range of Industries
E TS-Lindgren comprises ESCO’s RF Shielding & Test segment. Within
this segment, ETS-Lindgren is recognized as a global leader not only
for the depth and quality of its products and services, but for its leader-
ship role in the technical standards committees that drive RF shielding
and test regulations. Suppliers of electronic products — from cell phones
to aircraft — rely on ETS-Lindgren to provide innovative RF shielding and
test solutions to measure product performance and ensure regulatory
compliance. As products have increasing electronic content and operate
in closer proximity, test demands have increased and markets requiring
this testing have expanded. Markets served now include the electronic,
automotive, aerospace, medical and, increasingly, wireless industries.
e n d u S e r S B e n e F i t
▲
Availability of proven and
reliable products
▲
One source for multiple
RF shielding and test
requirements
▲
Customized solutions to
meet unique demands
8
t e St
eleCtromagnetiC and radio Fre-
quenCY meaSurement SYStemS.
In today’s increasingly electronic envi-
ronment, commercial and government
regulations require electromagnetic
compatibility (EMC) between products
and within products — such as wireless
hand-held devices with multiple capa-
bilities. ETS-Lindgren designs, manu-
factures and installs numerous types of
enclosures for testing electronic prod-
ucts to ensure electromagnetic compat-
ibility. ETS-Lindgren engineers, through
their leadership on standards commit-
tees, impact the emerging regulations
and creatively design test solutions.
B u s i n e s s s e g m e n t
ETS-Lindgren provided
the first Over-the-Air
wireless performance
test system and con-
tinues to set the indus-
try standard with high
quality, diverse test
solutions. With rapidly
emerging technolo-
gies such as Wi-Fi and
WiMAX™, its involve-
ment in the standards
committees and the
flexibility of its wire-
less test solutions, the
company is poised to
maintain its industry
leadership. Innovative
test solutions for the
wireless (left) and
medical (above left)
industries are key to
ETS-Lindgren’s
success.
Defense requirements
are expanding in
today’s aerospace and
military markets. Long
a trusted supplier,
ETS-Lindgren is well
known for its high per-
formance microwave
chambers, some of
which are designed to
test full size fighter
aircraft. ETS-Lindgren’s
microwave chambers
(right) allow precise
measurement for
secure applications.
V iSiOn
> E n g i nE E Ri n g
> i M A g i nA TiOn
m e d iC a l
aCo u S t i C
Shielded and Sterile enCloSureS
modular noiSe Control enClo-
For magnetiC reSonanCe imaging.
SureS For ProduCt qualitY teSting.
Combining its RF shielding expertise with
the desire to perform magnetic resonance
imaging (MRI) scans during surgical pro-
cedures, ETS-Lindgren developed the MRI
Interventional Suite. This new technology
provides the magnetic shielding required
for the proper operation of the MRI scan
while also providing a sterile environ-
ment, thus eliminating the need to move
the patient and potentially reducing mul-
tiple surgeries. ETS-Lindgren is the leader
in RF shielding for the medical industry
with significantly more installations glob-
ally than any other company.
Acoustic testing is critical to verify a
product design meets industry regulations
and the desired audio quality is achieved.
This is especially important for consumer
products, from dishwashers to hearing
aids, to name a few, to assure ideal sound
transmission. The addition of Acoustic
Systems, with its popular pre-engineered
panels for flexible designs, expands
ETS-Lindgren’s chamber offerings to new
markets, including industrial and con-
sumer products as well as the audiology
service industry. Customers now have one
source for EMC, MRI, and acoustic testing.
Manufacturers of small
electronic devices, such
as cell phones, require
quick and efficient testing
to verify performance.
ETS-Lindgren’s test cells
are ideal for engineering
design verification and
pre-compliance measure-
ments for quality control.
i n d u S t r i e S B e n e F i t
▲
Vision and position to
capture emerging RF
shielding and test trends
▲
Engineering expertise
ensures products that
perform as expected
▲
Imagination provides
innovative test solutions
9
E S C O TE Ch nOlOg iE S inC.
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Commitment to Communities
I n 2007 the ESCO Technologies Foundation marked its first full year of operation as a charitable non-profit entity. Funding from
the Company, as well as from many of our dedicated employees, ensured that the Foundation was able to support children and
families in need in areas where the Company has operations throughout the United States. Some of the recipients of Foundation
grants during the year are described below. As the Foundation grows, additional recipients will be considered for assistance.
WellSPring Center For hoPe The Wellspring Center for
angel on mY Shoulder ltd Headquartered in St. Germain,
Hope, a non-profit organization located in the Chicago area,
Wisconsin, this non-profit organization was founded with the
promotes an individual’s right to be physically safe by providing
hope of becoming the emotional backbone of people in the com-
emotional support, advocacy and crisis intervention. A grant
munity by improving the qualify of life for those who have been
was made by the Foundation to further Wellspring’s work in
afflicted with or affected by cancer. The Foundation’s grant
educating the community regarding the signs and effects of
assisted the organization in helping individuals, families and
domestic violence.
caregivers who demonstrated a need for support.
reVitalization 2000, inC . Dedicated to reaching out to
haBitat For humanitY During 2007, the Foundation sup-
disadvantaged kids in the Ville neighborhood of St. Louis,
ported Habitat for Humanity (HFH) organizations in DuPage
Revitalization 2000, Inc. (R2K) was given a grant by the
County, Illinois and St. Louis. HFH is dedicated to eliminating sub-
Foundation for two programs. The Claver Works Program pro-
standard housing and the St. Louis HFH took on the challenge of
vides training and supervision for students to do part-time lawn
building 25 houses in 2007. In addition to the Foundation’s finan-
and gardening work, giving them the opportunity to learn a
cial assistance, ESCO employees and family members volunteered
skill and the responsibility of work commitments as well as a
to work on one of the houses during two days of the build cycle.
small income opportunity. With the funding, R2K was able to
ESCO corporate employees hung siding and installed porches, and
offer this program throughout the summer to area students.
a group of DCSI employees painted the interior. Pictured below
The Foundation also funded the Botball Renaissance Program
is Kristen Everett of ESCO’s Tax Department applying her newly
once again. This program is an organized national robotics pro-
learned circular saw skills as Mindy
gram for youth in grades 7–12. With funding by the Foundation,
Anderson, HFH Crew Leader, over-
eight Ville students traveled to a regional Botball tournament at
sees her work.
Southern Illinois University. The students were mentored during
the year by a group of dedicated employees from the Company’s
DCSI subsidiary.
WingS oF hoPe 2007 was the first year the Foundation has
supported Wings of Hope (WoH). WoH was founded in St. Louis
but reaches across the world. The organization retains older air-
craft refurbished by volunteers to become life-saving transport.
Volunteers also maintain the planes and fly the missions. ESCO
Technologies Foundation funding was earmarked for transport
missions relating to children needing emergency or specialized
healthcare in the states where the Company has operations.
To make a tax-deductible contribution or to learn more about
the Foundation, please call 314-213-7277 or visit the Web
site at www.escotechnologiesfoundation.org.
10
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Financial Section
Contents
12 Management’s Discussion and Analysis
23 Consolidated Statements of Operations
24 Consolidated Balance Sheets
26 Consolidated Statements of Shareholders’ Equity
27 Consolidated Statements of Cash Flow
28 Notes to Consolidated Financial Statements
43 Management’s Statement of Financial Responsibility
43 Management’s Report on Internal Control Over Financial Reporting
44 Reports of Independent Registered Public Accounting Firm
46 Five-Year Financial Summary
47 Market Performance
48 Shareholders’ Summary
49 Management and Board of Directors
11
Management’s Discussion and Analysis
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto. The years 2007,
2006 and 2005 represent the fiscal years ended September 30, 2007,
2006 and 2005, respectively, and are used throughout the document.
introduction
ESCO Technologies Inc. and its wholly owned subsidiaries (ESCO,
the Company) are organized into three reporting units: Commu-
nications, Filtration/Fluid Flow (Filtration), and RF Shielding and
Test (Test). The Company’s business segments are comprised of the
following primary operating entities:
▶ Communications: Distribution Control Systems, Inc. (DCSI),
Hexagram, Inc. (Hexagram), acquired on February 1, 2006, Nexus
Energy Software, Inc. (Nexus), acquired on November 29, 2005,
and Comtrak Technologies, L.L.C. (Comtrak),
▶ Filtration: PTI Technologies Inc. (PTI), VACCO Industries (VACCO),
and the Filtertek companies (Filtertek),
▶ Test: EMC Group companies consisting primarily of ETS-Lindgren
L.P. (ETS) and Lindgren R.F. Enclosures, Inc. (Lindgren).
The Communications unit is a proven supplier of special purpose
fixed network communications systems for electric, gas and water
utilities, including hardware and software to support advanced
metering applications. DCSI’s Two-Way Automatic Communica-
tions System, known as TWACS®, is currently used for automatic
meter reading (AMR) and related advanced metering infrastructure
(AMI) functions serving over 200 utilities, as well as having load
management capabilities. Hexagram’s STAR® system, the premier
wireless AMI system, delivers two-way and one-way operation on
secure licensed radio frequencies for more than 100 utilities serving
electric, gas and water customers. Nexus provides best-in-class
utility data management solutions to more than 85 leading energy
companies that add value to existing billing and metering infra-
structure to allow both the utilities and their customers to better
manage energy-driven transactions and decision making. Comtrak’s
SecurVision® product line provides digital video surveillance and
security functions for large commercial enterprises and alarm moni-
toring companies. The Filtration unit develops, manufactures and
markets a broad range of filtration products used in the purifica-
tion and processing of liquids. These 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, lubrica-
tion and hydraulic systems, various health care applications, indus-
trial processing, satellite propulsion systems, and oil processing.
The Test unit is the industry leader in providing its customers with
the ability to identify, measure and contain magnetic, electromag-
netic and acoustic energy.
12
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
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 commit-
ted to delivering shareholder value through internal growth, ongoing
performance improvement initiatives, and selective acquisitions.
highlights of 2007 Operations
▶ Sales, net earnings and earnings per share were $527.5 million,
$33.7 million and $1.28 per share, respectively.
▶ Net cash provided by operating activities was $45.3 million.
▶ At September 30, 2007, cash on hand was $18.6 million.
▶ The Company received $49.1 million in orders from Pacific Gas &
Electric (PG&E) related to its electric and gas AMI deployment.
▶ Successful deployment of upgraded TWACS system software called
“TWACS NG” (formerly referred to as TNG) Version 1.6.3 at PG&E,
with Version 2.0 delivered in October 2007.
▶ Hexagram received a $13.5 million order for a water AMR project
in Kansas City, Missouri.
▶ The Company repurchased $10 million or 265,000 shares of its
common stock during 2007.
Results of Operations
nET SAlES
(Dollars in millions)
2007
2006
Fiscal year ended
Change Change
2006
2007
2005 vs. 2006 vs. 2005
Communications
$197.6
156.2
138.0
26.5% 13.2 %
Filtration
188.4
174.1
171.7
8.2%
1.4 %
Test
Total
141.5
128.6
119.4
10.0%
7.7 %
$527.5
458.9
429.1
14.9%
6.9 %
Communications
The 26.5% or $41.4 million increase in net sales in 2007 as com-
pared to the prior year was due to: an increase of $30.5 million at
Hexagram; an increase of $6.5 million at DCSI; an increase in sales
of $4.6 million at Nexus; partially offset by a $0.2 million decrease
in sales of Comtrak’s video security products.
The $30.5 million increase in sales of Hexagram’s RF AMI products
in 2007 as compared to 2006 was due to: a $21.6 million increase
in sales to PG&E related to their gas deployment; and a $3.1 million
increase in sales from the advanced metering project in Kansas City,
Missouri. In addition, Hexagram’s current year results represent
twelve months of sales compared to eight months in the prior year.
Management’s Discussion and Analysis
The $6.5 million increase in sales of DCSI’s AMR products in 2007
as compared to 2006 was due to: a $14.7 million increase in sales
to the electric utility cooperative (COOP) market; a $1.1 million
increase in sales to Puerto Rico Electric Power Authority (PREPA);
partially offset by $9.4 million of lower AMR product sales to
investor owned utilities (IOUs). Sales to IOUs decreased in 2007
as compared to the prior year due to: a $21.0 million decrease in
sales to TXU (Oncor), partially offset by increases in sales to: Duke
Energy of $6.0 million, EDESur of $4.5 million, and Florida Power
& Light of $2.6 million.
The $18.2 million or 13.2% increase in net sales in 2006 as
compared to 2005 was due to: the acquisitions of Hexagram and
Nexus with sales of $18.6 million and $9.6 million, respectively;
partially offset by an $8.6 million decrease in sales of Comtrak’s
video security products; and $1.5 million of lower shipments of
DCSI’s AMR products.
The $1.5 million decrease in sales of DCSI’s AMR products in
2006 as compared to 2005 was due to: an increase in sales to
TXU of $19.9 million and other IOUs of $3.0 million; offset by
$16.2 million of lower COOP sales; and an $8.1 million decrease
in sales to PREPA.
Comtrak’s sales were $7.3 million, $7.5 million, and $16.1 million
in 2007, 2006 and 2005, respectively. The decrease in sales in 2006
as compared to the prior year was due to an acceleration of ship-
ments in 2005 to meet the customer’s schedule.
Filtration
Net sales in 2007 increased $14.3 million or 8.2% compared to
the prior year primarily as a result of higher commercial aerospace
shipments at PTI of $6.4 million; a sales increase of $4.9 million
at VACCO driven by higher defense spares and T-700 shipments; and
a net sales increase at Filtertek of $3.2 million driven primarily by
higher commercial shipments.
Net sales in 2006 increased $2.4 million or 1.4% compared to 2005
primarily as a result of higher commercial aerospace shipments at
PTI of $5.6 million, a net sales increase at Filtertek of $3.3 million
driven by higher commercial shipments, partially offset by lower
defense spares and T-700 shipments at VACCO of $6.6 million.
Test
The net sales increase of $12.9 million or 10.0% in 2007 as
compared to the prior year was mainly due to: a $10.6 million
increase in net sales driven by project milestones on a large air-
craft chamber and completion of other test chambers; a $3.2 mil-
lion increase in net sales from the Company’s Asian operations;
partially offset by a $0.9 million decrease in net sales from the
Company’s European operations.
The net sales increase of $9.2 million or 7.7% in 2006 as compared
to 2005 was mainly due to: a $10.2 million increase in net sales
from the Company’s U.S. operations driven by sales of additional
test chambers and higher component sales, a $0.6 million increase
in net sales from the Company’s Asian operations; partially offset
by a $1.6 million decrease in net sales from the Company’s Euro-
pean operations due to the prior year completion of several test
chamber projects.
ORDERS AnD BACKlOg
New orders received in 2007 were $562.2 million, resulting in an
order backlog of $288.1 million at September 30, 2007 as compared
to an order backlog of $253.4 million at September 30, 2006. In
2007, the Company recorded $201.8 million of new orders related
to Communications products, $214.9 million related to Filtration
products, and $145.5 million related to Test products.
See “CAPITAL RESOURCES AND LIQUIDITY - Pacific Gas & Electric” on
page 17 for a discussion of PG&E contracts. The Company received
orders totaling $49.1 million from PG&E under these agreements
during 2007.
During 2007, Hexagram received a $13.5 million order for a water
AMR project in Kansas City, Missouri.
In 2006, the Company recorded $187.5 million of new orders
related to Communications products (including $19.0 million of
new orders and $6.0 million of acquired backlog from Hexagram and
$16.7 million of new orders and $9.0 million of acquired backlog
from Nexus), $172.1 million related to Filtration products, and
$119.6 million related to Test products.
SElling, gEnERAl AnD ADMiniSTRATiVE EXpEnSES
Selling, general and administrative expenses (SG&A) were $122.5 mil-
lion, or 23.2% of net sales in 2007, $106.9 million, or 23.3% of net
sales in 2006, and $84.2 million, or 19.6% of net sales in 2005.
The increase in SG&A expenses in 2007 as compared to the prior
year was primarily due to: a $4.8 million increase in SG&A related to
Hexagram (due to a full twelve months of SG&A expenses compared
to eight months included in the prior year); an increase of $4.3 mil-
lion at DCSI mainly due to an increase in engineering head count;
a $2.9 million increase related to Nexus (due to a full twelve months
compared to ten months in the prior year) and an increase in soft-
ware development head count; an increase of $2.1 million incurred
in the Test segment primarily to support new growth opportunities
in Asia; and an $0.8 million increase at Corporate mainly due to the
increase in stock option expense.
