ESCO
Annual Report 2013

Plain-text annual report

eS Co t e c h n o l o g i e s I n c . 2 0 1 3 A n n uAl R e p oRt eS Co A t A G l a n c e utIlIt y S o l u tIo nS In the electric power industry, Doble Engineering Com- pany has been helping more than 5500 clients in 110 countries improve operations and optimize system per- formance for nearly a century. This established com- pany with a loyal customer base is evolving to meet the changing needs of businesses and communities around the world. Doble is one of a kind — differentiated in its market by a portfolio delivered through superb products, consulting projects, laboratory services and the leading industry conferences. R F S hIe l dInG & teSt Many of the items used in daily life contain circuitry which can be sensitive to electronic interference. To ensure that they all operate as they were intended, testing must be done to ensure compliance with regu- latory standards and industry-defined performance criteria. From microwave antennas to test chambers to full turnkey measurement systems, ETS-Lindgren is the ESCO subsidiary that designs, manufactures and installs the components and systems required to perform those demanding tests. FIl tR A tIo n / F l uId F l o w Within this segment Crissair Inc., PTI Technologies Inc. and VACCO Industries are recognized as technology- driven leaders providing highly engineered fluid con- trol solutions for mission-critical systems. Their products include micro-propulsion devices, valves, regulators, actuators, reservoirs, manifolds, attenuators, pumps and filters. The companies serve a diverse group of end markets including commercial aerospace, space and defense, satellite communications and industrial. t o ou r S h a r e h o l d e r s Victor L. Richey, Chairman, Chief Executive Officer, and President; Gary E. Muenster, Executive Vice President and Chief Financial Officer; and Alyson S. Barclay, Senior Vice President, Secretary, and General Counsel 2013 turned out to be quite an interesting year for ESCO as we made several significant decisions which and on budget and we are seeing the margin improvements that we expected. We also shut down the Doble Lemke will result in a much different ESCO going operations in Germany due to its significant forward. These actions were taken to position under performance, and relocated their ESCO for continued growth in the future, as products and intellectual property to well as to provide more predictability and existing locations. higher profitability. These were difficult ESCO’s most significant strategic decision decisions because they had a direct impact was authorizing a sale process for the on our most important asset, our employees, divestiture of Aclara. Our board of directors, but they were necessary to ensure our overall working together with our executive long-term success. management team, determined that ESCO was Our first major initiative was the con- trading at a level which does not fully reflect solidation of our domestic Test business, the value of its underlying assets, especially specifically the closure and relocation of a given the high quality and performance of manufacturing facility in Glendale Heights, the Filtration, Test and Utility Solutions Illinois. Our facility footprint was too large businesses. The process is continuing and we and was negatively impacting our operating remain convinced this is the right decision margins. We completed this move on time for the company. 2 0 1 3 A n n uAl R e p oRt 1 t o ou r S h a r e h o l d e r s On the acquisition front, we purchased three businesses diverse management talent, engineering expertise, and in 2013, one to supplement Doble, and two related to our manufacturing capability necessary to innovate, adapt, aerospace Filtration group. We are pleased with their early and change. We work diligently with our customers to contributions and expect profitable growth in 2014. develop the innovative solutions they require which All of these actions were taken with 2014 and beyond continues to support our sales growth from new products in mind. Our Filtration, Test and Doble businesses and services. remain well positioned for success as they have truly Our growth and profitability will come from several differentiated technology and market leading positions. distinct sources: These actions made us more cost efficient, and therefore, ▶ Filtration: PTI, VACCO and Crissair supply highly more profitable. engineered fluid control products for nearly every commer- We often comment on the diversity of our products cial aircraft flying today, as well as providing sole-source, and end-markets as being one of our most recognizable mission-critical products that allow our Space Program to strengths — we firmly believe this remains true today. flourish in its exploration endeavors. TEQ produces highly While all businesses are regularly faced with uncertainty, engineered thermoformed products and packaging materi- fortunately for ESCO, our multi-segment platform continues als for medical, retail, food and electronic applications. to provide us with the resilience to withstand a multitude ▶ Utility Solutions Group: Doble serves a critical role in of challenges. enhancing the reliability of the electric grid worldwide The fundamental growth drivers of our business by providing test, diagnostic, asset quality, and risk have not changed. We are a company with broad-based mitigation solutions that allow utilities to proactively G l o bAl R eA Ch With operations in 27 locations around the world, the businesses of ESCO Technologies served markets in more than 80 countries on six continents in 2013. Markets Served ESCO Operations North America Cedar Park, TX Durant, OK Wood Dale, IL Europe Eura, Finland Glasgow, Scotland Guildford, England Greenwood Village, CO Luxembourg, Luxembourg Huntley, IL Minocqua, WI Oxnard, CA Palmdale, CA Raleigh, NC South El Monte, CA St. Louis, MO Valencia, CA Watertown, MA South America São Paulo, Brazil Stevenage, England Taufkirchen, Germany Trondheim, Norway Africa Pietermaritzburg, South Africa Asia Bangalore, India Beijing, China Dubai, UAE Tokyo, Japan Australia New South Wales, Australia 2 eS Co teCh n o l oG IeS I nC. address grid management and power delivery issues. maintain a strong and healthy balance sheet that gives us Doble currently provides hardware, software, services the flexibility to invest in this growth. and solutions to nearly 95 percent of all domestic We are confident we have the right strategies in place electric utilities. and we look forward to executing on them, while continu- ▶ RF Shielding/Test: Our Test and related Systems business ing to create shareholder value for years to come. supports the development of new products in dozens of We’d like to sincerely thank the employees of ESCO for industries worldwide. Our products assist in the advance- their exceptional commitment, passion and innovation, as ment of new technologies in the areas of wireless com- well as extending our appreciation to our Board of Directors munications, secure communications, medical imaging, for its strategic guidance and effective corporate gover- and asset protection. nance. We also want to thank our shareholders for their We remain extremely positive about our future. Our sales ongoing support. and earnings visibility over the next few years has become more clearly defined, and as a result, we remain confident that we have meaningful growth opportunities across all three segments. We continue to execute on our plan to position ESCO for long-term success and value creation, both organically and through acquisitions across all three platforms. We will Vic Richey Gary Muenster Chairman, Chief Executive Executive Vice President Officer, & President & Chief Financial Officer remain prudent and disciplined in our approach, and will November 27, 2013 2 0 1 3 A n n uAl R e p oRt 3 ut i l i t y S o l u t i o n s Doble’s portfolio includes world-class diagnostic testing and protection solutions, as well as enterprise asset management systems and services. Flagship products include dobleARMS, Protection Suite and F6000 series test equipment, and M4100 and M7100 Doble Testers. Doble Engineering Company develops, manufactures, and delivers diagnostic testing solutions for the electric power grid. Comprised of electrical equipment and en- There is a long-established market for the Doble M4100, the “Doble Test” synonymous with electric reliability and high maintenance standards in North America. Now Doble is terprise management systems, Doble’s solutions revolutionizing the diagnostic tools that are are designed to improve operations, minimize the hallmark of its equipment testing solu- risk, and optimize electrical power assets and tions with the introduction of the M7100 system performance. Doble Tester. With transformational, patent- The Power of InnovaTIon: Doble flagship pending technology, the M7100 Doble Tester products include protection diagnostics with will dramatically reduce testing time, allowing the Doble Protection Suite and F6000 series utilities to maximize their planned outage pe- test equipment, the M4100 and M7100 Doble riods by performing more maintenance during Testers, as well as the dobleARMS™ solutions the hours previously devoted to testing. introduced just last year. Doble’s Protection Suite and F6000 series Doble has gained a solid competitive ad- test equipment enable customers to optimize vantage with the development and launch of efficiency, maintain compliance and ensure the a new breed of application: dobleARMS — the delivery and availability of safe power. industry’s first true asset risk management sys- Knowledge CommunITIes: With more than tem. DobleARMS leverages Doble’s database of 80 years of conference experience, Doble electrical apparatus test data, which includes hosts, produces and directs more than twenty relevant data from as far back as the 1940s profitable and unparalleled technical confer- and now contains more than 30 million data ences per year. Each conference has an es- points. This innovative system provides action- tablished following and serves as an exclusive able intelligence through the combination of promotional platform for the Doble portfolio. real-time monitoring and event notification ParTnerIng for exCellenCe: Committed while sourcing historical comparative data and to their partners, customers and the science considering environmental risk factors. This in- that shapes the electric power industry, Doble formation empowers its users to make critical engineers serve on nearly 100 international financial and safety decisions about day-to-day standards committees at the leading industry and long-term operations of high value assets. associations, including IEEE, IEC and CIGRE. 4 eS Co teCh n o l oG IeS I nC. 2 0 1 3 A n n uAl R e p oRt 5 R F S h i e l d i n g & t e s t medICal marKeT: ETS-Lindgren is the leading In our RF Shielding novative products and systems to detect, The ETS-Lindgren subsidiary provides in- measure and manage electromagnetic, magnetic and acoustic energy for test facilities, provider of shielding, doors, and magnetic active compensation systems for MRI rooms, ensuring images are not degraded by RF inter- MRI rooms, data centers and other applications. ference from external sources. Better images TesT soluTIons: With electronic circuitry now enable faster and more accurate scans. embedded in products ranging from parking Patients and staff are also safeguarded from & Test business, we continue to innovate with new products such as the AMS-7000 Test System, the EMCenter, and EMQuest software, as well as expanding meters to pilotless drones, the need to test health and safety hazards with alarm systems. into the newly- electronics for compliance to specified perfor- For example, our systems can detect ferromag- created EMP market. mance criteria and regulatory standards grows netic objects before they enter an MRI room daily. The requirement for better performing and pose a risk to people or equipment; or devices and the growing use of wireless com- when ambient oxygen levels fall below safe munication devices will drive an increasing amounts required to sustain human life. need for this type of testing. In step with the healthcare industry’s goal ETS-Lindgren is the leading provider of of improving patient experience, ETS-Lindgren systems and components for electromag- has recently introduced graphic display and netic compatibility (EMC), microwave, radio ambient lighting systems. These systems cre- frequency (RF), and wireless over-the-air (OTA) ate a relaxing atmosphere and help patients performance testing. New product additions feel more comfortable during their procedure. and software enhancements provide additional new TeChnology: Threats to critical infra- opportunities for capturing a larger market structure, including power sources, trans- share of integrated turnkey systems solutions portation and data storage, from Intentional in the EMC and wireless markets. Electromagnetic Interference (IEMI) and Acoustic testing, both audiometric and com- Electromagnetic Pulse (EMP) are a reality in mercial, is addressed with sound isolation and today’s world. Our portfolio of products to reverberation chamber solutions. Lab testing combat these threats has expanded with the services are offered for sound transmission and launch of Red Edge™ technology — designed noise emission to assist customers with their for those with vulnerable assets, such as data product R&D efforts as well as to determine centers, communication centers, financial pre-compliance with regulatory standards. services institutions and electric utilities. 6 eS Co teCh n o l oG IeS I nC. 2 0 1 3 A n n uAl R e p oRt 7 F i l t r a t i o n / F l u i d F l o w From HEPA cabin air filters to actuators, manifolds and highly specialized valves, our Filtration companies continue to develop innovative new products for their aerospace, space and industrial market customers. With a focus on engineering, opera- the Company’s Filtration/Fluid Flow tional excellence and collaboration, business continues to deliver innovation and to Original Equipment Manufacturers and line replaceable units, spares and overhaul services to the after-market. A deep un- derstanding of the aerospace, defense and growth across all served markets. Inspired by industrial markets has resulted in proprietary a mutual vision, Crissair Inc. (Crissair), PTI products that comprehensively address the Technologies Inc. (PTI) and VACCO Industries needs of the manufacturer and operator. (VACCO) are committed to providing highly VACCO’s vent relief valves (VRVs) — one of engineered technology driven solutions to many products VACCO is designing and build- a diverse group of end markets including ing for the Space Launch System (SLS) — are commercial aerospace, space and defense, helping create the largest rocket built in the satellite communications and industrial. history of space exploration. PTI and Crissair CollaboraTIng for growTh: Drawing upon continue development of advanced flow a diverse background of solution-oriented control products that improve performance, technologies and innovative research, the lengthen operational life and maintain opti- Company’s Filtration/Fluid Flow businesses mal fluid quality on today’s most advanced collaborate to design, develop, manufacture aircraft systems. In addition, their research and distribute innovative, mission-critical and development programs have resulted in solutions that most comprehensively address the introduction of advanced antimicrobial the customer’s needs. Whether maintaining cabin air and potable water filters to improve existing long-term product relationships or aircraft cabin quality. strategically pursuing new markets, technical PosITIoned for The fuTure: Crissair, PTI and superiority, increased value and next genera- VACCO are recognized as well established lead- tion innovations are the keys to continued ers in providing solution-oriented excellence. growth and profitability. Today, our products are essential components buIlT on suCCess: The Filtration/Fluid Flow of filtration and fluid flow control processes in business is built upon successful integra- numerous major industries. The addition of the tion of technology, application knowledge Canyon Engineering line of products and tech- and engineering capability. The Company nologies will further enhance the company’s provides highly engineered products directly future opportunities for growth. 