**MANAGEMENT’S DISCUSSION AND ANALYSIS**AMI deliveries at PG&E and the shipment of water AMIproducts for the New York City water project; a $9.9million increase in net sales from Doble reflectingthe impact of a full twelve months of operationsversus ten months in the prior year; a $3.9 millionincrease in net sales at Aclara Software; partiallyoffset by a $41.3 million decrease in net sales atAclara PLS.The $41.3 million decrease in AclaraPLS’s net sales in 2009 compared to 2008 was mainlydue to: a $31.9 million decrease in sales to PG&Efor the electric AMIdeployment (2008 sales included $31.3 million ofrevenue recognized that had been deferred from prioryear periods), and an $11.6 million decrease insales to the Puerto Rico Electric Power Authority(PREPA), partially offset by a $10.2 millionincrease in sales to Idaho Power Company.The Company’s total sales to PG&E were $106.2million in 2009 (representing approximately 17% ofthe Company’s consolidated net sales) and $110.2million in 2008 (representing approximately 18% ofthe Company’s consolidated net sales).The 85.3% or $162.4 million increase in net salesin 2008 as compared to 2007 was due to: theacquisition of Doble with sales of $74.3 million; a$55.4 million increase in sales from Aclara RFprimarily due to higher gas and electric AMIdeliveries at PG&E; and a $31.7 million increase insales from Aclara PLS.The $31.7 million increasein Aclara PLS’s net sales in 2008 compared to 2007was mainly due to: a $34.0 million increase insales to PG&E for the electric AMI deployment (dueto the recognition of previously deferred revenuefrom the hardware, program management and softwareprovided to PG&E), a $16.8 million increase insales to PREPA, partially offset by a $18.4 milliondecrease in sales to other investor owned utilities(IOU) customers, such as Duke Energy and OncorElectric.**Test**The net sales decrease of $6.4 million or 4.4% in2009 as compared to the prior year was mainly due to:a $7.2 million decrease in net sales from thesegment’s European operations due to the timing oflarge chamber deliveries to the internationalwireless and electronics end-markets, a decrease incomponent shipments and unfavorable foreign currencyimpacts; and a $3.2 million decrease in net salesfrom the segment’s Asian operations due to a decreasein large chamber deliveries to the internationalwireless and electronics end-markets. This decreasewas partially offset by a $4.0 million increase innet sales from the segment’s U.S. operations drivenby the timing of domestic chamber deliveries.The net sales increase of $3.3 million or 2.3% in 2008 ascompared to 2007 was mainly due to the timing of testchamber sales and sales of components resulting in: a$5.2 million increase in net sales from the segment’sEuropean operations; a $2.7 million increase in netsales from the segment’s Asian operations; partiallyoffset by a $4.6 million decrease in net sales fromthe segment’s U.S. operations.**Filtration**Net sales in 2009 decreased $9.4 million or 8.1%compared to the prior year primarily due to: a $12.4million decrease in net sales at PTI due to lowercommercial aerospace shipments; a $2.1 milliondecrease in net sales at TekPack due to lower salesto commercial customers; partially offset by a $5.1million increase in net sales at VACCO driven byhigher military/defense aircraft product shipments.Net sales in 2008 increased $10.5 million or 9.9%compared to the prior year primarily due to a $5.5million increase in commercial aerospace shipments atPTI and a $3.5 million increase in net sales at VACCOdriven by higher space product shipments.**PACIFIC GAS & ELECTRIC**In November 2005, Aclara RF entered into a contract(the “Aclara RF Contract”) to provide equipment,software and services to PG&E in support of the gasutility portion of PG&E’s AMI project. The totalanticipated contract revenuefrom the gas portion of the Aclara RF Contract fromcommencement through the five-year full deployment isexpected to be up to approximately $225 million ofwhich $190 million has been recorded to date throughSeptember 30, 2009. The current outlook for 2010 PG&Egas product sales is expected to be approximately $40million as compared to $98 million in 2009. Equipmentis purchased only upon issuance of purchase ordersand release authorizations, and PG&E continues tohave the right to purchase products or services fromother suppliers.The Aclara RF Contract also provided PG&E the rightto purchase an RF fixed-network electric productfrom Aclara RF. The Company has received $11 millionof orders to date through September 30, 2009 relatedto the electric portion of the Aclara RF Contract.During 2009, PG&E completed its evaluation andselection of a competing electric product andnotified Aclara RF that no further electric productorders would be received. PG&E and Aclara RF are inthe final stages of a settlement of certain claimsraised by PG&E connected with delivery of theelectric product. The Company does not expect thesettlement will have an impact to the Company’searnings.