The increase in SG&A in 2006 as compared to the prior year was
primarily due to: $7.5 million of SG&A expenses related to Nexus;
$6.8 million of SG&A expenses related to Hexagram; $2.3 million of
stock option expense and higher costs related to engineering and
new product development.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
13
Management’s Discussion and Analysis
AMORTiZATiOn OF inTAngiBlE ASSETS
Amortization of intangible assets was $10.7 million in 2007,
$6.9 million in 2006 and $2.0 million in 2005. Amortization of
intangible assets included $2.1 million and $2.7 million of amor-
tization of acquired intangible assets related to the Hexagram and
Nexus acquisitions in 2007 and 2006, respectively. The amortization
of acquired intangible assets related to Hexagram and Nexus are
included in the Corporate operating segment’s results. The remain-
ing amortization expenses consist of other identifiable intangible
assets (primarily software, patents and licenses). The Company
recorded $6.2 million and $2.2 million in 2007 and 2006, respec-
tively, related to DCSI’s TWACS NG capitalized software.
OThER (inCOME) AnD EXpEnSES, nET
Other (income) and expenses, net, were $2.5 million, $(2.8) million
and $(1.6) million in 2007, 2006 and 2005, respectively. Other (in-
come) and expenses, net, in 2007 consisted primarily of: $2.6 million
of expenses within the Test segment related to the adverse arbitra-
tion award related to the delivery and installation contract completed
in 2005 for a shielded communication room in an international loca-
tion; partially offset by $(1.4) million of royalty income.
Other (income) and expenses, net, in 2006 consisted primarily of:
a $(1.8) million non-cash gain representing the reversal of a
liability related to an indemnification obligation with respect to
a previously divested subsidiary; $(2.3) million of royalty income;
partially offset by a $0.2 million charge related to the termination
of a subcontract manufacturer.
Other (income) and expenses, net, in 2005 consisted primarily
of: $(2.2) million of royalty income; and a $0.5 million charge
related to the termination of a supply agreement with a medical
device customer.
ASSET iMpAiRMEnT — 2005
In June 2005, the Company abandoned its plans to commercial-
ize certain sensor products within the Filtration segment resulting
in an asset impairment charge of $0.8 million to write off certain
patents and a related licensing agreement.
EARningS BEFORE inTEREST AnD TAXES (EBiT)
The Company evaluates the performance of its operating segments
based on EBIT, which the Company defines as earnings before
interest and taxes.
EBIT is not a defined GAAP measure. However, the Company believes
that EBIT provides investors and Management with a valuable and
alternative method for assessing the Company’s operating results.
Management evaluates the performance of its operating segments
14 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
based on EBIT and believes that EBIT is useful to investors to
demonstrate the operational profitability of the Company’s business
segments by excluding interest and taxes, which are generally ac-
counted for across the entire company on a consolidated basis. EBIT
is also one of the measures Management uses to determine resource
allocations and incentive compensation.
(Dollars in millions)
2007
2006
Fiscal year ended
Change Change
2006
2007
2005 vs. 2006 vs. 2005
Communications
% of net sales
Filtration
% of net sales
Test
% of net sales
$22.0
28.3
(22.3)% (27.1) %
38.8
11.1% 18.1% 28.1% (7.0)% (10.0) %
19.5
23.4
12.4% 11.2% 13.1% 1.2%
20.0% (12.9) %
(1.9) %
22.4
15.0
14.4
10.2% 11.7% 10.2% (1.5)%
(4.0)% 23.0 %
1.5 %
12.2
Corporate
(17.8)
(15.2)
(11.4) 17.1%
33.3 %
Total
% of net sales
$42.0
47.6
(11.8)% (23.2) %
8.0% 10.4% 14.4% (2.4)% (4.0) %
62.0
The reconciliation of EBIT to a GAAP financial measure is as follows:
(Dollars in millions)
2007
2006
2005
EBIT
Add: Interest income
Less: Income taxes
Net earnings
Communications
$42.0
0.7
47.6
1.3
62.0
1.9
(9.0)
(17.6)
(20.4)
$33.7
31.3
43.5
The decrease in EBIT in 2007 as compared to 2006 was due to:
a $10.8 million decrease at DCSI due to an increase in TWACS
NG software amortization expense of $4 million, an increase of
$4.3 million in SG&A expenses mainly due to an increase in engi-
neering head count, an increase in PG&E program support costs
and TWACS NG maintenance of $1.5 million, and higher shipping
expense of $0.9 million; partially offset by an increase of $4.4 mil-
lion in EBIT at Hexagram due to the increase in sales volumes
related to the PG&E deployment.
The decrease in EBIT in 2006 as compared to 2005 was due to:
a $7.8 million decrease at DCSI due to changes in product mix
gross margins (IOU vs. COOP), charges related to a terminated
subcontract manufacturer, higher warranty costs and amortization
of TWACS NG software; a $3.8 million decrease at Comtrak due to
lower shipments; a $0.7 million loss at Nexus due to the timing of
customer deployments and additional SG&A spending related
to engineering and new product initiatives; partially offset by
$1.8 million from Hexagram.
Management’s Discussion and Analysis
Filtration
inTEREST inCOME
EBIT increased in 2007 as compared to 2006 primarily due to:
a $2.8 million increase at PTI due to higher commercial aerospace
shipments; a $1.7 million increase at VACCO due to higher defense
spares shipments; partially offset by a $0.6 million decrease at
Filtertek due to increased raw material costs.
EBIT decreased in 2006 as compared to 2005 primarily due to:
a $4.3 million decrease at VACCO due to significantly lower defense
spares shipments; a $1.4 million decrease at Filtertek partly due to
increased material costs; partially offset by a $2.8 million increase
at PTI due to higher shipments of aerospace products. The 2005
operating results for Filtertek included a $1.9 million gain related
to the termination of a supply agreement with a medical device
customer that was not repeated in 2006.
Test
The decrease in EBIT in 2007 as compared to 2006 was mainly due
to: a $1.1 million decrease in EBIT from the Company’s European
operations as a result of lower sales volumes and U.K. facility move
costs; partially offset by a $0.4 million increase in EBIT from the
Company’s Asian operations on the higher sales volumes. In addi-
tion, the Company’s current year U.S. operations were negatively
impacted by $2.6 million of total costs associated with the arbitra-
tion judgment related to a 2005 U.S. Government project.
The increase in EBIT in 2006 as compared to the prior year was
mainly due to: a $2.1 million increase in EBIT from the Company’s
U.S. operations driven by sales of additional test chambers and
higher component sales; a $0.4 million increase in EBIT from the
Company’s European operations; and a $0.3 million increase in EBIT
from the Company’s Asian operations.
Corporate
Corporate office operating charges included in consolidated EBIT
increased by $2.6 million in 2007 as compared to 2006 mainly due
to: the 2007 absence of a $1.8 million non-cash gain recorded in
2006 related to an indemnification obligation with respect to a
previously divested subsidiary; a $0.7 million increase in pre-tax
stock option expense; $0.4 million of additional professional fees
incurred to support a research tax project; partially offset by a
$0.6 million decrease in pre-tax amortization of acquired intangible
assets related to Nexus and Hexagram.
Corporate office operating charges included in consolidated
EBIT increased by $3.8 million in 2006 as compared to 2005
mainly due to: $2.7 million of pre-tax amortization of acquired
intangible assets related to Nexus and Hexagram; $2.3 million of
pre-tax stock option expense; partially offset by a $1.8 million
non-cash gain representing the reversal of a liability related
to an indemnification obligation with respect to a previously
divested subsidiary. The “Reconciliation to Consolidated Totals
(Corporate)” in Note 14 to the Consolidated Financial Statements
represents Corporate office operating charges.
Interest income was $0.7 million in 2007, $1.3 million in 2006 and
$1.9 million in 2005. The decrease in interest income in 2007 and
2006 as compared to the prior year periods was due to lower aver-
age cash balances on hand resulting from the 2006 acquisitions.
inCOME TAX EXpEnSE
The 2007 effective tax rate was 21.1% compared to 36.0% in 2006
and 31.9% in 2005. The decrease in the 2007 effective tax rate
as compared to the prior year was due to: the favorable impact
of the research tax credit reduced 2007 income tax expense by
$4.4 million and the effective tax rate by 10.3%; resolution of
certain tax exposure items reduced current year income tax expense
by $2.3 million and the effective tax rate by 5.3%; the release of
a portion of the valuation allowance on capital loss carryforward
reduced income tax expense by $0.8 million and the effective tax
rate by 1.8%; and the effect of deferring U.S. tax on foreign earn-
ings and favorable adjustments to foreign tax accruals reduced 2007
tax expense by $1.1 million and the effective tax rate by 2.7%.
During 2007, the Company determined that certain tax accounts
had not been accurately recorded in the financial statements for
fiscal years 2001 to 2006. The effect in any individual year was not
material to the Company’s results of operations, financial position
or cash flows. The Company recorded $1.3 million as a cumulative
credit adjustment to tax expense to correct previously recorded tax
accounts during the fourth quarter of 2007.
The increase in the effective tax rate in 2006 as compared to the
prior year was due to: the effect of the foreign earnings repatria-
tion increased 2006 income tax expense by $2.4 million and the
effective rate by 4.8%; the adoption of SFAS 123(R) increased tax
expense by $0.7 million and the effective rate by 1.4%; the lower
volume of profit contributions of the Company’s foreign operations
(primarily Puerto Rico due to the lower sales to PREPA) adversely
impacted the tax rate; partially offset by the effect of a favorable
change in tax contingencies not related to the research tax credit
which decreased tax expense by $1.4 million and the effective tax
rate by 2.9% and the net effect of the research tax credit which
favorably impacted tax expense by $2.5 million and the effective
tax rate by 5%.
Capital Resources and liquidity
Working capital (current assets less current liabilities) increased
to $141.2 million at September 30, 2007 from $131.4 million at
September 30, 2006.
During 2007, cash and cash equivalents decreased $18.2 mil-
lion, primarily due to an increase in operating working capital
requirements. The $19.2 million increase in accounts receivable
at September 30, 2007 is mainly due to: $9.9 million related to
the Communications segment and $5.7 million related to the Test
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
15
Management’s Discussion and Analysis
segment, both due to timing and increased volume of sales. The
$16.9 million increase in inventories at September 30, 2007 is
mainly due to an $11.7 million increase within the Communica-
tions segment primarily related to the PG&E deployment. Accounts
payable increased by $15.1 million at September 30, 2007, of
which $6.0 million related to the Test segment and $3.1 million
related to the Communications segment, both due to the timing of
vendor payments on the higher level of inventory.
Net cash provided by operating activities was $45.3 million,
$58.6 million and $68.6 million in 2007, 2006 and 2005, respec-
tively. The decrease in 2007 is related to an increase in operat-
ing working capital requirements. The decrease in 2006 is related
to lower net earnings.
Capital expenditures were $19.5 million, $9.1 million and $8.8 mil-
lion in 2007, 2006 and 2005, respectively. The increase in 2007
compared to 2006 included: approximately $4 million of manufac-
turing equipment for the More Energy project at Filtertek Ireland
(Filtration segment); approximately $2 million for the Cedar Park
facility expansion (Test segment); approximately $1 million for the
DCSI facility expansion (Communications segment). There were no
commitments outstanding that were considered material for capital
expenditures at September 30, 2007.
At September 30, 2007, intangible assets, net, of $77.2 million
included $65.7 million of capitalized software. Approximately $58.6
million of the capitalized software balance represents software
development costs on the TWACS NG software within the Communi-
cations segment to further penetrate the IOU market. This software
is being deployed to efficiently handle the additional levels of
communications dictated by the size of the utility service territories
and the frequency of meter reads that are required under time-of-
use or critical peak pricing scenarios to meet the requirements of
large IOUs. At September 30, 2007, the Company had approximately
$2 million of commitments related to the development of TWACS
NG versions 2.0 and 3.0 which is expected to be spent during the
first quarter of fiscal 2008. The Company expects to spend up to ap-
proximately $6 million in fiscal 2008 on TWACS NG. Amortization is
on a straight-line basis over seven years and began in March 2006.
The Company recorded $6.2 million and $2.2 million in amortization
expense related to TWACS NG during 2007 and 2006, respectively.
At September 30, 2007, the Company had an available net operating
loss (NOL) carryforward for U.S. Federal tax purposes of approximately
$35 million. This NOL will expire between 2019 and 2025, and will be
available to reduce future Federal income tax cash payments.
16 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
The closure and relocation of the Filtertek Puerto Rico facility
was completed in March 2004. The Puerto Rico facility is included
in other current assets with a carrying value of $3.6 million at
September 30, 2007. The facility is being marketed for sale.
During 2005, the Company reached a settlement in the defense of
a certain revenue-generating patent used in the Filtration business.
Under the terms of the agreement, the Company received a cash
payment of $1.5 million, and in 2005 the Company recognized a
gain of $0.3 million, after deducting $0.2 million of professional
fees related to the settlement. The unrecognized gain is being
recorded on a straight-line basis in Other (income) and expenses,
net, over the remaining patent life, through 2011.
ACQuiSiTiOnS
On August 10, 2007, the Company acquired the assets and certain
liabilities of Wintec, LLC (Wintec) for a purchase price of $6 million.
Wintec is engaged in the design, manufacture and sale of metallic
elements, filters, and strainers for pneumatic/hydraulic applications
and surface tension devices for propellant management fluid control
with annual revenues of approximately $3.5 million. The assets
acquired consist of accounts receivable, inventory and property,
plant and equipment. The Company recorded approximately $5 mil-
lion of goodwill in connection with the transaction. In addition,
the Company recorded $0.2 million of amortizable intangible assets
consisting of customer contracts and order backlog which are being
amortized on a straight-line basis over periods ranging from nine
months to seventeen months. The operating results for Wintec,
since the date of acquisition, are included within VACCO in the
Filtration segment.
On February 1, 2006, the Company acquired the capital stock of
Hexagram for a purchase price of approximately $66 million. The
acquisition agreement also provides for contingent consideration of
up to $6.3 million over a five-year period following the acquisition
if Hexagram exceeds certain sales targets. During 2007, the Com-
pany paid $1.3 million of contingent consideration. Hexagram is a
radio-frequency (RF) fixed network AMI company headquartered in
Cleveland, Ohio. Hexagram broadens the Company’s served market
and provides an RF based AMI system serving primarily electric, gas
and water utilities. The operating results for Hexagram, since the
date of acquisition, are included within the Communications unit.
The Company recorded approximately $51 million of goodwill and
$3.5 million of trademarks as a result of the transaction. The Company
also recorded $6.6 million of identifiable intangible assets consisting
primarily of patents and proprietary know-how, customer contracts,
and order backlog which are being amortized on a straight-line basis
over periods ranging from six months to seven years.
On November 29, 2005, the Company acquired Nexus through an all
cash for shares merger transaction for approximately $29 million in
cash plus contingent cash consideration over the four-year period
Management’s Discussion and Analysis
following the merger if Nexus exceeds certain sales targets. Nexus
is a software company headquartered in Wellesley, Massachusetts.
Nexus broadens the Company’s served market and provides software
solutions that allow utilities to fully utilize the information produced
by the Company’s AMI systems. The operating results for Nexus, since
the date of acquisition, are included within the Communications unit.
The Company recorded approximately $24 million of goodwill as a
result of the transaction. The Company also recorded $2.7 million of
identifiable intangible assets consisting of customer contracts and
backlog value which are being amortized on a straight-line basis over
periods ranging from one year to three years.