8 eS Co teCh n o l oG IeS I nC. 2 0 1 3 A n n uAl R e p oRt 9 t eQ: th e r m o f o r m en g i n e e r e d Q u a l i t y award-winning, innovative and sustain- For nearly 30 years, TEQ has delivered able design, engineering and manufactur- ing solutions to the medical and commercial take over production of diagnostic probe cov- ers (a Class II medical device) for a leading thermometer manufacturer, TEQ not only built a fully-functional medical device facility within markets for thermoformed packages and months, but they also played a critical role in specialty products. re-examining the entire workflow process to Thermoform: Formerly named Tek Packaging, identify opportunities for increased efficien- TEQ was one of the first thermoformers in the cies. The result was a streamlined process they U.S. to become registered as a medical device use to produce, test and ship millions of covers manufacturer. In addition to maintaining this each day, with zero defects in the field. preferred certification, TEQ’s relentless pursuit The fuTure of TeQ: Through their commit- of precision and dedication to quality and inno- ment to continuous improvement and quality vation, as well as their partnerships with some assurance, TEQ is dedicated to becoming the of the best names in the industry, has resulted leading quality manufacturing company in in several market leading solutions. the thermoforming industry. engIneered: TEQ’s recent development of TEQethylene™, a 100% recyclable medical packaging solution that uses a High Density Polyethylene (HDPE) in combination with adhesive coated TYVEK®, a breathable HDPE thermoplastic lidding developed by DuPont, was revolutionary. And going further, TEQ also conducted a stability study to provide medical packaging customers with the data and labora- tory documents needed to meet FDA require- ments and justify new packaging designs. QualITy: With their solutions-focused ap- proach, TEQ has also developed a core compe- tency in designing and managing innovative and sustainable supply chain workflows. In fact, when TEQ was awarded a contract to 10 eS Co teCh n o l oG IeS I nC. C o m m i t m e n t t o C o m m u n i t i e s funded by donations from the company, The ESCO Technologies Foundation is our employees and outside donors. The Foundation’s mission is to support charitable Childhood Education Program which provides quality affordable child care. With equal emphasis on academics and play, children develop the skills and knowledge they need to organizations focusing on children and families excel in kindergarten and beyond. in communities where ESCO has operations. The PIoneer CenTer for human servICes organizations highlighted below are a few of (McHenry, IL): Pioneer Center is a social service over 30 core charities that we support annually. provider whose mission is to empower individu- neIghborhood houses (St. Louis, MO): als to achieve their full potential. They provide Neighborhood Houses operates programs that a variety of programs including vocational strive to provide a “home away from home” services to individuals with intellectual and for children and families in the St. Louis area. developmental disabilities, support programs This year our Foundation grant supported and case management for those battling mental their Caroline Mission program (featured in illness, emergency and transitional housing and pictures), a licensed and accredited Early support services to help homeless individuals, and therapy and support for victims of sexual assault. Our Foundation has supported the Pioneer Center since our inception in 2006. sPeCIal olymPICs of venTura CounTy (Los Angeles, CA): Special Olympics provides year-round sports training and athletic com- petition in a variety of Olympic-style sports for individuals with intellectual disabilities. The Special Olympics offers these athletes and their families a chance to interact with others who share similar life experiences. Athletes who participate in these programs have opportunities to develop physical fitness, self confidence and social skills. This year our Foundation grant supported transportation costs to competitions. 2 0 1 3 A n n uAl R e p oRt 11 M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto and refers to the Company’s results from continuing operations, except where noted. In the third quarter of 2013, the Company’s Board of Directors approved the initiation of a process to sell that portion of the Utility Solutions Group (USG) segment consisting of Aclara Technologies LLC (Aclara). The Company is still in the midst of the sale process and remains confident it will complete this divestiture. However, the Company can give no assurances as to whether the transaction will be successfully consummated. Aclara is reflected as discontinued operations and/or assets/ liabilities held for sale in the financial statements and related notes for all periods shown. Aclara’s pretax (loss) earnings recorded in discontinued operations was $(62.1) million and $19.5 million for the years ended September 30, 2013 and 2012, respectively. Aclara’s net sales were $184.5 million and $209.7 million for the years ended September 30, 2013 and 2012, respectively. Aclara’s operations were included within the Company’s USG segment prior to the classification as discontinued operations. The decrease in Aclara sales volumes in 2013 as compared to the prior year was mainly due to lower AMI product deliveries to electric utility cooperatives, partially offset by an increase in net sales to Southern California Gas Co (SoCalGas). Aclara’s pretax loss in 2013 as compared to pretax earnings in the prior year was due to the goodwill impairment charge of $48 million recorded in the fourth quarter of 2013; lower sales volumes; and changes in product mix (higher shipments of lower margin gas products as compared to higher margin electric products). See further discussion of the goodwill impairment in the Critical Accounting Policies section under “Goodwill and Other Long-Lived Assets.” The years 2013, 2012 and 2011 refer to the fiscal years ended September 30, 2013, 2012 and 2011, respectively, and are used throughout the document. Introduction ESCO Technologies Inc. and its wholly owned subsidiaries (the Company) are organized into three reportable operating segments: Filtration/Fluid Flow (Filtration), RF Shielding and Test (Test), and Utility Solutions Group (USG). The Company’s business segments are comprised of the following primary operating entities: ▶ Filtration: PTI Technologies Inc. (PTI), VACCO Industries (VACCO), Crissair, Inc. (Crissair), Canyon Engineering Products, Inc. (Canyon) and Thermoform Engineered Quality LLC (TEQ), ▶ Test: ETS-Lindgren Inc. (ETS-Lindgren), ▶ USG: Doble Engineering Company (Doble). Filtration: The companies within this segment primarily design and manufacture specialty filtration products including hydraulic filter elements and fluid control devices used in commercial aerospace applications, unique filter mechanisms used in micro-propulsion devices for satellites and custom designed filters for manned aircraft and submarines. Test: ETS-Lindgren is an industry leader in providing its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy. USG: Doble provides high-end, intelligent diagnostic test solutions for the electric power delivery industry and is a leading supplier of power factor and partial discharge testing instruments used to assess the integrity of high-voltage power delivery equipment. The Company continues to operate with meaningful growth prospects in its primary served markets and with considerable financial flexibility. The Company continues to focus on new products that incorporate proprietary design and process technologies. Management is committed to delivering shareholder value through internal growth, ongoing performance improvement initiatives, and acquisitions. Highlights of 2013 Continuing Operations ▶ Sales, net earnings from continuing operations and diluted earnings per share from continuing operations were $490.1 million, $31.3 million and $1.17 per share, respectively, compared to sales, net earnings and diluted earnings per share of $478.7 million, $34.8 million and $1.29 per share in 2012. ▶ Diluted earnings per share from continuing operations on an adjusted basis was $1.47 per share in 2013, which excludes $0.30 per share of restructuring costs related to the Test segment facility consolidation and the closure of the Doble Lemke facility in Germany. These restructuring activities were completed as of September 30, 2013. Management believes EPS As Adjusted is more representative of the Company’s 2013 ongoing performance and allows shareholders better visibility into the Company’s underlying operations. ▶ Net cash provided by operating activities from continuing operations was approximately $37 million in 2013. ▶ At September 30, 2013, cash on hand was $42.9 million and outstanding debt was $172 million, for a net debt position of approximately $129 million. (Net debt position is defined as total debt less net cash.) 12 ESCO TEChnOlOgiES inC. M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s ▶ 2013 entered orders from continuing operations were $516.7 million resulting in a book-to-bill ratio of 1.05x. Backlog from continuing operations at September 30, 2013, was $272.1 million compared to $245.6 million at September 30, 2012. ▶ In June 2013, the Company acquired the stock of Canyon for $9.2 million in cash, and additionally, purchased Canyon’s 70,000 square foot manufacturing facility located in Valencia, California for $7 million. Canyon designs and manufactures precision fluid control devices primarily for the aerospace industry. The operating results for Canyon, since the date of acquisition, are included as part of Crissair. ▶ The Company declared dividends of $0.32 per share, totaling $8.5 million in payments during 2013. Results of Continuing Operations NET SALES (Dollars in millions) 2013 2012 Fiscal year ended Change Change 2012 2013 2011 vs. 2012 vs. 2011 Filtration Test USG Total $214.1 194.8 166.7 175.9 109.3 108.0 167.6 176.5 106.7 9.9 % 16.2 % (0.3)% 1.2 % (5.2)% 1.2 % $490.1 478.7 450.8 2.4 % 6.2 % Net sales increased $11.4 million, or 2.4%, to $490.1 million in 2013 from $478.7 million in 2012. The increase in net sales in 2013 as compared to the prior year was due to: a $19.3 million increase in the Filtration segment; a $1.3 million increase in the USG segment; partially offset by a $9.2 million decrease in the Test segment. Filtration The $19.3 million, or 9.9%, increase in net sales in 2013 as compared to the prior year was due to: a $16.2 million increase in net sales from VACCO due to higher shipments of its Space and defense products; a $6.7 million increase in net sales at Crissair (the current year acquisition of Canyon contributed $3.3 million of this increase); partially offset by $3.2 million decrease in net sales at PTI driven by lower shipments of aerospace elements and couplings, and a $0.4 million decrease in net sales at TEQ. The $27.2 million, or 16.2%, increase in net sales in 2012 as compared to 2011 was due to: an $8.6 million increase in net sales from VACCO due to higher shipments of its Space products; a $6.6 million increase in net sales at TEQ mainly due to higher shipments to commercial customers; a $6.5 million increase in net sales at PTI driven by higher shipments of aerospace assemblies, elements and couplings; and a $5.5 million increase at Crissair mainly due to higher product shipments and price increases on its products. Test The sales decrease of $9.2 million, or 5.2%, in 2013 as compared to the prior year was due to: an $8 million decrease in net sales from the segment’s European operations due to timing of projects and softness in the European economy; a $6.4 million decrease in net sales from the Company’s Asian operations due to timing of chamber projects; partially offset by a $5.2 million increase in net sales from the segment’s U.S. operations due to an increase in projects in the EMP (electro- magnetic pulse) market. The net sales decrease of $0.6 million, or 0.3%, in 2012 as compared to 2011 was due to: a $6 million decrease in net sales from the segment’s U.S. operations primarily driven by lower shipments of shielding for a NASA project in Florida; a $1.3 million decrease in net sales from the segment’s European operations; partially offset by a $7 million increase in net sales from the segment’s Asian operations due to several chamber projects in China. USG The net sales increase of $1.3 million, or 1.2%, in 2013 as compared to the prior year and $1.3 million, or 1.2%, in 2012 as compared to 2011 was driven by an increase in services revenue at Doble. ORDERS AND BACKLOG New orders received from continuing operations in 2013 were $516.7 million as compared to $484.2 million in 2012, resulting in order backlog of $272.1 million at September 30, 2013, as compared to order backlog of $245.6 million at September 30, 2012. In 2013, the Company recorded $232.1 million of orders related to Filtration products, $177.7 million related to Test products, and $106.9 million related to USG products. Orders are entered into backlog as firm purchase order commitments are received. In 2012, the Company recorded $203.6 million of orders related to Filtration products, $168.5 million related to Test products, and $112.1 million related to USG products. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses (SG&A) were $129.8 million, or 26.5% of net sales in 2013, $128.2 million, or 26.8% of net sales in 2012, and $123.3 million, or 27.4% of net sales in 2011. The increase in SG&A expenses in 2013 as compared to the prior year was mainly due to an increase in professional fees and acquisition costs incurred at the Corporate level. 13 2013 AnnuAl RepoRt M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s The increase in SG&A expenses in 2012 as compared to 2011 was mainly due to: a $3.5 million increase within the Filtration segment due to new product development costs for additional Space product applications, additional content on Airbus platforms, and an increase in engineering head count; a $1.9 million increase within the Test segment due to the EMV acquisition (acquired February 28, 2011); partially offset by a $0.5 million decrease within the USG segment primarily due to lower new product development costs as projects were completed and the related products were introduced to the market. AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets was $6.2 million in 2013, $5.7 million in 2012 and $5 million in 2011. Amortization of intangible assets included $3.2 million, $3.8 million and $3.9 million of amortization of acquired intangible assets related to the Company’s acquisitions in 2013, 2012 and 2011, respectively. The amortization of acquired intangible assets related to the Company’s acquisitions is included in the Corporate operating segment’s results. The remaining amortization expenses consist of other identifiable intangible assets (primarily software, patents and licenses) and are included in the respective segment’s operating results. OTHER (INCOME) EXPENSES, NET Other (income) expenses, net, was $5.9 million in 2013, ($4.4) million in 2012 and ($7.8) million in 2011, respectively. The principal components in other (income) expenses, net, in 2013 included $4.1 million of restructuring costs related to the closure of the Doble Lemke facility in Germany; $2.6 million of restructuring costs within the Test segment as a result of the closure of the Glendale Heights, Illinois facility; and a $0.8 million gain on the sale of machinery and equipment within the Filtration segment. The principal component in other (income) expenses, net, in 2012 and 2011 was ($4.5) million and ($7.6) million, respectively, of income representing a revaluation of the earnout liability related to the Xtensible acquisition. There were no other individually significant items included in other (income) expenses, net, in 2013, 2012 or 2011. charges. EBIT, and EBIT margin on a consolidated basis and EPS on an adjusted basis are not recognized in accordance with U.S. generally accepted accounting principles (GAAP). However, the Company believes that EBIT and EBIT margin provide investors and Management with a valuable alternative method for assessing the Company’s operating results. Management evaluates the performance of its operating segments 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 accounted 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. The Company believes that the presentation of EBIT, EBIT margin and EPS on an adjusted basis provides important supplemental information to investors by facilitating comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results. The use of non-GAAP financial measures is not intended to replace any measures of performance determined in accordance with GAAP. EBIT Fiscal year ended (Dollars in millions) 2013 2012 2011 Filtration % of net sales $42.4 30.8 38.0 19.8% 19.5% 18.4% Test % of net sales USG % of net sales 16.3 9.8% 18.6 14.0 8.0% 10.5% 30.4 25.9 21.6 19.8% 24.0% 28.5% Change Change 2012 vs. 2012 vs. 2011 2013 11.6% 23.4 % 16.4% (24.7) % (16.6)% (14.8) % Corporate (28.0) (23.2) (23.3) (20.7)% 0.4 % Total % of net sales $52.3 56.5 54.7 10.7% 11.4% 12.5% (4.4)% (3.2) % The reconciliation of EBIT from Continuing Operations to a GAAP financial measure is as follows: (Dollars in millions) EBIT Less: Interest expense Less: Income taxes 2013 2012 2011 $52.3 (2.7) (18.3) 54.7 (2.5) (17.4) 56.5 (2.5) (16.9) Net earnings from continuing operations $31.3 34.8 37.1 EARNINGS BEFORE INTEREST AND TAXES (EBIT) Filtration The information reported herein includes the financial measures EBIT, EBIT as a percentage of net sales (EBIT margin), and EPS on an adjusted basis from continuing operations. The Company defines EBIT as earnings before interest and taxes from continuing operations, and defines EPS on an adjusted basis from continuing operations as GAAP EPS from continuing operations less defined restructuring EBIT increased $4.4 million in 2013 as compared to the prior year primarily due to the additional sales volumes at VACCO and Crissair as noted earlier. EBIT increased $7.2 million in 2012 as compared to 2011 mainly due to the additional sales volumes at all operating units within the segment as noted earlier. 