EX-13 8 c66668ex13.txt SECTIONS OF ANNUAL REPORT TO STOCKHOLDERS EXHIBIT NO. 13 2001 ESCO TECHNOLOGIES ANNUAL REPORT FIVE-YEAR FINANCIAL SUMMARY
(Dollars in millions, except per share amounts) 2001(1) 2000(2) 1999(3) 1998(4) 1997(5) ------- ------- ------- ------- ------- For years ended September 30: Net sales $ 344.9 300.2 416.1 365.1 378.5 Interest expense .1 .4 6.5 7.7 5.2 Earnings before income taxes 27.3 24.7 63.5 16.3 17.9 Net earnings before accounting change 30.1 16.8 50.5 11.3 11.8 Net earnings 30.1 16.8 25.5 11.3 11.8 Earnings per share: Earnings before accounting change Basic 2.43 1.37 4.09 .94 1.00 Diluted 2.35 1.33 4.00 .90 .96 Net earnings Basic 2.43 1.37 2.06 .94 1.00 Diluted 2.35 1.33 2.02 .90 .96 As of September 30: Working capital 87.4 62.8 95.3 60.3 62.3 Total assets 375.6 331.1 378.4 409.3 378.2 Long-term debt 8.3 .6 41.9 50.1 50.0 Shareholders' equity 287.3 259.4 248.7 224.1 205.0 ======= ======= ======= ======= =======
(1) Includes the acquisition of Bea. (see Footnote 2 of Notes to Consolidated Financial Statements). Also, includes the elimination of the net deferred tax valuation allowance of approximately $12.7 million or $0.99 per share. (2) Includes the acquisitions of Lindgren, Holaday, and Eaton Space Products and the sale of the Rantec microwave antenna business (see Footnote 2 of Notes to Consolidated Financial Statements). Also, includes the after-tax gain on the sale of the Riverhead, NY property of approximately $2.2 million or $0.18 per share and the after-tax gain on the sale of the Calabasas, CA property of approximately $0.5 million or $0.04 per share. (3) Includes the gain on sale of SEI, accounting change, $5.1 million of restructuring charges, and $3.9 million of other charges related to cost of sales. (see Footnotes 1 and 2 of Notes to Consolidated Financial Statements) (4) Includes the acquisitions of Euroshield and AMT. (5) Includes the acquisition of Filtertek in February 1997. 47 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion should be read in conjunction with the consolidated financial statements and notes thereto. The years 2001, 2000 and 1999 represent the fiscal years ended September 30, 2001, 2000 and 1999, respectively, and are used throughout the document. Introduction ESCO Technologies Inc. (ESCO, the Company) operates principally in four business segments: Filtration/Fluid Flow, Test, Communications and Other. ESCO develops, manufactures and markets a broad range of filtration products used in the separation, purification and processing of liquids and gases. The Company's engineered filtration products utilize membrane, precision screen and other technologies to protect critical processes and equipment from contaminants. Major applications include oil production and removal of contaminants in fuel, lube and hydraulic systems, various health care applications, including blood collection, food and beverage processing, potable water, and semiconductor production processes. ESCO is a leading supplier of radio frequency (RF) shielding and EMC test products. ESCO also supplies shielding to the growing Magnetic Resonance Imaging (MRI) market. The Company's Communications segment provides a well-proven communications system called TWACS(R) to the electric utility industry. The TWACS(R) system is currently used primarily for automatic meter reading (AMR) and its load management capabilities, and also provides a ready conduit into the home for future applications. The Company's business segments are comprised of the following primary operating entities: --Filtration/Fluid Flow: PTI Technologies Inc. (PTI) and Filtertek Inc. (Filtertek), --Test: EMC Group consisting of EMC Test Systems, L.P. (ETS) and Lindgren RF Enclosures, Inc. (Lindgren), --Communications: Distribution Control Systems, Inc. (DCSI) and Comtrak Technologies, L.L.C. (Comtrak), --Other: Rantec Power Systems Inc. (Rantec), --Systems & Electronics Inc. (SEI) is included as a divested business in 1999. ESCO continues to operate with meaningful growth prospects in its primary served markets, and with considerable financial flexibility. The Company continues to focus on new products that incorporate proprietary design and process technologies. Management is committed to delivering shareholder value through internal growth, selective acquisitions and share repurchase when warranted. Highlights of 2001 Operations Sales for the year ended September 30, 2001 increased $44.7 million, or 15% to $344.9 million compared to sales of $300.2 million in 2000. Sales growth from acquisitions accounted for approximately $28.6 million of the sales increase in 2001. New products introduced within the last three years accounted for $70.1 million of 2001 sales. The Company's Communications segment continued to show strong year over year growth as sales increased 38% and approximately $104 million of new orders were received in 2001. Gross profit margin increased to 31.4% in 2001 compared to 30.6% in the prior year, reflecting positive results from the Company's ongoing cost reduction programs and product mix changes. Operating profit margin (defined as net sales, less cost of sales, less SG&A expenses) increased to 10.7% of net sales in 2001, compared to 10.0% of net sales in 2000. The Company's EBIT margin from operations improved by 0.5% in 2001 compared to 2000. EBIT is defined as earnings before interest and taxes. In June 2001, the Company acquired Bea Filitri S.p.A. (Bea), headquartered in Milan, Italy. Bea is a supplier of filtration products to the pharmaceutical, food and beverage, health care, and petrochemical markets. Bea's operating results are included within the Filtration/Fluid Flow segment, since the date of acquisition. 13 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS Fiscal 2001 net earnings as reported, were $30.1 million, or $2.35 per share, compared to $16.8 million, or $1.33 per share, in 2000. During 2001, the Company's results were favorably impacted by an income tax adjustment of $12.7 million, or $0.99 per share, related primarily to the elimination of the Company's net deferred tax valuation allowance. Excluding this favorable income tax adjustment, 2001 net earnings from operations were $17.4 million, or $1.36 per share, compared to 2000 net earnings from operations of $14.1 million, or $1.11 per share. 2000 net earnings from operations exclude the after-tax gains from the sale of the Riverhead, NY and Calabasas, CA properties in 2000, which were approximately $2.7 million, or $0.22 per share. Recap of 2000 Performance The Company successfully completed three acquisitions during 2000: Lindgren, Holaday Industries, Inc. (Holaday), and the Eaton space products business (Eaton), formerly located in El Segundo, CA. The Lindgren and Holaday operating results are included within the Test segment and the Eaton results are included within the Filtration/Fluid Flow segment since the date of the respective acquisitions. Fiscal 2000 sales increased $56.9 million, or 23% to $300.2 million over 1999 "adjusted" sales of $243.3 million, mainly due to new product introductions and contributions from the 2000 acquisitions. Fiscal 2000 acquisitions contributed $25.7 million to sales in 2000. Operating profit, as defined above, increased $16.5 million to $30.1 million in 2000 over 1999 "adjusted" operating profit of $13.6 million. Fiscal 2000's net earnings, as reported, were $1.33 per share. In 2000, the Company sold properties in Riverhead, NY and Calabasas, CA, thereby, converting into cash properties retained after divestitures. Excluding the gains on the sale of these properties, 2000 net earnings from operations were $1.11 per share compared to 1999 "adjusted" net earnings of $0.61 per share. Refer to the table on page 21 of Management's Discussion and Analysis for the definition and reconciliation of "adjusted" net income in 1999. 1999 Strategic Actions In conjunction with the divestiture of SEI, the Company took a number of actions at September 30, 1999 to further sharpen its focus on its primary served markets. Other actions included abandoning the active pursuit of certain business areas, exiting non-core, underperforming businesses, and restructuring the corporate overhead of the Company. Results of Operations NET SALES Net sales of $344.9 million in 2001 increased $44.7 million (14.9%) from net sales of $300.2 million in 2000. Filtration/Fluid Flow, Test and Communications segments all had increased sales in 2001. Sales growth from acquisitions accounted for approximately $28.6 million of the sales increase, with the balance coming from organic growth. New products introduced within the last three years accounted for $70.1 million of 2001 sales. Net sales of $300.2 million in 2000 decreased $115.9 million (27.9%) from reported net sales of $416.1 million in 1999 due to the divestiture of SEI. The 1999 amount included SEI sales of $172.8 million. Excluding SEI sales from the 1999 results, 2000 net sales increased $56.9 million (23.4%) over 1999 "adjusted" net sales of $243.3 million. Acquisitions contributed $25.7 million to sales in 2000. 14 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS Filtration/Fluid Flow Net sales of $188.2 million in 2001 were $6.5 million (3.6%) higher than net sales of $181.7 million in 2000. Net sales increased in the health care and aerospace markets, offset by declines in the automotive and semiconductor markets. The current year acquisition of Bea contributed approximately $2.0 million to the increase in sales. The incremental sales contribution from the fiscal 2000 acquisition of the Eaton space products business was approximately $3.3 million in 2001. Net sales of $181.7 million in 2000 increased $12.8 million (7.6%) from net sales of $168.9 million in 1999, primarily due to new product introductions and increases in microfiltration sales. The acquisition of the Eaton space products business in fiscal 2000 contributed approximately $3.4 million of the increase in sales. Test Net sales increased $22.5 million (35.6%) to $85.5 million in 2001 compared to net sales of $63.0 million in 2000. Fiscal 2001 reflected the full year contributions from Lindgren and Holaday. Sales of the Company's Magnetic Resonance Imaging (MRI) products increased in 2001 by more than 15%, attributable to the growing health care market. This was partially offset by a decrease in the sale of large EMC test chambers to electronics and telecommunications customers as a result of the softening of these markets. The General Motors contract contributed approximately $4.6 million, $13.2 million and $3.1 million to sales in 2001, 2000 and 1999, respectively. Net sales of $63.0 million in 2000 increased $28.1 million (80.5%) over the $34.9 million in net sales recorded in 1999. The increase in 2000 over 1999 is primarily due to acquisitions, which contributed $22.1 million. The remaining increase in 2000 over 1999 is primarily the result of additional EMC test chamber sales. Communications Net sales of $59.1 million in 2001 were $16.4 million (38.3%) higher than net sales of $42.7 million in 2000. The increase in 2001 over 2000 is primarily the result of increased shipments to electric utility Cooperatives (Co-ops), together with continued shipments to other existing customers, such as Puerto Rico Electric Power Authority (PREPA), Wisconsin Public Service Corporation (WPS), and Florida Power & Light (FPL). The Company recorded approximately $104 million in new orders for its two-way automatic communications systems and load control transponders during 2001. The 2000 net sales increased $16.9 million over the $25.8 million in net sales recorded in 1999. The increase in 2000 over 1999, primarily is the result of increased shipments to PREPA, WPS and the Co-ops. Other Net sales were $12.2 million in 2001, $12.8 million in 2000 and $13.7 million in 1999. The decrease in net sales is due to the sale of the Rantec microwave antenna business in February 2000, which contributed approximately $2.1 million to sales in fiscal 2000 prior to its divestiture and contributed $3.5 million to sales in 1999. Excluding the microwave antenna business from the 2000 results, net sales increased $1.5 million or 14% in 2001. ORDERS AND BACKLOG Firm order backlog was $180.1 million at September 30, 2001, compared to $145.4 million at September 30, 2000. New orders totaling $379.6 million were received in 2001, compared with $288.7 million in 2000, reflecting a 31.5% increase. Approximately $186 million of new orders in 2001 related to Filtration/Fluid Flow products, approximately $79 million related to Test products, and approximately $104 million related to Communications products (automatic meter reading and load control products). GROSS PROFIT The Company computes gross profit as: net sales less cost of sales. The gross profit margin is the gross profit divided by net sales, expressed as a percentage. The gross profit margin was 31.4%, 30.6% and 22.7% in 2001, 2000 and 1999, respectively. The "adjusted" gross profit margin for 1999 was 27.6%. The increase in 2001 compared to 2000 is due primarily to a favorable sales mix and the results of the Company's ongoing cost improvement initiatives. The increase in 2000 compared to the reported 1999 results is due primarily to the lower margins in 1999 related to the defense businesses. Gross profit margin increased in 2000 compared to "adjusted" 1999 results due to operational improvements in all four operating segments, including favorable changes in sales mix and product pricing as well as successful cost containment programs. 