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 state-
ments from the date of acquisition.
pACiFiC gAS & ElECTRiC
In November 2005, DCSI entered into a contract to provide equip-
ment, software and services to Pacific Gas & Electric (PG&E) in
support of the electric portion of PG&E’s Advanced Metering Infra-
structure (AMI) project. Under this contract, equipment is purchased
by PG&E only upon issuance of purchase orders and release authori-
zations. These orders were initially expected to total approximately
$310 million over a five-year period although significant future devel-
opments explained in the following paragraph have impacted these
expectations and the Company now expresses no opinion as to the
amount of orders anticipated under the contract. Under the contract,
PG&E continues to retain the right to purchase products or services
from other suppliers for the electric portion of the AMI project. DCSI
has agreed to deliver to PG&E versions of its newly developed TWACS
NG software as it becomes available and is tested. Delivery of the
final software version for which DCSI has committed was required in
the fourth quarter of fiscal 2007 and is currently anticipated in the
first quarter of fiscal 2008. The parties are negotiating an amendment
to the current contract to conform to the parties’ performance, in-
cluding DCSI’s anticipated software delivery date. In accordance with
U.S. generally accepted accounting standards, the Company will defer
all revenue related to DCSI’s arrangement with PG&E until all software
is delivered and acceptance criteria have been met. The contract
provides for liquidated damages in the event of DCSI’s late develop-
ment or delivery of hardware and software, and includes indemnifica-
tion and other customary provisions. The contract may be terminated
by PG&E for default, for its convenience and in the event of a force
majeure lasting beyond certain prescribed periods. The Company
has guaranteed the obligations of DCSI under the contract. If PG&E
terminates the contract for its convenience, DCSI will be entitled to
recover certain costs.
During the third quarter of 2007, PG&E announced its plans to
request information and proposals from a small group of vendors in
order to evaluate such vendors’ ability to address potential future
functionality requirements for the electric portion of its service
territory currently included in DCSI’s contract. In July 2007, PG&E
issued requests for proposals (RFPs) to a group of vendors, includ-
ing the Company, for PG&E’s electric requirements. Prior to PG&E’s
issuance of this RFP, Hexagram agreed to provide 2,000 of its RF
fixed network electric units for PG&E testing. Testing of Hexagram’s
electric solution began in the fourth quarter of 2007. PG&E’s cur-
rent activities will impact the timing and/or receipt of future orders
from PG&E for its electric deployment and, until PG&E completes
this evaluation and determines whether it will modify its AMI proj-
ect plan, the Company cannot estimate the total value or the tim-
ing of orders that may be received under the DCSI PG&E contract.
In November 2005, Hexagram entered into a contract to provide
equipment, software and services to PG&E in support of the gas util-
ity portion of PG&E’s AMI project. Hexagram’s contract also provided
PG&E the option to purchase an RF based electric product from
Hexagram. The total anticipated contract revenue from commence-
ment through the five-year full deployment is expected to be up to
approximately $225 million excluding any potential purchases of
Hexagram’s RF based electric product. As with DCSI’s contract with
PG&E, equipment will be purchased only upon issuance of purchase
orders and release authorizations, and PG&E will continue to have
the right to purchase products or services from other suppliers for
the gas utility portion of the AMI project. The contract provides for
liquidated damages in the event of late deliveries, includes indem-
nification and other customary provisions, and may be terminated
by PG&E for default, for its convenience and in the event of a force
majeure lasting beyond certain prescribed periods. The Company has
guaranteed the performance of the contract by Hexagram.
BAnK CREDiT FACiliTY
Effective October 6, 2004, the Company entered into a $100 million
five-year revolving bank credit facility with a $50 million increase
option that has a final maturity and expiration date of October 6,
2009. The credit facility is available for direct borrowings and/or
the issuance of letters of credit, and is provided by a group of six
banks, led by Wells Fargo Bank as agent.
The credit facility requires, as determined by certain financial
ratios, a commitment fee ranging from 17.5 to 27.5 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
LIBOR or based on the prime rate, at the Company’s election. The
credit facility is secured by the unlimited guaranty of the Company’s
material domestic subsidiaries and a 65% pledge of the material
foreign subsidiaries’ share equity. The financial covenants of the
credit facility include limitations on leverage, minimum consoli-
dated EBITDA and minimum net worth.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
17
Management’s Discussion and Analysis
At September 30, 2007, the Company had approximately $96.4 mil-
lion available to borrow under the credit facility in addition to its
$18.6 million cash on hand. At September 30, 2007, the Company
had outstanding short-term borrowings of $2.8 million, and out-
standing letters of credit of $3.6 million ($0.8 million outstanding
under the credit facility). As of September 30, 2007, 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.
Subsequent to September 30, 2007, the Company announced its
intention to enter into a new credit facility led by National City
Bank in connection with the acquisition of Doble Engineering
Company. See “Subsequent Events” under Management’s Discussion
and Analysis.
ShARE REpuRChASES
In August 2006, the Company’s Board of Directors authorized an
open market common stock repurchase program for up to 1.2 mil-
lion shares, subject to market conditions and other factors which
covers the period through September 30, 2008. The Company
repurchased $10 million or 265,000 shares in 2007 under this
program. There were no stock repurchases during 2006. The Com-
pany repurchased $25 million or 670,072 shares in 2005 under
a previously authorized program.
pEnSiOn FunDing REQuiREMEnTS
The minimum cash funding requirements related to the Company’s
defined benefit pension plans are approximately $0.5 million in
2008, approximately $1.75 million in 2009 and approximately
$1.25 million in 2010. The Company made a voluntary cash contri-
bution of $1.4 million in 2006.
COnTRACTuAl OBligATiOnS
SuBSEQuEnT EVEnTS
The following table shows the Company’s contractual obligations as
of September 30, 2007:
(Dollars in millions)
Payments due by period
Contractual
Obligations
Long-Term Debt
Obligation
Capital Lease
Obligations
Operating Lease
Obligations
Purchase
Obligations(1)
Total
Less
than
1 year
1 to 3
years
More
3 to 5
than
years 5 years
Total
$ —
—
—
—
0.9
0.3
0.4
0.2
—
—
26.4
6.6
9.7
6.7
3.4
2.0
$ 29.3
2.0
8.9
—
10.1
—
6.9
—
3.4
(1) A purchase obligation is defined as a legally binding and enforceable agree-
ment to purchase goods and services that specifies all significant terms. Since
the majority of the Company’s purchase orders can be cancelled, they are not
included in the table above. TWACS NG software development costs for version
2.0 and version 3.0 are included.
The Company has no off balance sheet arrangements outstanding at
September 30, 2007.
On November 7, 2007, the Company announced an agreement to
acquire the stock of Doble Engineering Company, headquartered
in Watertown, Massachusetts, for $319 million in cash, subject to
adjustment for differences in working capital and cash on hand at
closing. The Company intends to fund the acquisition by a combina-
tion of existing cash and borrowings under a new credit facility led
by National City Bank. The transaction is expected to close in the
quarter ending December 31, 2007.
On November 26, 2007, the Company announced it had completed
the sale of the filtration portion of Filtertek Inc. to Illinois Tool
Works Inc. (ITW) for approximately $77.5 million in cash, subject
to closing working capital adjustments. The Tek Packaging divi-
sion of Filtertek is not included in the transaction. The net cash
proceeds from the sale, estimated at $70 million after taxes and
expenses, will be used to pay down a portion of the debt associ-
ated with the Doble Engineering Company acquisition, mentioned
above. The Company expects to record a gain on the sale for both
financial reporting and tax purposes, with a portion of the tax gain
being shielded from cash payments through the utilization of the
Company’s existing capital loss carryforward which was generated
from prior divestitures.
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 investiga-
tion 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.
18 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Management’s Discussion and Analysis
Market Risk Analysis
MARKET RiSK EXpOSuRE
Market risks relating to the Company’s operations result primar-
ily from changes in interest rates and changes in foreign currency
exchange rates.
At September 30, 2007 and 2006, the Company had no obligations
related to interest rate swaps.
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 foreign currency most significant to
the Company’s operations is the Euro. Net sales to customers out-
side of the United States were $121.2 million, $103.0 million, and
$103.8 million in 2007, 2006 and 2005, respectively. The Company
hedges certain foreign currency commitments by purchasing for-
eign currency forward contracts. The estimated fair value of open
forward contracts at September 30, 2007 was 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 judg-
ments 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 exer-
cise 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 and Finance Committee of
the Company’s Board of Directors on a periodic 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 Finan-
cial 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
Communications Unit: Within the Communications unit, approxi-
mately 95% of the unit’s revenue arrangements (approximately
35% of consolidated revenues) contain software components.
Revenue under these arrangements is recognized in accordance
with Statement of Position 97-2 (SOP 97-2), “Software Revenue
Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2,
Software Revenue Recognition, with Respect to Certain Transac-
tions.” The application of software revenue recognition requires
judgment, including the determination of whether a software
arrangement includes multiple elements and estimates of the fair
value of the elements, or vendor-specific objective evidence of fair
value (“VSOE”). Changes to the elements in a software arrangement,
and the ability to identify VSOE for those elements could materi-
ally impact the amount of earned and/or deferred revenue. There
have been no material changes to these estimates for the financial
statement periods presented and the Company believes that these
estimates generally should not be subject to significant variation in
the future. The remaining 5% of the unit’s revenues represent prod-
ucts sold under a single element arrangement and are recognized
when products are delivered to unaffiliated customers.
Filtration Unit: Within the Filtration operating unit, approximately
80% of operating unit revenues (approximately 30% of consolidated
revenues) are recognized when products are delivered (when title
and risk of ownership transfers) or when services are performed for
unaffiliated customers.
Approximately 20% of operating unit revenues (approximately 5%
of consolidated revenues) are recorded under the percentage-of-
completion provisions of SOP 81-1, “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts” because
the Company manufactures complex products for aerospace and
military customers under production contracts. The percentage-of-
completion method of accounting involves the use of various esti-
mating techniques to project costs at completion. These estimates
involve various assumptions and projections relative to the outcome
of future events over a period of several years, including future labor
productivity and availability, the nature and complexity of the work
to be performed, availability of materials, the impact of delayed
performance, and the timing of product deliveries. These estimates
are based on Management’s judgment and the Company’s substan-
tial experience in developing these types of estimates. Changes in
underlying assumptions/estimates may adversely affect financial
performance if they increase estimated project costs at completion,
or positively affect financial performance if they decrease estimated
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
19
Management’s Discussion and Analysis
project costs at completion. Due to the nature of these contracts and
the operating unit’s cost estimating process, the Company believes
that these estimates generally should not be subject to significant
variation in the future. There have been no material changes to these
estimates for the financial statement periods presented. The Company
regularly reviews its estimates to assess revisions in contract values
and estimated costs at completion.
Test Unit: Within the Test unit, approximately 50% of revenues
(approximately 15% of consolidated revenues) are recognized when
products are delivered (when title and risk of ownership transfers)
or when services are performed for unaffiliated customers. Certain
arrangements contain multiple elements which are accounted for
under the provisions of EITF 00-21, “Revenue Arrangements with
Multiple Deliverables.” The application of EITF 00-21 requires judg-
ment as to whether the deliverables can be divided into more than
one unit of accounting and whether the separate units of account-
ing have value to the customer on a stand-alone basis. Changes
to these elements could affect the timing of revenue recognition.
There have been no material changes to these elements for the
financial statement periods presented.
Approximately 50% of the unit’s revenues (approximately 15%
of consolidated revenues) are recorded under the percentage-of-
completion provisions of SOP 81-1, “Accounting for the Performance
of Construction-Type and Certain Production-Type Contracts” due
to the complex nature of the enclosures that are designed and
produced under these contracts. As discussed above, this method
of accounting involves the use of various estimating techniques
to project costs at completion, which are based on Management’s
judgment and the Company’s substantial experience in develop-
ing these types of estimates. Changes in underlying assumptions/
estimates may adversely or positively affect financial performance.
Due to the nature of these contracts and the operating unit’s cost
estimating process, the Company believes that these estimates
generally should not be subject to significant variation in the
future. There have been no material changes to these estimates for
the financial statement periods presented. The Company regularly
reviews its contract estimates to assess revisions in contract values
and estimated costs at completion.
inVEnTORY
Inventories are valued at the lower of cost (first-in, first-out) or
market value. Management regularly reviews 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
The Company operates in numerous taxing jurisdictions and is
subject to examination by various U.S. Federal, state and foreign
jurisdictions for various tax periods. Additionally, the Company has
retained tax liabilities and the rights to tax refunds in connection
with various divestitures of businesses in prior years. The Company’s
income tax positions are based on research and interpretations
of the income tax laws and rulings in each of the jurisdictions in
which the Company does business. Due to the subjectivity of inter-
pretations of laws and rulings in each jurisdiction, the differences
and interplay in tax laws between those jurisdictions, as well as the
inherent uncertainty in estimating the final resolution of complex
tax audit matters, Management’s estimates of income tax liabilities
may differ from actual payments or assessments.
While the Company has support for the positions taken on its
tax returns, taxing authorities are increasingly asserting alter-
nate interpretations of laws and facts, and are challenging cross
jurisdictional transactions. Cross jurisdictional transactions between
the Company’s subsidiaries involving transfer prices for products
and services, as well as various U.S. Federal, state and foreign tax
matters, comprise the Company’s income tax exposures. Manage-
ment regularly assesses the Company’s position with regard to tax
exposures and records liabilities for these uncertain tax positions
and related interest and penalties, if any, according to the prin-
ciples of SFAS No. 5, “Accounting for Contingencies.” The Company
has recorded an accrual that reflects Management’s estimate of the
likely outcome of current and future audits. A final determination of
these tax audits or changes in Management’s estimates may result
in additional future income tax expense or benefit.
At the end of each interim reporting period, Management esti-
mates the effective tax rate expected to apply to the full fiscal
year. The estimated effective tax rate contemplates the expected
jurisdiction where income is earned, as well as tax planning
strategies. Current and projected growth in income in higher tax
jurisdictions may result in an increasing effective tax rate over
time. If the actual results differ from Management’s estimates,
Management may have to adjust the effective tax rate in the
interim period such determination is made.
20 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Management’s Discussion and Analysis
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 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 Manage-
ment 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
In accordance with SFAS 142, Management annually reviews
goodwill and other long-lived assets with indefinite useful lives for
impairment or whenever events or changes in circumstances indi-
cate the carrying amount may not be recoverable. If the Company
determines that the carrying value of the long-lived asset may not
be recoverable, a permanent impairment charge is recorded for the
amount by which the carrying value of the long-lived asset exceeds
its fair value. Fair value is measured based on a discounted cash
flow method using a discount rate determined by Management to
be commensurate with the risk inherent in the Company’s current
business model. The estimates of cash flows and discount rate are
subject to change due to the economic environment, including such
factors as interest rates, expected market returns and volatility of
markets served. Management believes that the estimates of future
cash flows and fair value are reasonable; however, changes in es-
timates could result in impairment charges. 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 144.
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 assump-
tions 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 that will af-
fect net earnings in future years. Depending upon the performance
of the equity and bond markets in 2008, the Company could be
required to record a charge to equity. In addition, if the discount
rate was decreased by 25 basis points from 6.25% to 6.00%, the
projected benefit obligation for the defined benefit plan would
increase by approximately $1.0 million and result in an additional
after-tax charge to shareholders’ equity of approximately $1.0 mil-
lion. The discount rate used in measuring the Company’s pension
and postretirement welfare obligations was developed by matching
yields of actual high-quality corporate bonds to expected future
pension plan cash flows (benefit payments). Over 500 Aa-rated,
non-callable bonds with a wide range of maturities were used in the
analysis. After using the bond yields to determine the present value
of the plan cash flows, a single representative rate that resulted in
the same present value was developed.
Other Matters
COnTingEnCiES
As a normal incident of the businesses in which the Company is
engaged, various claims, charges and litigation are asserted or com-
menced against the Company. In the opinion of Management, final
judgments, if any, which might be rendered against the Company
are adequately reserved, covered by insurance, or are not likely to
have a material adverse effect on its financial statements.
QuAnTiTATiVE AnD QuAliTATiVE DiSClOSuRES ABOuT MARKET RiSK
Market risks relating to the Company’s operations result primar-
ily from changes in interest rates and changes in foreign currency
exchange rates. At September 30, 2007 and 2006, the Company had
no obligations related to interest rate swaps. See further discussion
in “Management’s Discussion and Analysis — Market Risk Analysis”
regarding the Company’s market risks.
COnTROlS AnD pROCEDuRES
The Company carried out an evaluation under the supervision of
and with the participation of Management, including the Company’s
Chief Executive Officer and Chief Financial Officer, of the effec-
tiveness of the design and operation of the Company’s disclosure
controls and procedures as of the end of the period covered by this
report. Based upon that evaluation, the Company’s Chief Executive
Officer and Chief Financial Officer concluded that the Company’s
disclosure controls and procedures are effective. Disclosure controls
and procedures are controls and procedures that are designed to
ensure that information required to be disclosed in company reports
filed or submitted under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within time periods
specified in the Securities and Exchange Commission’s rules and
forms. There have been no significant changes in the Company’s
internal controls or in other factors during the period covered by
this report that have materially affected, or are reasonably likely to
materially affect those controls and procedures.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
21
Management’s Discussion and Analysis
new Accounting pronouncements
In June 2006, the FASB issued FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an Interpretation of
FASB Statement No. 109” (FIN 48). FIN 48 prescribes a recogni-
tion threshold and measurement process for the financial statement
recognition and measurement of a tax position taken or expected to
be taken in a tax return. FIN 48 is effective for fiscal years begin-
ning after December 15, 2006. The Company estimates that the
adoption of FIN 48 will result in an increase to the opening balance
of retained earnings as of October 1, 2007 in the range of zero to
$5 million for income tax benefits not previously recognized.