14 ESCO TEChnOlOgiES inC. M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s Test The $2.3 million increase in EBIT in 2013 as compared to 2012 was due to product price increases and the savings being realized from the domestic facility consolidation. The increase was partially offset by approximately $3.4 million of restructuring costs consisting mainly of a facility lease termination charge, severance and relocation expenses and manufacturing inefficiencies resulting from the disruption, which are now completed. The $4.6 million decrease in EBIT in 2012 as compared to 2011 was due to: a $4 million decrease related to the segment’s U.S. operations driven by lower sales volumes within the U.S.; a $2.2 million decrease related to the segment’s European operations driven by project delays and unexpected turnover of key employees in Germany, and additional investments in SG&A; partially offset by a $1.5 million increase from the segment’s Asian operations due to higher sales volumes. USG The $4.3 million decrease in EBIT in 2013 as compared to the prior year was mainly due to $2.6 million of restructuring costs related to the closure of the manufacturing operation in Germany (Doble Lemke GmbH) and relocation of its partial discharge products and intellectual property to its existing lower cost locations in Europe. These shut-down costs consisted of personnel costs, asset impairment charges, and move related costs. In addition, a $4.5 million gain was recorded in 2012 related to the revaluation of the earnout liability related to the Xtensible acquisition. The $4.5 million decrease in EBIT in 2012 as compared 2011 was primarily due to a $3.1 million decrease in EBIT related to the revaluation of the earnout liability related to the Xtensible acquisition. Corporate Corporate operating charges included in consolidated EBIT increased to $28 million as compared to $23.2 million in 2012 mainly due to a $1.5 million pretax write-down of a Doble Lemke trade name and an increase in professional fees and acquisition costs. The “Reconciliation to Consolidated Totals (Corporate)” in Note 14 to the Consolidated Financial Statements represents Corporate office operating charges. INTEREST EXPENSE, NET Interest expense was $2.7 million in 2013, compared to $2.5 million in 2012 and 2011, respectively. The increase in interest expense in 2013 as compared to the prior year was due to higher average interest rates (1.6% vs. 1.2%) and higher average outstanding borrowings ($171 million vs. $126 million). INCOME TAX EXPENSE The effective tax rate from continuing operations for fiscal years 2013, 2012 and 2011 was 37.0%, 33.4% and 31.3%, respectively. The increase in the 2013 effective tax rate as compared to the prior year was primarily due to: an adjustment to the foreign valuation allowance which increased the 2013 effective tax rate by 3.3%; the extension of the research tax credit as a result of the American Taxpayer Relief Act of 2012 which reduced the 2013 effective tax rate by 2.2%; a purchase accounting charge which increased the 2012 effective tax rate by 1.0%; and the release of accruals related to uncertain tax positions as a result of the lapse of statute of limitations which reduced the 2012 effective tax rate by 3.7%. The increase in the 2012 effective tax rate as compared to 2011 was mainly due to: the December 31, 2011, expiration of the research tax credit which increased the 2012 effective tax rate by 1.0%; the repatriation of foreign subsidiary earnings which increased the 2012 effective tax rate by 1.2%; releasing a foreign valuation allowance which reduced the 2011 effective tax rate by 1.9%; a purchase accounting charge increased the 2012 effective tax rate by 1.0%; and the release of accruals related to uncertain tax positions as a result of the lapse of statute of limitations which reduced the 2012 effective tax rate by 3.0%. The Company’s foreign subsidiaries have accumulated unremitted earnings of $33.3 million and cash of $25.3 million at September 30, 2013. No deferred taxes have been provided on these accumulated unremitted earnings because these funds are not needed to meet the liquidity requirements of the Company’s U.S. operations and it is the Company’s intention to indefinitely reinvest these earnings in continuing international operations. In the event these foreign entities’ earnings were distributed, it is estimated that U.S. taxes, net of available foreign tax credits, of approximately $6 million would be due, which would correspondingly reduce the Company’s net earnings. No significant portion of the Company’s foreign subsidiaries’ earnings was taxed at a very low tax rate. Capital Resources and Liquidity The Company’s overall financial position and liquidity are strong. Working capital (current assets less current liabilities) increased to $163.6 million at September 30, 2013, from $139.2 million at September 30, 2012, mainly due to higher accounts receivable and inventory balances. The $8.6 million 15 2013 AnnuAl RepoRtM a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s increase in accounts receivable at September 30, 2013, was mainly due to: a $5.8 million increase within the Test segment and a $3 million increase in the USG segment due to the increase of sales in the fourth quarter. The $8.2 million increase in inventory at September 30, 2013, was mainly due to an $8 million increase in the Filtration segment due to: timing and volume of sales and accelerated material receipts for various programs at VACCO and $2.4 million due to the Canyon acquisition. Net cash provided by operating activities was $47.2 million, $53.2 million and $74.6 million in 2013, 2012 and 2011, respectively. The decrease in 2013 as compared to the prior year was due to a decrease in net earnings and higher operating working capital requirements. Capital expenditures from continuing operations were $13.9 million, $10.8 million and $11.3 million in 2013, 2012 and 2011, respectively. The increase in 2013 as compared to the prior year was mainly due to the purchase of the ETS-Lindgren facility in Minocqua, Wisconsin for $1.2 million and an increase in manufacturing equipment within the Filtration segment of approximately $2 million mainly due to the Felix Tool acquisition. There were no commitments outstanding that were considered material for capital expenditures at September 30, 2013. In addition, the Company incurred expenditures for capitalized software of $8.4 million, $5.3 million and $5.5 million in 2013, 2012 and 2011, respectively. The increase in 2013 as compared to the prior year was mainly attributable to the Test segment’s software development. The Company made required pension contributions of $3.9 million, $4.8 million and $5.2 million in 2013, 2012 and 2011, respectively. POTENTIAL SALE OF ACLARA The Company anticipates that the cash proceeds of the expected divestiture of Aclara will be used to accelerate the Company’s repayment of existing debt, while providing additional liquidity for acquisitions around its core businesses. See Item 1A. Risk Factors in our Annual Report on Form 10-K. ACQUISITIONS 2013 On June 26, 2013, the Company acquired the stock of Canyon Engineering Products, Inc. (Canyon) for $9.2 million in cash, and additionally, purchased Canyon’s 70,000 square foot manufacturing facility located in Valencia, California for $7 million. Canyon designs and manufactures precision fluid control devices primarily for the aerospace industry and Canyon’s products, technology and customers are very similar to Crissair, Inc. The operating results for Canyon, since the date of acquisition, are included as part of Crissair, Inc. within the Company’s Filtration segment. The Company recorded approximately $1.3 million of goodwill related to the transaction and $1.7 million of amortizable identifiable intangible assets consisting primarily of customer relationships. On December 31, 2012, the Company acquired the assets of Metrum Technologies LLC (Metrum) for a purchase price of $25 million in cash plus contingent consideration based on future revenues over the next four years. Metrum is a leading provider of wireless public network communications products for electric utility customers and also offers communications products and devices for distribution automation and demand response applications. The Company recorded approximately $25 million of goodwill, $11.2 million of amortizable identifiable intangible assets consisting primarily of customer relationships and patents / technology and contingent consideration valued at approximately $13 million. The operating results for the business, since the date of acquisition, are included within Aclara which is included in discontinued operations and/or assets/liabilities held for sale. On December 21, 2012, the Company acquired the assets of Felix Tool & Engineering, Inc. (Felix Tool) for a purchase price of $1.2 million in cash. Felix Tool is engaged in the design, manufacture and sale of customized perforated tubes for filtration applications in the aerospace and fluid power industry. The purchase price was allocated to property, plant and equipment and inventory based on fair market value at the date of acquisition and there were no intangible assets recorded upon the transaction. The operating results for the business, since the date of acquisition, are included within PTI in the Filtration segment. On December 10, 2012, the Company acquired the assets of Finepoint Marketing, Inc. (Finepoint) for a purchase price of $2.5 million. Finepoint is the electric power industry’s leading conference provider focused on medium and high voltage circuit breakers, as well as related substation and switchgear topics. The operating results for the business, since the date of acquisition, are included as part of Doble in the USG segment. The Company recorded approximately $1.3 million of goodwill as a result of the transaction and $1.2 million of amortizable identifiable intangible assets consisting of customer relationships. 16 ESCO TEChnOlOgiES inC.M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s 2011 DIVIDENDS On February 28, 2011, the Company acquired the capital stock of EMV Elektronische Messgerate Vertriebs - GmbH, together with its subsidiary EMSCREEN Electromagnetic Screening GmbH (collectively, EMV) for a purchase price of approximately $5 million, inclusive of cash acquired. EMV, with operations in Taufkirchen, Germany, provides turnkey systems and shielded environments for research, development and quality assurance testing of electronic equipment. EMV’s operating results, since the date of acquisition, are included within the Test segment and the Company recorded approximately $4.8 million of goodwill as a result of the transaction. All of the Company’s acquisitions have been accounted for using the purchase method of accounting, and accordingly, the respective purchase prices were allocated to the assets (including intangible assets) acquired and liabilities assumed based on estimated fair values at the date of acquisition. The financial results from these acquisitions have been included in the Company’s financial statements from the date of acquisition. BANK CREDIT FACILITY At September 30, 2013, the Company had approximately $265 million available to borrow under the credit facility, plus a $250 million increase option, in addition to $42.9 million cash on hand. The Company classified $50 million as the current portion of long-term debt as of September 30, 2013, as the Company intends to repay this amount within the next 12 months; however, the Company has no contractual obligation to repay such amount during the next twelve months. The Company’s ability to access the additional $250 million increase option of the credit facility is subject to acceptance by participating or other outside banks. The credit facility requires, as determined by certain financial ratios, a facility fee ranging from 17.5 to 35 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 financial covenants of the credit facility include a leverage ratio and an interest coverage ratio. As of September 30, 2013, 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. During 2010, the Company initiated a quarterly cash dividend payable at an annual rate of $0.32 per share. The Company paid dividends of $8.5 million, $8.6 million and $8.5 million in 2013, 2012 and 2011, respectively. OUTLOOK — 2014 Management continues to see strong growth in 2014 across the business. Management expects 2014 EPS from Continuing Operations – As Adjusted in the range of $1.50 to $1.60 per share, which excludes restructuring charges described below with EPS from Continuing Operations in the range of $1.45 to $1.55 per share. In addition, the 2014 effective tax rate from continuing operations is projected to be approximately 35%. On a quarterly basis, Management expects 2014 revenues and EPS to be more slightly balanced but still more second-half weighted. First quarter EPS from Continuing Operations – As Adjusted is expected to be in the range of $0.24 to $0.29 per share. During 2014, the Company plans to complete the exit and relocation of Crissair’s Palmdale, California operation into the Canyon facility in Valencia, California. This move is expected to be completed by September 30, 2014. The restructuring costs are expected to be approximately $2 million, or $0.05 per share. CONTRACTUAL OBLIGATIONS The following table shows the Company’s contractual obligations as of September 30, 2013: (Dollars in millions) Payments due by period Less than 1 year 1 to 3 3 to 5 years More than years 5 years Total $172.0 — — 172.0 6.4 2.6 3.8 — — — 15.0 5.0 6.7 2.6 0.7 Contractual Obligations Long-Term Debt Obligation Estimated Interest Payments(1) Operating Lease Obligations Purchase Obligations(2) Total $198.5 12.4 10.8 174.6 5.1 4.8 0.3 — — 0.7 (1) Estimated interest payments for the Company’s debt obligations were calculated based on Management’s determination of the estimated applicable interest rates and payment dates and excludes the effect of any Aclara sale consummation. (2) A purchase obligation is defined as a legally binding and enforceable agreement 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. 17 2013 AnnuAl RepoRt M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s As of September 30, 2013, the Company had $2.2 million of liabilities for uncertain tax positions. The unrecognized tax benefits have been excluded from the table above due to uncertainty as to the amounts and timing of settlement with taxing authorities. The Company has no off-balance-sheet arrangements outstanding at September 30, 2013. SHARE REPURCHASES In August 2012, the Company’s Board of Directors authorized an expanded stock repurchase program whereby Management may repurchase shares of its outstanding common stock in the open market and otherwise throughout the period ending September 30, 2013. This program was extended by the Company’s Board of Directors through September 30, 2014. The total value authorized is the lesser of $100 million, or the dollar limitation imposed by Section 6.07 of the Company’s Credit Agreement dated May 14, 2012. During 2013, the Company repurchased $9.7 million or approximately 270,000 shares. During 2012, the Company repurchased $5.4 million or approximately 150,000 shares. There were no stock repurchases during 2011. PENSION FUNDING REQUIREMENTS The minimum cash funding requirements related to the Company’s defined benefit pension plans are estimated to be approximately $2.8 million in 2014, approximately $3.4 million in 2015 and approximately $2.7 million in 2016. OTHER Management believes that, for the periods presented, inflation has not had a material effect on the Company’s results of operations. The Company is currently involved in various stages of investigation and remediation relating to environmental matters, intellectual property and general corporate 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. Market Risk Analysis MARKET RISK EXPOSURE Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign currency exchange rates. The Company is exposed to market risk related to changes in interest rates and selectively uses derivative financial instruments, including forward contracts and swaps, to manage these risks. There were no outstanding derivative instruments at September 30, 2013. The Company has determined that the market risk related to interest rates with respect to its variable debt is not material. The Company estimates that if market interest rates averaged one percentage point higher, the effect would have been less than 2% of net earnings for the year ended September 30, 2013. 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 outside of the United States were $153.7 million, $162.1 million, and $132.2 million in 2013, 2012 and 2011, respectively. The Company occasionally hedges certain foreign currency commitments by purchasing foreign currency forward contracts. The Company does not have material foreign currency market risk (e.g. net foreign currency transaction gain/loss was less than 2% of net earnings for fiscal years 2013, 2012 and 2011). Critical Accounting Policies The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires Management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying Consolidated Financial Statements. In preparing these financial statements, Management has made its best estimates and judgments of certain amounts included in the Consolidated Financial Statements, giving due consideration to materiality. The Company does not believe there is a great likelihood that materially different amounts would be reported under different conditions or using different assumptions related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. The Company’s senior Management discusses the critical accounting policies described below with the Audit 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 Financial Statements and other financial disclosure. It is not intended to be a comprehensive list of all significant accounting policies that are more fully described in Note 1 of Notes to Consolidated Financial Statements. 