Summary of Significant Accounting Policies (Policies)

12 Months Ended

Sep. 30, 2018

Accounting Policies [Abstract]

Principles Of Consolidation

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.

Basis Of Presentation

B.       Basis of Presentation

The Company’s fiscal year ends September 30. Throughout these Consolidated Financial Statements, unless the context indicates otherwise, references to a year (for example 2018) refer to the Company’s fiscal year ending on September 30 of that year.

The Company accounts for shipping and handling costs on a gross basis and they are included in net sales. The Company accounts for taxes collected from customers and remitted to governmental authorities on a net basis and they are excluded from net sales.

Nature Of Operations

C.       Nature of Operations

The Company is organized based on the products and services it offers, and classifies its business operations in segments for financial reporting purposes. Under the current organization structure, the Company has four segments for financial reporting purposes: Filtration/Fluid Flow (Filtration), RF Shielding and Test (Test), Utility Solutions Group (USG) and Technical Packaging.

Filtration: The companies within this segment primarily design and manufacture specialty filtration products, including hydraulic filter elements and fluid control devices used in commercial aerospace applications, unique filter mechanisms used in micro-propulsion devices for satellites, custom designed filters for manned aircraft and submarines, elastomeric-based signature reduction solutions to enhance U.S. Navy maritime survivability, precision-tolerance machined components for the aerospace and defense industry, and metal processing services.

Test: ETS-Lindgren Inc. provides its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy.

USG: The companies within this segment provide high-end, intelligent, diagnostic test and data management solutions for the electric power delivery industry, and decision support tools for the renewable energy industry, primarily wind.

Technical Packaging: The companies within this segment provide innovative solutions to the medical and commercial markets for thermoformed and precision molded pulp fiber packages and specialty products using a wide variety of thin gauge plastics and pulp.

Use Of Estimates

D.       Use of Estimates

The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ from those estimates.

Revenue Recognition

E.       Revenue Recognition

Filtration: Within the Filtration segment, approximately 85% of revenues (approximately 31% of consolidated revenues) are recognized when products are delivered (when title and risk of ownership transfers) or when services are performed for unaffiliated customers.

Approximately 15% of the segment’s revenues (approximately 6% of consolidated revenues) are recorded under the percentage-of-completion method. The majority of these contracts are cost-reimbursable contracts which provide for the payment of allowable costs incurred during the performance of the contract plus an incentive fee. The remainder of the contracts are fixed-price contracts. Products accounted for under this guidance include the design, development and manufacture of complex fluid control products, quiet valves, manifolds and systems primarily for the aerospace and military markets. For fixed-price contracts that are accounted for under this guidance, the Company estimates profit as the difference between total estimated revenue and total estimated cost of a contract and recognizes these revenues and costs based on units delivered. The percentage-of-completion method of accounting involves the use of various techniques to estimate expected costs at completion. These estimates are based on Management’s judgment and the Company’s substantial experience in developing these types of estimates.

Test: Within the Test segment, approximately 25% of revenues (approximately 6% of consolidated revenues) are recognized when products are delivered (when title and risk of ownership transfers) or when services are performed for unaffiliated customers.

Approximately 75% of the segment’s revenues (approximately 18% of consolidated revenues) are recorded under the percentage-of-completion method due to the complex nature of the enclosures that are designed and produced under these contracts. Products accounted for under this guidance include the construction and installation of complex test chambers to a buyer’s specifications that provide its customers with the ability to measure and contain magnetic, electromagnetic and acoustic energy. As discussed above, for arrangements that are accounted for under this guidance, the Company estimates profit as the difference between total revenue and total estimated cost of a contract and recognizes these revenues and costs based primarily on contract milestones. The percentage-of-completion method of accounting involves the use of various techniques to estimate expected costs at completion. These estimates are based on Management’s judgment and the Company’s substantial experience in developing these types of estimates.

USG: Within the USG segment, approximately 75% of revenues (approximately 21% of consolidated revenues) are recognized when products are delivered (when title and risk of ownership transfers), or when services are performed for unaffiliated customers. Approximately 17% of the segment’s revenues (approximately 5% of consolidated revenues) are recognized on a straight-line basis over the term. Approximately 8% of the segment’s revenues (approximately 2% of consolidated revenues) are recognized based on the terms of the software contract.

Technical Packaging: Within the Technical Packaging segment, 100% of revenues (approximately 11% of consolidated revenues) are recognized when products are delivered (when title and risk of ownership transfers) or when services are performed for unaffiliated customers.

See the further discussion of the Company’s revenue recognition in Note 1.W, below.

Cash And Cash Equivalents

F.       Cash and Cash Equivalents

Cash equivalents include temporary investments that are readily convertible into cash, such as money market funds, with original maturities of three months or less.