**ORDERS AND BACKLOG**New orders received in 2009 were $634.0 million,resulting in order backlog of $299.4 million atSeptember 30, 2009 as compared to order backlog of$284.5 million at September 30, 2008. In 2009, theCompany recorded $363.2 million of new orders relatedto USG products, $122.8 million related to Testproducts, and $148.0 million related to Filtrationproducts.In 2008, the Company recorded $365.3million of new orders related to USG products(including $7.0 million of Doble acquired backlog),$154.5 million related to Test products, and $113.2million related to Filtration products.**ESCO TECHNOLOGIES INC.**     11      **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS**The Company received orders for gas and electric AMIproducts totaling $80.0 million, $111.8 million and$49.1 million from PG&E during 2009, 2008 and 2007,respectively. Cumulative-to-date orders from PG&E forthe gas AMI deployment total 3.5 million units and$199 million through September 30, 2009.**2009**Aclara RF received $37.4 million in entered ordersfrom the City of New York for its fixed-networkAMI water project during 2009. Cumulative-to-dateorders total 493,000 units and $39.1 millionthrough September 30, 2009.In August 2009, VACCO received $32.2 million inmulti-year fluid flow product orders for the Navy’sVirginia Class submarine.In August 2009,TekPackaging LLC was awarded a five-year productioncontract with an initial purchase order received for$11.7 million. The total value of purchase ordersanticipated under this contract is between $40million to $50 million.Aclara PLS recorded $12.4million in entered orders from Idaho Power Companyduring 2009.Aclara PLS recorded $10.2 million and $22.4 millionin entered orders from PREPA during 2009 and 2008,respectively.In March 2009, Aclara Softwarereceived an order for approximately $5.0 millionfrom the City of Tallahassee, Florida for asystem-wide implementation of itsMeter Data Management System (MDMS) and ENERGYprism®AMI software applications.**2008**In July 2008, ETS-Lindgren signed a $16.7 millioncontract with the National Automotive Testing andR&D Infrastructure Project (NATRIP) in India toprovide two automotive chambers.In July 2008, Aclara RF was selected by the City ofNew York to provide its fixed-network AMI solutionfor the city’s entire water service territory. Thetotal value of purchase orders anticipated to beissued under this contract is $68.3 million.InJuly 2008, Aclara PLS’s TWACS® AMI product wasselected by Idaho Power Company for its entireelectric service territory. The total value ofpurchase orders anticipated to be issued under thiscontract is $25 million.In December 2007, AclaraPLS signed a contract with PREPA for a total valueof $35 million for the purchase of Aclara PLS TWACSAMI products.**SELLING, GENERAL AND ADMINISTRATIVE EXPENSES**Selling, general and administrative expenses(SG&A) were $152.4 million, or 24.6% of net salesin 2009, $147.3 million, or 24.0% of net sales in2008, and $108.2 million, or 24.7% of net salesin 2007.The increase in SG&A expenses in 2009 as compared tothe prior year was primarily due to a $5.0 millionincrease related to Doble, reflecting a full yearversus ten months in the prior year.The increase in SG&A expenses in 2008 as comparedto 2007 was primarily due to: $24.8 million of SG&Aexpenses related to Doble and an approximately$12.0 million increase in SG&A expenses related toAclara mainly due to an increase in sales,marketing, and engineering head count.**AMORTIZATION OF INTANGIBLE ASSETS**Amortization of intangible assets was $19.2 millionin 2009, $17.0 million in 2008 and $10.2 million in2007. The Company recorded $12.2 million and $11.0million in 2009 and 2008, respectively, related toAclara PLS’s TWACS NG capitalized software.Amortization of intangible assets included $4.7million and $4.2 million of amortization of acquiredintangible assets related to the Company’sacquisitions in 2009 and 2008, respectively. Theamortization of acquired intangible assets relatedto the Company’s acquisitions is included in theCorporate operating segment’s results. The remainingamortization expenses consist of other identifiableintangible assets (primarily software, patents andlicenses). Effective in fiscal year 2010, theCompany has re-evaluated the economic useful life ofits TWACS NG capitalized software as a result of thesuccessful acceptance in the international marketsand concluded the remaining TWACS NG asset value of$44 million has an expected remaining useful life often years (compared to its previous useful life ofseven years).**OTHER EXPENSES, NET**Other expenses, net, were $4.5 million, $0.2 millionand $2.8 million in 2009, 2008 and 2007,respectively. The principal item included in otherexpenses, net, in 2009 consisted of $2.3 million offacility exit/relocation charges incurred inconnection with the move of the Aclara RF facilityconsisting of leasehold improvement write-offs,lease contract termination costs and physical movecosts. There were noother individually significant items included inother expenses, net, in 2009 or 2008. Otherexpenses, net, in 2007 consisted primarily of: $2.6million of expenses within the Test segment relatedto an adverse arbitration award related to thedelivery and installation contract completed in 2005for a shielded communication room in aninternational location; partially offset by $0.6million of royalty income.