In September 2006, the FASB issued SFAS No. 158, “Employer’s
Accounting for Defined Benefit Pension and Other Postretire-
ment Plans” (SFAS 158), which amends SFAS 87 and SFAS 106 to
require recognition of the overfunded or underfunded status of
pension and other postretirement benefit plans on the balance
sheet. Under SFAS 158, gains and losses, prior service costs and
credits, and any remaining transition amounts under SFAS 87 and
SFAS 106 that have not yet been recognized through net periodic
benefit cost will be recognized in accumulated other comprehen-
sive income, net of tax effects. The measurement date — the date
at which the benefit obligation and plan assets are measured —
is required to be the Company’s fiscal year-end, which is the date
the Company currently uses. SFAS 158 is effective for publicly held
companies for fiscal years ending after December 15, 2006. The
Company adopted the provisions of SFAS 158 as of September 30,
2007 and recorded a pre-tax credit of $0.9 million to accumulated
other comprehensive income in equity.
In September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements” (SFAS 157), which defines fair value in generally
accepted accounting principles and expands disclosures about fair
value measurements. This Statement is effective for financial state-
ments issued for fiscal years beginning after November 15, 2007.
The adoption of SFAS 157 is not expected to have a material impact
to the Company’s financial position or results of operations.
Forward-looking information
Statements regarding future events and the Company’s future results
that are based on current expectations, estimates, forecasts and
projections about the Company’s performance and the industries in
which the Company operates, the Company’s ability to utilize NOLs,
adequacy of the Company’s credit facilities and future cash flows,
estimates of anticipated contract costs and revenues, the timing,
amount and success of claims for research credits, the timing and
success of software development efforts and resulting costs, accep-
tance by PG&E of the final version of DCSI’s TWACS NG software, the
22 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
anticipated value of the PG&E contract, timing of closing the Doble
acquisition, the outcome of current litigation, claims and charges,
recoverability of deferred tax assets, continued reinvestment of
foreign earnings, the impact of FIN 48 and SFAS 157, future costs
relating to environmental matters, share repurchases, investments,
sustained performance improvement, performance improvement
initiatives, growth opportunities, new product development, the
Company’s ability to increase shareholder value, acquisitions, and
the beliefs and assumptions of Management contained in the Letter
to Our Shareholders (pages 1-2), and Management’s Discussion
and Analysis and other statements contained herein which are
not strictly historical are considered “forward-looking statements”
within the meaning of the safe harbor provisions of the Federal
securities laws. Words such as expects, anticipates, targets, goals,
projects, intends, plans, believes, estimates, variations of such
words, and similar expressions are intended to identify such for-
ward-looking statements. Investors are cautioned that such state-
ments are only predictions, speak only as of the date of this report,
and the Company undertakes no duty to update. The Company’s
actual results in the future may differ materially from those project-
ed 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 those described under “Item 1A. Risk
Factors” in the Company’s Annual Report on Form 10-K for the fiscal
years ended September 30, 2007 and the following: actions by the
California Public Utility Commission; PG&E’s Board of Directors or
PG&E’s management impacting PG&E’s AMI projects; the timing
and success of DCSI’s software development efforts; the timing
and content of purchase order releases under the PG&E contracts;
and DCSI’s and Hexagram’s successful performance of the PG&E
contracts; satisfaction of closing conditions to the Doble acquisi-
tion; the timing and execution of real estate sales; termination
for convenience of customer contracts; timing and magnitude of
future contract awards; weakening of economic conditions in served
markets; the success of the Company’s competitors; changes in cus-
tomer demands or customer insolvencies; competition; intellectual
property rights; technical difficulties; the availability of selected
acquisitions; the timing, pricing and availability of shares offered
for sale; delivery delays or defaults by customers; performance
issues with key customers, suppliers and subcontractors; material
changes in the costs of certain raw materials; the successful sale of
the Company’s Puerto Rico facility; collective bargaining and labor
disputes; changes in laws and regulations including but not limited
to changes in accounting standards and taxation requirements;
costs relating to environmental matters; litigation uncertainty; and
the Company’s successful execution of internal operating plans.
Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
Years ended September 30,
Net sales
Costs and expenses:
Cost of sales
Selling, general and administrative expenses
Amortization of intangible assets
Interest income, net
Other (income) and expenses, net
Asset impairment
Total costs and expenses
Earnings before income tax
Income tax expense
Net earnings
Earnings per share:
Basic:
Net earnings
Diluted:
Net earnings
Average common shares outstanding (in thousands):
Basic
Diluted
See accompanying Notes to Consolidated Financial Statements.
2007
2006
2005
$ 527,537
458,865
429,115
349,891
122,502
10,705
(744)
2,455
—
300,309
106,882
6,872
(1,286)
(2,814)
—
281,654
84,241
1,973
(1,900)
(1,550)
790
484,809
409,963
365,208
42,728
9,015
$ 33,713
48,902
17,622
31,280
$
1.30
$
1.28
1.22
1.19
63,907
20,363
43,544
1.71
1.66
25,865
26,387
25,718
26,386
25,511
26,306
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
23
2007
2006
$ 18,638
36,819
102,994
83,816
11,520
67,871
25,264
34,063
1,345
50,984
24,251
10,042
260,350
207,257
5,543
48,767
101,076
5,184
5,497
46,089
86,312
1,444
160,570
139,342
82,293
78,277
70,588
68,754
149,466
77,242
10,772
$ 576,107
143,450
59,202
10,031
488,694
Consolidated Balance Sheets
(Dollars in thousands)
Years ended September 30,
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, less allowance for doubtful accounts of
$638 and $798 in 2007 and 2006, respectively
Costs and estimated earnings on long-term contracts, less progress
billings of $3,881 and $4,405 in 2007 and 2006, respectively
Inventories
Current portion of deferred tax assets
Other current assets
Total current assets
property, plant and equipment:
Land and land improvements
Buildings and leasehold improvements
Machinery and equipment
Construction in progress
Less accumulated depreciation and amortization
Net property, plant and equipment
Goodwill
Intangible assets, net
Other assets
See accompanying Notes to Consolidated Financial Statements.
24 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Consolidated Balance Sheets
(Dollars in thousands)
Years ended September 30,
liABiliTiES AnD ShAREhOlDERS’ EQuiTY
Current liabilities:
Short-term borrowings and current maturities of long-term debt
Accounts payable
Advance payments on long-term contracts, less costs incurred
of $20,314 and $19,532 in 2007 and 2006, respectively
Accrued salaries
Current portion of deferred revenue
Accrued other expenses
Total current liabilities
Long-term portion of deferred revenue
Pension obligations
Deferred tax liabilities
Other liabilities
Long-term debt
Total liabilities
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 29,159,629 and 29,030,995 shares in 2007 and 2006, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss), net of tax
Less treasury stock, at cost (3,416,966 and 3,166,026 common shares in
2007 and 2006, respectively)
Total shareholders’ equity
See accompanying Notes to Consolidated Financial Statements.
2007
2006
$
2,844 —
54,634
39,496
3,408
15,114
25,239
17,961
119,200
6,411
8,029
18,522
8,462
—
—
7,367
13,932
3,569
11,531
75,895
7,458
13,143
3,750
12,014
160,624
112,260
—
—
292
243,131
226,759
6,303
290
236,390
193,046
(2,070)
476,485
427,656
(61,002)
(51,222)
415,483
$ 576,107
376,434
488,694
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
25
Consolidated Statements of Shareholders’ Equity
(In thousands)
Years ended September 30,
Common Stock
Amount
Shares
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Treasury
Stock
Total
Balance, September 30, 2004
14,149
$142
221,711
115,963
(3,698)
(26,502) 307,616
Comprehensive income:
Net earnings
Translation adjustments
Minimum pension liability,
net of tax of $1,372
Comprehensive income
Stock options and stock compensation
plans, net of tax benefit of $(3,032)
Purchases into treasury
100 percent stock dividend
—
—
—
—
—
—
—
—
—
43,544
—
—
—
680
—
—
43,544
680
(2,548)
—
(2,548)
41,676
222
—
14,368
1
6,606
—
144
—
—
—
—
(144)
—
—
—
53
6,660
(24,928)
(24,928)
—
—
Balance, September 30, 2005
28,739
287
228,317
159,363
(5,566)
(51,377) 331,024
SAB 108 Cumulative effect adjustment
—
—
—
2,403
—
—
2,403
Comprehensive income:
Net earnings
Translation adjustments
Minimum pension liability,
net of tax of $(1,103)
Comprehensive income
Stock options and stock compensation
plans, net of tax benefit of $(3,173)
—
—
—
—
—
—
—
—
—
31,280
—
—
—
1,448
—
—
31,280
1,448
2,048
—
2,048
34,776
292
3
8,073
—
—
155
8,231
Balance, September 30, 2006
29,031
290
236,390
193,046
(2,070)
(51,222) 376,434
Comprehensive income:
Net earnings
Translation adjustments
Minimum pension liability,
net of tax of $(1,622)
Comprehensive income
SFAS 158 adjustment, net of tax of $(358)
Stock options and stock compensation
plans, net of tax benefit of $(828)
Purchases into treasury
—
—
—
—
—
129
—
—
—
—
—
—
2
—
—
—
—
—
—
6,741
—
33,713
—
—
—
—
—
—
—
4,252
3,558
—
563
—
—
—
—
—
—
—
33,713
4,252
3,558
41,523
563
227
6,970
(10,007) (10,007)
Balance, September 30, 2007
29,160
$292
243,131
226,759
6,303
(61,002) 415,483
See accompanying Notes to Consolidated Financial Statements.
26
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Consolidated Statements of Cash Flow
(Dollars in thousands)
Years ended September 30,
Cash flows from operating activities:
Net earnings
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization
Stock compensation expense
Changes in operating working capital
Effect of deferred taxes on tax provision
Pension contributions —
Change in deferred revenue and costs, net
Other
Net cash provided by operating activities
Cash flows from investing activities:
Acquisition of businesses, net of cash acquired
Capital expenditures
Additions to capitalized software
2007
2006
2005
$ 33,713
31,280
43,544
22,176
5,299
(37,663)
12,873
9,339
(474)
45,263
(8,250)
(19,503)
(30,094)
17,303
4,790
1,162
3,596
(1,350)
1,133
712
58,626
(91,968)
(9,117)
(27,977)
12,184
2,649
(4,634)
15,221
—
396
(804)
68,556
—
(8,848)
(8,342)
Net cash used by investing activities
(57,847)
(129,062)
(17,190)
Cash flows from financing activities:
Proceeds from long-term debt
Principal payments on long-term debt
Net increase in short-term borrowings
Purchases of common stock into treasury
Excess tax benefit from stock options exercised
Proceeds from exercise of stock options
Other
—
—
2,844
(10,007)
73
1,843
(350)
52,000
(52,000)
—
—
1,569
2,761
(1,559)
—
(519)
—
(24,928)
—
3,037
3,247
Net cash (used) provided by financing activities
(5,597)
2,771
(19,163)
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
(18,181)
36,819
(67,665)
104,484
32,203
72,281
Cash and cash equivalents at end of year
$ 18,638
36,819
104,484
Changes in operating working capital:
Accounts receivable, net
Costs and estimated earnings on long-term contracts, net
Inventories
Other current assets
Accounts payable
Advance payments on long-term contracts, net
Accrued expenses
Supplemental cash flow information:
Interest paid
Income taxes paid (including state, foreign & AMT)
See accompanying Notes to Consolidated Financial Statements.
$ (18,775)
(10,175)
(16,627)
(11,877)
15,138
(3,959)
8,612
(10,029)
3,047
1,822
737
7,675
594
(2,684)
$ (37,663)
1,162
$
109
3,731
456
10,768
8,910
(1,916)
(4,358)
(1,856)
(3,156)
2,468
(4,726)
(4,634)
33
6,269
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
27
notes to Consolidated Financial Statements
1. 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 2007 presentation.
B. BASiS OF pRESEnTATiOn
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, 2007 and 2006.
C. nATuRE OF OpERATiOnS
The Company has three industry operating units: Communications,
Filtration/Fluid Flow (Filtration), and Test. The Communications unit
is a proven supplier of special purpose communications systems for
electric, gas and water utilities, including hardware and software to
support advanced metering applications. The Filtration unit devel-
ops, manufactures and markets a broad range of filtration products
used in the purification and processing of liquids and gases. The
Test unit is an industry leader in providing its customers with the
ability to identify, measure and contain magnetic, electromagnetic
and acoustic energy.
D. uSE OF ESTiMATES
The preparation of financial statements in conformity with account-
ing 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
Communications Unit: Within the Communications unit, approxi-
mately 95% of the unit’s revenue arrangements (approximately 35%
of consolidated revenues) contain software components. Revenue
under these arrangements is recognized in accordance with State-
ment of Position 97-2 (SOP 97-2), “Software Revenue Recognition,”
as amended by SOP 98-9, “Modification of SOP 97-2, Software Rev-
enue Recognition, with Respect to Certain Transactions.” The unit’s
software revenue arrangements generally include multiple products
and services, or “elements” consisting of meter and substation hard-
ware, meter reading system software, program management support
during the deployment period and software support (post-contract
customer support, “PCS”). These arrangements typically require the
Company to deliver software at the inception of the arrangement
28 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
while the hardware and program management support are delivered
over the contractual deployment period. Software support is provided
during deployment and subsequent thereto. The software element
included in such arrangements is essential to the functionality
of the hardware and, therefore, the hardware is considered to be
software-related. Hardware is considered a specified element in the
software arrangement and vendor-specific objective evidence of fair
value (“VSOE”) has been established for this element. VSOE for the
hardware element is determined based on the price when sold sepa-
rately to customers. These revenue arrangements are divided into
separate units of accounting if the delivered item(s) has value to
the customer on a stand-alone basis, there is objective and reliable
evidence of the fair value of the undelivered item(s) and delivery/
performance of the undelivered item(s) is probable. For multiple ele-
ment arrangements, revenue is allocated to the individual elements
based on VSOE of the individual elements.
The application of these principles requires judgment, including the
determination of whether a software arrangement includes multiple
elements and estimates of the fair value of the elements. The VSOE
of the fair value of undelivered elements is determined based on
the historical evidence of stand-alone sales of these elements to
customers. Hardware revenues are generally recognized at the time
of shipment or receipt by customer depending upon contract terms.
VSOE generally does not exist for the software element; therefore, the
Company uses the residual method to recognize revenue when VSOE
exists for all other undelivered elements. Under the residual method,
the fair value of the undelivered elements is deferred and the remain-
ing portion of the arrangement fee is recognized as revenue.
SOP 97-2 requires the seller of software that includes post-contract
customer support (PCS) to establish VSOE of the undelivered ele-
ment of the contract in order to account separately for the PCS
revenue. The Company determines VSOE by a consistent pricing of
PCS and PCS renewals as a percentage of the software license fees
or by reference to contractual renewals, when the renewal terms
are substantive. Revenues for PCS are recognized ratably over the
maintenance term specified in the contract (generally in 12 monthly
increments). Revenues for program management support are recog-
nized when services have been provided. The Company determines
VSOE for program management support based on hourly rates when
services are performed separately.
In November 2005, DCSI and Hexagram entered into arrangements
with a large utility company to provide software, program manage-
ment services, training and PCS that includes an option for the
customer to purchase a significant quantity of hardware over an
initial deployment period of approximately five years and subse-
quently over the remaining initial contract term of up to fifteen
years. The software, program management services and training
will be delivered over the initial hardware deployment period of
approximately five years. PCS will be provided at no charge during
the first year of the initial deployment period, after which it will be
provided over subsequent annual periods throughout the contract
term if the customer chooses to continue PCS. Because the program
notes to Consolidated Financial Statements
management services are based on a fixed price per month rather
than on a time and materials basis, the Company is unable to es-
tablish VSOE for the program management services in this arrange-
ment. The Company is able to establish VSOE for the PCS based on
contractual renewal rates that are consistent with other arrange-
ments and for the training based on pricing when sold separately.