18 ESCO TEChnOlOgiES inC.M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s REVENUE RECOGNITION Filtration Segment: Within the Filtration segment, approximately 60% of segment revenues (approximately 26% 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 40% of segment revenues (approximately 18% of consolidated revenues) are recorded under the percentage- of-completion provisions 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 estimating 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 substantial 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 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 Segment: Within the Test segment, approximately 65% of revenues (approximately 22% 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 and the application of the guidance requires judgment as to whether the deliverables can be divided into more than one unit of accounting and whether the separate units of accounting 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 35% of the segment’s revenues (approximately 12% of consolidated revenues) are recorded under the percentage-of-completion method 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 developing these types of estimates. Changes in underlying assumptions/estimates may adversely or positively affect financial performance in a period. 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. USG Segment: Within the USG segment, approximately 100% of the segment’s revenues (approximately 22% of consolidated revenues) represent products and services sold under a single element arrangement and are recognized when products are delivered (when title and risk of ownership transfers), when services are performed for unaffiliated customers or on a straight-line basis over the lease term. Discontinued Operations (Aclara): Approximately 100% of Aclara’s revenue arrangements contain software components and/or multiple element arrangements. The application of generally accepted accounting principles requires judgment, including the determination of whether an arrangement includes multiple elements and estimates of the fair value of the elements, using vendor-specific objective evidence of fair value (VSOE), if it exists, otherwise third-party evidence (TPE) or estimated selling price (ESP). Changes to the elements in an arrangement, and the ability to identify fair value for those elements could materially 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. 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 19 2013 AnnuAl RepoRtM a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s 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 interpretations 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. Management 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 principles of Financial Accounting Standards Board (FASB) ASC Topic 740, Income Taxes (ASC 740). The Company has recorded an accrual that reflects the recognition and measurement process for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return based upon ASC 740. Additional future income tax expense or benefit may be recognized once the positions are effectively settled. It is the Company’s policy to follow FASB ASC 740-10-45-20 and record the tax effects of changes in the opening balance of unrecognized tax benefits in net earnings from continuing operations. At the end of each interim reporting period, Management estimates 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 if such determination is made. 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 Management believes it is more likely than not such assets will not be recovered, taking into consideration historical operating results, expectations of future earnings, tax planning strategies, and the expected timing of the reversals of existing temporary differences. GOODWILL AND OTHER LONG-LIVED ASSETS Management annually reviews goodwill and other long- lived assets with indefinite useful lives for impairment or whenever events or changes in circumstances indicate 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 estimates could result in impairment charges. At September 30, 2013, the Company has determined that no reporting units in continuing operations are at risk of material goodwill impairment as the fair value of each reporting unit substantially exceeded its carrying value. At September 30, 2013, the Company completed its preliminary annual goodwill impairment evaluation using the two-step goodwill impairment test and determined that a portion of the goodwill related to Aclara was impaired. In the first step of 20 ESCO TEChnOlOgiES inC.M a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s the analysis, the Company compared the estimated fair value of the Aclara reporting unit to its carrying value, including goodwill. The fair value of the reporting unit was determined based on a weighting of income and market approaches. Since the carrying value of the Aclara reporting unit exceeded the estimated fair value, the Company performed the second step of the impairment analysis in order to determine the implied fair value of the reporting unit over the fair value amounts assigned to all of the assets and liabilities of the reporting unit as if it were to be acquired in a business combination and the current fair value of the reporting unit (as calculated in the first step) was the purchase price. The implied fair value of the reporting unit’s goodwill was then compared to the carrying value of the goodwill and any excess of carrying value over the implied fair value represents the non-cash impairment charge. The impairment of Aclara’s goodwill was impacted by Aclara’s expected operating results and the range of bids from potential buyers. The results of the second step preliminary analysis showed that the implied fair value of goodwill was $58 million related to Aclara. Therefore, in the fourth quarter of 2013, the Company recorded a goodwill impairment charge of $48 million and is included within discontinued operations. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and are reviewed annually for impairment. 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 The Company is currently involved in various stages of investigation and remediation relating to environmental matters, intellectual property and general corporate 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign currency exchange rates. The Company is exposed to market risk related to changes in interest rates and selectively uses derivative financial instruments, including forward contracts and swaps, to manage these risks. There were no outstanding derivative instruments at September 30, 2013. See further discussion in “Management’s Discussion and Analysis — Market Risk Analysis” regarding the Company’s market risks. PENSION PLANS AND OTHER POSTRETIREMENT BENEFIT PLANS CONTROLS AND PROCEDURES The measurement of liabilities related to pension plans and other postretirement benefit plans is based on Management’s assumptions related to future events including interest rates, return on pension plan assets, and health care cost trend rates. Actual pension plan asset performance will either decrease or increase unamortized pension losses/gains that will affect net earnings in future years. Depending upon the performance of the equity and bond markets in 2014, the Company could be required to record a charge to other comprehensive income/loss. In addition, if the discount rate was decreased by 25 basis points from 4.75% to 4.5%, the projected benefit obligation for the defined benefit plan would increase by approximately $2.6 million and result in an additional after-tax charge to other comprehensive income/loss of approximately $1.6 million. 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 400 Aa-rated, non-callable 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 effectiveness 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 the 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, the Company’s internal control over financial reporting. 21 2013 AnnuAl RepoRtM a n a g e m e n t ’ s di s c u s s i o n a n d A n a l y s i s New Accounting Pronouncements In July 2012, the FASB issued Accounting Standards Update No. 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (ASU 2012-02). This ASU updates the rules on testing indefinite-lived intangible assets other than goodwill for impairment and permits the option to perform a qualitative assessment of the fair value of indefinite-lived intangible assets. This update is effective for fiscal years, and interim periods within those years, beginning after September 15, 2012, and did not have a material impact on the Company’s financial statements. 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 timing, success and financial impact of the Aclara sale process, the use of expected proceeds from any sale of Aclara, amount and timing of 2014 revenues, growth, EPS from Continuing Operations, and EPS from Continuing Operations – As Adjusted, adequacy of the Company’s credit facilities and future cash flows, the timing of and restructuring costs associated with the closure and consolidation of the Crissair facility into the Canyon facility, minimum cash funding required by or a charge to equity connected with the Company’s defined benefit plans and other postretirement benefit plans, expected benefits payable from the Company’s defined benefit plans and other postretirement benefit plans, outcome of current litigation, claims and charges, material foreign currency risk, the likelihood that materially different amounts would be reported in connection with the Company’s application of the accounting policies described herein, the likelihood that revenue estimates used in the Test and Filtration segments’ contracts recorded under the percentage-of-completion method will change materially, the amount of NOLs not realizable, continued reinvestment of foreign earnings and the resulting U.S. tax liability in the event such earnings are repatriated, the accuracy of the Company’s estimates utilized in software revenue recognition, the accuracy of the Company’s estimates utilized to project costs at completion in the Test segment and Filtration segment, income tax liabilities, the effective tax rate, the timing and amount of the reduction of unrecognized tax benefits, valuation of deferred tax assets, repayment of debt within the next 12 months, the recognition of costs related to share-based compensation arrangements, future costs relating to environmental matters, share repurchases, investments, sustained performance improvement, market risk related to interest rates, 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 1-3), 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 forward-looking statements. Investors are cautioned that such statements are only predictions, speak only as of the date of this report, and the Company undertakes no duty to update them except as may be required by applicable laws or regulations. The Company’s actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company’s operations and business environment including, but not limited to those described under “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013, and the following: the receipt of acceptable offers, the ability to negotiate acceptable terms and conditions, available financing and the receipt of necessary government and customer approvals in connection with the sale of Aclara; the impacts of natural disasters on the Company’s operations and those of the Company’s customers and suppliers; the timing and content of future customer orders; 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 customer demands or customer insolvencies; competition; intellectual property rights; technical difficulties; the availability of selected acquisitions; delivery delays or defaults by customers; performance issues with key customers, suppliers and subcontractors; material changes in the costs of certain raw materials; 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 restructuring and consolidation plans. 22 ESCO TEChnOlOgiES inC.C o n s o l i d a t e d S t a t e m e n t s o f op e r a t i o n s (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 expense, net Other (income) expenses, net Total costs and expenses Earnings before income tax Income tax expense Net earnings from continuing operations (Loss) earnings from discontinued operations, net of tax (benefit) expense of $(5,215), $7,397 and $7,535, in 2013, 2012 and 2011, respectively Net (loss) earnings Earnings (loss) per share: Basic: Continuing operations Discontinued operations Net (loss) earnings Diluted: Continuing operations Discontinued operations Net (loss) earnings Average common shares outstanding (in thousands): Basic Diluted See accompanying Notes to Consolidated Financial Statements. 2013 2012 2011 $ 490,079 478,699 450,816 295,863 129,809 6,179 2,693 5,940 294,655 128,152 5,674 2,469 (4,433) 273,845 123,293 4,988 2,493 (7,808) 440,484 426,517 396,811 49,595 18,335 31,260 (56,863) $ (25,603) $ 1.18 (2.15) $ (0.97) $ 1.17 (2.13) $ (0.96) 52,182 17,408 34,774 12,105 46,879 1.30 0.46 1.76 1.29 0.44 1.73 54,005 16,922 37,083 15,418 52,501 1.39 0.58 1.97 1.38 0.57 1.95 26,450 26,802 26,699 27,030 26,588 26,903 C o n s o l i d a t e d S t a t e m e n t s o f C o m p r e h e n s i v e I n c o m e (lo s s ) (Dollars in thousands) Years ended September 30, Net (loss) earnings Other comprehensive income (loss), net of tax: Foreign currency translation adjustments Amortization of prior service costs and actuarial gains (losses) Change in fair value of interest rate swap Total other comprehensive income (loss), net of tax 2013 2012 $ (25,603) 46,879 644 8,078 — 8,722 (2,018) (4,171) 2 (6,187) 2011 52,501 (333) (4,354) 289 (4,398) Comprehensive (loss) income $ (16,881) 40,692 48,103 See accompanying Notes to Consolidated Financial Statements. 23 2013 AnnuAl RepoRt 2013 2012 $ 42,850 30,215 91,980 83,414 20,717 90,228 23,349 15,930 108,867 14,567 82,063 22,313 12,940 97,932 393,921 343,444 7,178 54,316 74,948 3,426 4,984 47,624 69,293 3,039 139,868 124,940 (64,332) (62,389) 75,536 62,551 180,217 282,949 9,469 150,236 176,486 279,640 9,638 161,994 $ 1,092,328 1,033,753 C o n s o l i d a t e d ba l a n c e S h e e t s (Dollars in thousands) Years ended September 30, ASSETS Current assets: Cash and cash equivalents Accounts receivable, less allowance for doubtful accounts of $1,124 and $1,217 in 2013 and 2012, respectively Costs and estimated earnings on long-term contracts, less progress billings of $30,887 and $30,534 in 2013 and 2012, respectively Inventories Current portion of deferred tax assets Other current assets Assets held for sale – current 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 Intangible assets, net Goodwill Other assets Assets held for sale - other Total Assets See accompanying Notes to Consolidated Financial Statements. 24 ESCO TEChnOlOgiES inC. C o n s o l i d a t e d ba l a n c e S h e e t s (Dollars in thousands) Years ended September 30, LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Current maturities of long-term debt Accounts payable Advance payments on long-term contracts, less costs incurred of $23,853 and $31,534 in 2013 and 2012, respectively Accrued salaries Current portion of deferred revenue Accrued other expenses Liabilities held for sale – current Total current liabilities Pension obligations Deferred tax liabilities Other liabilities Long-term debt Liabilities held for sale – other 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 30,147,504 and 30,044,486 shares in 2013 and 2012, respectively Additional paid-in capital Retained earnings Accumulated other comprehensive loss, net of tax Less treasury stock, at cost (3,707,407 and 3,453,249 common shares in 2013 and 2012, respectively) Total shareholders’ equity Total Liabilities and Shareholders’ Equity See accompanying Notes to Consolidated Financial Statements. 2013 2012 $ 50,000 38,537 17,543 21,730 17,508 21,453 63,585 50,000 35,253 21,700 19,613 16,332 20,577 40,730 230,356 204,205 19,089 99,795 3,348 122,000 16,026 35,480 88,675 947 65,000 8,133 490,614 402,440 — 301 284,565 407,512 (16,656) — 300 279,392 441,566 (25,378) 675,722 695,880 (74,008) (64,567) 601,714 631,313 $ 1,092,328 1,033,753 25 2013 AnnuAl RepoRt C o n s o l i d a t e d S t a t e m e n t s o f S h a r e h o l d e r s ’ eq u i t y (In thousands) Common Stock Shares Amount Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Total Balance, September 30, 2010 29,839 $298 270,943 359,274 (14,793) (59,740) 555,982 Comprehensive income: Net earnings Translation adjustments Net unrecognized actuarial loss, net of tax of $2,689 Interest rate swap, net of tax of $(187) Cash dividends declared ($0.32 per share) Stock options and stock compensation plans, net of tax benefit of $(55) — — — — — — — — — — — — — — — 52,501 — — — (8,534) 118 2 4,864 — — (333) (4,354) 289 — — — — — — — 52,501 (333) (4,354) 289 (8,534) 293 5,159 Balance, September 30, 2011 29,957 300 275,807 403,241 (19,191) (59,447) 600,710 Comprehensive income: Net earnings Translation adjustments Net unrecognized actuarial loss, net of tax of $2,769 Interest rate swap, net of tax of $(1) Cash dividends declared ($0.32 per share) Stock options and stock compensation plans, net of tax benefit of $(123) Purchases into treasury — — — — — 87 — — — — — — — — — — — — — 46,879 — — — (8,554) 3,585 — — — — (2,018) (4,171) 2 — — — — — — — — 46,879 (2,018) (4,171) 2 (8,554) 283 3,868 (5,403) (5,403) Balance, September 30, 2012 30,044 300 279,392 441,566 (25,378) (64,567) 631,313 Comprehensive income (loss): Net (loss) earnings Translation adjustments Net unrecognized actuarial gain, net of tax of $(5,468) Cash dividends declared ($0.32 per share) Stock options and stock compensation plans, net of tax benefit of $(84) Purchases into treasury — — — — 104 — — — — — 1 — — — — — (25,603) — — (8,451) 5,173 — — — — 644 8,078 — — — — — — — (25,603) 644 8,078 (8,451) 262 5,436 (9,703) (9,703) Balance, September 30, 2013 30,148 $301 284,565 407,512 (16,656) (74,008) 601,714 See accompanying Notes to Consolidated Financial Statements. 