**EARNINGS BEFORE INTEREST AND TAXES (EBIT)**The Company evaluates the performance of itsoperating segments based on EBIT, which the Companydefines as earnings before interest and taxes.EBIT is not a defined GAAP measure. However, theCompany believes that EBIT provides investors andManagement with a valuable and alternative method forassessing the Company’s operating results.**ESCO TECHNOLOGIES INC.**     12     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS**Management evaluates the performance of its operatingsegments based on EBIT and believes that EBIT isuseful to investors to demonstrate the operationalprofitability of the Company’s business segments byexcluding interest and taxes, which are generallyaccounted for across the entire company on aconsolidated basis. EBIT is also one of the measuresManagement uses to determine resource allocations andincentive compensation.**EBIT**                                   **Change**  Change   Fiscal year ended  **2009**  2008 (Dollars in millions) **2009**  2008  2007  **vs. 2008**  vs. 2007  USG **$****62.5**   66.6   22.6   **(6.2****)%**  194.7%% of net sales  **16.7****%**  18.9%  11.9%  **(2.2****)%**  7.0%Test  **14.1**   13.9   14.4   **1.4****%**  (3.5)%% of net sales  **10.2****%**  9.6%  10.2%  **0.6****%**  (0.6)%Filtration  **18.1**   21.2   18.4   **(14.6****)%**  15.2%% of net sales  **17.0****%**  18.3%  17.4%  **(1.3****)%**  0.8%Corporate  **(24.1****)**  (20.6)  (17.4)  **17.0****%**  18.4% Total **$****70.6**   81.1   38.0   **(12.9****)%**  113.4%% of net sales  **11.4****%**  13.2%  8.7%  **(1.8****)%**  4.5% The reconciliation of EBIT to a GAAP financial measure is as follows:             (Dollars in millions) **2009**  2008  2007  EBIT **$****70.6**   81.1   38.0 Less: Interest expense  **(7.4****)**  (9.8)  — Add: Interest income  **—**   —   0.7 Less: Income taxes  **(13.9****)**  (23.7)  (7.9) Net earnings fromcontinuing operations **$****49.3**   47.6   30.8  **USG**The $4.1 million decrease in EBIT in 2009 as comparedto 2008 was due to: a decrease in EBIT from theAclara Group due to lower margins on product sales, a$2.3 million charge related to the Aclara RF facilityrelocation, mentioned in other expenses, net, aboveand an increase in amortization for the TWACS NGcapitalized software. Additionally, 2008 included$15.0 million of EBIT associated with the PG&E/AclaraPLS deferred revenue recognized in 2008.The $44.0 million increase in EBIT in 2008 ascompared to 2007 was due to: the EBIT contributionfrom Doble; and an increase in EBIT from Aclararelated to the increased sales volumes.**Test**The $0.2 million increase in EBIT in 2009 ascompared to the prior year was due to a reduction ofthe segment’s SG&A expenses.The $0.5 milliondecrease in EBIT in 2008 as compared to the prioryear was mainly due to: a decrease in EBIT from theCompany’s U.S. operations due to changes in productmix and $0.9 million of non-recurring costsassociated with the facility consolidation inAustin, Texas that was completed in January 2008;partially offset by a $1.2 million increase in EBITfrom the Company’s European and Asian operationsrelated to the increased sales volumes.**Filtration**EBIT decreased $3.1 million in 2009 as compared to2008 due to: lower commercial aerospace shipments atPTI; and an increase in research and developmentcosts and higher bid and proposal costs incurred inthe pursuit of a significant number of Space relatedprojects at VACCO.EBIT increased $2.8 million in 2008 as compared to2007 mainly due to: higher commercial aerospaceshipments at PTI; and an increase at TekPack due tohigher commercial product shipments.**Corporate**Corporate operating charges included in consolidatedEBIT increased by $3.5 million in 2009 as compared to2008 primarily due to: a $0.9 million increase inshare-based compensation expense; and a $0.5 millionincrease in amortization of acquired intangibleassets.Corporate operating charges included inconsolidated EBIT increased by $3.2 million in 2008as compared to 2007 mainly due to: a $2.1 millionincrease in amortization of acquired intangibleassets primarily due to the 2008 acquisition of Dobleand a $0.6 million decrease in royalty income.The “Reconciliation to Consolidated Totals(Corporate)” in Note 15 to the Consolidated FinancialStatements represents Corporate office operatingcharges.**INTEREST EXPENSE (INCOME), NET**Interestexpense was $7.4 million in 2009 compared tointerest expense of $9.8 million in 2008 and interestincome of $0.7 million in 2007, respectively. Thedecrease in interest expense in 2009 as compared to2008 was due to favorable interest rates and loweroutstanding borrowings under the revolving creditfacility. The increase in interest expense in 2008 ascompared to 2007 was due to the outstandingborrowings under the revolving credit facilityrelated to the Doble acquisition.