Accounts Receivable

G.       Accounts Receivable

Accounts receivable have been reduced by an allowance for amounts that the Company estimates are uncollectible in the future. This estimated allowance is based on Management’s evaluation of the financial condition of the customer and historical write-off experience.

Costs And Estimated Earnings On Long-Term Contracts

H.       Costs and Estimated Earnings on Long-Term Contracts

Costs and estimated earnings on long-term contracts represent unbilled revenues, including accrued profits, accounted for under the percentage-of-completion method, net of progress billings.

Inventories

I.       Inventories

Inventories are valued at the lower of cost (first-in, first-out) or market value. Inventories are regularly reviewed for excess quantities and obsolescence based upon historical experience, specific identification of discontinued items, future demand, and market conditions. Inventories under long-term contracts reflect accumulated production costs, factory overhead, initial tooling and other related costs less the portion of such costs charged to cost of sales.

Property, Plant And Equipment

J.       Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation and amortization are computed primarily on a straight-line basis over the estimated useful lives of the assets: buildings, 10-40 years; machinery and equipment, 3-10 years; and office furniture and equipment, 3-10 years. Leasehold improvements are amortized over the remaining term of the applicable lease or their estimated useful lives, whichever is shorter. Long-lived tangible assets are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. Impairment losses are recognized based on fair value.

Leases

K.       Leases

Lease agreements are evaluated to determine whether they are capital or operating leases in accordance with ASC 840, Leases (ASC 840). When any one of the four test criteria in ASC 840 is met, the lease then qualifies as a capital lease. Capital leases are capitalized at the lower of the net present value of the total amount payable under the leasing agreement (excluding finance charges) or the fair market value of the leased asset. Capital lease assets are depreciated on a straight-line basis, over a period consistent with the Company’s normal depreciation policy for tangible fixed assets. The Company allocates each lease payment between a reduction of the lease obligation and interest expense using the effective interest method. Rent expense for operating leases, which may include free rent or fixed escalation amounts in addition to minimum lease payments, is recognized on a straight-line basis over the duration of the lease term. Capital lease obligations are included within other long-term liabilities (long-term portion) and accrued other expenses (current portion).

Goodwill And Other Long-Lived Assets

L.       Goodwill and Other Long-Lived Assets

Goodwill represents the excess of purchase price over the fair value of net identifiable assets acquired in business acquisitions. Management annually reviews goodwill and other long-lived assets with indefinite useful lives for impairment or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. If the Company determines that the carrying value of the long-lived asset may not be recoverable, a permanent impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value. Fair value is measured based on a discounted cash flow method using a discount rate determined by Management to be commensurate with the risk inherent in the Company’s current business model.

Other intangible assets represent costs allocated to identifiable intangible assets, principally customer relationships, capitalized software, patents, trademarks, and technology rights. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. See Note 3 regarding goodwill and other intangible assets activity.

Capitalized Software

M.       Capitalized Software

The costs incurred for the development of computer software that will be sold, leased, or otherwise marketed are charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is typically established upon completion of a detailed program design. Costs incurred after this point are capitalized on a project-by-project basis. Capitalized costs consist of internal and external development costs. Upon general release of the product to customers, the Company ceases capitalization and begins amortization, which is calculated on a project-by-project basis as the greater of (1) the ratio of current gross revenues for a product to the total of current and anticipated future gross revenues for the product or (2) the straight-line method over the estimated economic life of the product. The Company generally amortizes the software development costs over a three-to-seven year period based upon the estimated future economic life of the product. Factors considered in determining the estimated future economic life of the product include anticipated future revenues, and changes in software and hardware technologies. Management annually reviews the carrying values of capitalized costs for impairment or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. If expected cash flows are insufficient to recover the carrying amount of the asset, then an impairment loss is recognized to state the asset at its net realizable value.

Income Taxes

N.       Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets may be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance when Management believes it is more likely than not such assets will not be recovered, taking into consideration historical operating results, expectations of future earnings, tax planning strategies, and the expected timing of the reversals of existing temporary differences.

Research And Development Costs

O. Research and Development Costs

Company-sponsored research and development costs include research and development and bid and proposal efforts related to the Company’s products and services. Company-sponsored product development costs are charged to expense when incurred. Customer-sponsored research and development costs incurred pursuant to contracts are accounted for similarly to other program costs. Customer-sponsored research and development costs refer to certain situations whereby customers provide funding to support specific contractually defined research and development costs. Total Company and customer-sponsored research and development expenses were approximately $13.1 million, $14.0 million and $12.2 million for 2018, 2017 and 2016, respectively. These expense amounts exclude certain engineering costs primarily associated with product line extensions, modifications and maintenance, which amounted to approximately $13.1 million, $10.4 million and $8.2 million for 2018, 2017 and 2016, respectively.