For the DCSI arrangement, the pricing for the optional hardware
includes a discount that the Company has determined to be more-
than-insignificant. In accordance with applicable software revenue
recognition guidance, the Company will defer all revenue related to
the DCSI arrangement until all software is delivered and acceptance
criteria have been met. At that time, revenue otherwise allocable
to the software, program management services, training and initial
bundled PCS will be reduced by the rate of the significant incremen-
tal discount offered on the hardware products. The portion of the
arrangement consideration allocated to the significant incremental
discount will be recognized ratably over the discount period (up
to twenty years) similar to a subscription. The remaining arrange-
ment consideration will be recognized ratably over the period the
program management services will be performed (the initial deploy-
ment period of approximately five years). Additional annual fees are
payable in each subsequent year that PCS is provided and will be
recognized over the respective PCS period. The amount paid by the
customer for optional purchases of hardware during the deployment
period related to both the DCSI and Hexagram arrangements will be
recognized upon delivery and acceptance, if applicable, assuming
all other revenue recognition criteria have been met.
Approximately 5% of unit revenues are recognized when products
are delivered (when title and risk of ownership transfers) or when
services are performed for unaffiliated customers. Products include
the SecurVision® digital video surveillance systems.
Filtration Unit: Within the Filtration operating unit, approximately
80% of operating unit revenues (approximately 30% of consolidated
revenues) are recognized when products are delivered (when title
and risk of ownership transfers) or when services are performed for
unaffiliated customers.
Approximately 20% of operating unit revenues (approximately 5%
of consolidated revenues) are recorded under the percentage-of-
completion provisions of SOP 81-1, “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts.” Products
accounted for under SOP 81-1 include the design, development
and manufacture of complex fluid control products, quiet valves,
manifolds and systems primarily for the aerospace and military mar-
kets. For arrangements that are accounted for under SOP 81-1, the
Company estimates profit as the difference between total estimated
revenue and total estimated cost of a contract and recognizes
these revenues and costs based on units delivered. The percentage-
of-completion method of accounting involves the use of various
techniques to estimate expected costs at completion.
Test Unit: Within the Test unit, approximately 50% of revenues
(approximately 15% of consolidated revenues) are recognized when
products are delivered (when title and risk of ownership transfers)
or when services are performed for unaffiliated customers. Certain
arrangements contain multiple elements which are accounted for
under the provisions of EITF 00-21, “Revenue Arrangements with
Multiple Deliverables.” The multiple elements generally consist of
materials and installation services used in the construction and
installation of standard shielded enclosures to measure and contain
magnetic and electromagnetic energy. The installation process does
not involve changes to the features or capabilities of the equipment
and does not require proprietary information about the equipment
in order for the installed equipment to perform to specifications.
There is objective and reliable evidence of fair value for each of
the units of accounting, as a result, the arrangement revenue is al-
located to the separate units of accounting based on their relative
fair values. Typically, fair value is the price of the deliverable when
it is regularly sold on a stand-alone basis.
Approximately 50% of the unit’s revenues (approximately 15%
of consolidated revenues) are recorded under the percentage-of-
completion provisions of SOP 81-1, “Accounting for the Performance
of Construction-Type and Certain Production-Type Contracts” due
to the complex nature of the enclosures that are designed and
produced under these contracts. Products accounted for under SOP
81-1 include the construction and installation of complex test
chambers to a buyer’s specifications that provide its customers
with the ability to measure and contain magnetic, electromagnetic
and acoustic energy. As discussed above, for arrangements that are
accounted for under SOP 81-1, the Company estimates profit as the
difference between total estimated revenue and total estimated
cost of a contract and recognizes these revenues and costs based
on either (a) units delivered or (b) contract milestones.
If a reliable measure of output cannot be established (which applies
in less than 8% of Test unit revenues or 2% of consolidated rev-
enues), input measures (e.g., costs incurred) are used to recognize
revenue. Given the nature of the Company’s operations related to
these contracts, costs incurred represent an appropriate measure of
progress towards completion.
The percentage-of-completion method of accounting involves the
use of various techniques to estimate expected costs at completion.
These estimates are based on Management’s judgment and the Com-
pany’s substantial experience in developing these types of estimates.
F. CASh AnD CASh EQuiVAlEnTS
Cash equivalents include temporary investments that are readily
convertible into cash, such as Eurodollars, commercial paper and
treasury bills with original maturities of three months or less.
g. ACCOunTS RECEiVABlE
Accounts receivable have been reduced by an allowance for amounts
that the Company estimates are uncollectible in the future. This
estimated allowance is based on Management’s evaluation of the fi-
nancial condition of the customer and historical write-off experience.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
29
notes to Consolidated Financial Statements
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. 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 lOng-liVED 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.” Management annually reviews goodwill and
other long-lived assets with indefinite useful lives for impairment
or whenever events or changes in circumstances indicate the carry-
ing amount may not be recoverable. If the Company determines that
the carrying value of the long-lived asset may not be recoverable,
a permanent impairment charge is recorded for the amount by which
the carrying value of the long-lived asset exceeds its fair value.
Fair value is measured based on a discounted cash flow method
using a discount rate determined by Management to be commensu-
rate with the risk inherent in the Company’s current business model.
Other intangible assets represent costs allocated to identifiable
intangible assets, principally capitalized software, patents, trade-
marks, and technology rights. See Note 4 regarding goodwill and
other intangible assets activity.
l. CApiTAliZED SOFTWARE
The costs incurred for the development of computer software that
will be sold, leased, or otherwise marketed are charged to expense
when incurred as research and development until technological
feasibility has been established for the product. Technological
feasibility is typically established upon completion of a detailed
program design. Costs incurred after this point are capitalized on
a project-by-project basis in accordance with SFAS No. 86, “Ac-
counting for the Costs of Computer Software to be Sold, Leased or
30 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Otherwise Marketed.” Costs that are capitalized primarily consist of
external development costs. Upon general release of the product to
customers, the Company ceases capitalization and begins amortiza-
tion, which is calculated on a project-by-project basis as the greater
of (1) the ratio of current gross revenues for a product to the total
of current and anticipated future gross revenues for the product or
(2) the straight-line method over the estimated economic life of the
product. The Company generally amortizes the software development
costs over a three- to seven-year period based upon the estimated
future economic life of the product. Factors considered in deter-
mining the estimated future economic life of the product include
anticipated future revenues, and changes in software and hardware
technologies. The carrying values of capitalized costs are evaluated
for impairment on an annual basis to determine if circumstances
exist which indicate the carrying value of the asset may not be
recoverable. If expected cash flows are insufficient to recover the
carrying amount of the asset, then an impairment loss is recognized
to state the asset at its net realizable value.
M. 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 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.
n. 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 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.
O. 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
notes to Consolidated Financial Statements
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 reimburse-
ment, 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 develop-
ment project, are expensed as incurred.
p. 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 adjust-
ments are recorded as a separate component of accumulated other
comprehensive income.
Q. 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 issu-
able upon the assumed exercise of dilutive common share options
and vesting of performance-accelerated restricted shares using the
treasury stock method.
The number of shares used in the calculation of earnings per share
for each year presented is as follows:
(In thousands)
2007
2006
2005
Weighted Average Shares
Outstanding — Basic
Dilutive Options and performance-
accelerated restricted stock
25,865
25,718
25,511
522
668
795
Adjusted Shares — Diluted
26,387
26,386
26,306
Options to purchase 602,731 shares at prices ranging from $36.07 -
$54.88 were outstanding during the year ended September 30,
2007, but were not included in the respective computation of
diluted EPS because the options’ exercise price was greater than the
average market price of the common shares. Options to purchase
264,430 shares at prices ranging from $42.99 - $54.88 were out-
standing during the year ended September 30, 2006, but were not
included in the respective computation of diluted EPS because the
options’ exercise price was greater than the average market price
of the common shares. Options to purchase 34,967 shares at prices
ranging from $35.18 - $50.26 were outstanding during the year
ended September 30, 2005, but were not included in the respective
computation 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 2013. Approximately
14,000, 9,000 and 36,000 restricted shares were outstanding but
unearned at September 30, 2007, 2006 and 2005, respectively, and,
therefore, were not included in the respective years’ computations
of diluted EPS.
R. ShARE-BASED COMpEnSATiOn
Prior to October 1, 2005, the Company accounted for its stock op-
tion plans using the intrinsic value method of accounting provided
under APB Opinion No. 25, “Accounting for Stock Issued to Employ-
ees,” (APB 25) and related Interpretations, as permitted by FASB
Statement No. 123, “Accounting for Stock-Based Compensation,”
(SFAS 123) under which no compensation expense was recognized
for stock option grants. Accordingly, share-based compensation for
stock options was included as a pro forma disclosure in the financial
statement footnotes for periods prior to fiscal 2006.
Effective October 1, 2005, the Company adopted the fair value
recognition provisions of FASB Statement No. 123(R), “Share-Based
Payment,” (SFAS 123(R)) using the modified-prospective transition
method. Results for prior periods have not been restated.
The Company provides compensation benefits to certain key employ-
ees under several share-based plans providing for employee stock
options and/or performance-accelerated restricted shares (restricted
shares), and to non-employee directors under a non-employee
directors compensation plan.
S. COMpREhEnSiVE inCOME (lOSS)
SFAS 130, “Reporting Comprehensive Income” requires the Company
to report separately the translation adjustments of SFAS 52 defined
above, and changes to the minimum pension liability, as compo-
nents of comprehensive income or loss. Management has chosen to
disclose the requirements of this Statement within the Consolidated
Statements of Shareholders’ Equity.
Accumulated other comprehensive income (loss) as shown on the
consolidated balance sheet of $6.3 million and $(2.1) million at
September 30, 2007 and 2006, respectively, consisted of $8.8 mil-
lion and $4.5 million related to currency translation adjustments;
$(2.5) million and $(6.6) million related to the minimum pension
liability, respectively.
T. DEFERRED REVEnuE AnD COSTS
Deferred revenue and costs are recorded for products or services
that have not been provided but have been invoiced under con-
tractual agreements or paid for by a customer, or when products or
services have been provided but the criteria for revenue recogni-
tion have not been met. If there is a customer acceptance provi-
sion or there is uncertainty about customer acceptance, revenue
and costs are deferred until the customer has accepted the product
or service. At September 30, 2007, approximately $12 million of
deferred costs are included within other current assets on the
consolidated balance sheet.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
31
notes to Consolidated Financial Statements
Deferred revenue also includes the long-term portion of unearned
income related to two intellectual property agreements. The amount
is being amortized into income on a straight-line basis over the
remaining patent life through 2011. The current portion of approxi-
mately $0.6 million is included in the current portion of deferred
revenue on the consolidated balance sheet.
u. nEW ACCOunTing STAnDARDS
In June 2006, the FASB issued FASB Interpretation No. 48, “Ac-
counting for Uncertainty in Income Taxes, an Interpretation of
FASB Statement No. 109” (FIN 48). FIN 48 prescribes a recognition
threshold and measurement process for the financial statement
recognition and measurement of a tax position taken or expected to
be taken in a tax return. FIN 48 is effective for fiscal years begin-
ning after December 15, 2006. The Company estimates that the
adoption of FIN 48 will result in an increase to the opening balance
of retained earnings as of October 1, 2007 in the range of zero to
$5 million for income tax benefits not previously recognized.
In September 2006, the FASB issued SFAS No. 158, “Employer’s
Accounting for Defined Benefit Pension and Other Postretirement
Plans” (SFAS 158), which amends SFAS 87 and SFAS 106 to require
recognition of the overfunded or underfunded status of pension
and other postretirement benefit plans on the balance sheet. Under
SFAS 158, gains and losses, prior service costs and credits, and any
remaining transition amounts under SFAS 87 and SFAS 106 that
have not yet been recognized through net periodic benefit cost will
be recognized in accumulated other comprehensive income, net of
tax effects. The measurement date — the date at which the benefit
obligation and plan assets are measured — is required to be the
Company’s fiscal year-end, which is the date the Company currently
uses. SFAS 158 is effective for publicly-held companies for fiscal
years ending after December 15, 2006. The Company adopted the
provisions of SFAS 158 as of September 30, 2007 and recorded a
pre-tax credit of $0.9 million to accumulated other comprehensive
income in equity.
In September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements” (SFAS 157), which defines fair value in generally
accepted accounting principles and expands disclosures about fair
value measurements. This Statement is effective for financial state-
ments issued for fiscal years beginning after November 15, 2007.
The adoption of SFAS 157 is not expected to have a material impact
to the Company’s financial position or results of operations.
2. Acquisitions
On August 10, 2007, the Company acquired the assets and certain
liabilities of Wintec, LLC (Wintec) for a purchase price of $6 million.
Wintec is engaged in the design, manufacture and sale of metallic
elements, filters, and strainers for pneumatic/hydraulic applications
and surface tension devices for propellant management fluid control
with annual revenues of approximately $3.5 million. The assets
acquired consist of accounts receivable, inventory and property,
plant and equipment. The Company recorded approximately $5 mil-
lion of goodwill in connection with the transaction. In addition,
the Company recorded $0.2 million of amortizable intangible assets
consisting of customer contracts and order backlog which are being
amortized on a straight-line basis over periods ranging from nine
months to seventeen months. The operating results for Wintec,
since the date of acquisition, are included within VACCO in the
Filtration segment.
On February 1, 2006, the Company acquired the capital stock of
Hexagram, Inc. (Hexagram) for a purchase price of approximately
$66 million. The acquisition agreement also provides for contin-
gent consideration of up to $6.25 million over the five-year period
following the acquisition if Hexagram exceeds certain sales targets.
During 2007, the Company paid $1.3 million of contingent consider-
ation. Hexagram is an RF fixed network AMI company headquartered
in Cleveland, Ohio. Hexagram broadens the Company’s served market
and provides an RF based AMI system serving primarily electric,
gas and water utilities. The operating results for Hexagram, since
the date of acquisition, are included within the Communications
unit. The Company recorded $6.6 million of amortizable identifiable
intangible assets consisting primarily of patents and proprietary
know-how, customer contracts, and order backlog which are being
amortized on a straight-line basis over periods ranging from six
months to seven years.
On November 29, 2005, the Company acquired Nexus Energy Soft-
ware, Inc. (Nexus) through an all cash for shares merger transac-
tion for approximately $29 million in cash plus contingent cash
consideration over the four-year period following the merger if
Nexus exceeds certain sales targets. Nexus is a software company
headquartered in Wellesley, Massachusetts. Nexus broadens the
Company’s served market and provides software solutions that allow
utilities to fully utilize the information produced by the Company’s
AMI systems. The operating results for Nexus, since the date of
acquisition, are included within the Communications unit. The
Company recorded $2.7 million of identifiable intangible assets
consisting primarily of customer contracts and order backlog which
are being amortized on a straight-line basis over periods ranging
from one year to three years. In connection with the acquisition
of Nexus, the Company acquired approximately $13 million of net
operating loss carryforward that will expire between 2017 and 2025
and is subject to a Section 382 limitation.
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 state-
32 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
notes to Consolidated Financial Statements
ments from the date of acquisition. Pro forma financial information
related to the Hexagram and Nexus acquisitions was not presented
as it was not significant to the Company’s results of operations.
None of the goodwill recorded as part of the Nexus or Hexagram
acquisitions is expected to be deductible for U.S. Federal or state
income tax purposes.
3. Asset impairment
In June 2005, the Company abandoned its plans to commercial-
ize certain sensor products within the Filtration segment resulting
in an asset impairment charge of $0.8 million to write off certain
patents and a related licensing agreement.