**INCOME TAX EXPENSE**The 2009 effective tax rate from continuingoperations was 22.0% compared to 33.3% in 2008 and20.3% in 2007. The decrease in the 2009 effectivetax rate as compared to the prior year was dueprimarily to the decrease in uncertain tax positions(tax liabilities) for the fiscal years 2003 through2007, of which $3.5 million or 5.5% is the result ofthe closing of a U.S. taxing authority’s examinationof the Company’s research credit claims; and $5.0million or 7.9% is the result of the confirmation ofthe Company’s tax position for the deduction oflosses realized on the disposition**ESCO TECHNOLOGIES INC.**     13     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS**of a portion of the MicroSep business in 2004. Theoverall decrease in uncertain tax positions reduced2009 income tax expense by $8.6 million and theeffective tax rate by 13.6%; the impact of an exportincentive reduced 2008 income tax expense by $1.6million and the effective tax rate by 2.2%.The increase in the 2008 effective tax rate ascompared to 2007 was due to lower tax credits in 2008as compared to 2007. The research tax credit reduced2008 income tax expense by $1.0 million and theeffective tax rate by 1.4%; the impact of an exportincentive reduced 2008 income tax expense by $1.6million and the effective tax rate by 2.2%; theimpact of the domestic production deduction reduced2008 income tax expense by $0.8 million and theeffective tax rate by 1.1%. The research tax creditreduced 2007 income tax expense by $4.4 million andthe 2007 effective tax rate by 11.4% as a result ofthe cumulative effect of research credits for years2006 and 2007 being realized.**Capital Resources and Liquidity**Working capital from continuing operations (currentassets less current liabilities) increased to $116.2million at September 30, 2009 from $100.6 million atSeptember 30, 2008.The $26.1 million decrease inaccounts receivable at September 30, 2009 is mainlydue to: approximately $13.0 million related to theTest segment and approximately $9.0 million relatedto the USG segment, both driven by timing and volumeof sales and increased cash collections. The $17.0million increase in inventories at September 30, 2009is mainly due to an increase of $15.0 million in theUSG segment inventories to shorten lead times.Net cash provided by operating activities fromcontinuing operations was $77.5 million, $77.1million and $45.2 million in 2009, 2008 and 2007,respectively. The increase in 2008 as compared to2007 is related to an increase in pretax earningsand improvements in operating working capitalrequirements.Capital expenditures from continuing operations were$9.3 million, $16.7 million and $12.4 million in2009, 2008 and 2007, respectively. The decrease in2009 as compared to 2008 was primarily due to theETS Austin, TX facility expansion that occurredduring 2008 within the Test segment and a decreasein facility expansion costs at Aclara PLS. Therewere no commitments outstanding that were consideredmaterial for capital expenditures at September 30,2009.**DIVESTITURES**On March 13, 2009, the Company completed the saleof the business and most of the assets of Comtrakfor $3.1 million, net, of cash. This business isreflected as a discontinued operation in thefinancial statements and related notes for allperiods presented. Comtrak’s operations werepreviously included within the Company’s UtilitySolutions Group segment. A pretax loss of $1.2million related to the sale and its 2009 resultsof operations are reflected in the Company’sfiscal 2009 results in discontinued operations.On November 25, 2007, the Company completed the saleof the filtration portion of Filtertek Inc.(Filtertek) to Illinois Tool Works Inc. for $74.4million, net. The TekPack division of Filtertekwas notincluded in the transaction. The Filtertekbusinesses are accounted for as discontinuedoperations in the financial statements and relatednotes for all periods presented. A pretax loss of$0.2 million related to Filtertek is reflected inthe Company’s fiscal 2008 results in discontinuedoperations. Filtertek’s operations were includedwithin the Company’s Filtration segment prior todivestiture. The operations of the TekPackbusiness are reflected in continuing operationsand continue to be included in the Filtrationsegment.**ACQUISITIONS****2009**On September 21, 2009, the Company acquired aminority interest in Firetide, Inc. for $4 millionin cash. Firetide, Inc. is a provider of wirelessinfrastructure mesh network management systems whichwill enable communications with other Smart Gridassets and this technology will be used in Aclara’sSmart Communications Network solution. Thisinvestment is accounted for under the cost methodand is classified as a long-term other asset on theCompany’s consolidated balance sheet as of September30, 2009.On July 2, 2009, the Company acquired certain assetsof Complus Systems Pvt Ltd. (Complus) in India forapproximately $1.2 million in cash and formed a newIndian entity. The entity will operate as ETS-Indiaand its operating results, since the date ofacquisition, are included within the Test segment.