15 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses (SG&A) for 2001 were $71.5 million, or 20.7% of net sales, compared with $61.8 million, or 20.6% of net sales for 2000. The increase in SG&A spending in 2001 is mainly due to the 2000 acquisitions being included for the entire fiscal year 2001, as well as additional investments in research and development, engineering, and marketing within the Filtration/Fluid Flow and Communications segments. SG&A expenses in 2000 were $61.8 million, or 20.6% of net sales, compared with $74.4 million, or 17.9% of net sales for 1999. "Adjusted" SG&A expenses were $53.6 million, or 22.0% of net sales in 1999. The 2000 SG&A expenses included $4.9 million of additional expenses related to the 2000 acquisitions. The percentage decrease from "adjusted" 1999 SG&A expenses is the result of favorable leverage achieved on the higher sales volume. OPERATING PROFIT The Company evaluates the performance of its operating segments based on operating profit, which the Company defines as net sales, less cost of sales, and less SG&A expenses. Operating profit, as defined by the Company, excludes certain costs which are included in Other costs and expenses, net, in the Consolidated Statements of Operations, and which would be included in the determination of operating income as defined within generally accepted accounting principles. These items are discussed in the respective segment information below. Operating profit of $36.8 million (10.7% of net sales) in 2001 increased $6.7 million (22.5%) from $30.1 million (10% of net sales) in 2000. In 2001, operating profit dollars increased in all segments. Operating profit of $30.1 million (10% of net sales) in 2000 increased $15.2 million (102%) from $14.9 million in 1999. The 1999 operating profit amount included $10.4 million related to SEI. Fiscal 2000 operating profit increased $16.5 million over prior year "adjusted" operating profit of $13.6 million. Filtration/Fluid Flow Operating profit of $16.8 million (8.9% of net sales) in 2001 increased slightly over operating profit of $16.6 million (9.1% of net sales) in 2000. The current year was impacted by non-recurring costs related to the consolidation of the Eaton space products business into existing Company owned facilities and increases in other facility operating costs. In addition, during 2001, the Company made significant investments in new product development and market expansion opportunities, primarily in microfiltration. Operating profit of $16.6 million (9.1% of net sales) in 2000 was $4.7 million (39.5%) higher than operating profit of $11.9 million (7.0% of net sales) in 1999. The increase was primarily the result of new product introductions and increases in microfiltration profitability. Increased shipments of disposable water filter cartridges also contributed to the growth in profitability in 2000. Test Operating profit increased approximately $2.4 million to $9.3 million (10.9% of net sales) in 2001 compared to $6.9 million (11.0% of net sales) in 2000. The increase in 2001 is mainly due to the full year contributions from the Lindgren and Holaday acquisitions, which occurred in the second half of fiscal 2000, offset by a smaller revenue contribution from the General Motors contract which is nearing completion. Operating profit of $6.9 million (11.0% of net sales) in 2000 was $2.9 million (72.5%) higher than operating profit of $4.0 million (11.5% of net sales) in 1999. The increase in 2000 over 1999, was primarily the result of contributions from the General Motors contract. Fiscal 2000 was also favorably impacted by the mid-year acquisitions mentioned above. Communications Operating profit of $12.6 million (21.4% of net sales) in 2001 was $3.7 million, or 41.6% higher than operating profit of $8.9 million (20.8% of net sales) in 2000. Operating profit of $8.9 million (20.8% of net sales) in 2000 was $9.3 million higher than operating profit of ($0.4) million in 1999. The increase in operating profit in 2001 versus 2000, as well as 2000 versus 1999, in both dollars and as a percentage of net sales is due to increased shipments of automatic meter reading (AMR) equipment at DCSI. The Company is increasing its engineering and new product development expenditures in the Communications segment in order to continue its growth in the 16 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS AMR markets. The 1999 operating profit was impacted by certain nonrecurring charges at Comtrak, discussed on page 22 of Management's Discussion and Analysis. Other Operating profit was $1.4 million, ($0.3) million and ($8.8) million in 2001, 2000 and 1999, respectively. The increase in operating profit in 2001 over 2000, and in 2000 over 1999, is mainly related to the improved operations of Rantec's Power Systems business and the February 2000 sale of the microwave antenna business. The 1999 results were impacted by the nonrecurring charges related to the microwave antenna business, discussed on page 22. INTEREST EXPENSE Interest expense decreased to $0.1 million in 2001 from $0.4 million in 2000, primarily as a result of lower outstanding average borrowings throughout 2001. The timing of operating cash flows throughout 2001 also decreased the average outstanding borrowings. Interest expense decreased to $0.4 million in 2000 from $6.5 million in 1999, primarily as a result of lower outstanding average borrowings throughout 2000. With the exception of $1 million of foreign debt, all outstanding debt from fiscal 1999 was repaid in October 1999 from the proceeds of the sale of SEI. OTHER COSTS AND EXPENSES, NET Other costs and expenses, net, were $9.4 million, $8.0 million and $4.9 million in 2001, 2000 and 1999, respectively. The 2001 net amount includes: Goodwill amortization of $3.4 million; patent and other intangible amortization of $1.4 million; approximately $2.1 million of net costs related to the consolidation of PTI's filtration businesses into new facilities in Oxnard, CA and the consolidation of the Stockton, CA manufacturing facility into the Huntley, IL facility; and other miscellaneous costs. Other costs and expenses, net, in 2000, of $8.0 million consisted of the following items: Goodwill amortization of $2.6 million; patent and other intangible amortization of $1.3 million; approximately $2.0 million of net costs related to the Filtration/Fluid Flow segment, including the consolidation of PTI's filtration businesses into new facilities in Oxnard, CA, expenses related to the planned upgrade of production equipment to improve manufacturing efficiency at Filtertek, and costs related to the microfiltration business; approximately $1.0 million of net costs related to the Test segment primarily related to the write-off of an investment in a third party EMC related start-up company which filed bankruptcy in 2000; and other miscellaneous costs. GAIN ON SALE OF PROPERTIES The gain on the sale of properties in fiscal 2000 represents $2.2 million from the sale of the Riverhead, NY property and $0.8 million from the sale of the Calabasas, CA property. These properties were related to previously divested companies. INCOME TAX (BENEFIT) EXPENSE Income tax benefit of ($2.8) million for 2001 reflects current tax expense of $0.4 million, deferred tax benefit of ($5.7) million, and foreign, state and local tax expense of $2.4 million. Income tax expense of $7.9 million for 2000 reflects current tax expense of $0.3 million, deferred tax expense of $6.3 million, and foreign, state and local tax expense of $1.4 million. Based on the Company's historical pretax income, together with the projection of future taxable income, Management believes it is more likely than not that the Company will realize the benefits of the net deferred tax asset existing at September 30, 2001. In order to realize the aforementioned net deferred tax asset, the Company will need to generate future taxable income of approximately $154 million, of which $130 million is required to be realized prior to the expiration of the net operating loss (NOL) carryforward, of which $8 million will expire in 2006; $6 million will expire in 2007; $23 million will expire in 2009; $38 million will expire in 2010; $4 million will expire in 2011; $11 million will expire in 2018; and $40 million will expire in 2019. The net operating loss carryforward will be available to reduce future Federal income tax cash payments. In 2001, as the result of certain residual tax effects related to the 2000 sale of the property in Calabasas, CA, the Company utilized approximately $2 million of the remaining $33 million capital loss carryforward available from the sale of its Hazeltine subsidiary in 1996. The remaining capital loss carryforward of approximately $31 million expired on September 30, 2001. 17 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS The valuation reserve in the amount of $10.8 million maintained for the deferred tax asset related to the capital loss carryforward was eliminated due to the expiration of the capital loss carryforward. Additionally, in 2001 the Company eliminated its remaining net deferred tax valuation allowance of $12.7 million, which was the allowance representing the amount of the deferred tax asset associated with temporary differences and NOLs which Management believed would likely not be realized due to limitations on future use. The effective tax rate in 2001 was (10.4%), compared with 32.0% in 2000 primarily due to the favorable impact of the elimination of the net deferred tax valuation allowance. On an operational basis, Management estimates the 2001 effective tax rate would have been 36.1%, excluding the net favorable income tax adjustment of $12.7 million, previously described. An analysis of the effective tax rates for 2001, 2000 and 1999 is included in the notes to the consolidated financial statements. CHANGE IN ACCOUNTING PRINCIPLE - 1999 The Company adopted the provisions of Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities" in the first quarter of 1999 which resulted in a non-cash, after-tax charge of approximately $25 million, which was recognized as a cumulative effect of an accounting change. The charge related to precontract, start-up and organization costs incurred in anticipation of specific future contract awards which were based on specific customer identified requirements. Capital Resources & Liquidity Working capital increased to $87.4 million at September 30, 2001 from $62.8 million at September 30, 2000. During 2001, cash and cash equivalents increased by $8.9 million. Inventories increased $3.7 million primarily due to the 2001 acquisition of Bea. Other current assets increased by $10.7 million primarily due to an increase in the current portion of deferred tax assets. Net cash provided by operating activities was $33.0 million in 2001 compared to $20.0 million in 2000. The increase in 2001 is primarily due to the Company's additional earnings and improved working capital resulting from ongoing asset management initiatives. Net cash provided by operating activities was $20.0 million in 2000 compared to $25.9 million in 1999. Net cash provided by operating activities in 2000 increased $5.4 million from the 1999 adjusted amount of $14.6 million, which excludes $11.3 million related to SEI. Capital expenditures of $11.9 million, $10.4 million and $8.3 million, in 2001, 2000 and 1999, respectively, primarily included manufacturing equipment. Capital expenditures related to SEI were $1.1 million in 1999. There were no commitments outstanding that were considered material for capital expenditures at September 30, 2001. At September 30, 2001, the Company had available a net operating loss (NOL) carryforward for tax purposes of approximately $130 million. This NOL will expire beginning in year 2006 and ending in year 2019, and will be available to reduce future Federal income tax cash payments. ACQUISITIONS/DIVESTITURES On June 8, 2001, the Company acquired all of the