26 ESCO TEChnOlOgiES inC. C o n s o l i d a t e d S t a t e m e n t s o f C a s h F l o w s (Dollars in thousands) Years ended September 30, Cash flows from operating activities: Net (loss) earnings Adjustments to reconcile net earnings to net cash provided by operating activities: 2013 2012 2011 $ (25,603) 46,879 52,501 Net loss (earnings) from discontinued operations, net of tax Depreciation and amortization Stock compensation expense Changes in current assets and liabilities Effect of deferred taxes on tax provision Change in acquisition earnout obligation Pension contributions Change in deferred revenue and costs, net Other Net cash provided by operating activities – continuing operations Net cash provided by discontinued operations Net cash provided by operating activities Cash flows from investing activities: Acquisition of businesses, net of cash acquired Change in restricted cash (acquisition escrow) Capital expenditures Additions to capitalized software Net cash used by investing activities – continuing operations Net cash used by investing activities – discontinued operations Net cash used by investing activities Cash flows from financing activities: Proceeds from long-term debt Principal payments on long-term debt Dividends paid Purchases of shares into treasury Deferred financing costs Proceeds from exercise of stock options Other Net cash provided (used) by financing activities Effect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Changes in current assets and liabilities: Accounts receivable, net Costs and estimated earnings on long-term contracts, net Inventories Other assets Accounts payable Advance payments on long-term contracts, net Accrued expenses Supplemental cash flow information: Interest paid Income taxes paid (including state & foreign) See accompanying Notes to Consolidated Financial Statements. 56,863 14,805 4,577 (19,031) 10,084 — (3,900) 913 (1,626) 37,082 10,069 47,151 (19,452) — (13,862) (8,408) (41,722) (35,031) (76,753) 122,000 (65,000) (8,451) (9,703) — 1,750 998 41,594 643 12,635 30,215 $ 42,850 $ (6,377) (6,150) (5,219) (2,513) 3,120 (4,157) 2,265 $ (19,031) (12,105) 14,495 4,356 (3,451) 1,086 (4,459) (4,800) 2,373 1,694 46,068 7,096 53,164 — 1,367 (10,799) (5,344) (14,776) (15,036) (29,812) 192,455 (202,455) (8,554) (5,403) (1,937) (184) 801 (25,277) (2,018) (3,943) 34,158 30,215 8,881 (1,593) (8,590) 4,186 (1,535) (1,967) (2,833) (3,451) (15,418) 13,476 4,470 (5,596) 3,551 (7,595) (5,230) (300) 2,007 41,866 32,750 74,616 (3,732) 1,361 (11,315) (5,492) (19,178) (11,053) (30,231) 49,370 (78,370) (8,534) — — 762 370 (36,402) (333) 7,650 26,508 34,158 (14,078) (231) (13,136) (1,159) 325 17,977 4,706 (5,596) $ 2,573 11,680 1,588 16,544 1,959 21,895 27 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 1. Summary of Significant Accounting Policies D. USE OF ESTIMATES 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. 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, 2013, and 2012. The assets of Aclara Technologies LLC (Aclara) are classified as held for sale and are accounted for as discontinued operations in accordance with accounting principles generally accepted in the United States of America (GAAP). Prior period amounts have been reclassified to conform to the current period presentation. See Note 2. C. NATURE OF CONTINUING OPERATIONS The Company has three reportable segments: Filtration/Fluid Flow (Filtration), RF Shielding and Test (Test), and Utility Solutions Group (USG). Filtration: The companies within this segment primarily design and manufacture specialty filtration products including hydraulic filter elements and fluid control devices used in commercial aerospace applications, unique filter mechanisms used in micro-propulsion devices for satellites and custom designed filters for manned aircraft and submarines. Test: ETS-Lindgren Inc. (ETS-Lindgren) is an industry leader in providing its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy. USG: Doble Engineering Company (Doble) provides high-end, intelligent, diagnostic test solutions for the electric power delivery industry. The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The Company regularly evaluates the estimates and assumptions related to the allowance for doubtful trade receivables, inventory obsolescence, warranty reserves, value of equity-based awards, goodwill and purchased intangible asset valuations, asset impairments, employee benefit plan liabilities, income tax liabilities and assets and related valuation allowances, uncertain tax positions, estimates on long-term contracts, and litigation and other loss contingencies. Actual results could differ from those estimates. E. REVENUE RECOGNITION Filtration Segment: Within the Filtration segment, approximately 60% of revenues (approximately 26% 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 40% of segment revenues (approximately 18% of consolidated revenues) are recorded under the percentage- of-completion method. Products accounted for under this guidance include the design, development and manufacture of complex fluid control products, quiet valves, manifolds and systems primarily for the aerospace and military markets. For arrangements that are accounted for under this guidance, 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 Segment: Within the Test segment, approximately 65% of revenues (approximately 22% 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 generally consisting of materials and installation services used in the construction and installation of standard 28 ESCO TEChnOlOgiES inC.no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 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, and, as a result, the arrangement revenue is allocated 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 35% of the segment’s revenues (approximately 12% of consolidated revenues) are recorded under the percentage-of-completion method due to the complex nature of the enclosures that are designed and produced under these contracts. Products accounted for under this guidance 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 this guidance, 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 5% of Test segment revenues or 2% of consolidated revenues), 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 Company’s substantial experience in developing these types of estimates. USG Segment: Within the USG segment, approximately 100% of segment revenues (approximately 22% of consolidated revenues) are recognized when products are delivered (when title and risk of ownership transfers), when services are performed for unaffiliated customers or on a straight-line basis over the lease term. Discontinued Operations (Aclara): Approximately 100% of Aclara’s revenue arrangements contain software components and/or multiple element arrangements. 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. The revenue arrangements generally include multiple products and services, or “elements” consisting of meter and substation hardware, meter reading system software, program management support during the deployment period and software support (post- contract customer support or “PCS”). These arrangements typically require the Company to deliver software at the inception of the arrangement while the hardware and program management support are delivered over the contractual deployment period. Software support is provided during deployment and subsequent thereto. The Company allocates consideration to each deliverable in an arrangement based on its relative selling price. When arrangements have both software and non-software elements, the Company allocates consideration to each element using vendor-specific objective evidence (VSOE), if it exists, otherwise third-party evidence (TPE) is utilized. If neither VSOE nor TPE of selling price exists for a unit of accounting, the Company uses estimated selling price (ESP). 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 or, if applicable, the stated renewal rate in the agreement. TPE is determined by the prices charged by the Company’s competitors for a similar deliverable when sold separately. The objective of ESP is to determine the price at which the Company would transact if the product or service were sold on a stand-alone basis. 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. Hardware is considered a specified element in the software arrangement and VSOE has been established for this element. VSOE for the hardware element is determined based on the 29 2013 AnnuAl RepoRtno t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s price when sold separately 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 TPE or ESP based on the number of endpoints. The Company has established VSOE for the PCS element 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 recognized when services have been provided. The Company determines VSOE for program management support based on hourly rates when services are performed separately. F. CASH AND CASH EQUIVALENTS Cash equivalents include temporary investments that are readily convertible into cash, such as money market funds. 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 financial condition of the customer and historical write-off experience. H. COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS Costs and estimated earnings on long-term contracts represent unbilled revenues, including accrued profits, accounted for under the percentage-of-completion method, net of progress billings. I. INVENTORIES Inventories are valued at the lower of cost (first-in, first- out) or market value. Inventories are regularly reviewed for excess quantities and obsolescence based upon historical experience, specific identification of discontinued items, future demand, and market conditions. 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. 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, 3-10 years; and office furniture and equipment, 3-10 years. Leasehold improvements are amortized over the remaining term of the applicable lease or their estimated useful lives, whichever is shorter. Long-lived tangible assets are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. Impairment losses are recognized based on fair value. 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. Management annually reviews goodwill and other long-lived assets with indefinite useful lives for impairment or whenever events or changes in circumstances indicate 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. See Note 2. Other intangible assets represent costs allocated to identifiable intangible assets, principally capitalized software, patents, trademarks, 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. Capitalized costs consist of internal and external development costs. Upon general release of the product to customers, the Company ceases capitalization and begins amortization, which 30 ESCO TEChnOlOgiES inC.no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 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 determining the estimated future economic life of the product include anticipated future revenues, and changes in software and hardware technologies. Management annually reviews the carrying values of capitalized costs for impairment or whenever events or changes in circumstances indicate the carrying amount 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. 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. N. RESEARCH AND DEVELOPMENT COSTS Company-sponsored research and development costs include research and development and bid and proposal efforts related to the Company’s products and services. Company-sponsored product development costs are charged to expense when incurred. Customer-sponsored research and development costs incurred pursuant to contracts are accounted for similarly 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. O. FOREIGN CURRENCY TRANSLATION The financial statements of the Company’s foreign operations are translated into U.S. dollars in accordance with FASB ASC Topic 830, Foreign Currency Matters. The resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income. P. EARNINGS PER SHARE Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated using the weighted average number of common shares outstanding during the period plus shares issuable upon the assumed exercise of dilutive common share options and vesting of performance-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) 2013 2012 2011 Weighted Average Shares Outstanding — Basic Dilutive Options and Performance- Accelerated Restricted Stock 26,450 26,699 26,588 352 331 315 Shares — Diluted 26,802 27,030 26,903 Options to purchase 78,166 shares at prices ranging from $36.70-$37.98 were outstanding during the year ended September 30, 2013, 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 126,787 shares at prices ranging from $35.69-$45.81 were outstanding during the year ended September 30, 2012, 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 372,653 shares at prices ranging from $32.55-$54.88 were outstanding during the year ended September 30, 2011, but were not included in the respective 31 2013 AnnuAl RepoRtno t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 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 2014. Approximately 156,000, 175,000 and 173,000 restricted shares were outstanding but unearned at September 30, 2013, 2012 and 2011, respectively, and, therefore, were not included in the respective years’ computations of diluted EPS. Q. 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. Share-based payment expense is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the requisite service period (generally the vesting period of the award). R. ACCUMULATED OTHER COMPREHENSIVE LOSS Accumulated other comprehensive loss of $(16.7) million at September 30, 2013, consisted of $(20.6) million related to the pension net actuarial loss; and $3.9 million related to currency translation adjustments. Accumulated other comprehensive loss of $(25.4) million at September 30, 2012, consisted of $(28.7) million related to the pension net actuarial loss; and $3.3 million related to currency translation adjustments. S. DEFERRED REVENUE AND COSTS Deferred revenue and costs are recorded when products or services have been provided but the criteria for revenue recognition have not been met. If there is a customer acceptance provision or there is uncertainty about customer acceptance, revenue and costs are deferred until the customer has accepted the product or service. T. DERIVATIVE FINANCIAL INSTRUMENTS All derivative financial instruments are reported on the balance sheet at fair value. The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as a hedge and on the type of hedge. For each derivative instrument designated as a cash flow hedge, the effective portion of the gain or loss on the derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. For each derivative instrument designated as a fair value hedge, the gain or loss on the derivative and the offsetting gain or loss on the hedged item are recognized immediately in earnings. Regardless of type, a fully effective hedge will result in no net earnings impact while the derivative is outstanding. To the extent that any hedge is ineffective at offsetting cash flow or fair value changes in the underlying hedged item, there could be a net earnings impact. U. NEW ACCOUNTING STANDARDS In July 2012, the FASB issued Accounting Standards Update No. 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (ASU 2012-02). This ASU updates the rules on testing indefinite-lived intangible assets other than goodwill for impairment and permits the option to perform a qualitative assessment of the fair value of indefinite-lived intangible assets. This update is effective for fiscal years, and interim periods within those years, beginning after September 15, 2012, and did not have a material impact on the Company’s financial statements. 