**2008**On November 30, 2007, the Company acquired thecapital stock of Doble for a purchase price ofapproximately $328 million, net of cash acquired.Doble, headquartered in Watertown, Massachusetts, isa worldwide leader in providing high-end intelligentdiagnostic test solutions for the electric utilityindustry. The acquisition aligns with the Company’slong-term growth strategy of expanding its productsand services in the utility industry. The operatingresults for Doble, since the date of acquisition, areincluded within the USG segment.On July 31, 2008, the Company acquired the capitalstock of LDIC GmbH and LDIC AG (collectively “LDIC”)for a purchase price of approximately $13 million,net of cash acquired. LDIC, with operations inGermany and Switzerland, is a manufacturer ofpartial**ESCO TECHNOLOGIES INC.**     14     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS**discharge diagnostic testing instruments and systemsserving the international electric utility industry.The operating results for LDIC, since the date ofacquisition, are included within Doble in the USGsegment.All of the Company’s acquisitions have been accountedfor using the purchase method of accounting, andaccordingly, the respective purchase prices wereallocated to the assets (including intangible assets)acquired and liabilities assumed based on estimatedfair values at the date of acquisition. The financialresults from these acquisitions have been included inthe Company’s financial statements from the date ofacquisition.**BANK CREDIT FACILITY**At September 30, 2009, the Company had approximately$193 million available to borrow comprised of:approximately $143 million available under itscredit facility, plus a $50 million increase option,in addition to $44.6 million cash on hand. AtSeptember 30, 2009, the Company had outstandingborrowings of $180.5 million, and outstandingletters of credit of $7.2 million. The Companyclassified $50 million as the current portion onlong-term debt as of September 30, 2009, as theCompany intends to repay this amount within the nexttwelve months; however, the Company has nocontractual obligation to repay such amount duringthe next twelve months. As of September 30, 2009,the Company was in compliance with all bankcovenants. Cash flow from operations and borrowingsunder the bank credit facility are expected toprovide adequate resources to meet the Company’scapital requirements and operational needs for theforeseeable future.The credit facility requires, as determined bycertain financial ratios, a facility fee ranging from15 to 25 basis points per annum on the unusedportion. The terms of the facility provide thatinterest on borrowings may be calculated at a spreadover the LIBOR or based on the prime rate, at theCompany’s election. The credit facility is secured bythe unlimited guaranty of the Company’s materialdomestic subsidiaries and a 65% pledge of thematerial foreign subsidiaries’ share equity. Thefinancial covenants of the credit facility include aleverage ratio and an interest coverage ratio.**OUTLOOK — 2010**During 2010, the Company anticipates gas AMI productdeliveries to PG&E will be significantly lower thanthe quantities delivered in 2009 as the contract isentering the latter stages of deployment. Thecurrent outlook for 2010 PG&E gas product sales isexpected to be approximately $40 million as comparedto $98 million in 2009. As a result, Managementexpects 2010 consolidated revenues to decreaseapproximately three to five percent and EBIT todecline marginally compared to 2009. In addition,the 2010 effective tax rate is projected to beapproximately 38%. Given the PG&E project wind-downand higher effective tax rate, Management expectsEPS to be lower in 2010 as compared to 2009. On aquarterly basis, the Company expects 2010 revenuesand EPS to be heavily “second half” weighted as theywere in 2009 and 2008.**CONTRACTUAL OBLIGATIONS**The following table shows the Company’s contractualobligations as of September 30, 2009:                     (Dollars in millions) Payments due by period       Less          More Contractual     than  1 to 3  3 to 5  than Obligations Total  1 year  years  years  5 years  Long-Term DebtObligation $180.5   50.0   —   130.5   — Estimated InterestPayments(1)  5.6   2.7   2.9   —   — Operating LeaseObligations  29.6   7.4   11.8   5.2   5.2 Purchase Obligations(2)  —   —   —   —   —  Total $215.7   60.1   14.7   135.7   5.2   (1) Estimated interest payments for theCompany’s debt obligations werecalculated based on Management’s determination of theestimated applicable interest rates and paymentdates. (2) A purchase obligation is defined as alegally binding and enforceable agreement to purchasegoods and services that specifies all significantterms. Since the Company’s purchase orders can becancelled, they are not included in the table above.As of September 30, 2009, the Company had $3.3million of liabilities for uncertain tax positions.The unrecognized tax benefits have been excluded fromthe table above due to uncertainty as to the amountsand timing of settlement with taxing authorities.TheCompany has no off balance sheet arrangementsoutstanding at September 30, 2009.**SHARE REPURCHASES**In August 2009, the Company’s Board of Directorsextended its previously authorized open marketcommon stock repurchase program of the Company’sshares at a value not to exceed $30 million,subject to market conditions and other factorswhich covers the period through September 30, 2010.There were no stock repurchases during 2009 or2008. The Company repurchased $10 million or265,000 shares in 2007 under a previouslyauthorized program.