outstanding common stock of Bea Filtri S.p.A. (Bea) for approximately $13.5 million in cash and debt. Bea, headquartered in Milan, Italy, is a supplier of filtration products to the pharmaceutical, food and beverage, healthcare, and petrochemical markets. Bea's assets and liabilities, and related operating results, since the date of acquisition, are included within the Company's Filtration/Fluid Flow segment. On June 2, 2000, the Company purchased Holaday Industries, Inc. (Holaday) for approximately $4 million in cash. Holaday, headquartered in Eden Prairie, MN, is a leading supplier of specialty measurement probes to the EMC test, health and safety, and microwave markets. The operating results for Holaday, since the date of acquisition, are included within the Company's Test segment. On April 9, 2000, the Company acquired all of the outstanding common stock of Lindgren RF Enclosures, Inc. (formerly known as The Curran Company) and Lindgren, Inc. (doing business through its subsidiary, Rayproof Ltd.) (collectively Lindgren) for approximately $22 million in cash plus additional consideration based upon the future operating performance of Lindgren. Lindgren is a leading supplier of radio frequency (RF) shielding products and 18 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS components used by manufacturers of medical equipment, communications systems and electronic products. The operating results for Lindgren, since the date of acquisition, are included within the Company's Test segment. On March 31, 2000, the Company acquired the Eaton space products business (Eaton), formerly located in El Segundo, CA, for approximately $6 million in cash. Eaton manufactures specialty valves and other fluid flow components for satellite launch vehicles and aircraft applications and has been integrated into the Company's Filtration/Fluid Flow segment, since the date of acquisition. All of the Company's acquisitions have been accounted for using the purchase method of accounting. The goodwill recorded as a result of the above transactions is being amortized over 20 years, until the adoption of SFAS 142. In February 2000, the Company completed the sale of its microwave antenna product line, which had historically operated as part of Rantec Microwave & Electronics, Inc. The Company transferred the contract order backlog and operating assets of the microwave antenna business for $2.1 million in cash, and in September 2000, sold the related land and buildings in Calabasas, CA for approximately $6 million. In December 1999, the Company sold the Riverhead, NY property, used by the Company's former Hazeltine subsidiary for approximately $2.6 million. On September 30, 1999, the Company sold SEI to Engineered Support Systems, Inc. for $85 million in cash, less working capital adjustments. BANK CREDIT FACILITY On April 11, 2000, the Company entered into a $75 million revolving credit facility, with the option to increase it to $100 million through April 11, 2002. The credit facility was amended on February 28, 2001 to allow for borrowings in foreign currencies. The credit facility is available for direct borrowings and/or the issuance of letters of credit. The maturity of the credit facility is April 11, 2005, and is provided by a group of five banks, led by Bank of America. At September 30, 2001, the Company had approximately $61.7 million available to borrow under the credit facility as well as $14.5 million of cash on hand. The credit facility requires, as determined by certain financial ratios, a commitment fee ranging from 20-30 basis points per annum on the unused portion. The terms of the facility provide that interest on borrowings may be calculated at a spread over the London Interbank Offered Rate (LIBOR) or based on the prime rate, at the Company's election. Substantially all of the assets of the Company are pledged under the credit facility. The financial covenants of the credit facility include limitations on leverage and minimum consolidated EBITDA. As of September 30, 2001, the Company is in compliance with all bank covenants. Cash flow from operations and borrowings under the bank credit facility are expected to provide adequate resources to meet the Company's capital requirements and operational needs for the foreseeable future. SHARE REPURCHASE In February 2001, the Company authorized an open market repurchase program of up to 1.3 million shares, which is subject to market conditions and other factors and covers the period ending September 29, 2003. Approximately 77,000, 516,000 and 177,000 shares were repurchased in 2001, 2000 and 1999, respectively. In June 2000, the Company initiated an odd lot share repurchase program which extended through September 2000 whereby the Company repurchased approximately 25,000 shares, which are included in the 516,000 of shares repurchased in 2000, above. OTHER Management believes that, for the periods presented, inflation has not had a material effect on the Company's results of operations. The Company is currently involved in various stages of investigation and remediation relating to environmental matters. Based on current information available, Management does not believe the aggregate costs involved in the resolution of these matters will have a material adverse effect on the Company's operating results, capital expenditures or competitive position. 19 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS 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 has interest rate exposure relating to floating rate lease obligations and, accordingly, during 2001, entered into interest rate swaps totaling approximately $23 million to mitigate this exposure. In addition, the Company has interest rate exposure relating to floating rate obligations denominated in EURO dollars, therefore, in September 2001, the Company entered into an interest rate swap of approximately $4 million to mitigate this exposure. These swaps are accounted for as cash flow hedges under the provisions of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" as of and for the year ended September 30, 2001. The Company is subject to foreign currency exchange rate risk relating to receipts from customers and payments to suppliers in foreign currencies. The Company hedges certain foreign currency commitments by purchasing foreign currency forward contracts. New Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued SFAS 141, "Business Combinations", and SFAS 142, "Goodwill and Other Intangible Assets". SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The Company is required to adopt the provisions of SFAS 141 immediately. Management expects to adopt the provisions of SFAS 142 effective October 1, 2001, the beginning of the Company's fiscal year 2002. SFAS 141 will require that upon adoption of SFAS 142, the Company evaluate its existing intangible assets and goodwill, and make any necessary reclassifications in order to conform with the new criteria in SFAS 141. Upon adoption of SFAS 142, the Company plans to reassess the useful lives and residual values of all recorded intangible assets, other than goodwill, and make any necessary amortization period adjustments by December 31, 2001. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of SFAS 142 by December 31, 2001. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle. Upon adoption of SFAS 141 and SFAS 142, the Company does not anticipate a significant impact to the carrying value of the Company's goodwill. 20 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS 1999 Strategic Actions RECONCILIATION OF ADJUSTED NET INCOME - 1999 In conjunction with the divestiture of SEI, the Company took a number of actions at September 30, 1999 to further sharpen its focus on its primary served markets. Other actions included abandoning the active pursuit of certain business areas, exiting non-core, underperforming businesses, and restructuring the corporate overhead of the Company. The following table is not intended to present 1999 net earnings as defined within generally accepted accounting principles (GAAP), and is presented for informational purposes only. The table provides a reconciliation between the 1999 reported results of operations and what Management believes the 1999 operating results may have been after removing certain nonrecurring items and assuming that all of the actions taken during 1999 to reorient the business were complete at the beginning of the period. Management believes the estimated 1999 adjusted operating results provide a meaningful presentation for purposes of comparing ESCO's subsequent financial performance.
1999 Elimination Adjusting 1999 (Dollars in millions, rounded) As Reported of SEI(a) Items As Adjusted ----------- ----------- --------- ----------- Net sales $ 416.1 172.8 -- $ 243.3 ----------- ----------- --------- ----------- Cost of sales 317.7 139.6 (2.0)(b) 176.1 Other charges related to cost of sales 3.9 -- (3.9)(c) -- SG&A expenses 74.4 21.6 .8 (d) 53.6 Interest expense (income) 6.5 .6 (8.2)(e) (2.3) Other, net 4.9 .3 (.3)(c) 4.3 Restructuring charges 5.1 -- (5.1)(c) -- Gain on sale of SEI (59.9) -- 59.9 (c) -- ----------- ----------- --------- ----------- Total costs and expenses 352.6 162.1 41.2 231.7 ----------- ----------- --------- ----------- Earnings before tax 63.5 10.7 (41.2) 11.6 Income tax expense 13.0 3.7 (5.4)(f) 3.9 ----------- ----------- --------- ----------- Net earnings before accounting change 50.5 7.0 (35.8) 7.7 ----------- ----------- --------- ----------- Cumulative effect of accounting change, net of tax (25.0) -- 25.0 (c) -- ----------- ----------- --------- ----------- Net earnings $ 25.5 7.0 (10.8) $ 7.7 =========== =========== ========= =========== Diluted EPS $ 2.02 $ .61
-------------------------------------------------------------------------------- (a) Represents the operations of SEI which were included in the 1999 GAAP reported results of operations. (b) Represents the 1999 operating results of Rantec's microwave antenna business which was being offered for sale in 1999 and was sold in February 2000. Fiscal 1999 net sales included $4.9 million related to Rantec's microwave antenna business. (c) Represents the elimination of the nonrecurring items: includes the gain related to the divestiture of SEI, other charges related to the strategic initiatives described on the following page, and the accounting change (SOP 98-5) adopted in the 1999 first quarter. (d) Represents the net amount of the remaining corporate office operating expenses after the divestiture of SEI. This amount reflects a $4.2 million cost reduction from the $5 million amount recorded in 1999 and previously absorbed by the operations of SEI. (e) Represents the estimated net interest impact of the SEI transaction proceeds and the cash impact of the other cost saving actions noted above, assuming that they occurred at the beginning of the period. The amount noted assumes all outstanding debt was repaid and the excess cash proceeds were invested with a 6% yield, representing the yields in effect in 1999. (f) Represents the amount necessary to reflect the adjusted effective tax rate at 33%, which represents the Company's estimated 1999 effective tax rate excluding the nonrecurring items. 21 2001 ESCO TECHNOLOGIES ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS OTHER CHARGES RELATED TO COST OF SALES, RESTRUCTURING CHARGES AND GAIN ON SALE OF SEI - 1999 The Company recognized certain nonrecurring items in the 1999 fourth quarter results of operations which resulted in $3.9 million of other charges related to cost of sales and $5.1 million of restructuring charges. In addition, in 1999, the Company recorded a gain on the sale of SEI of $59.9 million. The 1999 other charges related to cost of sales represent the write-off of inventory related to the abandonment of High Pressure Air Reducing Quiet Manifolds for surface ships ($2.2 million) and the Vehicle Location Systems ($.6 million) business. Additionally, the Company wrote down the Rantec microwave antenna product line inventory ($1.1 million) to net realizable value. The Rantec microwave business was sold in February 2000. The 1999 restructuring charges were comprised of the following: costs related to exiting the microwave antenna business area ($1.1 million); a write-off of the license agreement ($1.8 million) related to the abandonment of the Vehicle Location System business; and certain personnel separation costs ($2.2 million). The gain on the sale of SEI of $59.9 million is calculated as: the gross proceeds of $85 million; less SEI's net book value of $30.6 million; less working capital adjustments of $4.0 million; less transaction related expenses of $4.9 million; plus the $14.4 million curtailment gain related to pension and retiree medical liabilities transferred to the buyer. The other charges related to cost of sales noted above are included in the calculation of 1999 gross profit discussed above. Forward-Looking Information The statements contained in the Chairman's Letter to Shareholders (pgs. 2-5), the business summaries (pgs. 6-11), and Management's Discussion and Analysis that are not strictly historical are "forward looking" statements within the meaning of the safe harbor provisions of the federal securities laws. Investors are cautioned that such statements are only predictions, and speak only as of the date of this report. The Company's actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company's operations and business environment including, but not limited to: further weakening of economic conditions in served markets; changes in customer demands or customer insolvencies; electricity shortages; competition; intellectual property matters; consolidation of internal operations; integration of recently acquired businesses; delivery delays or defaults by customers; performance issues with key suppliers and subcontractors; collective bargaining labor disputes; and the Company's successful execution of internal operating plans. 