Foreign Currency Translation

P. Foreign Currency Translation

The financial statements of the Company’s foreign operations are translated into U.S. dollars in accordance with FASB ASC Topic 830, Foreign Currency Matters. The resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income.

Earnings Per Share

Q. Earnings Per Share

Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated using the weighted average number of common shares outstanding during the period plus shares issuable upon the assumed exercise of dilutive common share options and vesting of performance-accelerated restricted shares using the treasury stock method. There are no anti-dilutive shares.

The number of shares used in the calculation of earnings per share for each year presented is as follows:

(in thousands)	2018		2017		2016
Weighted Average Shares Outstanding — Basic		25,874		25,774		25,762
Performance- Accelerated Restricted Stock		184		221		206
Shares — Diluted		26,058		25,995		25,968

Share-Based Compensation

R. Share-Based Compensation

The Company provides compensation benefits to certain key employees under several share-based plans providing for employee stock options and/or performance-accelerated restricted shares (restricted shares), and to non-employee directors under a non-employee directors compensation plan. Share-based payment expense is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the requisite service period (generally the vesting period of the award).

Accumulated Other Comprehensive Loss

S. Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss of $(31.5) million at September 30, 2018 consisted of $(30.9) million related to the pension net actuarial loss; $(0.5) million related to currency translation adjustments; and $(0.1) million related to forward exchange contracts. Accumulated other comprehensive loss of $(27.3) million at September 30, 2017 consisted of $(28.9) million related to the pension net actuarial loss; $1.7 million related to currency translation adjustments; and $(0.1) million related to forward exchange contracts.

Deferred Revenue And Costs

T. Deferred Revenue and Costs

Deferred revenue and costs are recorded when products or services have been provided or cash has been received but the criteria for revenue recognition have not been met. If there is a customer acceptance provision or there is uncertainty about customer acceptance, revenue and costs are deferred until the customer has accepted the product or service.

Derivative Financial Instruments

U. Derivative Financial Instruments

All derivative financial instruments are reported on the balance sheet at fair value. The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as a hedge and on the type of hedge. For each derivative instrument designated as a cash flow hedge, the effective portion of the gain or loss on the derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. For each derivative instrument designated as a fair value hedge, the gain or loss on the derivative and the offsetting gain or loss on the hedged item are recognized immediately in earnings. Regardless of type, a fully effective hedge will result in no net earnings impact while the derivative is outstanding. To the extent that any hedge is ineffective at offsetting cash flow or fair value changes in the underlying hedged item, there could be a net earnings impact.

Fair Value of Financial Measurements

V. Fair Value Measurements

Fair value is defined as the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties or the amount that would be paid to transfer a liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of Management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.

The accounting guidance establishes a three-level hierarchy for disclosure of fair value measurements, based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, as follows:

Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 –Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Financial Assets and Liabilities

The Company has estimated the fair value of its financial instruments as of September 30, 2018 using available market information or other appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, receivables, inventories, payables and other current assets and liabilities approximate fair value because of the short maturity of those instruments. The carrying amounts due under the revolving credit facility approximate fair value as the interest on outstanding borrowings is calculated at a spread over the London Interbank Offered Rate (LIBOR) or based on the prime rate, at the Company’s election.

Nonfinancial Assets and Liabilities

The Company’s nonfinancial assets such as property, plant and equipment, and other intangible assets are not measured at fair value on a recurring basis; however they are subject to fair value adjustments in certain circumstances, such as when there is evidence that an impairment may exist. No impairments were recorded during 2018.

New Accounting Standards

W. New Accounting Standards

Revenue Recognition

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This guidance has been further clarified and amended. This new standard became effective for the Company as of October 1, 2018, and will be adopted using the modified retrospective transition method. Under this method, the Company will record the cumulative effect of adopting the new standard in the first quarter of 2019.

Because the new standard impacts the Company’s business processes, systems and controls, it developed a project plan to guide the implementation. This project plan included analyzing the standard’s impact on the Company’s contract portfolio, comparing the Company’s historical accounting policies and practices to the requirements of the new standard, and identifying differences from applying the requirements of the new standard to the Company’s contracts. The Company developed internal controls to ensure that it adequately evaluated its portfolio of contracts under the five-step model to ensure proper assessment of the Company’s operating results under ASU 2014-09. Management reported on the progress of the implementation to the Company’s Audit Committee and the Board of Directors on a regular basis during the project’s duration. The primary impact of the adoption of ASU 2014-09 on the Company’s portfolio of contracts and its Consolidated Financial Statements is that more of the Company’s contracts within the Filtration and Technical Packaging segments will recognize revenue and earnings over time as the work progresses versus at a single point of time.