4. goodwill and Other intangible Assets
Included on the Company’s Consolidated Balance Sheets at Septem-
ber 30, 2007 and 2006 are the following intangible assets gross
carrying amounts and accumulated amortization:
(Dollars in millions)
Goodwill:
Gross carrying amount
Less: accumulated amortization
Net
Intangible assets with determinable lives:
Patents
Gross carrying amount
Less: accumulated amortization
Net
Capitalized software
Gross carrying amount
Less: accumulated amortization
Net
Other
Gross carrying amount
Less: accumulated amortization
Net
2007
2006
$ 158.4
8.9
$ 149.5
152.4
8.9
143.5
$ 17.9
14.7
$ 3.2
$ 83.4
17.7
$ 65.7
$ 9.9
5.1
$ 4.8
17.6
13.9
3.7
55.2
10.0
45.2
9.5
2.8
6.7
The changes in the carrying amount of goodwill attributable to each
business segment for the years ended September 30, 2007 and 2006
are as follows:
(Dollars in millions)
Communications
Filtration
Test
Balance as of
September 30, 2005
Acquisitions
$ —
39.8
29.1
(Hexagram and Nexus)
74.6
—
—
Balance as of
September 30, 2006
Acquisitions
Balance as of
September 30, 2007
74.6
0.8
39.8
5.2
29.1
—
$75.4
45.0
29.1
Amortization expense related to intangible assets with determin-
able lives was $10.7 million, $6.9 million and $2.0 million in
2007, 2006 and 2005, respectively. The increase in amortization
expense in 2007 as compared to the prior year was due to the
Company’s TWACS NG software. The Company recorded $6.2 million
and $2.2 million of amortization expense related to DCSI’s TWACS
NG software in 2007 and 2006, respectively. Patents are amortized
over the life of the patents, generally 17 years. Capitalized software
is amortized over the estimated useful life of the software, gener-
ally three to seven years. Estimated intangible assets amortization
for fiscal year 2008 is approximately $14 million. Intangible asset
amortization for fiscal years 2009 through 2012 is estimated at
approximately $16 million to $19 million per year. The increase
in intangible asset amortization is related to the additional costs
associated with the TWACS NG software.
5. Accounts Receivable
Accounts receivable, net of the allowance for doubtful accounts,
consist of the following at September 30, 2007 and 2006:
(Dollars in thousands)
Commercial
2007
2006
$ 97,714
81,986
U.S. Government and prime contractors
5,280
1,830
Total
$102,994
83,816
Intangible assets with indeterminable lives:
Trademarks
$ 3.5
3.5
6. inventories
The Company performed its annual evaluation of goodwill and intan-
gible assets for impairment during the fourth quarter of fiscal 2007
and concluded no impairment existed at September 30, 2007.
Inventories consist of the following at September 30, 2007 and
2006:
(Dollars in thousands)
Finished goods
Work in process — including
long-term contracts
Raw materials
Total
2007
2006
$22,211
12,834
17,660
13,211
28,000
24,939
$67,871
50,984
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
33
notes to Consolidated Financial Statements
7. property, plant and Equipment
Depreciation expense of property, plant and equipment for the
years ended September 30, 2007, 2006 and 2005 was $11.5 million,
$10.4 million and $10.1 million, respectively.
The Company leases certain real property, equipment and machinery
under noncancelable operating leases. Rental expense under these
operating leases for the years ended September 30, 2007, 2006 and
2005 was $7.8 million, $7.3 million and $6.3 million, respectively.
Future aggregate minimum lease payments under operating leases
that have initial or remaining noncancelable lease terms in excess
of one year as of September 30, 2007 are:
(Dollars in thousands)
Years ending September 30:
2008
2009
2010
2011
2012 and thereafter
Total
8. income Tax Expense
$ 6,639
5,428
4,238
3,516
6,619
$26,440
The components of income before income taxes consisted of the
following for the years ended September 30:
(Dollars in thousands)
2007
2006
2005
United States
Foreign
$37,051
43,920
52,543
5,677
4,982
11,364
Total income before income taxes $42,728
48,902
63,907
The principal components of income tax expense from continuing
operations for the years ended September 30, 2007, 2006 and 2005
consist of:
(Dollars in thousands)
2007
2006
2005
Federal
Current (including Alternative
Minimum Tax)
$ (6,419)
3,571
874
11,473
10,291
15,313
1,051
2,066
2,673
2,414
(518)
(21)
Deferred
State and local:
Current
Deferred
Foreign:
Current
Deferred
Total
34 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
The actual income tax expense from continuing operations for the
years ended September 30, 2007, 2006 and 2005 differs from the
expected tax expense for those years (computed by applying the
U.S. Federal corporate statutory rate) as follows:
2007
2006
2005
Federal corporate statutory rate
35.0%
35.0%
35.0%
State and local, net of Federal benefits
2.8
Foreign — Puerto Rico
Foreign — Other
Foreign earnings repatriation
Research credit
SFAS 123(R)
Change in tax contingencies
Release of valuation allowance
Other, net
(0.6)
(2.1)
—
(10.3)
3.8
(5.3)
(1.8)
(0.4)
2.4
0.5
(0.5)
4.8
(5.0)
1.4
(2.9)
—
0.3
2.4
(4.6)
(1.6)
—
—
—
—
—
0.7
Effective income tax rate
21.1%
36.0%
31.9%
During 2007, the Company determined that certain tax accounts
had not been accurately recorded in the financial statements for
fiscal years 2001 to 2006. The effect in any individual year was not
material to the Company’s results of operations, financial position
or cash flows. The Company recorded $1.3 million as a cumulative
credit adjustment to tax expense to correct previously recorded tax
accounts during the fourth quarter of 2007.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at September 30,
2007 and 2006 are presented below.
(Dollars in thousands)
Deferred tax assets:
2007
2006
Inventories, long-term contract accounting,
contract cost reserves and others
$
3,828
Pension and other postretirement benefits
3,339
Net operating loss carryforward — domestic
12,311
Net operating loss carryforward — foreign
3,092
Alternative Minimum Tax credit carryforward
Capital loss carryforward
Other compensation-related costs
and other cost accruals
Research credit carryforward
Total deferred tax assets
Deferred tax liabilities:
1,858
5,449
5,103
2,895
3,306
7,381
779
7,888
11,285
15,178
13,979
6,635
56,501
47,805
Plant and equipment, depreciation methods,
acquisition asset allocations, and other
(38,780)
(17,028)
1,510
1,213
1,854
(666)
392
(71)
Net deferred tax asset before
valuation allowance
$ 9,015
17,622
20,363
Less valuation allowance
Net deferred tax assets
17,721
30,777
(10,979)
(10,276)
$
6,742
20,501
notes to Consolidated Financial Statements
Management believes that, based on the Company’s historical pretax
income, together with the projection of future taxable income, and
after consideration of the valuation allowance, it is more likely than
not that the Company will realize the benefits of the net deferred
tax assets existing at September 30, 2007. In order to realize this
net deferred tax asset, the Company will need to generate future
taxable income of approximately $19 million. At September 30,
2007, the Company had an available net operating loss (NOL) for
U.S. Federal tax purposes of approximately $35 million. This NOL
will expire between 2019 and 2025 and will be available to reduce
future Federal income tax cash payments. The Company anticipates
being able to utilize the NOL carryforward to reduce future Federal
income tax cash payments.
The Company has established a valuation allowance of $7.9 million
against the capital loss carryforward generated in 2004, as such
loss carryforward may not be realized in future periods. In addition,
the Company has established a valuation allowance against certain
NOL carryforwards in foreign jurisdictions which may not be realized
in future periods. The valuation allowance established against the
foreign NOL carryforwards was $3.1 million and $2.9 million at Sep-
tember 30, 2007 and 2006, respectively. The Company classifies its
valuation allowance related to deferred taxes on a pro rata basis.
The Company completed its analysis of available research credits for
fiscal years 2000 through 2006 and recorded total research credit
claims, net, of $5.6 million. The Company expects the net research
credits related to fiscal year 2007 to be approximately $1.4 million.
The expiration of the research credits is between 2020 and 2027.
The Company anticipates being able to utilize the research credits
to reduce future Federal and state income tax cash payments.
No deferred taxes have been provided on the accumulated unremit-
ted earnings of the Company’s foreign subsidiaries as of September
30, 2007. The Company’s intention is to reinvest these earnings
indefinitely. In the event these foreign entities’ earnings were dis-
tributed, it is estimated that U.S. taxes, net of available foreign tax
credits, of approximately $3.2 million would be due, which would
correspondingly reduce the Company’s net earnings.
On October 22, 2004, the American Jobs Creation Act (the “AJCA”)
was signed into law. The AJCA includes a deduction of 85% of cer-
tain foreign earnings that are repatriated, as defined in the AJCA.
In 2006, the Company recognized a charge of $2.4 million for the
accrual of income taxes associated with the repatriation under the
AJCA of approximately $39.5 million of foreign earnings.
During 2006, the Company adopted the provisions of SEC Staff
Accounting Bulletin No. 108 and recorded $2.4 million as a
cumulative state tax expense adjustment to 2006 beginning
retained earnings.
The Company operates within multiple taxing jurisdictions and is
subject to audit in these jurisdictions. These audits can involve
complex issues which may require an extended period of time to re-
solve. The Company regularly reviews its potential tax liabilities for
tax years subject to audit. Changes in the Company’s potential tax
liability occurred during the year ended September 30, 2007, and
may occur in the future as the Company’s assessment changes based
on examinations in various jurisdictions and/or changes in tax laws,
regulations and case law. Accordingly, the Company’s estimate of in-
come tax liabilities may differ from actual payments or assessments.
9. Debt
At September 30, 2007 and 2006, there were $2.8 million and
zero outstanding borrowings under the revolving credit facility,
respectively. Effective October 6, 2004, the Company entered into a
$100 million five-year revolving bank credit facility with a $50 mil-
lion increase option that has a final maturity and expiration date of
October 6, 2009. The credit facility is available for direct borrow-
ings and/or the issuance of letters of credit, and is provided by
a group of six banks, led by Wells Fargo Bank as agent. At Septem-
ber 30, 2007, the Company had approximately $96.4 million avail-
able to borrow under the credit facility in addition to $18.6 million
cash on hand. At September 30, 2007, the Company had outstand-
ing letters of credit of $3.6 million ($0.8 million outstanding under
the credit facility).
The credit facility requires, as determined by certain financial
ratios, a commitment fee ranging from 17.5 to 27.5 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. The facility is secured by the unlimited
guaranty of the Company’s material domestic subsidiaries and a 65%
pledge of the material foreign subsidiaries’ share equity. The finan-
cial covenants of the credit facility include limitations on leverage,
minimum consolidated EBITDA and minimum net worth.
During 2007 and 2006, the maximum aggregate short-term borrow-
ings at any month-end were $9 million and $47 million, respec-
tively; the average aggregate short-term borrowings outstanding
based on month-end balances were $1.7 million and $3.9 million,
respectively; and the weighted average interest rates were 6.24%,
5.25%, and not applicable in 2005. The letters of credit issued
and outstanding under the credit facility totaled $0.8 million and
$0.8 million at September 30, 2007, and 2006, respectively.
Subsequent to September 30, 2007, the Company announced its in-
tention to enter into a new credit facility led by National City Bank
in connection with the acquisition of Doble Engineering Company.
See further discussion in Note 16 “Subsequent Events” in the Notes
to the Consolidated Financial Statements.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
35
notes to Consolidated Financial Statements
10. Capital Stock
The 29,159,629 and 29,030,995 common shares as presented in the
accompanying Consolidated Balance Sheets at September 30, 2007
and 2006 represent the actual number of shares issued at the respec-
tive dates. The Company held 3,416,966 and 3,166,026 common
shares in treasury at September 30, 2007 and 2006, respectively.
In August 2006, the Company’s Board of Directors authorized an
open market common stock repurchase program for up to 1.2 mil-
lion shares, subject to market conditions and other factors which
covers the period through September 30, 2008. The Company
repurchased 265,000 shares during 2007 under this program. There
were no stock repurchases during 2006. The Company repurchased
670,072 shares in 2005 under a previously authorized program.
11. Share-Based Compensation
The Company provides compensation benefits to certain key
employees under several share-based plans providing for employee
stock options and/or performance-accelerated restricted shares
(restricted shares), and to non-employee directors under a non-
employee directors compensation plan. During fiscal 2004, the
Board of Directors authorized and the shareholders approved, the
2004 Incentive Compensation Plan, which states, in part, that on
February 5, 2004, there shall be 2,000,000 shares added to the
authorized shares allocated for the grant of stock options, stock
appreciation rights, performance-accelerated restricted stock, or
other full value awards. Of these, shares up to 600,000 may be
utilized for performance-accelerated restricted stock or other full
value awards. At September 30, 2007, the maximum number of
full value shares available for issue under the 2004 Incentive
Compensation Plan and the 2001 Stock Incentive Plan was
600,000 and 270,502 shares, respectively.
Stock Option plans
The Company’s stock option awards are generally subject to graded
vesting over a three-year service period. All outstanding options
were granted at prices equal to fair market value at the date of
grant. The options granted prior to September 30, 2003 have a ten-
year contractual life from date of issuance, expiring in various pe-
riods through 2013. Beginning in fiscal 2004, the options granted
have a five-year contractual life from date of issuance. Beginning
with fiscal 2006 awards, the Company recognizes compensation cost
on a straight-line basis over the requisite service period for the
entire award. Prior to fiscal 2006, the Company calculated the pro
forma compensation cost using the graded vesting method.
The fair value of each option award is estimated as of the date of
grant using a Black-Scholes option pricing model. The weighted
average assumptions for the periods indicated are noted below.
Expected volatility is based on historical volatility of ESCO’s stock
calculated over the expected term of the option. The expected
term was calculated in accordance with Staff Accounting Bulletin
No. 107 using the simplified method for “plain-vanilla” options.
The risk-free rate for the expected term of the option is based on
the U.S. Treasury yield curve in effect at the date of grant. 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 2007, 2006 and
2005, respectively: expected dividend yield of 0% in all periods;
expected volatility of 27.3%, 28.0% and 23.5%; risk-free interest
rate of 4.6%, 4.6% and 3.9%; and expected term of 3.50 years,
3.50 years and 3.58 years.
Information regarding stock options awarded under the option plans is as follows:
October 1
Granted
Exercised
Cancelled
September 30,
At September 30,
Reserved for future grant
Exercisable
FY2007
FY2006
FY2005
Estimated
Weighted
Avg. price
$26.60
$45.71
$21.56
$40.59
Shares
1,387,348
296,280
(101,683)
(23,004)
Estimated
Weighted
Avg. Price
$ 20.48
$ 44.63
$ 15.95
$ 35.77
Shares
1,324,548
328,080
(232,371)
(32,909)
Estimated
Weighted
Avg. Price
$ 13.63
$ 35.55
$ 10.94
$ 24.96
Shares
1,356,094
376,200
(388,340)
(19,406)
1,558,941
$30.35
1,387,348
$ 26.60
1,324,548
$ 20.48
878,238
951,066
1,146,741
1,428,032
$21.99
753,415
$ 16.46
755,612
$ 12.29
36 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
longer performance period as it is not probable the performance
condition will be met. The restricted share award grants were valued
at the stock price on the date of grant. Pre-tax compensation
expense related to the restricted share awards was $1.5 million,
$1.5 million and $1.9 million for fiscal years ended September 30,
2007, 2006 and 2005, respectively.
The following summary presents information regarding outstanding
restricted share awards as of September 30, 2007 and changes dur-
ing the period then ended:
Options Outstanding
Weighted-
Nonvested at October 1, 2006
Number
Outstanding at
Sept. 30, 2007
Average Weighted
Average
Exercise
Price
Remaining
Contractual
Life
Granted
Vested
Cancelled
Weighted
Shares Avg. Price
155,730
$34.33
63,530
$45.75
(51,200)
$24.60
(4,000)
$34.80
notes to Consolidated Financial Statements
The aggregate intrinsic value of options exercised during 2007,
2006 and 2005 was $2.4 million, $7.9 million and $12.4 million,
respectively. The aggregate intrinsic value of stock options out-
standing and exercisable at September 30, 2007 was $12.3 million.
The weighted-average contractual life of stock options outstand-
ing at September 30, 2007 was 3.0 years. The weighted-average
fair value of stock options granted in 2007, 2006, and 2005 was
$12.25, $12.17, and $11.28, respectively.