22 2001 ESCO TECHNOLOGIES ANNUAL REPORT CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended September 30, (Dollars in thousands, except per share amounts) 2001 2000 1999 ---------- ---------- ---------- Net sales $ 344,904 300,157 416,102 Costs and expenses: Cost of sales 236,526 208,263 317,681 Other charges related to cost of sales -- -- 3,927 Selling, general and administrative expenses 71,537 61,819 74,429 Interest expense, net 130 359 6,460 Other, net 9,438 7,969 4,871 Gain on sale of properties -- (2,989) -- Restructuring charges -- -- 5,145 Gain on sale of SEI -- -- (59,867) ---------- ---------- ---------- Total costs and expenses 317,631 275,421 352,646 ---------- ---------- ---------- Earnings before income tax 27,273 24,736 63,456 Income tax (benefit) expense (2,834) 7,917 13,001 ---------- ---------- ---------- Net earnings before accounting change 30,107 16,819 50,455 Cumulative effect of accounting change, net of tax -- -- (25,009) ---------- ---------- ---------- Net earnings $ 30,107 16,819 25,446 ========== ========== ========== Earnings per share: Net earnings before accounting change: Basic $ 2.43 1.37 4.09 Diluted 2.35 1.33 4.00 ---------- ---------- ---------- Net earnings: Basic $ 2.43 1.37 2.06 Diluted 2.35 1.33 2.02 ---------- ---------- ---------- Average common shares outstanding (in thousands): Basic 12,382 12,307 12,332 Diluted 12,805 12,668 12,614 ========== ========== ==========
See accompanying notes to consolidated financial statements. 23 2001 ESCO TECHNOLOGIES ANNUAL REPORT CONSOLIDATED BALANCE SHEETS
As of September 30, (Dollars in thousands) 2001 2000 ---------- ---------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 14,506 5,620 Accounts receivable, less allowance for doubtful accounts of $1,122 and $1,309 in 2001 and 2000, respectively 61,351 58,982 Costs and estimated earnings on long-term contracts, less progress billings of $21,913 and $15,139 in 2001 and 2000, respectively 6,637 6,141 Inventories 48,167 44,457 Other current assets 20,769 10,104 ---------- ---------- Total current assets 151,430 125,304 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT: Land and land improvements 2,561 2,545 Buildings and leasehold improvements 29,470 27,477 Machinery and equipment 71,289 65,564 Construction in progress 4,620 3,821 ---------- ---------- 107,940 99,407 Less accumulated depreciation and amortization 42,902 36,844 ---------- ---------- Net property, plant and equipment 65,038 62,563 Excess of cost over net assets of purchased businesses, less accumulated amortization of $12,674 and $9,245 in 2001 and 2000, respectively 102,163 90,997 Deferred tax assets 38,573 30,808 Other assets 18,373 21,461 ---------- ---------- $ 375,577 331,133 ========== ==========
See accompanying notes to consolidated financial statements. 24 2001 ESCO TECHNOLOGIES ANNUAL REPORT CONSOLIDATED BALANCE SHEETS
As of September 30, (Dollars in thousands) 2001 2000 ---------- ---------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Short-term borrowings and current maturities of long-term debt $ 122 4,136 Accounts payable 35,180 31,206 Advance payments on long-term contracts, less costs incurred of $809 and $3,364 in 2001 and 2000, respectively 1,534 2,903 Accrued expenses 27,233 24,246 ---------- ---------- Total current liabilities 64,069 62,491 ---------- ---------- Other liabilities 15,890 8,610 Long-term debt 8,338 610 ---------- ---------- Total liabilities 88,297 71,711 ---------- ---------- Commitments and contingencies -- -- SHAREHOLDERS' EQUITY: Preferred stock, par value $.01 per share, authorized 10,000,000 shares -- -- Common stock, par value $.01 per share, authorized 50,000,000 shares; Issued 13,409,934 and 13,224,834 shares in 2001 and 2000, respectively 134 132 Additional paid-in capital 206,282 205,514 Retained earnings since elimination of deficit at September 30, 1993 99,649 69,542 Accumulated other comprehensive loss (6,518) (4,766) ---------- ---------- 299,547 270,422 Less treasury stock, at cost (985,469 and 956,527 common shares in 2001 and 2000, respectively) (12,267) (11,000) ---------- ---------- Total shareholders' equity 287,280 259,422 ---------- ---------- $ 375,577 331,133 ========== ==========
See accompanying notes to consolidated financial statements. 25 2001 ESCO TECHNOLOGIES ANNUAL REPORT CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Years ended September 30, Common Stock Additional Other ------------------ Paid-in Retained Comprehensive Treasury (in thousands) Shares Amount Capital Earnings Income (Loss) Stock Total -------- -------- ---------- -------- ------------- -------- ---------- Balance, September 30, 1998 12,642 $ 126 200,913 27,277 (1,740) (2,497) 224,079 ---------- Comprehensive income: Net earnings -- -- -- 25,446 -- -- 25,446 Translation adjustments -- -- -- -- (2,390) -- (2,390) Minimum pension liability, net -- -- -- -- 2,260 -- 2,260 ---------- Comprehensive income -- -- -- -- -- -- 25,316 ---------- Stock options and stock compen- sation plans 141 2 806 -- -- 48 856 Purchases into treasury -- -- -- -- -- (1,562) (1,562) -------- -------- ---------- -------- ------------- -------- ---------- Balance, September 30, 1999 12,783 128 201,719 52,723 (1,870) (4,011) 248,689 --------- Comprehensive income: Net earnings -- -- -- 16,819 -- -- 16,819 Translation adjustments -- -- -- -- (2,896) -- (2,896) ---------- Comprehensive income -- -- -- -- -- -- 13,923 ---------- Stock options and stock compen- sation plans 442 4 3,795 -- -- 59 3,858 Purchases into treasury -- -- -- -- -- (7,048) (7,048) -------- -------- ---------- -------- ------------- -------- ---------- Balance, September 30, 2000 13,225 132 205,514 69,542 (4,766) (11,000) 259,422 ---------- Comprehensive income: Net earnings -- -- -- 30,107 -- -- 30,107 Translation adjustments -- -- -- -- (209) -- (209) Minimum pension liability, net -- -- -- -- (639) -- (639) Interest rate swap adjustment, net -- -- -- -- (904) -- (904) ---------- Comprehensive income -- -- -- -- -- -- 28,355 ---------- Stock options and stock compen- sation plans 185 2 768 -- -- 414 1,184 Purchases into treasury -- -- -- -- -- (1,681) (1,681) -------- -------- ---------- -------- ------------- -------- ---------- Balance, September 30, 2001 13,410 $ 134 206,282 99,649 (6,518) (12,267) 287,280 ======== ======== ========== ======== ============= ======== ==========
See accompanying notes to consolidated financial statements. 26 2001 ESCO TECHNOLOGIES ANNUAL REPORT CONSOLIDATED STATEMENTS OF CASH FLOW
Years ended September 30, (Dollars in thousands) 2001 2000 1999 ---------- ---------- ---------- Cash flows from operating activities: Net earnings $ 30,107 16,819 25,446 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 15,100 14,185 17,021 Changes in operating working capital (9,441) (20,532) 11,271 Write-off of assets related to accounting change, net of tax -- -- 25,009 Gain on sale of SEI -- -- (59,867) Effect of deferred taxes on tax provision (5,669) 6,270 11,560 Other 2,889 3,259 (4,550) ---------- ---------- ---------- Net cash provided by operating activities 32,986 20,001 25,890 ---------- ---------- ---------- Cash flows from investing activities: Capital expenditures (11,881) (10,363) (8,291) (Acquisition) divestiture of businesses (13,559) (29,996) 85,000 ---------- ---------- ---------- Net cash (used) provided by investing activities (25,440) (40,359) 76,709 ---------- ---------- ---------- Cash flows from financing activities: Proceeds from long-term debt 7,356 80 96 Principal payments on long-term debt (740) (49,322) (8,297) Net decrease in short-term borrowings (3,988) (8,506) (9,494) Purchases of common stock into treasury (1,681) (6,215) (1,562) Other, including exercise of stock options 393 2,232 126 ---------- ---------- ---------- Net cash provided (used by) financing activities 1,340 (61,731) (19,131) ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents 8,886 (82,089) 83,468 Cash and cash equivalents at beginning of year 5,620 87,709 4,241 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 14,506 5,620 87,709 ========== =========== ========== Changes in operating working capital: Accounts receivable, net $ 1,632 (10,907) 5,150 Costs and estimated earnings on long-term contracts, net (497) (2,122) 12,891 Inventories (1,650) 1,553 (9,230) Other current assets (10,665) 859 (1,402) Accounts payable 1,174 (704) 734 Advance payments on long-term contracts, net (1,369) 2,221 (6,821) Accrued expenses 1,934 (11,432) 9,949 ---------- ---------- ---------- $ (9,441) (20,532) 11,271 ========== =========== ========== Supplemental cash flow information: Interest paid $ 425 867 6,579 Income taxes paid 4,106 1,132 254 ========== =========== ==========
See accompanying notes to consolidated financial statements. 27 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of significant accounting policies (a) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of ESCO Technologies Inc. (ESCO) and its wholly owned subsidiaries (the Company). All significant intercompany transactions and accounts have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the 2001 presentation. Effective July 10, 2000, the Company changed its name from ESCO Electronics Corporation to ESCO Technologies Inc. (b) BASIS OF PRESENTATION Effective September 30, 1993, the Company implemented an accounting readjustment in accordance with the accounting provisions applicable to a "quasi-reorganization" which restated assets and liabilities to fair values and eliminated the deficit in retained earnings. Fair values of the Company's financial instruments are estimated by reference to quoted prices from market sources and financial institutions, as well as other valuation techniques. The estimated fair value of each class of financial instruments approximated the related carrying value at September 30, 2001 and 2000. (c) NATURE OF OPERATIONS The Company is a leading supplier of engineered filtration products to the process, health care and transportation markets worldwide. The Company's filtration products include depth filters, membrane based microfiltration products and precision screen filters. The balance of the Company's sales is derived primarily from radio frequency (RF) shielding and EMC test products and special purpose communication systems, where the Company is well positioned in niche markets based on proprietary products. The Company operates in four principal industry segments: Filtration/Fluid Flow, Test, Communications and Other. (d) USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions, including estimates of anticipated contract costs and revenues utilized in the earnings process, that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (e) REVENUE RECOGNITION Revenue is recognized on commercial sales when products are shipped or when services are performed. Revenue on production contracts is recorded when specific contract terms are fulfilled, usually by delivery or acceptance (the units of production or delivery methods). Revenues from cost reimbursement contracts are recorded as costs are incurred, plus fees earned. Revenue under long-term contracts for which units of production or delivery are inappropriate measures of performance is recognized on the percentage-of-completion method based upon incurred costs compared to total estimated costs under the contract, or are based upon equivalent units produced. Revenue under engineering contracts is generally recognized as milestones are attained. (f) CASH AND CASH EQUIVALENTS Cash equivalents include temporary investments that are readily convertible into cash, such as EURO dollars, commercial paper and treasury bills with original maturities of three months or less. (g) COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS Costs and estimated earnings on long-term contracts represent unbilled revenues, including accrued profits and retention on long-term contracts accounted for under the percentage-of-completion method, net of progress billings. (h) INVENTORIES Inventories are carried at the lower of cost (first-in, first-out) or market. 