**ESCO TECHNOLOGIES INC.**     15     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS****PENSION FUNDING REQUIREMENTS**The minimum cash funding requirements related tothe Company’s defined benefit pension plans areapproximately $1.3 million in 2010, approximately$3.0 million in 2011 and approximately $3.5 millionin 2012.**OTHER**Management believes that, for the periods presented,inflation has not had a material effect on theCompany’s results of operations.The Company iscurrently involved in various stages of investigationand remediation relating to environmental matters.Based on current information available, Managementdoes not believe the aggregate costs involved in theresolution of these matters will have a materialadverse effect on the Company’s operating results,capital expenditures or competitive position.**Market Risk Analysis****MARKET RISK EXPOSURE**Market risks relating to the Company’s operationsresult primarily from changes in interest rates andchanges in foreign currency exchange rates. TheCompany is exposed to market risk related to changesin interest rates and selectively uses derivativefinancial instruments, including forward contractsand swaps, to manage these risks. During 2009, theCompany entered into two $40 million one-year forwardinterest rate swaps effective October 5, 2009, tohedge some of its exposure to variability in futureLIBOR-based interest payments on variable rate debt.In addition, during 2008, the Company entered into atwo-year amortizing interest rate swap to hedge someof its exposure to variability in future LIBOR-basedinterest payments on variable rate debt. The swapnotional amount for the first year was $175 millionamortizing to $100 million in the second year. Allderivative instruments are reported on the balancesheet at fair value. The derivative instrument isdesignated as a cash flow hedge and the gain or losson the derivative is deferred inaccumulated other comprehensive income untilrecognized in earnings with the underlying hedgeditem. Based on the interest rate swaps outstanding,the interest rates on approximately 50% of theCompany’s total borrowings were effectively fixed asof September 30, 2009. The following is a summary ofthe notional transaction amounts and fair values forthe Company’s outstanding derivative financialinstruments by risk category and instrument type, asof September 30, 2009.                   Notional  Average  Average  Fair (Dollars in thousands) Amount  Rec Rate  Pay Rate  Value  Interest rate swap  $100,000         0.31%  3.99% $(685)Interest rate swaps* $80,000          N/A   1.52% $(778)  * These swaps represent forward-startingswaps and will be effective in October 2009.The Company is also subject to foreign currencyexchange rate risk inherent in its sales commitments,anticipated sales, anticipated purchases and assetsand liabilities denominated in currencies other thanthe U.S. dollar. The foreign currency mostsignificant to the Company’s operations is the Euro.Net sales to customers outside of the United Stateswere $110.7 million, $130.9 million, and $85.5million in 2009, 2008 and 2007, respectively. TheCompany hedges certain foreign currency commitmentsby purchasing foreign currency forward contracts. Theestimated fair value of open forward contracts atSeptember 30, 2009 was not material.**Critical Accounting Policies**The preparation of financial statements in conformitywith GAAP requires Management to make estimates andassumptions in certain circumstances that affectamounts reported in the accompanying ConsolidatedFinancial Statements. In preparing these financialstatements, Management has made its best estimatesand judgments of certain amounts included in theConsolidated Financial Statements, giving dueconsideration to materiality. The Company does notbelieve there is a great likelihood that materiallydifferent amounts would be reported under differentconditions or using different assumptions related tothe accounting policies described below. However,application of these accounting policies involves theexercise of judgment and use of assumptions as tofuture uncertainties and, as a result, actual resultscould differ from these estimates. The Company’ssenior Management discusses the critical accountingpolicies described below with the Audit and FinanceCommittee of the Company’s Board of Directors on aperiodic basis.The following discussion of critical accountingpolicies is intended to bring to the attention ofreaders those accounting policies which Managementbelieves are critical to the Consolidated FinancialStatements and other financial disclosure. It is notintended to be a comprehensive list of allsignificant accounting policies that are more fullydescribed in Note 1 of Notes to ConsolidatedFinancial Statements.