Summary information regarding stock options outstanding at
September 30, 2007 is presented below:
Range of
Exercise Prices
$ 5.39 - $10.72
$12.64 - $14.52
$17.29 - $32.32
$35.18 - $42.10
$42.99 - $54.88
Range of
Exercise Prices
$ 5.39 - $10.72
$12.64 - $14.52
$17.29 - $32.32
$35.18 - $54.88
201,426
268,486
186,455
303,630
598,944
2.0 years
4.5 years
1.7 years
2.0 years
3.6 years
$ 7.19
$13.76
$23.51
$35.31
$45.20
1,558,941
3.0 years
$30.35
Exercisable Options Outstanding
Number
Exercisable at
Sept. 30, 2007
201,426
268,486
186,455
294,699
951,066
Weighted
Average
Exercise
Price
$ 7.19
$13.76
$23.51
$38.64
$21.99
performance-accelerated Restricted Share Awards
The performance-accelerated restricted shares (restricted shares)
vest over five years with accelerated vesting if certain performance
targets are achieved. In these cases, if it is probable that the per-
formance condition will be met, the Company recognizes compen-
sation cost on a straight-line basis over the shorter performance
period; otherwise, it will recognize compensation cost over the
longer service period. Compensation cost for the majority of the
outstanding restricted share awards is being recognized over the
Nonvested at September 30, 2007
164,060
$41.77
non-Employee Directors plan
The non-employee directors compensation plan provides to each
non-employee director a retainer of 800 common shares per quarter.
Compensation expense related to the non-employee director grants
was $0.8 million, $1.0 million and $0.7 million for the years ended
September 30, 2007, 2006 and 2005, respectively.
The total share-based compensation cost that has been recognized
in results of operations and included within SG&A was $5.3 million,
$4.8 million and $2.6 million for the years ended September 30,
2007, 2006 and 2005, respectively. The total income tax benefit
recognized in results of operations for share-based compensation
arrangements was $1.2 million, $1.2 million and $1.0 million for
the years ended September 30, 2007, 2006 and 2005, respectively.
The Company has elected to use tax law ordering rules when
calculating the income tax benefit associated with its share-based
payment arrangements. In addition, the Company elected to use
the simplified method of calculating the pool of excess tax benefits
available to absorb tax deficiencies recognized subsequent to the
adoption of SFAS No. 123(R)-3, “Transition Election related to
Accounting for the Tax Effects of Share-Based Payment Awards.”
As of September 30, 2007, there was $10.2 million of total unrecog-
nized compensation cost related to share-based compensation
arrangements. That cost is expected to be recognized over a
weighted-average period of 3.0 years.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
37
notes to Consolidated Financial Statements
pro Forma net Earnings
The following table provides pro forma net earnings and earnings
per share had the Company applied the fair value method of SFAS
123 for the year ended September 30, 2005:
Pro forma (Unaudited)
(Dollars in thousands,
except per share amounts)
Net earnings, as reported
Add: stock-based employee
compensation expense included
in reported net earnings, net of tax
Less: total stock-based employee
compensation expense determined
2005
$43,544
1,165
under fair value based methods, net of tax
(3,476)
Pro forma net earnings
Net earnings per share:
Basic — as reported
Basic — pro forma
Diluted — as reported
Diluted — pro forma
$41,233
$1.71
1.62
1.66
1.57
The Company adopted Statement of Financial Accounting Standards
No. 158, “Employer’s Accounting for Defined Benefit Pension and
Other Postretirement Plans” (SFAS 158) as of September 30, 2007.
SFAS 158 requires an employer to recognize the overfunded or
underfunded status of a defined benefit postretirement plan as an
asset or liability in its statement of financial position and to recog-
nize changes in that funded status in the year in which the changes
occur through comprehensive income. As a result of adopting the
provisions of SFAS 158, the Company recorded a pre-tax credit of
$0.9 million to accumulated other comprehensive income in equity
as of September 30, 2007.
The Company uses a measurement date of September 30 for its
pension and other postretirement benefit plans. The Company has
an accrued benefit liability of $0.7 million and $1.8 million at
September 30, 2007 and 2006, respectively, related to its other
postretirement benefit obligations. All other information related to
its postretirement benefit plans is not considered material to the
Company’s results of operations or financial condition.
The following tables provide a reconciliation of the changes in the
pension plans and fair value of assets over the two-year period
ended September 30, 2007, and a statement of the funded status as
of September 30, 2007 and 2006:
12. Retirement and Other Benefit plans
(Dollars in millions)
Pension Benefits
2007
2006
Substantially all domestic employees are covered by the defined
contribution pension plan maintained by the Company. Effective
December 31, 2003, the Company’s defined benefit plan was frozen
and no additional benefits will be accrued after that date. As a
result, the accumulated benefit obligation and projected benefit
obligation are equal. These frozen retirement income 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. 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 per-
centage 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. Effective December 31,
2004, no new retirees are eligible for life insurance benefits.
Reconciliation of benefit obligation
Net benefit obligation at beginning of year
$ 48.2
50.2
Service cost
Interest cost
Actuarial (gain) loss
Plan amendments
Gross benefits paid
—
—
2.7
(2.9)
(1.8)
—
2.6
(2.9)
0.1
(1.8)
Net benefit obligation at end of year
$ 46.2
48.2
(Dollars in millions)
Pension Benefits
2007
2006
Reconciliation of fair value of plan assets
Fair value of plan assets at beginning of year
$ 35.1
Actual return on plan assets
Employer contributions
Gross benefits paid
4.7
0.2
(1.8)
Fair value of plan assets at end of year
$ 38.2
32.7
2.6
1.6
(1.8)
35.1
38 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
notes to Consolidated Financial Statements
(Dollars in millions)
Funded Status
Pension Benefits
2007
2006
Funded status at end of year
$(8.0)
(13.1)
Unrecognized prior service cost
—
Unrecognized net actuarial (gain) loss
—
0.1
10.1
Accrued benefit cost
(8.0)
(2.9)
Amounts recognized in the Balance Sheet
consist of:
Current liability
Noncurrent liability
Accrued benefit cost
(0.2) —
(7.8) —
—
Additional minimum liability
Intangible asset
Accumulated other comprehensive income
(before tax effect)
—
—
—
Accrued benefit liability
(8.0)
(2.9)
(10.3)
0.1
10.2
(2.9)
present value was developed. The expected long-term rate of
return on plan assets assumption was determined by reviewing the
actual investment return of the plans since inception and evaluat-
ing those returns in relation to expectations of various investment
organizations to determine whether long-term future returns are
expected to differ significantly from the past.
The following weighted-average assumptions were used to
determine the net periodic benefit cost for the pension plans:
Discount rate
Rate of increase in
compensation levels
Expected long-term rate of
2007
2006
2005
5.75%
5.25%
6.00%
n/A
N/A
N/A
return on assets
8.25%
8.25%
8.25%
The following weighted-average assumptions were used to
determine the net periodic benefit obligations for the pension plans:
Amounts recognized in Accumulated Other
Comprehensive Income consist of:
Net actuarial loss
Prior service cost
5.0 —
0.1 —
Discount rate
Rate of increase in
compensation levels
2007
2006
6.25%
5.75%
n/A
N/A
Accumulated Other Comprehensive Income
$5.1
—
The following table provides the components of net periodic benefit
cost for the plans for the years ended September 30, 2007, 2006
and 2005:
Pension Benefits
(Dollars in millions)
2007
2006
2005
Service cost
Interest cost
$ —
2.7
—
2.6
Expected return on plan assets
(2.8)
(2.7)
Net actuarial (gain) loss
Net periodic benefit cost
Defined contribution plans
Total
0.4
0.3
3.6
$ 3.9
0.4
0.3
2.9
3.2
—
2.6
(2.9)
0.2
(0.1)
2.4
2.3
The discount rate used in measuring the Company’s pension
obligations was developed by matching yields of actual high-
quality corporate bonds to expected future pension plan cash
flows (benefit payments). Over 500 Aa-rated, non-callable bonds
with a wide range of maturities were used in the analysis. After
using the bond yields to determine the present value of the plan
cash flows, a single representative rate that resulted in the same
The assumed rate of increase in compensation levels is not
applicable in 2007, 2006 and 2005 as the plan was frozen as of
December 31, 2003.
The asset allocation for the Company’s pension plans at the end
of 2007 and 2006, the Company’s acceptable range and the target
allocation for 2008, by asset category, follows:
Target Acceptable Percentage of Plan
Assets at Year-end
Range
Allocation
Asset Category
Equity securities
Fixed income
Cash/cash equivalents
2008
60%
40%
0%
2007
2006
50-70%
30-50%
0-5%
69%
29%
2%
66%
32%
2%
The Company’s pension plan assets are managed by outside invest-
ment managers and assets are rebalanced when the target ranges
are exceeded. Pension plan assets consist principally of marketable
securities including common stocks, bonds, and interest-bearing de-
posits. The Company’s investment strategy with respect to pension
assets is to achieve a total rate of return (income and capital ap-
preciation) that is sufficient to accomplish the purpose of providing
retirement benefits to all eligible and future retirees of the pension
plan. The Company regularly monitors performance and compliance
with investment guidelines.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
39
notes to Consolidated Financial Statements
EXpECTED CASh FlOWS
14. Business Segment information
Information about the expected cash flows for the pension and
other postretirement benefit plans follows:
(Dollars in millions)
Pension
Benefits
Other
Benefits
Expected Employer Contributions — 2008
$ 0.2
0.1
Expected Benefit Payments
2008
2009
2010
2011
2012-2016
2.4
2.5
2.6
2.7
$15.0
0.1
0.1
0.1
0.1
0.3
13. Other Financial Data
Items charged to operations during the years ended September 30,
2007, 2006 and 2005 included the following:
(Dollars in thousands)
2007
2006
2005
Salaries and wages
(including fringes)
$137,999
119,286
100,372
Maintenance and repairs
5,545
4,719
3,897
Research and development
(R&D) costs:
Company-sponsored
$ 25,357
20,043
16,829
Customer-sponsored
7,618
6,323
5,687
Total R&D
$ 32,975
26,366
22,516
Other engineering costs
9,082
9,069
7,763
Total R&D and other
engineering costs
$ 42,057
35,435
30,279
As a % of net sales
8.0%
7.7%
7.1%
Customer-sponsored R&D is defined in Note 1(O) of Notes to Con-
solidated Financial Statements.
A reconciliation of the changes in accrued product warranty liabil-
ity for the years ended September 30, 2007, 2006, and 2005 is as
follows:
(Dollars in thousands)
2007
2006
Balance as of October 1
$1,422
1,487
Additions charged to expense
1,771
2,357
2005
2,147
1,108
Deductions
(1,732)
(2,422)
(1,768)
Balance as of September 30
$1,461
1,422
1,487
The Company is organized based on the products and services that
it offers. Under this organizational structure, the Company has
three reporting units: Communications, Filtration and Test. The
Communications unit is a proven supplier of special purpose fixed
network communications systems for electric, gas and water utili-
ties, including hardware and software to support advanced metering
applications. DCSI’s Two-Way Automatic Communications System,
known as TWACS®, is currently used for automatic meter reading
(AMR) and related advanced metering infrastructure (AMI) functions
serving over 200 utilities, as well as having load management capa-
bilities. Hexagram’s STAR® system, the premier wireless AMI system,
delivers two-way and one-way operation on secure licensed radio
frequencies for more than 100 utilities serving electric, gas and
water customers. Nexus provides best-in-class utility data manage-
ment solutions to more than 85 leading energy companies that add
value to existing billing and metering infrastructure to allow both
the utilities and their customers to better manage energy-driven
transactions and decision making. Comtrak’s SecurVision® product
line provides digital video surveillance and security functions for
large commercial enterprises and alarm monitoring companies.
The Filtration unit’s primary operations consist of: PTI Technologies
Inc. (PTI), VACCO Industries (VACCO) and the Filtertek companies
(Filtertek). PTI and VACCO develop and manufacture a wide range
of filtration products and are leading suppliers of filters to the
commercial and defense aerospace, satellite and industrial markets.
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. Each of the
components of the Filtration segment is presented separately due to
differing long-term economics. Test segment operations represent
the EMC Group, consisting primarily of ETS-Lindgren L.P. (ETS) and
Lindgren R.F. Enclosures, Inc. (Lindgren). The EMC Group is princi-
pally involved in the design and manufacture of EMC test equip-
ment, test chambers, and electromagnetic absorption materials.
The EMC Group also manufactures radio frequency (RF) shielding
products and components used by manufacturers of medical equip-
ment, communications systems, electronic products, and shielded
rooms for high security data processing and secure communica-
tion. 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 per-
formance of its operating units 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, capitalized software and fixed
assets directly associated with the production processes of the
segment. Segment depreciation and amortization is based upon
the direct assets listed above.
40 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
notes to Consolidated Financial Statements
nET SAlES
(Dollars in millions)
Year ended September 30,
Communications
PTI
VACCO
Filtertek
Filtration subtotal
Test
Consolidated totals
2007
$197.6
52.7
37.2
98.5
188.4
141.5
$527.5
2006
156.2
46.4
32.3
95.4
174.1
128.6
458.9
2005
138.0
40.7
38.9
92.1
171.7
119.4
429.1
CApiTAl EXpEnDiTuRES
(Dollars in millions)
Year ended September 30,
2007
2006
2005
Communications
$ 7.0
PTI
VACCO
Filtertek
Filtration subtotal
Test
Corporate
0.4
0.6
7.4
8.4
4.0
0.1
3.4
0.2
1.0
3.8
5.0
0.7
—
9.1
1.9
1.0
0.7
4.0
5.7
1.2
—
8.8
No customers exceeded 10% of net sales in the periods presented.
Consolidated totals
$ 19.5
EBiT
(Dollars in millions)
Year ended September 30,
Communications
PTI
VACCO
Filtertek
Filtration subtotal
Test
Reconciliation to consolidated
2007
$ 22.0
9.4
7.8
6.2
23.4
14.4
2006
28.3
6.6
6.1
6.8
19.5
15.0
2005
38.8
3.8
10.4
8.2
22.4
12.2
totals (Corporate)
(17.8)
(15.2)
(11.4)
Consolidated EBIT
Add: interest income
42.0
0.7
Earnings before income tax
$ 42.7
47.6
1.3
48.9
62.0
1.9
63.9
iDEnTiFiABlE ASSETS
(Dollars in millions)
Year ended September 30,
Communications
PTI
VACCO
Filtertek
Filtration subtotal
Test
Reconciliation to consolidated
totals (Corporate assets)
2007
$ 151.6
32.5
16.8
68.6
117.9
72.0
2006
97.9
32.0
15.7
62.9
110.6
50.3
234.6
229.9
Consolidated totals
$576.1
488.7
2005
52.4
36.7
19.7
91.5
147.9
80.7
142.8
423.8
Corporate assets consist primarily of goodwill, deferred taxes,
acquired intangible assets and cash balances.
DEpRECiATiOn AnD AMORTiZATiOn
(Dollars in millions)
Year ended September 30,
2007
2006
2005
Communications
$ 10.3
PTI
VACCO
Filtertek
Filtration subtotal
Test
Reconciliation to consolidated
totals (Corporate)
1.4
0.8
6.2
8.4
1.3
2.2
Consolidated totals
$ 22.2
5.0
1.5
0.7
6.0
8.2
1.3
2.0
1.5
0.7
6.2
8.4
1.4
2.8
17.3
0.4
12.2
gEOgRAphiC inFORMATiOn
net sales
(Dollars in millions)
Year ended September 30,
2007
2006
2005
United States
$406.3
355.9
325.3
Europe
Far East
Other
45.9
38.0
37.3
40.2
36.1
26.7
56.0
29.6
18.2
Consolidated totals
$527.5
458.9
429.1
long-lived assets
(Dollars in millions)
Year ended September 30,
2007
2006
2005
United States
Europe
Other
Consolidated totals
$ 54.6
14.0
9.7
$ 78.3
51.3
10.6
6.9
68.8
50.3
10.9
6.0
67.2
Net sales are attributed to countries based on location of customer.
Long-lived assets are attributed to countries based on location of
the asset.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
41
notes to Consolidated Financial Statements
15. Commitments and Contingencies
At September 30, 2007, the Company had $3.6 million in let-
ters of credit outstanding 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. With respect to 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 are adequately reserved, covered
by insurance, or are not likely to have a material adverse effect on
its financial condition or results of operation.
16. Subsequent Events
On November 7, 2007, the Company announced an agreement to
acquire the stock of Doble Engineering Company, headquartered
in Watertown, Massachusetts, for $319 million in cash, subject to
adjustment for differences in working capital and cash on hand at
17. Quarterly Financial information (unaudited)
closing. The Company intends to fund the acquisition by a combina-
tion of existing cash and borrowings under a new credit facility led
by National City Bank. The transaction is expected to close in the
quarter ending December 31, 2007.