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 progress payments received. In accordance with industry practice, costs incurred on contracts in progress include amounts relating to programs having production cycles longer than one year, and a portion thereof will not be realized within one year. 28 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (i) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are recorded at cost. Depreciation and amortization are computed primarily on a straight-line basis over the estimated useful lives of the assets: buildings, 10-40 years; machinery and equipment, 5-10 years; and office furniture and equipment, 5-10 years. Leasehold improvements are amortized over the remaining term of the applicable lease or their estimated useful lives, whichever is shorter. (j) EXCESS OF COST OVER NET ASSETS OF PURCHASED BUSINESSES Assets and liabilities related to business combinations accounted for as purchase transactions are recorded at their respective fair values. Excess of cost over the fair value of net assets purchased (goodwill) is amortized on a straight-line basis over the periods estimated to be benefited. The excess of cost over the fair value of net assets is primarily being amortized over a period not exceeding 30 years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. See further discussion below in "New Accounting Standards." (k) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to dispose. (l) 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. (m) RESEARCH AND DEVELOPMENT COSTS Company-sponsored research and development costs include research and development and bid and proposal efforts related to the Company's products and services. Company-sponsored product development costs are charged to expense when incurred. Customer-sponsored research and development costs incurred pursuant to contracts are accounted for similar to other program costs. (n) FOREIGN CURRENCY TRANSLATION The financial statements of the Company's foreign operations are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards (SFAS) No. 52 "Foreign Currency Translation" (SFAS 52). The resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income. (o) 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 performance shares by using the treasury stock method. 29 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The number of shares used in the calculation of earnings per share for each year presented is as follows:
(In thousands) 2001 2000 1999 -------- -------- -------- Weighted Average Shares Outstanding -- Basic 12,382 12,307 12,332 Dilutive Options and Performance Shares 423 361 282 -------- -------- -------- Adjusted Shares -- Diluted 12,805 12,668 12,614 ======== ======== ========
Options to purchase 12,500 shares (at per share prices of $25.18 - $27.28), 95,500 shares (at per share prices of $15.72 - $19.22) and 176,000 shares (at per share prices of $11.44 - $19.22) were outstanding during the years ended September 30, 2001, 2000 and 1999, respectively, but were not included in the respective computations of diluted EPS because the options' exercise price was greater than the average market price of the common shares. These options expire in various periods through 2011. Approximately 181,000, zero and 190,000 performance shares were outstanding but unearned at September 30, 2001, 2000 and 1999, respectively, and therefore, were not included in the respective years' computations of diluted EPS. (p) STOCK-BASED COMPENSATION The Company measures its compensation cost of equity instruments issued under employee compensation plans under the provisions of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related Interpretations. (q) COMPREHENSIVE INCOME (LOSS) SFAS 130, "Reporting Comprehensive Income" requires the Company to report separately the translation adjustments of SFAS 52 defined above, changes to the minimum pension liability, and changes in fair value of the Company's interest rate swaps designated as a cash flow hedge, as components of comprehensive income or loss. Management has chosen to disclose the requirements of this Statement within the Consolidated Statements of Shareholders' Equity. (r) ACCOUNTING CHANGE - 1999 During the first quarter of 1999, the Company adopted Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities." Precontract costs were incurred by the Company and capitalized under the previous guidance provided by SOP 81-1, "Accounting for Performance of Construction-type Contracts." As a result of adopting SOP 98-5 in 1999, the Company expensed these costs which were recognized as a cumulative effect of an accounting change. The effect of this accounting change was recognized in the 1999 Consolidated Statement of Operations. (s) ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS 137 and 138 (SFAS 133) requires that all derivative instruments be recorded on the balance sheet at their fair value. The accounting treatment of changes in fair value is dependent upon whether or not a derivative instrument is designated as a hedge and if so, the type of hedge. For derivatives designated as a fair value hedge, the changes in fair value are recognized in other comprehensive income until the hedged item is settled and recognized in earnings. The Company has interest rate exposure relating to floating rate lease obligations and, accordingly, during 2001, entered into interest rate swaps totaling approximately $23 million to mitigate this exposure. In addition, the Company has interest rate exposure relating to floating rate obligations denominated in EURO dollars, therefore, in September 2001, the Company entered into an interest rate swap of approximately $4 million to mitigate this exposure. These interest rate swaps are accounted for as cash flow hedges under the provisions of SFAS 133 as of and for the year ended September 30, 2001. At September 30, 2001, other comprehensive income included an after-tax decline in fair value of approximately $0.9 million. 30 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (t) NEW ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board issued SFAS 141, "Business Combinations", and SFAS 142, "Goodwill and Other Intangible Assets". SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The Company is required to adopt the provisions of SFAS 141 immediately, and Management expects to adopt the provisions of SFAS 142 effective October 1, 2001, the beginning of the Company's fiscal year 2002. SFAS 141 will require that upon adoption of SFAS 142, the Company evaluate its existing intangible assets and goodwill, and make any necessary reclassifications in order to conform with the new criteria in SFAS 141. Upon adoption of SFAS 142, the Company plans to reassess the useful lives and residual values of all recorded intangible assets, other than goodwill, and make any necessary amortization period adjustments by December 31, 2001. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of SFAS 142 by December 31, 2001. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle. Upon adoption of SFAS 141 and SFAS 142, the Company does not anticipate a material impact to the carrying value of the Company's goodwill. 2. Acquisitions/Divestitures On June 8, 2001, the Company acquired all of the outstanding common stock of Bea Filtri S.p.A. (Bea) for approximately $13.5 million in cash and debt. Bea, headquartered in Milan, Italy, is a supplier of filtration products to the pharmaceutical, food and beverage, healthcare, and petrochemical markets. Bea broadens the Company's microfiltration product offering and increases the Company's penetration in European markets. Bea's assets and liabilities, and related operating results, since the date of acquisition, are included within the Company's Filtration/Fluid Flow segment. On June 2, 2000, the Company purchased Holaday Industries, Inc. (Holaday) for approximately $4 million in cash. Holaday, headquartered in Eden Prairie, MN, is a leading supplier of specialty measurement probes to the EMC test, health and safety, and microwave markets. The operating results for Holaday, since the date of acquisition, are included within the Company's Test segment On April 9, 2000, the Company acquired all of the outstanding common stock of Lindgren RF Enclosures, Inc. (formerly known as The Curran Company) and Lindgren, Inc. (doing business through its subsidiary, Rayproof Ltd.) (collectively Lindgren) for approximately $22 million in cash plus additional consideration based upon the future operating performance of Lindgren. Lindgren is a leading supplier of radio frequency (RF) shielding products and components used by manufacturers of medical equipment, communications systems and electronic products. The operating results for Lindgren, since the date of acquisition, are included within the Company's Test segment. On March 31, 2000, the Company acquired the Eaton space products business (Eaton), formerly located in El Segundo, CA, for approximately $6 million in cash. Eaton manufactures specialty valves and other fluid flow components for satellite launch vehicles and aircraft applications and has been integrated into the Company's Filtration/Fluid Flow segment, since the date of acquisition. In February 2000, the Company completed the sale of its microwave antenna business, which had historically operated as part of Rantec Microwave & Electronics, Inc. The Company transferred the contract order backlog and operating assets of the microwave antenna business for $2.1 million in cash, and in September 2000, sold the related land and buildings in Calabasas, CA for approximately $6 million. 31 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assuming the acquisitions of Holaday, Lindgren and Eaton as well as the divestiture of the Rantec microwave antenna business had occurred on October 1, 1999, (the beginning of fiscal 2000), pro forma unaudited net sales, net earnings and diluted EPS for the year ended September 30, 2000 would have been approximately $325 million, $17.3 million and $1.36 per share, respectively. These unaudited pro forma amounts are not necessarily indicative of the results of operations that would have occurred had these actions been completed on October 1, 1999, or of future results of operations. On September 30, 1999, the Company completed the sale of its Systems & Electronics Inc. (SEI) subsidiary to Engineered Support Systems, Inc. The Company sold 100% of the common stock of SEI for $85 million in cash, less working capital adjustments, resulting in a $59.9 million gain recorded in the 1999 results of operations. Certain assets and liabilities of SEI were retained by the Company, including the net operating loss carryforward. Included in the 1999 consolidated statements of operations are the operating results of SEI prior to its divestiture as follows: net sales of $172.8 million; cost of sales of $139.6 million, SG&A expenses of $21.6 million; other costs and expenses, net, of $0.9 million; and earnings before income taxes of $10.7 million. 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. The goodwill recorded as a result of the transactions is being amortized over 20 years, until the adoption of SFAS 142. 3. Accounts receivable Accounts receivable consist of the following at September 30, 2001 and 2000:
(Dollars in thousands) 2001 2000 ---------- ---------- Commercial $ 57,513 55,619 U. S. Government and prime contractors 3,838 3,363 ---------- ---------- Total $ 61,351 58,982 ========== ==========
Commercial accounts receivable increased primarily due to the acquisition of Bea in 2001. 4. Inventories Inventories consist of the following at September 30, 2001 and 2000:
(Dollars in thousands) 2001 2000 ---------- ---------- Finished goods $ 12,065 8,709 Work in process-- including long-term contracts 17,089 17,258 Raw materials 19,013 18,490 ---------- ---------- Total $ 48,167 44,457 ========== ==========
Inventories increased approximately $3.7 million mainly to support the near term sales demand and due to the acquisition of Bea in 2001. 32 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Property, plant and equipment Depreciation expense of property, plant and equipment for the years ended September 30, 2001, 2000 and 1999 was $10.3 million, $10.3 million and $13.6 million (including SEI), 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, 2001, 2000 and 1999 amounted to $6.8 million, $5.0 million and $6.3 million, respectively. Future aggregate minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of September 30, 2001 are:
(Dollars in thousands) Years ending September 30: -------------------------- 2002 $ 5,628 2003 5,188 2004 4,676 2005 4,171 2006 and thereafter 5,748 -------- Total $ 25,411 ========
6. Income tax expense For the year ended September 30, 2001, pre-tax earnings related to U.S. and non-U.S. tax jurisdictions are $21.7 million and $5.6 million, respectively. Fiscal 2000 and 1999 pre-tax earnings related to non-U.S. tax jurisdictions were insignificant. The principal components of income tax expense for the years ended September 30, 2001, 2000 and 1999 consist of:
(Dollars in thousands) 2001 2000 1999 ---------- ---------- ---------- Federal: Current (including Alternative Minimum Tax) $ 413 275 -- Deferred (including elimination of valuation allowance) (5,669) 6,270 11,560 State, local and non-U.S 2,422 1,372 1,441 ---------- ---------- ---------- Total $ (2,834) 7,917 13,001 ========== ========== ==========
The actual income tax expense for the years ended September 30, 2001, 2000 and 1999 differs from the expected tax expense for those years (computed by applying the U.S. Federal corporate statutory rate) as follows:
(Dollars in thousands) 2001 2000 1999 ---------- ---------- ---------- Federal corporate statutory rate 35.0% 35.0% 35.0% Change in tax valuation allowance: Utilization of capital loss carryforward (2.5) (4.3) (19.3) Elimination of valuation allowance (46.5) -- -- Other -- (3.2) 5.9 State and local, net of Federal benefits 4.2 2.0 1.1 Non-U.S. (2.8) .5 1.2 Other, net 2.2 2.0 (3.4) ---------- ---------- ---------- Effective income tax rate (10.4)% 32.0% 20.5% ========== ========== ==========
33 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at September 30, 2001 and 2000 are presented below:
(Dollars in thousands) 2001 2000 ---------- ---------- Deferred tax assets: Inventories, long-term contract accounting, contract cost reserves and others $ 4,243 2,644 Pension and other postretirement benefits 3,535 3,846 Net operating loss carryforward 45,361 48,345 Capital loss carryforward -- 11,537 Other compensation-related costs and other cost accruals 5,801 875 ---------- ---------- Total deferred tax assets 58,940 67,247 Deferred tax liabilities: Plant and equipment, depreciation methods, acquisition asset allocations, and other (5,089) (5,107) ---------- ---------- Net deferred tax asset before valuation allowance 53,851 62,140 Less valuation allowance -- (24,237) ---------- ---------- Net deferred tax assets $ 53,851 37,903 ========== ==========
Net deferred tax assets are classified in the Consolidated Balance Sheets as follows:
(Dollars in thousands) 2001 2000 ---------- ---------- Current deferred tax assets (included in Other current assets) $ 15,278 7,095 Noncurrent deferred tax assets 38,573 30,808 ---------- ---------- $ 53,851 37,903 ========== ==========
Based on the Company's historical pretax income, together with the projection of future taxable income, Management believes it is more likely than not that the Company will realize the benefits of the net deferred tax asset existing at September 30, 2001. In order to realize the aforementioned net deferred tax asset, the Company will need to generate future taxable income of approximately $154 million, of which $130 million is required to be realized prior to the expiration of the net operating loss (NOL) carryforward, of which $8 million will expire in 2006; $6 million will expire in 2007; $23 million will expire in 2009; $38 million will expire in 2010; $4 million will expire in 2011; $11 million will expire in 2018; and $40 million will expire in 2019. The net operating loss carryforward may be used to reduce future income tax cash payments. In 2001, as the result of certain residual tax effects related to the fiscal 2000 sale of the property in Calabasas, CA, the Company utilized approximately $2 million of the remaining $33 million capital loss carryforward available from the sale of its Hazeltine subsidiary in 1996. The remaining capital loss carryforward of approximately $31 million expired on September 30, 2001. The valuation reserve in the amount of $10.8 million maintained for the deferred tax asset represented by the capital loss carryforward was eliminated by the expiration of the capital loss carryforward. In addition, in 2001, the Company eliminated its remaining net deferred tax valuation allowance of $12.7 million, which was the allowance representing the amount of the deferred tax asset associated with temporary differences and NOLs which Management believed would likely not be realized due to limitations on future use. 34 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. Debt Long-term debt consists of the following at September 30, 2001 and 2000:
(Dollars in thousands) 2001 2000 ---------- ---------- Long-term borrowings under the revolving credit facility $ 7,249 -- Other debt 1,200 746 Less current maturities of long-term debt (111) (136) ---------- ---------- Long-term debt $ 8,338 610 ========== ==========
On April 11, 2000, the Company entered into a $75 million revolving credit facility, with the option to increase it to $100 million through April 11, 2002. The credit facility was amended on February 28, 2001 to allow for borrowings in foreign currencies. The credit facility is available for direct borrowings and/or the issuance of letters of credit. The maturity of the bank credit facility is April 11, 2005, and is provided by a group of five banks, led by Bank of America. At September 30, 2001, the Company had approximately $61.7 million available to borrow under the credit facility as well as $14.5 million of cash on hand. The credit facility requires, as determined by certain financial ratios, a commitment fee ranging from 20-30 basis points per annum on the unused portion. The terms of the facility provide that interest on borrowings may be calculated at a spread over the London Interbank Offered Rate (LIBOR) or based on the prime rate, at the Company's election. Substantially all of the assets of the Company are pledged under the credit facility. The financial covenants of the credit facility include limitations on leverage and minimum consolidated EBITDA. As of September 30, 2001, the Company is in compliance with all bank covenants. During 2001 and 2000, the maximum aggregate short-term borrowings at any month-end were $5.5 million and $21 million, respectively; the average aggregate short-term borrowings outstanding based on month-end balances were $1.7 million and $8.1 million, respectively; and the weighted average interest rates were 6.4% in 2001, 7.5% in 2000 and 6.3% in 1999. The letters of credit issued and outstanding under the credit facility totaled $6.1 million and $7.9 million at September 30, 2001 and 2000, respectively. Short-term borrowings under the credit facility totaled zero and $4.0 million as of September 30, 2001 and 2000, respectively. Long-term borrowings under the revolving credit facility were $7.2 million (related to the Bea acquisition and based in the local currency) and zero at September 30, 2001 and 2000, respectively. In addition, the Company has other borrowings in foreign countries of approximately $1.2 million, of which $0.1 million is due within one year. 8. Capital stock The 13,409,934 and 13,224,834 common shares as presented in the accompanying Consolidated Balance Sheets at September 30, 2001 and 2000 represent the actual number of shares issued at the respective dates. The Company held 985,469 and 956,527 common shares in treasury at September 30, 2001 and 2000, respectively. In conjunction with the sale of SEI on September 30, 1999, the previously outstanding Deposit and Trust Agreement was terminated. The Company has various Stock Option Plans which permit the Company to grant key management employees (1) options to purchase shares of the Company's common stock or (2) stock appreciation rights with respect to all or any part of the number of shares covered by the options. All outstanding options were granted at prices equal to fair market value at the date of grant. 35 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Information regarding stock options awarded under the Option Plans is as follows:
FY 2001 FY 2000 FY 1999 ---------------------- ---------------------- ----------------------- Estimated Estimated Estimated Shares Avg. Price Shares Avg. Price Shares Avg. Price --------- ---------- --------- ---------- ---------- ---------- October 1, 792,699 $ 10.62 1,437,442 $ 9.35 953,716 $ 8.61 Granted 175,250 $ 18.65 99,250 $ 12.90 522,600 $ 10.76 Exercised (151,298) $ 9.18 (558,738) $ 7.37 (17,270) $ 7.72 Cancelled (20,003) $ 12.91 (185,255) $ 12.16 (21,604) $ 12.00 -------- ---------- ---------- ---------- ---------- ---------- September 30, 796,648 $ 12.60 792,699 $ 10.62 1,437,442 $ 9.35 At September 30, Reserved for future grant 342,063 405,566 242,725 Exercisable 370,854 $ 10.72 363,647 $ 10.65 698,464 $ 9.36 ========= ========== ========== ========= ========== ==========
Summary information regarding stock options outstanding at September 30, 2001 is presented below:
OPTIONS OUTSTANDING ------------------------------------------------------------------- NUMBER WEIGHTED-AVERAGE WEIGHTED Range of OUTSTANDING AT REMAINING AVERAGE Exercise Prices SEPTEMBER 30, 2001 CONTRACTUAL LIFE EXERCISE PRICE --------------- ------------------ ---------------- -------------- $5.93 - $7.37 100,797 5.0 YEARS $ 6.56 $9.14 - $12.91 446,198 7.1 YEARS $10.93 $14.19 - $19.22 206,153 8.4 YEARS $17.01 $21.44 - $27.28 43,500 9.6 YEARS $22.90 ------------------ ---------------- -------------- 796,648 7.3 YEARS $12.60 ================== ================ ==============
EXERCISABLE OPTIONS OUTSTANDING --------------------------------------- NUMBER WEIGHTED Range of EXERCISABLE AT AVERAGE Exercise Prices SEPTEMBER 30, 2001 EXERCISE PRICE --------------- ------------------ -------------- $5.93 - $7.37 100,797 $ 6.56 $9.14 - $12.91 216,348 $10.93 $14.19 - $19.22 53,709 $17.64 $21.44 - $27.28 -- -- ------------------ -------------- 370,854 $10.72 ================== ==============
The options have a ten year contractual life from date of issuance, expiring in various periods through 2011. The increase in exercised shares and cancelled shares in 2000 is mainly due to the sale of SEI. Employees of SEI had 90 days, subsequent to the divestiture, to exercise their exercisable stock options prior to their cancellation. In February 2001, the Company authorized a stock repurchase program to purchase up to 1.3 million shares of its common stock in the open market, subject to market conditions and other factors, through September 30, 2003. Approximately 77,000, 516,000 and 177,000 shares were repurchased during fiscal years 2001, 2000 and 1999, respectively. 36 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During 2001, the Board of Directors authorized, and the shareholders approved, the Performance Share Plan (the Plan). The maximum number of shares available for issue under the Plan was 532,814 shares. As of September 30, 2001, 331,831 shares have been awarded and 80,000 shares have been earned. At September 30, 2001, there were 40,000 shares of restricted stock outstanding. In February 2000, the Company amended and restated the Preferred Stock Purchase Rights Plan such that each Right entitles the holder to purchase one one-hundredth of a share of preferred stock at an initial purchase price of $60. The Rights remain in existence until February 3, 2010, unless renewed, redeemed earlier (at one cent per Right), exercised or exchanged under the terms of the plan. Under certain conditions involving the acquisition of, or an offer for, 20% or more of the Company's common stock, all holders of Rights, except an acquiring entity, would be entitled (1) to purchase, at a defined price, common stock of the Company or an acquiring entity at a value twice the defined price, or (2) at the option of the Board, to exchange each Right for one share of common stock. The Company adopted the disclosure-only provisions of SFAS No. 123. Under APB No. 25, no compensation cost was recognized for the Company's stock option plans. Had compensation cost for the Company's stock option plans and performance share plans been determined based on the fair value at the grant date for awards outstanding during 2001 and 2000 consistent with the provisions of this Statement, the Company's net earnings and net earnings per share would have been as shown in the table below:
Pro forma (Unaudited) (Dollars in thousands, except per share amounts) 2001 2000 ---------- ---------- Net earnings $ 29,405 16,214 Net earnings per share: Basic 2.37 1.32 Diluted 2.30 1.28 ========== ==========
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2001 and 2000, respectively: expected dividend yield of 0% in both periods; expected volatility of 37.5% and 29.2%, risk-free interest rate of 4.6% and 5.8%, and expected life based on historical exercise periods of 4.21 years and 4.06 years. To determine the fair value of grants under the Performance Share Plans, the probability that performance milestones would be met was applied to the ESCO stock price on the date of grant. This probability was based on an estimated average annual growth rate of 10.0% and an annualized volatility of 37.9% and 38.3% in 2001 and 2000, respectively. 9. Retirement and other benefit plans Substantially all employees are covered by defined benefit or defined contribution pension plans maintained by the Company for the benefit of its employees. Benefits are provided to employees under defined benefit pay-related and flat-dollar plans, which are primarily noncontributory. Annual contributions to retirement plans equal or exceed the minimum funding requirements of the Employee Retirement Income Security Act or applicable local regulations. On September 30, 1999, the Company completed the sale of SEI to Engineered Support Systems, Inc. which accounts for significant fluctuations in amounts in 2000 as compared to 1999. 37 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Net periodic benefit cost for the years ended September 30, 2001, 2000 and 1999 is comprised of the following:
(Dollars in millions) 2001 2000 1999 -------- -------- -------- Defined benefit plans: Service cost $ 1.4 1.4 4.1 Interest cost 2.5 2.1 6.7 Expected return on plan assets (3.0) (2.8) (7.5) Amortization of service costs .1 .1 .3 Net actuarial (gain) loss (.5) (.5) .8 Curtailment gain -- (.7) (8.5) Settlement loss -- -- 2.9 -------- -------- -------- Net periodic benefit cost .5 (.4) (1.2) Defined contribution plans .7 .6 .7 -------- -------- -------- Total $ 1.2 .2 (.5) ======== ======== ========
The Company recognized a curtailment gain in 2000 as a result of the sale of the Rantec microwave business in February 2000 and also recognized a curtailment gain and a settlement loss in 1999 as a result of the sale of SEI. The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for defined benefit pension plans with accumulated benefit obligations in excess of plan assets were $5.1 million, $4.7 million and $2.6 million, respectively, as of September 30, 2001, and $2.1 million, $1.3 million and zero, respectively, as of September 30, 2000. The net benefit obligation of the Company's defined benefit pension plans as of September 30, 2001 and 2000 is shown below:
(Dollars in millions) 2001 2000 -------- -------- Change in benefit obligation-- Net benefit obligation at beginning of year $ 29.6 27.1 Service cost 1.4 1.4 Interest cost 2.5 2.1 Plan amendments .1 .2 Actuarial (gain) loss 3.9 .3 Gross benefits paid (1.0) (.8) Curtailments -- (.7) -------- -------- Net benefit obligation at end of year $ 36.5 29.6 ======== ========
The plan assets of the Company's defined benefit pension plans at September 30, 2001 and 2000 are shown below:
(Dollars in millions) 2001 2000 -------- -------- Change in plan assets: Fair value of plan assets at beginning of year $ 35.9 28.5 Actual return on plan assets (6.8) 8.0 Employer contributions -- .2 Gross benefits paid (1.0) (.8) -------- -------- Fair value of plan assets at end of year $ 28.1 35.9 ======== ========
Pension plan assets consist principally of marketable securities including common stocks, bonds, and interest-bearing deposits. 38 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's defined benefit pension plans recognized the following net amounts at September 30, 2001 and 2000:
(Dollars in millions) 2001 2000 -------- -------- Funded status at end of year $ (8.4) 6.3 Unrecognized prior service cost .5 .5 Unrecognized net actuarial (gain) loss 4.1 (10.2) -------- -------- Accrued benefit cost $ (3.8) (3.4) ======== ======== Amounts recognized in the balance sheet consist of: Prepaid benefit cost $ .2 .1 Accrued benefit cost (4.0) (3.5) Additional minimum liability (.8) (.1) Intangible asset .2 .1 Accumulated other comprehensive income .6 -- -------- -------- Accrued benefit liability (Included in Other liabilities) $ (3.8) (3.4) ======== ========
The benefit obligations of the defined benefit plans as of September 30, 2001 and 2000 were based on discount rates of 7.25% and 7.75%, respectively, and an assumed rate of increase in compensation levels of 4.5% in 2001 and 2000. The 2001, 2000 and 1999 pension expense for the defined benefit plans was based on a 7.25%, 7.75% and 7.75% discount rate, respectively, a 4.5%, 4.5% and 4% increase in compensation levels, respectively, and a 9.5%, 9.5% and 10% expected long-term rate of return on plan assets, respectively. In addition to providing retirement income benefits, the Company provides unfunded postretirement health and life insurance benefits to certain retirees. To qualify, an employee must retire at age 55 or later and the employee's age plus service must equal or exceed 75. Retiree contributions are defined as a percentage of medical premiums. Consequently, retiree contributions increase with increases in the medical premiums. The life insurance plans are noncontributory and provide coverage of a flat dollar amount for qualifying retired employees. Net periodic postretirement benefit cost is comprised of the following:
(Dollars in millions) 2001 2000 1999 -------- -------- -------- Service cost $ -- .1 .2 Interest cost .1 .1 .7 Net amortization and deferral (.2) (.3) (.3) Curtailment gain recognized -- (.3) (8.7) -------- -------- -------- Net periodic postretirement benefit cost $ (.1) (.4) $ (8.1) ======== ======== ========
The net benefit obligation for postretirement benefits at September 30, 2001 and 2000 is shown below:
(Dollars in millions) 2001 2000 ---- ---- Net benefit obligation at beginning of year $1.2 1.0 Service cost -- .1 Interest cost .1 .1 Actuarial (gain) loss .5 .4 Curtailments -- (.3) Gross benefits paid (.1) (.1) ---- ---- Net benefit obligation at end of year $1.7 1.2 ==== ====
39 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The plan assets for postretirement benefits at September 30, 2001 and 2000 are shown below:
(Dollars in millions) 2001 2000 ---- ---- Fair value of plan assets at beginning of year $ -- -- Employer contributions .1 .1 Gross benefits paid (.1) (.1) ---- ---- Fair value of plan assets at end of year $ -- -- ==== ====
The Company recognized the following net amounts for postretirement benefits at September 30, 2001 and 2000:
(Dollars in millions) 2001 2000 ----- ---- Funded status at end of year $(1.7) (1.2) Unrecognized prior service cost -- -- Unrecognized net actuarial (gain) loss (3.1) (3.8) ----- ---- Accrued benefit costs $(4.8) (5.0) ----- ---- Amounts recognized in the balance sheet consist of-- Accrued benefit liability (Included in Other liabilities) $(4.8) (5.0) ===== ====
The net benefit obligations of the plans as of September 30, 2001 and 2000 were based on discount rates of 7.25% and 7.75%, respectively. The September 30, 2001 net benefit obligation was based on a health care cost trend of 5.5% for fiscal 2001. The September 30, 2000 net benefit obligation was based on a health care cost trend of 6.5% for fiscal 2000, gradually grading down to an ultimate rate of 5.5% by 2002. A 1% increase in the health care cost trend rate for each year would increase the September 30, 2001 net benefit obligation by approximately $45,000, while a 1% decrease in the health care cost trend rate for each year would decrease the September 30, 2001 net benefit obligation by approximately $50,000. The fiscal 2001 and 2000 net periodic benefit costs were based on discount rates of 7.25% and 7.75%, respectively. The net periodic benefit cost was based on an assumed health care cost trend of 5.5% for 2001 and 6.5% for 2000 gradually grading down to 5.5% by fiscal year 2002. A 1% increase in the health care cost trend rate for each year would increase the aggregate of the service cost and interest cost components of the fiscal 2001 net periodic benefit cost by approximately $3,900, while a 1% decrease in the health care cost trend rate for each year would decrease the aggregate of the service cost and interest cost components of the fiscal 2001 net periodic benefit cost by approximately $4,600. 10. Other financial data Items charged to operations during the years ended September 30, 2001, 2000 and 1999 included the following:
(Dollars in thousands) 2001 2000 1999 ------- ------- ------- Maintenance and repairs $ 4,952 4,870 7,078 Salaries and wages 91,649 78,206 132,671 ------- ------- ------- Research and development costs: Company-sponsored $ 9,396 6,177 7,716 Customer-sponsored 5,231 3,961 8,332 ------- ------- ------- Total $14,627 10,138 16,048 ======= ======= =======
40 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The increase in salaries and wages in 2001 compared to 2000 is due to the Company's acquisition activities. The decreases in salaries and wages and in research and development costs in 2000 compared to 1999 are due to the sale of SEI in 1999. The increase in research and development costs in 2001 compared to 2000 is mainly due to the Company's acquisition activities and increased spending in the Company's Communications segment related to product enhancements and additional product offerings. Accrued expenses included accrued employee compensation of $9.1 million and $7.5 million at September 30, 2001 and 2000, respectively. Other liabilities include the accrued benefit liabilities related to the Company's defined benefit pension plans, the accrued benefit liabilities related to the Company's postretirement benefits, miscellaneous tax liabilities, and liabilities related to the Company's cash flow hedges. 11. Business segment information The Company is organized based on the products and services that it offers. Under this organizational structure, the Company operates in four principal segments: Filtration/Fluid Flow, Test, Communications and Other. Filtration/Fluid Flow operations consist of PTI Technologies Inc. (PTI) and Filtertek Inc. (Filtertek). PTI develops and manufactures a wide range of filtration products and is a leading supplier of filters to the commercial aerospace market and microfiltration market. Filtertek develops and manufactures a broad range of high-volume, original equipment manufacturer (OEM) filtration products at its facilities in North America, South America and Europe. Test segment operations represent the EMC Group, consisting of EMC Test Systems, L.P. (ETS) and Lindgren. The EMC Group is principally involved in the design and manufacture of EMC test equipment, test chambers, and electromagnetic absorption materials. The EMC Group also manufactures radio frequency (RF) shielding products and components used by manufacturers of medical equipment, communications systems, electronic products, and shielded rooms for high security data processing and secure communication. Communications operations consist of Distribution Control Systems, Inc. (DCSI) which is principally involved in providing two-way power line communication systems for the utility industry. These systems provide the electric utilities with a patented communication technology for demand-side management, distribution automation and automatic meter reading capabilities. Communications also includes the operations of Comtrak, L.L.C. The Divested Business segment consists of Systems & Electronics Inc. (SEI). As of September 30, 1999, ESCO sold SEI to Engineered Support Systems, Inc. The Other segment is principally comprised of Rantec Power Systems Inc., formerly a part of Rantec Microwave & Electronics, Inc. (Rantec) which produces power supplies widely used in high performance displays, such as cockpit instrumentation, engineering workstations and medical imaging. Rantec's microwave antenna business was sold in February 2000. Accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1. In accordance with SFAS 131, the Company evaluates the performance of its operating segments based on operating profit, which is defined as: net sales, less cost of sales, and less SG&A expenses. Intersegment sales and transfers are not significant. Segment assets consist primarily of customer receivables, inventories and fixed assets directly associated with the production processes of the segment. Segment assets also include goodwill. Segment depreciation and amortization is based upon the direct assets listed above.