2. Assets Held for Sale As previously disclosed, during the third quarter of 2013, the Company’s Board of Directors approved the initiation of a process to sell that portion of the Company’s USG segment represented by its subsidiary Aclara Technologies LLC (Aclara). Aclara is a supplier of special purpose fixed- network communications systems for electric, gas and water utilities including hardware and software to support advanced metering applications. Aclara’s assets and liabilities constitute a disposal group to be classified as held for sale and Aclara constitutes a component of the Company with operations and cash flows that are clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. The results of operations of a component of an entity that either has been disposed of or is classified as held for sale shall be reported in discontinued operations. Accordingly, Aclara is reflected as discontinued operations and/or assets/ liabilities held for sale in the consolidated financial statements and related notes for all periods presented. Aclara’s pretax (loss) earnings recorded in discontinued operations was $(62.1) million, $19.5 million, and $22.9 million for the years ended September 30, 2013, 2012 and 2011, respectively. The 2013 pretax loss was due to the $48 million goodwill impairment charge recorded in the fourth quarter of 2013; lower sales volumes; and changes in product mix (higher shipments of lower margin gas products as compared to higher margin electric products). Aclara’s net 32 ESCO TEChnOlOgiES inC.no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s sales were $184.5 million, $209.7 million, and $242.9 million for the years ended September 30, 2013, 2012 and 2011, respectively. Aclara’s operations were included within the Company’s USG segment prior to the classification as discontinued operations. The major classes of Aclara assets and liabilities held for sale included in the Consolidated Balance Sheets at September 30, 2013 and 2012 are shown below: goodwill was impacted by Aclara’s expected operating results and the range of bids from potential buyers. The results of the second step preliminary analysis showed that the implied fair value of goodwill was $58 million for the Aclara unit. Therefore, in the fourth quarter of 2013, the Company recorded a goodwill impairment charge of $48 million included within Discontinued Operations. 3. Acquisitions (Dollars in millions) Assets: Accounts receivable, net Inventories Other current assets Current assets Net property, plant & equipment Intangible assets, net Goodwill Other assets 2013 2012 2013 $ 55.5 34.9 18.5 108.9 14.5 66.0 57.9 11.8 67.6 26.0 4.3 97.9 13.3 55.0 81.6 12.1 Total assets 259.1 259.9 Liabilities: Accounts payable Accrued expenses and other current liabilities Current liabilities Other liabilities Total liabilities 22.2 41.4 63.6 16.0 $ 79.6 18.8 21.9 40.7 8.1 48.8 The Company completed its preliminary annual goodwill impairment evaluation using the two-step goodwill impairment test and determined that a portion of the goodwill related to Aclara was impaired. In the first step of the analysis, the Company compared the estimated fair value of the Aclara reporting unit to its carrying value, including goodwill. The fair value of the reporting unit was determined based on a weighting of income and market approaches. Since the carrying value of the Aclara reporting unit exceeded the fair value, the Company performed the second step of the impairment analysis in order to determine the implied fair value of the reporting unit over the fair value amounts assigned to all of the assets and liabilities of the reporting unit as if it were to be acquired in a business combination and the current fair value of the reporting unit (as calculated in the first step) was the purchase price. The implied fair value of the reporting units’ goodwill was then compared to the carrying value of the goodwill and any excess of carrying value over the implied fair value represents the non-cash impairment charge. The impairment of Aclara’s On June 26, 2013, the Company acquired the stock of Canyon Engineering Products, Inc. (Canyon) for $9.2 million in cash, and additionally, purchased Canyon’s 70,000 square foot manufacturing facility located in Valencia, California, for $7 million. Canyon designs and manufactures precision fluid control devices primarily for the aerospace industry and Canyon’s products, technology and customers are very similar to Crissair, Inc. The operating results for Canyon, since the date of acquisition, are included as part of Crissair, Inc. within ESCO’s Filtration segment. The Company recorded approximately $1.3 million of goodwill related to the transaction and $1.7 million of amortizable identifiable intangible assets consisting primarily of customer relationships. On December 31, 2012, the Company acquired the assets of Metrum Technologies LLC (Metrum) for a purchase price of $25 million in cash plus contingent consideration based on future revenues over the next four years. Metrum is a leading provider of wireless public network communications products for electric utility customers and also offers communications products and devices for distribution automation and demand response applications. The Company recorded approximately $25 million of goodwill, $11.2 million of amortizable identifiable intangible assets consisting primarily of customer relationships and patents/technology and contingent consideration valued at approximately $13 million. The operating results for the business, since the date of acquisition, are included within Aclara which is included in discontinued operations and/or assets held for sale. On December 21, 2012, the Company acquired the assets of Felix Tool & Engineering, Inc. (Felix Tool) for a purchase price of $1.2 million in cash. Felix Tool is engaged in the 33 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s design, manufacture and sale of customized perforated tubes for filtration applications in the aerospace and fluid power industry. The purchase price was allocated to property, plant and equipment and inventory based on fair market value at the date of acquisition and there were no intangible assets recorded upon the transaction. The operating results for the business, since the date of acquisition, are included within PTI Technologies Inc. in the Filtration segment. On December 10, 2012, the Company acquired the assets of Finepoint Marketing, Inc. (Finepoint) for a purchase price of $2.5 million. Finepoint is the electric power industry’s leading conference provider focused on medium and high voltage circuit breakers, as well as related substation and switchgear topics. The operating results for the business, since the date of acquisition, are included as a part of Doble in the USG segment. The Company recorded approximately $1.3 million of goodwill as a result of the transaction and $1.2 million of amortizable identifiable intangible assets consisting of customer relationships. 2011 On February 28, 2011, the Company acquired the capital stock of EMV Elektronische Messgerate Vertriebs - GmbH, together with its subsidiary EMSCREEN Electromagnetic Screening GmbH (collectively, EMV) for a purchase price of approximately $5 million, inclusive of cash acquired. EMV, with operations in Taufkirchen, Germany, provides turnkey systems and shielded environments for research, development and quality assurance testing of electronic equipment. EMV’s operating results, since the date of acquisition, are included within the Test segment and the Company recorded approximately $4.8 million of goodwill as a result of the transaction. All of the Company’s acquisitions have been accounted for using the purchase method of accounting and accordingly, the respective purchase prices were allocated to the assets (including intangible assets) acquired and liabilities assumed based on estimated fair values at the date of acquisition. The financial results from these acquisitions have been included in the Company’s financial statements from the date of acquisition. Pro forma financial information related to the Company’s 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 acquisitions mentioned above is expected to be deductible for U.S. Federal or state income tax purposes. 4. Goodwill and Other Intangible Assets Included on the Company’s Consolidated Balance Sheets at September 30, 2013, and 2012 are the following intangible assets gross carrying amounts and accumulated amortization: (Dollars in millions) Goodwill 2013 $ 282.9 2012 279.6 Intangible assets with determinable lives: Patents Gross carrying amount Less: accumulated amortization Net Capitalized software Gross carrying amount Less: accumulated amortization Net Customer Relationships Gross carrying amount Less: accumulated amortization Net Other Gross carrying amount Less: accumulated amortization Net $ 0.9 0.6 $ 0.3 $ 32.1 15.3 $ 16.8 $ 64.1 17.9 $ 46.2 $ 0.4 0.2 $ 0.2 0.8 0.6 0.2 23.0 11.7 11.3 61.4 14.7 46.7 0.2 0.2 — Intangible assets with indefinite lives: Trade names $ 116.7 118.2 The Company performed its annual evaluation of goodwill and intangible assets for impairment during the fourth quarter of fiscal 2013 and concluded no impairment existed at September 30, 2013, related to continuing operations. The changes in the carrying amount of goodwill attributable to each business segment for the years ended September 30, 2013, and 2012 are as follows: (Dollars in millions) USG Test Filtration Total Balance as of September 30, 2011 Acquisitions/adjustments Balance as of September 30, 2012 Acquisitions/adjustments Balance as of September 30, 2013 $ 216.1 34.8 (0.5) (0.1) 29.3 280.2 (0.6) — 215.6 34.7 0.3 1.7 29.3 279.6 3.3 1.3 $ 217.3 35.0 30.6 282.9 34 ESCO TEChnOlOgiES inC. no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s Amortization expense related to intangible assets with determinable lives was $6.2 million, $5.7 million and $5 million in 2013, 2012 and 2011, 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, generally three to seven years. Customer relationships are generally amortized over twenty years. Intangible asset amortization for fiscal years 2014 through 2018 is estimated at approximately $7 million per year. 5. Accounts Receivable remaining noncancelable lease terms in excess of one year as of September 30, 2013, are: (Dollars in thousands) Years ending September 30: 2014 2015 2016 2017 2018 and thereafter Total $ 4,994 4,219 2,519 1,472 1,749 $14,953 Accounts receivable, net of the allowance for doubtful accounts, consist of the following at September 30, 2013, and 2012: 8. Income Tax Expense (Dollars in thousands) Commercial U.S. Government and prime contractors Total 6. Inventories 2013 $88,938 3,042 $91,980 2012 80,048 3,366 83,414 Inventories consist of the following at September 30, 2013, and 2012: (Dollars in thousands) Finished goods Work in process — including long-term contracts Raw materials Total 2013 2012 $20,925 19,753 30,884 38,419 $90,228 27,217 35,093 82,063 7. Property, Plant and Equipment Depreciation expense of property, plant and equipment for the years ended September 30, 2013, 2012 and 2011 was $8.6 million, $8.1 million and $7.8 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, 2013, 2012 and 2011 was $5 million, $5 million and $8.1 million, respectively. Future aggregate minimum lease payments under operating leases that have initial or Total income tax expense (benefit) for the years ended September 30, 2013, 2012 and 2011 was allocated to income tax expense as follows: (Dollars in thousands) 2013 2012 2011 Income tax expense from Continuing Operations Income tax (benefit) expense $18,335 17,408 16,922 from Discontinued Operations (5,215) 7,397 7,535 Total income tax expense $13,120 24,805 24,457 The components of income from continuing operations before income taxes consisted of the following for the years ended September 30: (Dollars in thousands) 2013 2012 2011 United States Foreign $43,159 6,436 46,883 5,299 49,702 4,303 Total income before income taxes $49,595 52,182 54,005 The principal components of income tax expense (benefit) from continuing operations for the years ended September 30, 2013, 2012 and 2011 consist of: (Dollars in thousands) 2013 2012 2011 Federal Current Deferred State and local: Current Deferred Foreign: Current Deferred Total $10,723 2,942 11,144 2,954 9,667 4,672 896 642 1,372 309 1,801 464 2,033 1,099 1,863 (234) 3,049 (2,731) $18,335 17,408 16,922 35 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s The actual income tax expense (benefit) from continuing operations for the years ended September 30, 2013, 2012 and 2011 differs from the expected tax expense for those years (computed by applying the U.S. Federal corporate statutory rate) as follows: 2013 2012 2011 Federal corporate statutory rate State and local, net of Federal benefits Foreign Research credit Domestic production deduction Change in uncertain tax positions Purchase accounting adjustment Executive compensation Valuation allowance Other, net 35.0% 2.7 (1.9) (2.5) (2.5) 0.1 — 1.8 4.0 0.3 35.0% 3.3 (0.7) (0.3) (2.4) (3.6) 1.0 0.6 0.2 0.3 35.0% 3.7 (2.3) (1.3) (2.2) (0.5) — 0.5 (1.7) 0.1 Effective income tax rate 37.0% 33.4% 31.3% The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at September 30, 2013, and 2012 are presented below: (Dollars in thousands) Deferred tax assets: 2013 2012 Inventories, long-term contract accounting, contract cost reserves and other $ 6,825 Pension and other postretirement benefits Net operating loss carryforward — domestic Net operating loss carryforward — foreign Capital loss carryforward Other compensation-related costs 7,417 848 3,955 240 7,819 13,437 562 3,841 240 and other cost accruals State credit carryforward Total deferred tax assets Deferred tax liabilities: Goodwill Acquisition assets Depreciation, software amortization Net deferred tax liabilities before valuation allowance Less valuation allowance 19,325 1,099 17,589 997 39,709 44,485 (14,576) (12,783) (61,403) (63,323) (36,396) (33,799) (72,666) (65,420) (942) (3,780) state research and other credit carryforwards of $1.1 million of which $1 million expires between 2023 and 2028. The remaining $0.1 million does not have an expiration date. At September 30, 2013, the Company has established a valuation allowance of $0.4 million against state credit carryforwards and $0.4 million against state net operating loss (NOL) carryforwards that are not expected to be realized in future periods. In addition, the Company has established a valuation allowance of $0.2 million at September 30, 2013 and 2012, respectively, against the capital loss carryforward generated in 2008, as such loss carryforward may not be realized in future periods. Lastly, 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 $2.8 million and $0.7 million at September 30, 2013, and 2012, respectively. The Company classifies its valuation allowance related to deferred taxes on a pro rata basis by taxing jurisdiction. The Company’s foreign subsidiaries have accumulated unremitted earnings of $33.3 million and cash of $25.3 million at September 30, 2013. No deferred taxes have been provided on these accumulated unremitted earnings because these funds are not needed to meet the liquidity requirements of the Company’s U.S. operations and it is the Company’s intention to indefinitely reinvest these earnings in continuing international operations. In the event these foreign entities’ earnings were distributed, it is estimated that U.S. taxes, net of available foreign tax credits, of approximately $6 million would be due, which would correspondingly reduce the Company’s net earnings. No significant portion of the Company’s foreign subsidiaries’ earnings was taxed at a very low tax rate. As of September 30, 2013, the Company had $2.2 million of unrecognized benefits (see table below), which, net of Federal benefit, if recognized, would affect the Company’s effective tax rate. A reconciliation of the Company’s unrecognized tax benefits for the years ended September 30, 2013, and 2012 is presented in the table below: Net deferred tax liabilities $ (76,446) (66,362) (Dollars in millions) The Company has a foreign net operating loss carryforward of $14 million at September 30, 2013, which reflects tax loss carryforwards in Brazil, Germany, India, Japan and the United Kingdom. $12.7 million of the tax loss carryforwards have no expiration date while the remaining $1.3 million will expire between 2020 and 2022. The Company has state net operating loss carryforwards of $9.9 million at September 30, 2013 which expire between 2018 and 2033. The Company also has net Balance as of October 1, Increases related to prior year tax positions Decreases related to prior year tax positions Increases related to current year tax positions Decreases related to settlements with taxing authorities Lapse of statute of limitations Balance as of September 30, 2013 2012 $ 1.8 0.5 — 0.2 3.6 — (0.3) 0.1 (0.1) — (1.6) (0.2) $ 2.2 1.8 36 ESCO TEChnOlOgiES inC. no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s The Company anticipates a $1.1 million reduction in the amount of unrecognized tax benefits in the next 12 months as a result of a lapse of the applicable statute of limitations. The Company’s policy is to include interest related to unrecognized tax benefits in income tax expense and penalties in operating expense. As of September 30, 2013, 2012 and 2011, the Company had accrued interest related to uncertain tax positions of $0.1 million, $0.1 million and $0.2 million, respectively, net of Federal income tax benefit, on its Consolidated Balance Sheet. No significant penalties have been accrued. The principal jurisdictions for which the Company files income tax returns are U.S. Federal and the various city, state, and international locations where the Company has operations. The U.S. Federal tax years for the periods ended September 30, 2010, and forward remain subject to income tax examination. Various state tax years for the periods ended September 30, 2009, and forward remain subject to income tax examinations. The Company is subject to income tax in many jurisdictions outside the United States, none of which is individually material to the Company’s financial position, statements of cash flows, or results of operations. 