**REVENUE RECOGNITION*****USG Segment:***Within the USG segment, approximately96% of the segment’s revenue arrangements(approximately 60% of consolidated revenues) containsoftware components. Revenue under thesearrangements is recognized in accordance with FASBASC Subtopic 985-605, *Software — Revenue Recognition*. Theapplication of software revenue recognition requiresjudgment, including the determination of whether asoftware arrangement includes multiple elements andestimates of the fair value of the elements, orvendor-specific objective evidence of fair value(“VSOE”). Changes to the elements in a softwarearrangement, and the ability to identify VSOE forthose elements could materially impact the amount ofearned and/or deferred revenue. There have**ESCO TECHNOLOGIES INC.**     16     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS**been no material changes to these estimates for thefinancial statement periods presented and the Companybelieves that these estimates generally should not besubject to significant variation in the future. Theremaining 4% of the segment’s revenues representproducts sold under a single element arrangement andare recognized when services are performed forunaffiliated customers or when products are delivered(when title and risk of ownership transfers).***TestSegment:***Within the Test segment, approximately 40%of revenues (approximately 10% of consolidatedrevenues) are recognized when products are delivered(when title and risk of ownership transfers) or whenservices are performed for unaffiliated customers.Certain arrangements contain multiple elements whichare accounted for under the provisions of FASB ASCSubtopic 605-25, *Revenue Recognition:Multiple-Element Arrangements*. The application of theapplicable guidance requires judgment as to whetherthe deliverables can be divided into more than oneunit of accounting and whether the separate units ofaccounting have value to the customer on astand-alone basis. Changes to these elements couldaffect the timing of revenue recognition. There havebeen no material changes to these elements for thefinancial statement periods presented.Approximately 60% of the segment’s revenues(approximately 15% of consolidated revenues) arerecorded under the percentage-of-completionprovisions of FASB ASC Subtopic 605-35, *RevenueRecognition: Construction-Type and Production-TypeContracts*due to the complex nature of theenclosures that are designed and produced underthese contracts. As discussed above, this method ofaccounting involves the use of various estimatingtechniques to project costs at completion, which arebased on Management’s judgment and the Company’ssubstantial experience in developing these types ofestimates. Changes in underlying assumptions/estimates may adversely or positively affectfinancial performance. Due to the nature of thesecontracts and the operating unit’s cost estimatingprocess, the Company believes that these estimatesgenerally should not be subject to significantvariation in the future. There have been no materialchanges to these estimates for the financialstatement periods presented. The Company regularlyreviews its contract estimates to assess revisionsin contract values and estimated costs atcompletion.***Filtration Segment:***Within the Filtration segment,approximately 60% of segment revenues (approximately10% of consolidated revenues) are recognized whenproducts are delivered (when title and risk ofownership transfers) or when services are performedfor unaffiliated customers.Approximately 40% of segment revenues(approximately 5% of consolidated revenues) arerecorded under the percentage-of-completionprovisions of FASB ASC Subtopic 605-35, *RevenueRecognition: Construction-Type andProduction-Type Contracts*because the Companymanufactures complex products for aerospace andmilitary customers under production contracts.The percentage-of-completion method of accountinginvolves the use of various estimating techniquesto project costs at completion. These estimatesinvolve various assumptions and projectionsrelative to the outcome of future events over aperiod of several years, including future laborproductivity and availability, the nature andcomplexity of the work to be performed,availability of materials, the impact of delayedperformance, and the timing of productdeliveries. These estimates are based onManagement’s judgment and the Company’ssubstantial experience in developing these typesof estimates. Changes in underlyingassumptions/estimates may adversely affectfinancial performance if they increase estimatedproject costs at completion, or positively affectfinancial performance if they decrease estimatedproject costs at completion. Due to the nature ofthese contracts and the operating unit’s costestimating process, the Company believes thatthese estimates generally should not be subjectto significant variation in the future. Therehave been no material changes to these estimatesfor the financial statement periods presented.The Company regularly reviews its estimates toassess revisions in contract values and estimatedcosts at completion.**INVENTORY**Inventories are valued at the lower of cost(first-in, first-out) or market value. Managementregularly reviews inventories on hand compared tohistorical usage and estimated future usage andsales. Inventories under long-term contracts reflectaccumulated production costs, factory overhead,initial tooling and other related costs less theportion of such costs charged to cost of sales andany unliquidated progress payments. In accordancewith industry practice, costs incurred on contractsin progress include amounts relating to programshaving production cycles longer than one year, and aportion thereof may not be realized within one year.