NET SALES Year ended September 30, (Dollars in millions) 2001 2000 1999 ------ ------ ------ Filtration/Fluid Flow $188.2 181.7 168.9 Test 85.5 63.0 34.9 Communications 59.1 42.7 25.8 Other 12.1 12.8 13.7 Divested Business -- -- 172.8 ------ ------ ------ Consolidated totals $344.9 300.2 416.1 ====== ====== ======
41 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OPERATING PROFIT Year ended September 30, (Dollars in millions) 2001 2000 1999 ----- ----- ----- Filtration/Fluid Flow $16.8 16.6 11.9 Test 9.3 6.9 4.0 Communications 12.6 8.9 (.4) Other 1.4 (.3) (8.8) Divested Business -- -- 10.4 Reconciliation to consolidated totals (Corporate) (3.3) (2.0) (2.2) ----- ----- ----- Consolidated totals $36.8 30.1 14.9 ===== ===== =====
Operating profit, as defined by the Company, excludes certain costs which are included in Other costs and expenses, net, in the Consolidated Statements of Operations, and which would be included in the determination of operating income as defined within generally accepted accounting principles. In fiscal 2001, these items consist of approximately $2.1 million of costs related to the Filtration/Fluid Flow segment as a result of the consolidation of PTI's filtration business into new facilities in Oxnard, CA; consolidation costs of the Stockton, CA manufacturing facility into the Huntley, IL facility; and other miscellaneous costs. In 2000, these items consist of approximately $2.0 million of net costs related to the Filtration/Fluid Flow segment as a result of the consolidation of PTI's filtration businesses into new facilities in Oxnard, CA; expenses related to the planned upgrade of production equipment to improve manufacturing efficiency at Filtertek; and costs related to the microfiltration business. In addition, related to the Test segment in 2000, are approximately $1.0 million of Other costs and expenses, net, primarily related to the write-off of an investment in a third party EMC related start-up company which filed bankruptcy in 2000. The 1999 operating profit includes $3.9 million of other charges related to cost of sales and $5.1 million of restructuring charges related to the strategic actions undertaken in 1999. The total nonrecurring charges included in 1999 operating profit amounted to $9.1 million. The Other segment in 1999 also includes $3.8 million of charges related to cost growth on certain development programs at Rantec Power Systems. The Company is also presenting EBITDA by segment for informational purposes only. EBITDA is defined as earnings before interest, taxes, depreciation and amortization.
EBITDA 2001 2000 ------------------------------- ------------------------------- Year ended September 30, EBIT DEPRECIATION/ EBITDA EBIT Depreciation/ EBITDA (Dollars in millions) AMORTIZATION Amortization ----- ------------ ------ ----- ------------ ------ Filtration/Fluid Flow $11.5 10.8 22.3 12.4 10.7 23.1 Test 7.5 2.5 10.0 4.7 1.6 6.3 Communications 11.9 1.2 13.1 8.2 1.2 9.4 Other (Rantec & Corporate) (3.5) .6 (2.9) (.2) .7 .5 ----- ----- ----- ----- ----- ----- Consolidated totals $27.4 15.1 42.5 25.1 14.2 39.3 ===== ===== ===== ===== ===== =====
42 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
IDENTIFIABLE ASSETS As of September 30, (Dollars in millions) 2001 2000 1999 ------ ------ ------ Filtration/Fluid Flow $213.4 198.2 195.0 Test 62.3 61.2 22.2 Communications 22.4 21.6 14.2 Other 7.5 7.4 18.9 Reconciliation to consolidated totals (Corporate assets) 70.0 42.7 128.0 ------ ------ ------ Consolidated totals $375.6 331.1 378.3 ====== ====== ======
Corporate assets consist primarily of deferred taxes and cash balances.
CAPITAL EXPENDITURES, NET Year ended September 30, (Dollars in millions) 2001 2000 1999 ----- ----- ----- Filtration/Fluid Flow $ 9.4 9.0 6.3 Test 1.1 .3 .2 Communications .9 .5 .4 Other .5 .6 .3 Divested Business -- -- 1.1 ----- ----- ----- Consolidated totals $11.9 10.4 8.3 ===== ===== =====
Depreciation and amortization is included in the EBITDA table, noted above.
GEOGRAPHIC INFORMATION Net sales to customers (Dollars in millions) 2001 2000 1999 ------ ------ ------ North America $276.3 234.6 346.9 Europe 43.4 46.1 37.0 Far East 15.0 9.5 23.5 Other 10.2 10.0 8.7 ------ ------ ------ Consolidated totals $344.9 300.2 416.1 ====== ====== ======
LONG-LIVED ASSETS (Dollars in millions) 2001 2000 1999 ----- ----- ----- North America $53.8 55.9 63.8 Europe 11.2 6.7 7.5 ----- ----- ----- Consolidated totals $65.0 62.6 71.3 ===== ===== =====
Net sales are attributed to countries based on location of customer. Long-lived assets are attributed to countries based on location of the asset. 43 2001 ESCO TECHNOLOGIES ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Commitments and Contingencies At September 30, 2001, the Company had $6.1 million in letters of credit outstanding as guarantees of contract performance. As a normal incidence of the businesses in which the Company is engaged, various claims, charges and litigation are asserted or commenced against the Company. In the opinion of management, final judgments, if any, which might be rendered against the Company in current litigation are adequately reserved, covered by insurance, or would not have a material adverse effect on its financial statements. 13. Quarterly financial information (Unaudited)
Dollars in thousands, FIRST SECOND THIRD FOURTH FISCAL except per share amounts) QUARTER QUARTER QUARTER QUARTER YEAR ---------- ---------- ---------- ---------- ---------- 2001 Net sales $ 82,871 86,905 87,862 87,266 344,904 Gross profit 25,245 27,230 28,015 27,888 108,378 Net earnings 3,978 4,287 4,557 17,285 30,107 Earnings per share (GAAP Reported): Basic .32 .35 .37 1.39 2.43 Diluted .31 .34 .35 1.33 2.35 ---------- ---------- ---------- ---------- ---------- Earnings per share (From Operations - pro forma) Basic .32 .35 .37 .37 1.41 Diluted .31 .34 .35 .36 1.36 ========== ========== ========== ========== ========== 2000 Net sales $ 65,865 70,062 79,235 84,995 300,157 Gross profit 19,628 21,576 24,699 25,991 91,894 Net earnings 5,056 3,517 3,708 4,538 16,819 Earnings per share (GAAP Reported): Basic .41 .29 .30 .37 1.37 Diluted .40 .28 .29 .36 1.33 ---------- ---------- ---------- ---------- ---------- Earnings per share (From Operations - pro forma) Basic .22 .29 .30 .33 1.14 Diluted .22 .28 .29 .32 1.11 ========== ========== ========== ========== ==========
The 2001 fourth quarter GAAP Reported reflects the elimination of the net deferred tax valuation allowance of approximately $12.7 million or $0.97 per share. The 2001 earnings per share From Operations - pro forma excludes the elimination of the net deferred tax valuation allowance of approximately $12.7 million or $0.99 per share. The 2000 first quarter GAAP Reported net earnings reflects the impact of the after-tax gain on the sale of the Riverhead, NY property of approximately $2.2 million or $0.18 per share. The 2000 fourth quarter GAAP Reported net earnings reflects the after-tax gain on the sale of the Calabasas, CA property of approximately $0.5 million or $0.04 per share. The 2000 earnings per share From Operations pro - forma excludes the gains on the sale of the Riverhead, NY and the Calabasas, CA properties as described above. 44 2001 ESCO TECHNOLOGIES ANNUAL REPORT Independent Auditors' Report THE BOARD OF DIRECTORS AND SHAREHOLDERS ESCO TECHNOLOGIES INC.: We have audited the accompanying consolidated balance sheets of ESCO Technologies Inc. and subsidiaries as of September 30, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended September 30, 2001. These consolidated financial statements are the responsibility of the Company's Management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ESCO Technologies Inc. and subsidiaries as of September 30, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2001, in conformity with accounting principles generally accepted in the United States of America. As discussed in note 1 to the consolidated financial statements, in 1999, the Company adopted Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities". /s/ KPMG LLP St. Louis, Missouri November 13, 2001 46 2001 ESCO TECHNOLOGIES ANNUAL REPORT Shareholders' Summary Shareholders' Annual Meeting The Annual Meeting of the shareholders of ESCO Technologies Inc. will be held at 10 a.m. Tuesday, February 5, 2002, at the Hilton St. Louis Frontenac Hotel, 1335 South Lindbergh Boulevard, St. Louis County, Missouri 63131. Notice of the meeting and a proxy statement were sent to shareholders with this Annual Report. 10-K Report A copy of the Company's 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission is available to shareholders without charge. Direct your written request to the Investor Relations Department, ESCO Technologies Inc., 8888 Ladue Road, Suite 200, St. Louis, Missouri 63124. Investor Relations Additional investor-related information may be obtained by contacting the Director of Investor Relations at (314) 213-7277 or toll free at (888) 622-3726. Information is also available through the Company's website at www.escotechnologies.com or by email at pmoore@escotechnologies.com. Transfer Agent and Registrar Shareholder inquiries concerning lost certificates, transfer of shares or address changes should be directed to: Transfer Agent/Registrar Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016-3572 1 (800) 368-5948 E-mail: info@rtco.com Capital Stock Information ESCO Technologies Inc. common stock shares (symbol ESE) are listed on the New York Stock Exchange. There were approximately 4,300 holders of record of shares of common stock at September 30, 2001. 48 Common Stock Market Prices The Company's common stock and associated preferred stock purchase rights (subsequently referred to as common stock) are listed on the New York Stock Exchange under the symbol "ESE." The following table summarizes the high and low prices of the Company's common stock for each quarter of fiscal 2001 and 2000.
2001 2000 ------------------- ------------------- Quarter HIGH LOW High Low ------- ------ ------ ------ ------ First $21.50 $16.38 $12.63 $ 9.50 Second 26.25 19.75 17.13 11.50 Third 32.67 23.67 20.13 15.50 Fourth 30.45 21.90 20.00 17.06 ====== ====== ====== ======
47