9. Debt Debt consists of the following at September 30, 2013, and 2012: (Dollars in thousands) Revolving credit facility, including current portion 2013 2012 $172,000 115,000 Current portion of long-term debt (50,000) (50,000) Total long-term debt, less current portion $ 122,000 65,000 On May 14, 2012, the Company entered into a new $450 million five-year revolving credit facility with JPMorgan Chase Bank, N.A., as administrative agent, PNC Bank, N.A., as syndication agent, and eight other participating lenders (the “Credit Facility”). The Credit Facility replaced the Company’s $330 million revolving credit facility that would otherwise have matured in November, 2012. Through a credit facility expansion option, the Company may elect to increase the size of the Credit Facility by entering into incremental term loans, in any agreed currency, at a minimum of $25 million each up to a maximum of $250 million aggregate. At September 30, 2013, the Company had approximately $265 million available to borrow under the Credit Facility, plus a $250 million increase option, in addition to $42.9 million cash on hand. The Company classified $50 million as the current portion of long-term debt as of September 30, 2013, as the Company intends to repay this amount within the next twelve months; however, the Company has no contractual obligation to repay such amount during the next twelve months. The Company’s ability to access the additional $250 million increase option of the Credit Facility is subject to acceptance by participating or other outside banks. The credit facility requires, as determined by certain financial ratios, a facility fee ranging from 17.5 to 35 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 financial covenants of the Credit Facility include a leverage ratio and an interest coverage ratio. During 2013 and 2012, the maximum aggregate short-term borrowings at any month-end were $191 million and $141 million, respectively; the average aggregate short- term borrowings outstanding based on month-end balances were $171 million and $126 million, respectively; and the weighted average interest rates were 1.55%, 1.20%, and 1.40% for 2013, 2012 and 2011, respectively. The letters of credit issued and outstanding under the Credit Facility totaled $13 million and $15.3 million at September 30, 2013, and 2012, respectively. 10. Capital Stock The 30,147,504 and 30,044,486 common shares as presented in the accompanying Consolidated Balance Sheets at September 30, 2013, and 2012 represent the actual number of shares issued at the respective dates. The Company held 3,707,407 and 3,453,249 common shares in treasury at September 30, 2013, and 2012, respectively. In August 2012, the Company’s Board of Directors authorized an expanded stock repurchase program whereby Management may repurchase shares of its outstanding common stock in the open market and otherwise throughout the period ended September 30, 2013. This program was extended by the Company’s Board of Directors through September 30, 2014. The total value authorized was the lesser of $100 million, or the dollar limitation imposed by Section 6.07 of the Company’s Credit Agreement dated May 14, 2012. The Company repurchased approximately 270,000 shares in 2013 and 150,000 shares during 2012. There were no stock repurchases in 2011. 37 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 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. 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 10-year contractual life from date of issuance, expiring in various periods through 2013. Beginning in fiscal 2004, the options granted have a five-year contractual life from date of issuance. The Company recognizes compensation cost on a straight-line basis over the requisite service period for the entire award. The fair value of each option award is estimated as of the date of grant using the 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 Company utilizes historical company data to develop its expected term assumption. 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. There were no stock option grants during 2013, 2012 or 2011. 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 FY2013 FY2012 FY2011 Estimated Weighted Shares Avg. Price 125,816 $36.29 — — (51,116) $34.70 (7,350) $37.30 67,350 $37.39 Estimated Weighted Shares Avg. Price 435,054 — (100,872) (208,366) 125,816 $35.58 — $14.98 $45.18 $36.29 Estimated Weighted Shares Avg. Price 761,931 — (104,912) (221,965) 435,054 $35.15 — $13.18 $44.67 $35.58 500,000 67,350 $37.39 1,301,090 125,149 $36.31 1,115,776 397,073 $35.42 The aggregate intrinsic value of options exercised during 2013, 2012 and 2011 was $0.3 million, $2 million and $2.4 million, respectively. The aggregate intrinsic value of stock options outstanding and exercisable at September 30, 2013, was zero. The weighted-average fair value of stock options per share granted in 2013, 2012 and 2011 and 2010 was zero respectively. Summary information regarding stock options outstanding at September 30, 2013, is presented below: Range of Exercise Prices $32.55 $37.54 Exercisable Options Outstanding Number Exercisable at Sept. 30, 2013 2,000 65,350 67,350 Weighted Average Exercise Price $ 32.55 $ 37.54 $ 37.39 Options Outstanding Weighted- Number Remaining Outstanding at Contractual Life Sept. 30, 2013 Average Weighted Average Exercise Price 2,000 1.3 years $ 32.55 65,350 .02 years $ 37.54 67,350 .06 years $ 37.39 Performance-accelerated Restricted Share Awards The performance-accelerated restricted shares (restricted shares) have a five-year term with accelerated vesting if certain targets based on market conditions are achieved. In these cases, if it is probable that the performance condition will be met, the Company recognizes compensation 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 Range of Exercise Prices $32.55 $37.54 38 ESCO TEChnOlOgiES inC. no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 12. Retirement and Other Benefit Plans Substantially all domestic employees were covered by a defined contribution pension plan maintained by the Company. Effective December 31, 2003, the Company’s defined benefit plan was frozen and no additional benefits have been 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. In conjunction with the acquisition of Doble, the Company assumed responsibility for its defined benefit plan and has frozen the plan effective December 31, 2008, and no additional benefits have been accrued after that date. Effective October 1, 2009, the Company’s defined benefit plan and Doble’s benefit plan were merged into one plan. The annual contributions to the defined benefit retirement plans equal or exceed the minimum funding requirements of the Employee Retirement Income Security Act. In addition to providing retirement income benefits, the Company provides unfunded postretirement health and life insurance benefits to certain retirees. To qualify, an employee must retire at age 55 or later and the employee’s age plus service must equal or exceed 75. Retiree contributions are defined as a percentage of medical premiums. Consequently, retiree contributions increase with increases in the medical premiums. The life insurance plans are noncontributory and provide coverage of a flat dollar amount for qualifying retired employees. Effective December 31, 2004, no new retirees were eligible for life insurance benefits. 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 $0.8 million at September 30, 2013, and 2012, 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 outstanding restricted share awards is being recognized over the shorter performance period as it is probable the performance condition will be met. The restricted share award grants were valued at the stock price on the date of grant. Pretax compensation expense related to the restricted share awards for continuing operations was $4 million, $3.8 million and $3.4 million for the fiscal years ended September 30, 2013, 2012 and 2011, respectively. The following summary presents information regarding outstanding restricted share awards as of September 30, 2013, and changes during the period then ended: Nonvested at October 1, 2012 Granted Vested Cancelled Weighted Shares Avg. Price 404,448 111,131 (81,834) (8,500) $32.65 $38.76 $37.39 $34.48 Nonvested at September 30, 2013 425,245 $33.29 Non-Employee Directors Plan The non-employee directors compensation plan provides to each non-employee director a retainer of 900 common shares per quarter. Compensation expense related to the non- employee director grants was $0.6 million, $0.6 million and $0.6 million for the years ended September 30, 2013, 2012 and 2011, respectively. Total Share-Based Compensation The total share-based compensation cost that has been recognized in results of operations and included within SG&A from continuing operations was $4.6 million, $4.4 million and $4.5 million for the years ended September 30, 2013, 2012 and 2011, respectively. The total income tax benefit recognized in results of operations for share-based compensation arrangements was $1.3 million, $1.6 million and $1.8 million for the years ended September 30, 2013, 2012 and 2011, 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. As of September 30, 2013, there was $5.6 million of total unrecognized compensation cost related to share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.4 years. 39 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s The following table provides the components of net periodic benefit cost for the plans for the years ended September 30, 2013, 2012 and 2011: (Dollars in millions) 2013 2012 2011 Service cost Interest cost Expected return on plan assets Net actuarial loss Settlement gain Net periodic benefit cost Defined contribution plans Total $ 0.1 3.6 0.1 3.8 (4.1) 1.5 2.1 (0.1) — (4.4) 1.3 4.6 $ 5.9 1.3 4.5 5.8 0.1 3.9 (4.2) 1.1 — 0.9 3.7 4.6 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 400 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. 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 evaluating 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 return on assets 2013 2012 2011 3.75% 4.50% 5.00% N/A N/A N/A 7.50% 7.50% 8.00% The following weighted-average assumptions were used to determine the net periodic benefit obligations for the pension plans: Discount rate Rate of increase in compensation levels 2013 2012 4.75% 3.75% N/A N/A 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, 2013, and a statement of the funded status as of September 30, 2013, and 2012: (Dollars in millions) 2013 2012 Reconciliation of benefit obligation Net benefit obligation at beginning of year Service cost Interest cost Actuarial (gain) loss Settlements Gross benefits paid $ 97.1 0.1 3.6 (9.7) (0.3) (3.6) 83.2 0.1 3.8 13.4 — (3.4) Net benefit obligation at end of year $ 87.2 97.1 (Dollars in millions) 2013 2012 Reconciliation of fair value of plan assets Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Gross benefits paid Settlements $ 61.1 6.2 4.5 (3.9) — 50.5 9.0 5.0 (3.4) — Fair value of plan assets at end of year $ 67.9 61.1 (Dollars in millions) 2013 2012 Funded Status Funded status at end of year Unrecognized prior service cost Unrecognized net actuarial (gain) loss Accrued benefit cost Amounts recognized in the Balance Sheet consist of: Noncurrent asset Current liability Noncurrent liability Accumulated other comprehensive (income)/loss (before tax effect) Amounts recognized in Accumulated Other Comprehensive (Income)/Loss consist of: Net actuarial loss Prior service cost $ (19.3) — — (36.0) — — (19.3) (36.0) — (0.3) (19.0) — (0.5) (35.5) 34.8 48.3 34.8 — 48.2 0.1 48.3 Accumulated Other Comprehensive (Income)/Loss $ 34.8 40 ESCO TEChnOlOgiES inC. no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s The assumed rate of increase in compensation levels is not applicable in 2013, 2012 and 2011 as the plan was frozen in earlier years. The fair values of the Company’s defined benefit plan investments as of September 30, 2013, by asset category, are as follows: (Dollars in millions) Level 1 Level 2 Level 3 Total The asset allocation for the Company’s pension plans at the end of 2013 and 2012, the Company’s acceptable range and the target allocation for 2014, by asset category, follows: Allocation Target Acceptable Percentage of Plan Range Assets at Year-end 2012 2013 2014 Asset Category Equity securities Fixed income Cash/cash equivalents 38% 62% 0% 34-42% 58-66% 0-5% 34% 65% 1% 59% 39% 2% International funds Fixed Income Funds Real Estate Investments Investments at Fair Value: Cash and Cash Equivalents Common and Preferred Stock Funds: Domestic large capitalization Domestic small/mid capitalization $ 0.9 — — 0.9 4.8 6.5 9.7 43.8 2.2 — — — — — — — — — 4.8 6.5 9.7 — 43.8 2.2 — — 67.9 Total Investments at Fair Value $ 67.9 The Company’s pension plan assets are managed by outside investment managers and assets are rebalanced when the target ranges are exceeded. Pension plan assets consist principally of funds which invest in marketable securities including common stocks, bonds, and interest-bearing deposits. The Company’s investment strategy with respect to pension assets is to achieve a total rate of return (income and capital appreciation) 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. FAIR VALUE OF FINANCIAL MEASUREMENTS FASB ASC 825, Financial Instruments, establishes a three-level hierarchy for disclosure of fair value measurements, based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, as follows: Level 1: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. The Company is required to separately disclose assets and liabilities measured at fair value on a recurring basis, from those measured at fair value on a nonrecurring basis. For assets that are measured using quoted prices in active markets, the total fair value is the published market price per unit multiplied by the number of units held without consideration of transaction costs, which have been determined to be immaterial. Assets that are measured using significant other observable inputs are primarily valued by reference to quoted prices of markets that are not active. The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Cash and cash equivalents: The carrying value of cash represents fair value as it consists of actual currency, and is classified as Level 1. Common and preferred stock funds: The plans’ common and preferred stock funds primarily consist of investments in listed U.S. and international companies’ stocks. The stock investments are valued using quoted prices from the various public markets. Most equity securities trade on formal exchanges, both domestic and foreign (e.g. NYSE, NASDAQ, LSE), and can be accurately described as active markets. The observable valuation inputs are unadjusted quoted prices that represent active market trades. Fixed income funds: Fixed income funds consist of investments in U.S. and foreign corporate credit, U.S. and foreign government issues (including agencies and mortgages), U.S. Treasuries, U.S. state and municipal securities and asset- backed securities. These investments are generally priced by institutional bids, which reflect estimated values based on underlying model frameworks at various dealers and vendors, or are formally listed on exchanges, where dealers exchange bid and ask offers to arrive at most executed transaction prices. 41 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s Real estate investments: The plan invests in U.S. real estate through indirect ownership entities, which are structured as limited partnerships or private real estate investment trusts (REITs). EXPECTED CASH FLOWS 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 — 2014 $ 3.1 Expected Benefit Payments 2014 2015 2016 2017 2018 2019-2023 13. Other Financial Data 4.3 4.4 4.9 4.9 5.0 $ 28.1 0.1 0.1 0.1 0.1 — 0.1 0.4 Items charged to continuing operations during the years ended September 30, 2013, 2012 and 2011 included the following: (Dollars in thousands) 2013 2012 2011 Salaries and wages (including fringes) Maintenance and repairs Research and development (R&D) costs: Company-sponsored Customer-sponsored Total R&D Other engineering costs Total R&D and other engineering costs $ 151,805 138,192 129,572 3,568 4,368 4,248 12,704 15,014 27,718 7,715 14,293 9,171 23,464 12,217 14,936 8,527 23,463 7,406 $ 35,433 35,681 30,869 As a % of net sales 7.2% 7.5% 6.8% A reconciliation of the changes in accrued product warranty liability for the years ended September 30, 2013, 2012 and 2011 is as follows: (Dollars in thousands) 2013 2012 2011 Balance as of October 1, $ 1,536 2,120 1,967 Additions charged to expense Deductions 1,048 (704) 197 (781) 770 (617) Balance as of September 30, $ 1,880 1,536 2,120 42 14. Business Segment Information The Company is organized based on the products and services it offers. Under this organizational structure, the Company has three reporting segments: Filtration/Fluid Flow (Filtration), RF Shielding and Test (Test), and Utility Solutions Group (USG). The Filtration segment’s operations consist of: PTI Technologies Inc., VACCO Industries, Crissair, Inc., Canyon Engineering Products, Inc. and Thermoform Engineered Quality LLC. The companies within this segment design and manufacture specialty filtration products including hydraulic filter elements and fluid control devices used in commercial aerospace applications, unique filter mechanisms used in micro-propulsion devices for satellites and custom designed filters for manned aircraft and submarines. Test segment operations consist of ETS-Lindgren Inc. (ETS-Lindgren). ETS-Lindgren is an industry leader in providing its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy. ETS-Lindgren also manufactures radio frequency shielding products and components used by manufacturers of medical equipment, communications systems, electronic products, and shielded rooms for high-security data processing and secure communication. The USG segment’s operations consist of Doble Engineering Company (Doble). Doble provides high-end, intelligent diagnostic test solutions for the electric power delivery industry and is a leading supplier of power factor and partial discharge testing instruments used to assess the integrity of high-voltage power delivery equipment. Previously, USG also included Aclara Technologies LLC. See Note 2. 