Based on review and analysis of the Company’s contracts, the standard primarily impacts the Filtration and Technical Packaging segments, which have long-term production contracts with the U.S. Government and other commercial customers. Revenue for certain of the contracts within the Filtration segment, and the majority of contracts within the Technical Packaging segment will be recognized over time primarily as: (i) services performed or products installed by the Company are for the enhancement of assets owned and controlled by the customer, (ii) customized products and services performed do not have an alternative use to the Company; and (iii) there is continuous transfer of control to the customer.

Prior to adoption of the new standard, revenue was generally recognized for these contracts as units were delivered, while under the new standard, revenue will be recognized over time, principally as costs are incurred. This change will generally result in an acceleration of revenue for these contracts. The Company determined that revenues in the Test and USG segments are expected to follow a revenue recognition pattern under the new guidance consistent with the Company’s current practice. The Company identified required changes under the new guidance for the recognition of capitalization of commissions on contracts within the Company’s Test segment; however, based on the review of contracts within the Test segment, changes related to this item are expected to have an inconsequential impact on the timing or amount of liabilities accrued as compared to current business practices.

At the adoption date, the impact of recognizing these revenues under the new standard for historical periods ending prior to September 30, 2018 is expected to result in a cumulative pretax transition adjustment to increase retained earnings by approximately $5 million, related to the Filtration and Technical Packaging segments. In addition, the transition adjustment will establish contract assets of approximately $35 million, with corresponding decreases in inventory of approximately $30 million and in contract liabilities (deferred revenue and customer deposits) and accounts receivables, primarily reflecting the conversion of contracts to the cost-to-cost method. This change is not expected to have a significant impact on the Company’s future operating results as the revenue on contracts that would have been recognized under the units-of-delivery method in future years will essentially be replaced by the acceleration of revenue on contracts into earlier periods using the cost-to-cost method. The new standard will have no impact on cash flows and does not affect the economics of the underlying customer contracts.

The Company implemented changes to its financial reporting processes, systems and controls to comply with the disclosure requirements of the new guidance including: (i) changes to balances in contract assets and contract liabilities; and (ii) disaggregation of revenues. The Company expects to change the presentation of certain financial statement accounts to align with the new standard. The most notable change will be presenting costs and estimated earnings in excess of billings as contract assets and billings in excess of costs and estimated earnings as contract liabilities. The Company will report contract balances as a net contract asset or liability position on a contract-by-contract basis at the end of each reporting period.

Other Standards

In January 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which gives entities the option to reclassify to retained earnings the tax effects resulting from the Act related to items in accumulated other comprehensive income (loss) (AOCI) that the FASB refers to as having been stranded in AOCI. This new standard is effective for annual periods beginning after December 15, 2018. The Company adopted this ASU in the fourth quarter of 2018 and, as a result of adopting this standard, the Company reclassified $6.3 million from AOCI to retained earnings.

In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which updates ASC 715, Compensation – Retirement Benefits. This update permits only the service cost component of net periodic pension and postretirement expense to be reported with other compensation costs, while all other components are required to be reported separately in other deductions, outside any subtotal of operating income. These updates are effective for fiscal years beginning after December 15, 2017, with early adoption permitted, and must be adopted on a retrospective basis. The updates change presentation only and will not impact the Company’s results of operations.

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedge Activities, which updates ASC 815, Derivatives and Hedging. This update is intended to amend the hedge accounting model to enable entities to better align the economics of risk management activities and financial reporting. The updates eliminate the requirement to separately measure and report hedge ineffectiveness and simplify hedge documentation and effectiveness assessment requirements. These updates are effective for fiscal years beginning after December 15, 2018, with early adoption permitted, and must be adopted using a modified retrospective approach. These updates are not expected to materially impact the Company’s results of operations.

In January 2017, the FASB issued Accounting Standards Update (ASU) No. 2017-04, Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates Step 2 from the goodwill impairment test. Under the amendments in this update, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The new standard is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment test performed on testing dates after January 1, 2017. The Company adopted this standard in the fourth quarter of 2017 with its annual goodwill impairment tests. The adoption of ASU 2017-04 did not have an impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplified the income tax consequences, accounting for forfeitures and classification on the Statements of Consolidated Cash Flows. The Company adopted this standard in 2017 resulting in the income tax expense in the third quarter and fiscal year 2017 being favorably impacted by additional tax benefits on share-based compensation that vested during the third quarter of 2017 decreasing the effective tax rate by 5.1% and 1.1%, respectively.

In February 2016, the FASB issued ASU No. 2016-062, Leases (Topic 842), which, among other things, requires an entity to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. This standard will increase an entity’s reported assets and liabilities. The new standard is effective for fiscal years beginning after December 15, 2018 and mandates a modified retrospective transition period for all entities. The Company is currently assessing the impact of this new standard on its consolidated financial statements and related disclosures.