On November 26, 2007, the Company announced it had completed
the sale of the filtration portion of Filtertek Inc. to Illinois Tool
Works Inc. (ITW) for approximately $77.5 million in cash, subject
to closing working capital adjustments. The Tek Packaging divi-
sion of Filtertek is not included in the transaction. The net cash
proceeds from the sale, estimated at $70 million after taxes and
expenses, will be used to pay down a portion of the debt associ-
ated with the Doble Engineering Company acquisition, mentioned
above. The Company expects to record a gain on the sale for both
financial reporting and tax purposes, with a portion of the tax gain
being shielded from cash payments through the utilization of the
Company’s existing capital loss carryforward which was generated
from prior divestitures. As discussed in Note 8 to the Consolidated
Financial Statements, there is a valuation allowance established
against the capital loss carryforward as of September 30, 2007.
(Dollars in thousands, except per share amounts)
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Fiscal
Year
2007
Net sales
Net earnings (loss)
Basic earnings (loss) per share:
Net earnings (loss)
Diluted earnings (loss) per share:
Net earnings (loss)
2006
Net sales
Net earnings
Basic earnings per share:
Net earnings
Diluted earnings per share:
Net earnings
$ 98,813
129,068
137,523
162,133
527,537
(1,381)
9,618
8,854
16,622
33,713
(.05)
.37
.34
.65
1.30
$
(.05)
.36
.33
.64
1.28
$90,586
122,884
123,626
121,769
458,865
2,204
7,343
11,163
10,570
31,280
.09
.29
.43
.41
1.22
$
.08
.28
.42
.40
1.19
During 2007, the Company determined that certain tax accounts
had not been accurately recorded in the financial statements for
fiscal years 2001 to 2006. The effect in any individual year was not
material to the Company’s results of operations, financial position
or cash flows. The Company recorded $1.3 million as a cumulative
credit adjustment to tax expense to correct previously recorded tax
accounts during the fourth quarter of 2007.
42 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Management’s Statement of Financial Responsibility
The Company’s Management is responsible for the fair presentation
of the Company’s financial statements in accordance with account-
ing principles generally accepted in the United States of America,
and for their integrity and accuracy. Management is confident that
its financial and business processes provide accurate information on
a timely basis.
Management, with the oversight of ESCO’s Board of Directors, has
established and maintains a strong ethical climate in which the
Company’s affairs are conducted. Management also has established
an effective system of internal controls that provide reasonable as-
surance as to the integrity and accuracy of the financial statements,
and responsibility for the Company’s assets. KPMG LLP, the Company’s
independent accountants, reports directly to the Audit and Finance
Committee of the Board of Directors. The Audit and Finance Commit-
tee has established policies consistent with newly enacted corporate
reform laws for auditor independence. In accordance with corporate
governance listing requirements of the New York Stock Exchange:
▶ A majority of Board members are independent of the Company
and its Management.
▶ All members of the key Board committees — the Audit and Fi-
nance, the Human Resources and Compensation and the Nominat-
ing and Corporate Governance Committees — are independent.
▶ The independent members of the Board meet regularly without
the presence of Management.
▶ The Company has a clear code of ethics and a conflict of inter-
est policy to ensure that key corporate decisions are made by
individuals who do not have a financial interest in the outcome,
separate from their interest as Company officials.
▶ The charters of the Board committees clearly establish their
respective roles and responsibilities.
▶ The Company has an ethics officer and an ombudsman hot line
available to all domestic employees and all foreign employees have
local ethics officers and access to the Company’s ombudsman.
The Company has a strong financial team, from its executive leader-
ship to each of its individual contributors. Management monitors
compliance with its financial policies and practices over critical
areas including internal controls, financial accounting and report-
ing, accountability, and safeguarding of its corporate assets. The
internal audit control function maintains oversight over the key
areas of the business and financial processes and controls, and
reports directly to the Audit and Finance Committee. Additionally,
all employees are required to adhere to the ESCO Code of Business
Conduct and Ethics, which is monitored by the ethics officer.
Management is dedicated to ensuring that the standards of financial
accounting and reporting that are established are maintained. The
Company’s culture demands integrity and a commitment to strong
internal practices and policies.
The Consolidated Financial Statements have been audited by KPMG
LLP, whose report is included herein.
Victor L. Richey
Chairman, Chief Executive Officer,
and President
Gary E. Muenster
Senior Vice President
and Chief Financial Officer
Management’s Report on internal Control Over Financial Reporting
The Company’s Management is responsible for establishing and
maintaining adequate internal control over financial reporting (as
defined in the Securities Exchange Act Rule 13a-15(f)). Our internal
control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accor-
dance with generally accepted accounting principles in the United
States of America.
Because of its inherent limitations, any system of internal control
over financial reporting, no matter how well designed, may not
prevent or detect misstatements due to the possibility that a control
can be circumvented or overridden or that misstatements due to error
or fraud may occur that are not detected. Also, because of changes in
conditions, internal control effectiveness may vary over time.
Management assessed the effectiveness of the Company’s internal
control over financial reporting as of September 30, 2007 using cri-
teria established in Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Com-
mission (COSO) and concluded that the Company maintained effective
internal control over financial reporting as of September 30, 2007
based on these criteria.
Our internal control over financial reporting as of September 30,
2007, as well as our assessment of the effectiveness of our internal
control over financial reporting as of September 30, 2007, have
been audited by KPMG LLP, an independent registered public ac-
counting firm, as stated in the report which is included herein.
Victor L. Richey
Chairman, Chief Executive Officer,
and President
Gary E. Muenster
Senior Vice President
and Chief Financial Officer
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
43
Report of independent Registered public Accounting Firm
The Board of Directors and Shareholders
ESCO Technologies Inc.:
each of the years in the three-year period ended September 30, 2007,
in conformity with U.S. generally accepted accounting principles.
We have audited the accompanying consolidated balance sheets
of ESCO Technologies Inc. and subsidiaries (the Company) as of
September 30, 2007 and 2006, and the related consolidated state-
ments of operations, shareholders’ equity and cash flows for each
of the years in the three-year period ended September 30, 2007.
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 the standards of
the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to ob-
tain 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 pre-
viously present fairly, in all material respects, the financial position
of ESCO Technologies Inc. and subsidiaries as of September 30, 2007
and 2006, and the results of their operations and their cash flows for
As discussed in Notes 1 and 12 to the consolidated financial
statements, the Company adopted Statement of Financial
Accounting Standards No. 158, Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans, as of
September 30, 2007. Additionally, as discussed in Note 1 to
the consolidated financial statements, the Company adopted
Statement of Financial Accounting Standards No. 123(R), Share-
Based Payment, effective October 1, 2005 and, as discussed in
Note 8 to the consolidated financial statements, the Company
changed its method of quantifying errors in 2006.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of ESCO Technologies Inc.’s internal control over
financial reporting as of September 30, 2007, based on criteria
established in Internal Control — Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Com-
mission (COSO), and our report dated November 29, 2007, expressed
an unqualified opinion on management’s assessment of, and the
effective operation of, internal control over financial reporting.
St. Louis, Missouri
November 29, 2007
44 E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Report of independent Registered public Accounting Firm
The Board of Directors and Shareholders
ESCO Technologies Inc.:
We have audited management’s assessment, included in the ac-
companying Management’s Report on Internal Control Over Financial
Reporting, that ESCO Technologies Inc. (the Company) maintained
effective internal control over financial reporting as of Septem-
ber 30, 2007, based on criteria established in Internal Control
— Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). ESCO Technolo-
gies Inc.’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management’s assess-
ment and an opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards required that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over
financial reporting, evaluating management’s assessment, testing
and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides
a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted account-
ing principles. A company’s internal control over financial report-
ing includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements
in accordance with generally accepted accounting principles, and
the receipts and expenditures of the company are being made only
in accordance with authorizations of management and directors
of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use,
or disposition of the company’s assets that could have a material
effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projec-
tions of any evaluation of effectiveness to future periods are sub-
ject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
In our opinion, management’s assessment that ESCO Technologies
Inc. maintained effective internal control over financial report-
ing as of September 30, 2007, is fairly stated, in all material
respects, based on criteria established in Internal Control —
Integrated Framework issued by COSO. Also, in our opinion, ESCO
Technologies Inc. maintained, in all material respects, effective
internal control over financial reporting as of September 30, 2007,
based on criteria established in Internal Control — Integrated
Framework issued by COSO.
We also have audited, in accordance with the standards of the Pub-
lic Company Accounting Oversight Board (United States), the con-
solidated balance sheets of ESCO Technologies Inc. and subsidiaries
as of September 30, 2007 and 2006, 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,
2007, and our report dated November 29, 2007, expressed an un-
qualified opinion on those consolidated financial statements.
St. Louis, Missouri
November 29, 2007
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
45
Five-Year Financial Summary
(Dollars in millions, except per share amounts)
2007
2006
2005
2004
2003
For years ended September 30:
Net sales
Net earnings from continuing operations
Net earnings (loss) from discontinued operations —
Net earnings (loss) before accounting change
Net earnings (loss)
Earnings (loss) per share:
Basic:
Continuing operations
Discontinued operations —
Cumulative effect of accounting change, net of tax
Net earnings (loss)
Diluted:
Continuing operations
Discontinued operations —
Cumulative effect of accounting change, net of tax
Net earnings (loss)
As of September 30:
Working capital
Total assets
Long-term debt
Shareholders’ equity
$527.5
33.7
33.7
33.7
1.30
—
1.30
1.28
—
1.28
141.2
576.1
—
$415.5
458.9
31.3
—
31.3
31.3
1.22
—
—
1.22
1.19
—
—
1.19
131.4
488.7
—
376.4
429.1
43.5
—
43.5
43.5
1.71
—
—
1.71
1.66
—
—
1.66
197.2
423.8
—
331.0
422.1
37.8
(2.1)
35.7
35.7
1.47
(0.09)
—
1.38
1.42
(0.08)
—
1.34
165.2
402.4
0.4
307.6
396.7
26.7
(66.5)
(39.7)
(41.1)
1.05
(2.62)
(0.06)
(1.63)
1.02
(2.53)
(0.06)
(1.57)
120.5
393.4
0.5
275.4
See Note 2 of Notes to Consolidated Financial Statements for discussion of acquisition activity.
Common Stock Market price
ESCO’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 common stock for each quarter of fiscal
2007 and 2006.
Quarter
First
Second
Third
Fourth
2007
2006
high
$49.28
49.20
52.41
43.50
low
41.88
40.67
34.73
29.63
High
$50.75
52.76
58.03
58.42
Low
32.57
43.84
47.65
45.30
ESCO historically has not paid cash dividends on its common stock. Management continues to evaluate its cash dividend policy. There are no
current plans to initiate a dividend.
46
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
Market performance
Russell 2000®
Peer Group
ESCO Technologies Inc.
The adjacent graph presents a comparison of the cumulative total
shareholder return on the Company’s common stock as measured
against the Russell 2000 Index and a peer group (the “2007 Peer
Group”). The Company is not a component of the 2007 Peer Group,
but it is a component of the Russell 2000 Index. The measurement
period begins on September 30, 2002 and measures at each Septem-
ber 30 thereafter. These figures assume that all dividends, if any,
paid over the measurement period were reinvested, and the starting
value of each index and the investments in the Company’s common
stock were $100 at the close of trading on September 30, 2002.
$350
300
250
200
150
100
ESCO Technologies Inc.
Russell 2000 Index
2007 Peer Group
ESCO Technologies inc.
Russell 2000 Index
2007 Peer Group
9/02
9/03
9/04
9/05
9/06
9/07
9/02
9/03
9/04
9/05
9/06
9/07
$100
140.15
209.78
310.03
285.08
205.82
100
136.50
162.12
191.23
210.20
236.14
100
136.29
168.38
196.60
226.06
294.15
The 2007 Peer Group is the same peer group included in the
performance graph in last year’s proxy statement and designated
the “2006 Peer Group”. The 2007 Peer Group is comprised of
six companies, which correspond to the Company’s three indus-
try segments as follows: Filtration/Fluid Flow segment (36%
of the Company’s 2007 total revenue) — Pall Corporation and
Clarcor Inc.; Communications segment (37% of the Company’s
2007 total revenue) — Badger Meter Inc., Itron Inc. and Roper
Industries Inc.; and Test segment (27% of the Company’s 2007
total revenue) — Tektronix Inc.
In calculating the composite return of the 2007 Peer Group,
the return of each company comprising the 2007 Peer Group is
weighted by (a) its market capitalization in relation to the other
companies in its corresponding Company industry segment, and
(b) the percentage of the Company’s 2007 total revenue repre-
sented by its corresponding Company industry segment.
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
47
Shareholders’ Summary
ShAREhOlDERS’ AnnuAl MEETing
inVESTOR RElATiOnS
The Annual Meeting of the shareholders of ESCO Technologies Inc.
will be held at 9:30 a.m. Wednesday, February 6, 2008, at the
Company’s Corporate headquarters, 9900A Clayton Road, St. Louis,
Missouri 63124. Notice of the meeting and a proxy statement were
sent to shareholders with this Annual Report.
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 web site at www.escotechnologies.com or via e-mail
to pmoore@escotechnologies.com.
CERTiFiCATiOnS
TRAnSFER AgEnT AnD REgiSTRAR
Pursuant to New York Stock Exchange (NYSE) requirements, the
Company submitted to the NYSE the annual certifications, dated
February 23, 2007 and February 27, 2006, by the Company’s chief
executive officer that he was not aware of any violations by the
Company of NYSE’s corporate governance listing standards. In
addition, the Company filed with the Securities and Exchange
Commission the certifications by the Company’s chief executive
officer and chief financial officer required under Section 302 of
the Sarbanes-Oxley Act of 2002 as exhibits to the Company’s
Forms 10-K for its fiscal years ended September 30, 2007 and
September 30, 2006.
10-K REpORT
A copy of the Company’s 2007 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., 9900A
Clayton Road, St. Louis, Missouri 63124.
The Form 10-K is also available on the Company’s web site at
www.escotechnologies.com.
Shareholder inquiries concerning lost certificates, transfer of shares
or address changes should be directed to:
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 2,700 holders of record of shares of common
stock at November 15, 2007.
inDEpEnDEnT REgiSTERED puBliC A CCOunTing FiRM
KPMG LLP
10 South Broadway, Suite 900
St. Louis, Missouri 63102
48
E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
heading
Management and Board of Directors
ExECuTivE OffiCERS
victor l. Richey
Chairman, Chief Executive
Officer, & President
Alyson S. Barclay
Vice President, Secretary &
General Counsel
gary E. Muenster
Senior Vice President &
Chief Financial Officer
CORpORATE STAff
Charles J. Kretschmer
Vice President
Deborah J. hanlon
Vice President
Human Resources
OpERATing ExECuTivES
David f. Atkinson
President
Filtertek Inc.
Bruce E. Butler
President
ETS-Lindgren LP
Sam R. Chapetta
Filtration Group Vice President &
President
PTI Technologies Inc.
Martin flusberg
President
Nexus Energy Software, Inc.
William M. giacone
Vice President &
General Manager — Lindgren
ETS-Lindgren LP
Antonio E. gonzalez
President
VACCO Industries
Bruce S. Kessler
Executive Vice President &
General Manager
Distribution Control Systems, Inc.
Kent A. Marty
General Manager
Comtrak Technologies, LLC
Sam A. Mazzola
President
Tek Packaging
gary l. Moore
President
Hexagram, Inc.
Bruce A. phillips
Group President
Communications
BOARD Of DiRECTORS
James M. McConnell 2
Retired President &
Chief Executive Officer
Instron Corp.
James M. Stolze 2
Vice President &
Chief Financial Officer
Stereotaxis, Inc.
victor l. Richey 1
Chairman, Chief Executive
Officer, & President
larry W. Solley 3,4
Retired
Executive Vice President
Emerson Electric Co.
Donald C. Trauscht 1,2,3,4
(Lead Director)
Chairman
BW Capital Corp.
James D. Woods 3
Chairman Emeritus &
Retired Chief Executive Officer
Baker Hughes Inc.
Bryan Sayler
Senior Vice President &
General Manager — ETS
ETS-Lindgren LP
Committee Membership
1 Executive Committee
2 Audit and Finance Committee
3 Human Resources and
Compensation Committee
4 Nominating and Corporate
Governance
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E S C O TE Ch nOlOg iE S inC.
2 0 0 7 A n n u Al REpO R T
2 0 0 7 A n n u Al REpO R T
49
Cover3
ESCO Technologies Inc.
9900A Clayton Road
St. Louis, MO 63124
www.escotechnologies.com