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. The operating units within each reporting segment have been aggregated because of similar economic characteristics and meet the other aggregation criteria of FASB ASC 280. The Company evaluates the performance 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. ESCO TEChnOlOgiES inC. no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s NET SALES (Dollars in millions) Year ended September 30, 2013 2012 Filtration Test USG Consolidated totals $214.1 166.7 109.3 194.8 175.9 108.0 $ 490.1 478.7 2011 167.6 176.5 106.7 450.8 No customers exceeded 10% of sales in 2013, 2012 or 2011. EBIT (Dollars in millions) Year ended September 30, 2013 2012 2011 Filtration Test USG Reconciliation to consolidated $ 42.4 16.3 21.6 38.0 14.0 25.9 30.8 18.6 30.4 totals (Corporate) (28.0) (23.2) (23.3) Consolidated EBIT Less: interest expense 52.3 (2.7) Earnings before income tax $ 49.6 54.7 (2.5) 52.2 56.5 (2.5) 54.0 IDENTIFIABLE ASSETS (Dollars in millions) Year ended September 30, 2013 2012 Filtration $ 122.9 102.4 Test 72.3 USG Corporate (includes assets held for sale) 794.7 98.4 92.8 66.6 776.0 Consolidated totals $ 1,092.3 1,033.8 Corporate assets consist primarily of goodwill, deferred taxes, acquired intangible assets, cash balances and assets held for sale. CAPITAL EXPENDITURES (Dollars in millions) Year ended September 30, 2013 2012 2011 Filtration Test USG Corporate $ 6.6 3.2 3.9 0.2 4.4 2.2 3.6 0.6 3.3 1.5 6.5 — Consolidated totals $ 13.9 10.8 11.3 In addition to the above amounts, the Company incurred ex- penditures for capitalized software of $8.4 million, $5.3 million and $5.5 million in 2013, 2012 and 2011, respectively. DEPRECIATION AND AMORTIZATION (Dollars in millions) Year ended September 30, 2013 2012 2011 $ 4.2 2.5 4.6 3.5 $14.8 3.9 2.5 3.4 4.7 3.3 2.2 3.1 4.9 14.5 13.5 Filtration Test USG Corporate Consolidated totals GEOGRAPHIC INFORMATION Net sales (Dollars in millions) 2011 318.6 45.9 56.9 14.1 — 15.3 450.8 Year ended September 30, 2013 2012 United States Asia Europe Canada India Other $336.4 59.5 51.5 14.3 10.2 18.2 316.6 66.3 61.7 12.6 7.5 14.0 Consolidated totals $490.1 478.7 Long-lived assets (Dollars in millions) Year ended September 30, 2013 2012 United States Europe Other Consolidated totals $72.8 2.2 0.5 $75.5 59.2 2.6 0.8 62.6 Net sales are attributed to countries based on location of customer. Long-lived assets are attributed to countries based on location of the asset. 15. Commitments and Contingencies At September 30, 2013, the Company had $13 million in letters of credit outstanding as guarantees of contract performance. The Company is currently involved in various stages of investigation and remediation relating to environmental matters, intellectual property and general corporate 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. 43 2013 AnnuAl RepoRt no t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s 16. Quarterly Financial Information (Unaudited) (Dollars in thousands, except per share amounts) 2013 Net sales Net earnings from continuing operations Net (loss) earnings from discontinued operations First Quarter Second Third Quarter Quarter Fourth Quarter Fiscal Year $ 110,518 118,039 116,922 144,600 490,079 5,343 31,260 6,514 (5,097) (3,964) (1,617) (46,185) (56,863) 13,880 5,523 Net (loss) earnings 246 1,559 4,897 (32,305) (25,603) Basic earnings (loss) per share: Net earnings from continuing operations Net (loss) earnings from discontinued operations Net (loss) earnings Diluted earnings (loss) per share: Net earnings from continuing operations Net (loss) earnings from discontinued operations Net (loss) earnings 0.20 (0.19) 0.21 (0.15) 0.25 (0.06) 0.52 (1.75) 1.18 (2.15) 0.01 0.06 0.19 (1.23) (0.97) 0.20 (0.19) 0.21 (0.15) 0.24 (0.06) 0.52 (1.73) 1.17 (2.13) 0.01 0.06 0.18 (1.21) (0.96) Dividends declared per common share $ 0.08 0.08 0.08 0.08 0.32 2012 Net sales Net earnings from continuing operations Net earnings (loss) from discontinued operations Net earnings Basic earnings (loss) per share: Net earnings from continuing operations Net earnings (loss) from discontinued operations Net earnings Diluted earnings (loss) per share: Net earnings from continuing operations Net earnings (loss) from discontinued operations Net earnings $ 111,480 125,237 118,432 123,550 478,699 6,191 (984) 7,575 2,627 11,540 2,251 9,468 8,211 34,774 12,105 5,207 10,202 13,791 17,679 46,879 0.24 (0.04) 0.20 0.23 (0.04) 0.19 0.28 0.10 0.38 0.28 0.10 0.38 0.08 0.43 0.09 0.52 0.43 0.08 0.51 0.08 0.35 0.31 0.66 0.35 0.30 0.65 0.08 1.30 0.46 1.76 1.29 0.44 1.73 0.32 Dividends declared per common share $ 0.08 See Notes 2 and 3 of Notes to Consolidated Financial Statements for discussion of divestiture and acquisition activity. Beginning in the third quarter of 2013, Aclara was classified as discontinued operations and assets/liabilities held for sale. Prior period amounts have been reclassified to conform to the current period presentation. 44 ESCO TEChnOlOgiES inC. M a n a g e m e n t ’ s S t a t e m e n t o f F i n a n c i a l R e s p o n s i b i l i t y The Company’s Management is responsible for the fair presentation of the Company’s financial statements in accordance with accounting 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 assurance as to the integrity and accuracy of the financial statements, and responsibility for the Company’s assets. KPMG LLP, the Company’s independent registered public accounting firm, reports directly to the Audit and Finance Committee of the Board of Directors. The Audit and Finance Committee has established policies consistent with 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 Finance, the Human Resources and Compensation and the Nominating 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 in- terest 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 a Corporate Ethics Committee, ethics officers at each operating location 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 leadership to each of its individual contributors. Management monitors compliance with its financial policies and practices over critical areas including internal controls, financial accounting and reporting, 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 Corporate Ethics Committee. 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, Executive Vice President, and Chief Financial Officer and President Gary E. Muenster 45 2013 AnnuAl RepoRtM a n a g e m e n t ’ s R e p o r t o n I n t e r n a l C o n t r o l ov e r F i n a n c i a l R e p o r t i n g The Company’s Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). 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 accordance 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, 2013, using criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and concluded that the Company maintained effective internal control over financial reporting as of September 30, 2013, based on these criteria. Our internal control over financial reporting as of September 30, 2013, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in its report which is included herein. Victor L. Richey Chairman, Chief Executive Officer, Executive Vice President, and Chief Financial Officer and President Gary E. Muenster 46 ESCO TEChnOlOgiES inC.R e p o r t o f I n d e p e n d e n t R e g i s t e r e d pu b l i c A c c o u n t i n g F i r m The Board of Directors and Shareholders ESCO Technologies Inc.: We have audited the accompanying Consolidated Balance Sheets of ESCO Technologies Inc. and subsidiaries as of September 30, 2013, and 2012, and the related Consolidated Statements of Operations, Comprehensive Income (Loss), Shareholders’ Equity, and Cash Flows for each of the years in the three-year period ended September 30, 2013. We also have audited ESCO Technologies Inc.’s internal control over financial reporting as of September 30, 2013, based on criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). ESCO Technologies Inc.’s Management is responsible for these Consolidated Financial Statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on ESCO Technologies Inc.’s internal control over financial reporting 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the Consolidated Financial Statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by Management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. 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 accounting principles. A company’s internal control over financial reporting 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 that 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, projections of any evaluation of effectiveness to future periods are subject 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, the Consolidated Financial Statements referred to above present fairly, in all material respects, the financial position of ESCO Technologies Inc. and subsidiaries as of September 30, 2013, and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2013, in conformity with U.S. generally accepted accounting principles. Also in our opinion, ESCO Technologies Inc. maintained, in all material respects, effective internal control over financial reporting as of September 30, 2013, based on criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. St. Louis, Missouri November 27, 2013 47 2013 AnnuAl RepoRtF i v e -y e a r F i n a n c i a l S u m m a r y (Dollars in millions, except per share amounts) 2013 2012 2011 2010 2009 For years ended September 30: Net sales Net earnings from continuing operations Net (loss) earnings from discontinued operations Net (loss) earnings Earnings (loss) per share: Basic: Continuing operations Discontinued operations Net (loss) earnings Diluted: Continuing operations Discontinued operations Net (loss) earnings As of September 30: Working capital Total assets Total debt Shareholders’ equity $490.1 478.7 450.8 350.0 329.2 31.3 (56.9) (25.6) $1.18 (2.15) $(0.97) $ 1.17 (2.13) $(0.96) 34.8 12.1 46.9 1.30 0.46 1.76 1.29 0.44 1.73 37.1 15.4 52.5 1.39 0.58 1.97 1.38 0.57 1.95 163.6 1,092.3 172.0 601.7 139.2 1,033.8 115.0 631.3 122.5 1,011.8 125.0 600.7 17.5 27.3 44.8 0.66 1.04 1.70 0.65 1.03 1.68 109.4 974.3 154.0 556.0 0.32 21.2 28.2 49.4 0.81 1.07 1.88 0.80 1.06 1.86 116.2 923.7 180.5 517.3 — Cash dividends declared per common share $0.32 0.32 0.32 See Notes 2 and 3 of Notes to Consolidated Financial Statements for discussion of divestiture and acquisition activity. Beginning in the third quarter of 2013, Aclara was classified as discontinued operations and assets/liabilities held for sale. Prior period amounts have been reclassified to conform to the current period presentation. C o m m o n S t o c k M a r k e t pr i c e ESCO’s common stock is 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 2013 and 2012. 2013 2012 High $39.31 42.42 41.31 35.70 Low 34.00 37.85 31.20 30.25 High $31.97 38.37 36.90 39.50 Low 23.75 28.48 32.98 33.05 Quarter First Second Third Fourth 48 ESCO TEChnOlOgiES inC. M a r k e t pe r f o r m a n c e Performance Graph 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 “2013 Peer Group”). The Company is not a component of the 2013 Peer Group, but it is a component of the Russell 2000 Index. The measurement period begins on September 30, 2008 and measures at each September 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, 2008. ESCO Technologies Inc. Russell 2000 Index 2013 Peer Group The 2013 Peer Group is comprised of seven companies that correspond to the Company’s three industry segments as follows: Utility Solutions Group segment (22% of the Company’s 2013 total revenue) — Badger Meter Inc., Itron Inc., Echelon Corporation and Roper Industries Inc.; Test segment (34% of the Company’s 2013 total revenue) — Aeroflex Holding Corporation; and Filtration/Fluid Flow segment (44% of the Company’s 2013 total revenue) — Pall Corporation and Clarcor Inc. ESCO Technologies Inc. Russell 2000 Index 2013 Peer Group $200 175 150 125 100 75 50 25 9/08 9/09 9/10 9/11 9/12 9/13 9/08 9/09 9/10 9/11 9/12 9/13 100.00 81.79 69.59 53.83 82.85 71.48 100.00 90.45 102.53 98.91 130.47 169.68 100.00 93.29 107.59 107.53 129.69 154.57 In calculating the composite return of the 2013 Peer Group, the return of each company comprising the 2013 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 2013 total revenue represented by its corresponding Company industry segment. For purposes of these calculations, 2013 total revenue excludes discontinued operations. The Company anticipates that the composition of the Peer Group may change in future years to reflect changes in the Utility Solutions segment resulting from the anticipated sale of Aclara. 49 2013 AnnuAl RepoRt S h a r e h o l d e r s ’ S u m m a r y SHAREHOLDERS’ ANNUAL MEETING INVESTOR RELATIONS The Annual Meeting of Shareholders of ESCO Technologies Inc. will be held at 9:30 a.m. Central Time on Wednesday, February 5, 2014, at the Company’s Corporate Headquarters, 9900A Clayton Road, St. Louis, Missouri 63124. You may access this Annual Report as well as the Notice of the meeting and the Proxy Statement on the Company’s Annual Meeting website at http://www.cfpproxy.com/5157. CERTIFICATIONS Pursuant to New York Stock Exchange (NYSE) requirements, the Company submitted to the NYSE the annual certifications, dated February 15, 2013 and February 22, 2012, 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, 2013 and September 30, 2012. 10-K REPORT A copy of the Company’s 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission is available to shareholders without charge. Direct your written request to Kate Lowrey, Director of Investor Relations, ESCO Technologies Inc., 9900A Clayton Road, St. Louis, Missouri 63124. The Form 10-K is also available on the Company’s website at www.escotechnologies.com. Additional investor-related information may be obtained by contacting the Director of Investor Relations at (314) 213-7277 or toll free at (888) 622-3726. Information is also available through the Company’s website at www.escotechnologies.com or via e-mail to klowrey@escotechnologies.com. TRANSFER AGENT AND REGISTRAR 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 2,251 holders of record of shares of common stock at November 8, 2013. INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM KPMG LLP 10 South Broadway, Suite 900 St. Louis, Missouri 63102 50 ESCO TEChnOlOgiES inC.BO A R D O F DI R E C T O R S Gary E. Muenster Executive Vice President & Chief Financial Officer Victor L. Richey 1 Chairman, Chief Executive Officer, & President Larry W. Solley 3,4 Retired Executive Vice President Emerson Electric Co. James M. Stolze 2 Retired Vice President & Chief Financial Officer Stereotaxis, Inc. 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. Committee Membership 1 Executive Committee 2 Audit and Finance Committee 3 Human Resources and Compensation Committee 4 Nominating and Corporate Governance Committee M a n a g e m e n t a n d bo a r d o f di r e c t o r s EX E C U T I V E OF F I C E R S Victor L. Richey Chairman, Chief Executive Officer, & President Gary E. Muenster Executive Vice President & Chief Financial Officer Alyson S. Barclay Senior Vice President, Secretary & General Counsel CO R P O R A T E ST A F F OP E R A T I N G EX E C U T I V E S Deborah J. Boniske Vice President Human Resources Mark S. Dunger Vice President Planning & Development Richard A. Garretson Vice President Tax Charles J. Kretschmer Vice President Michele A. Marren Vice President & Corporate Controller David B. Zabetakis President Doble Engineering Company Sam R. Chapetta Filtration Group Vice President & President, PTI Technologies Inc. Antonio E. Gonzalez President VACCO Industries Mike Alfred President Crissair, Inc. Randall K. Loga President Thermoform Engineered Quality LLC Bruce E. Butler President ETS-Lindgren LP William M. Giacone Senior Vice President & General Manager, Americas ETS-Lindgren LP Mark Mawdsley Senior Vice President & Managing Director, Asia ETS-Lindgren LP Bryan Sayler Senior Vice President, Test Solutions ETS-Lindgren LP This annual report is printed with soy-based process inks on recycled paper with 10% post-consumer waste. m o c . c n i g n i l d n a w . w w w O M , s i u o L . t S . c n I s e t a i c o s s A & g n i l d n a W : n g i s e D ESCO Technologies Inc. 9900A Clayton Road St. Louis, MO 63124 www.escotechnologies.com 

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