**INCOME TAXES**The Company operates in numerous taxing jurisdictionsand is subject to examination by various U.S.Federal, state and foreign jurisdictions for varioustax periods. Additionally, the Company has retainedtax liabilities and the rights to tax refunds inconnection with various divestitures of businesses inprior years. The Company’s income tax positions arebased on research and interpretations of the incometax laws and rulings in each of the jurisdictions inwhich the Company does business. Due to thesubjectivity of interpretations of laws and rulingsin each jurisdiction, the differences and interplayin tax laws between those jurisdictions, as well asthe inherent uncertainty in estimating the finalresolution of complex tax audit matters, Management’sestimates of income tax liabilities may differ fromactual payments or assessments.**ESCO TECHNOLOGIES INC.**     17     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS**Management regularly assesses the Company’s positionwith regard to tax exposures and records liabilitiesfor these uncertain tax positions and relatedinterest and penalties, if any, according to theprinciples of FASB ASC Topic 740, *Income Taxes*(ASC740). The Company has recorded an accrual thatreflects the recognition and measurement process forthe financial statement recognition and measurementof a tax position taken or expected to be taken on atax return based upon ASC 740. Additional futureincome tax expense or benefit may be recognized oncethe positions are effectively settled. It is theCompany’s policy to follow FASB ASC 740-10-45-20 andrecord the tax effects of changes in the openingbalance of unrecognized tax benefits in net earningsfrom continuing operations.At the end of each interim reporting period,Management estimates the effective tax rate expectedto apply to the full fiscal year. The estimatedeffective tax rate contemplates the expectedjurisdiction where income is earned, as well as taxplanning strategies. Current and projected growth inincome in higher tax jurisdictions may result in anincreasing effective tax rate over time. If theactual results differ from Management’s estimates,Management may have to adjust the effective tax ratein the interim period if such determination is made.Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilitiesare recognized for the future tax consequencesattributable to differences between the financialstatement carrying amounts of existing assets andliabilities and their respective tax bases. Deferredtax assets and liabilities are measured using enactedtax rates expected to apply to taxable income in theyears in which those temporary differences areexpected to be recovered or settled. Deferred taxassets may be reduced by a valuation allowance if itis more likely than not that some portion of thedeferred tax assets will not be realized. The effecton deferred tax assets and liabilities of a change intax rates is recognized in income in the period thatincludes the enactment date. The Company regularlyreviews its deferred tax assets for recoverabilityand establishes a valuation allowance when Managementbelieves it is more likely than not such assets willnot be recovered, taking into considerationhistorical operating results, expectations of futureearnings, tax planning strategies, and the expectedtiming of the reversals of existing temporarydifferences.**GOODWILL AND OTHER LONG-LIVED ASSETS**In accordance with FASB ASC Topic 350, *Intangibles —Goodwill and Other*(ASC 350), Management annuallyreviews goodwill and other long-lived assets withindefinite useful lives for impairment or wheneverevents or changes in circumstances indicate thecarrying amount may not be recoverable. If theCompany determines that the carrying value of thelong-lived asset may not be recoverable, a permanentimpairment charge is recorded for the amount by whichthe carrying value of the long-lived asset exceedsits fair value. Fair value is measured based on adiscounted cash flow method using a discount ratedetermined by Management to be commensurate with therisk inherent in the Company’s current businessmodel. The estimates of cash flows and discount rateare subject to change due to the economicenvironment, including such factors as interestrates, expected market returns and volatility ofmarkets served. Management believes that theestimates of future cash flows and fair value arereasonable; however, changes in estimates couldresult in impairment charges. At September 30, 2009,the Companyhas determined that no reporting units are at risk ofmaterial goodwill impairment. Intangible assets withestimable useful lives are amortized over theirrespective estimated useful lives to their estimatedresidual values, and reviewed annually forimpairment.**PENSION PLANS AND OTHER POSTRETIREMENT BENEFIT PLANS**The measurement of liabilities related to pensionplans and other post-retirement benefit plans isbased on Management’s assumptions related to futureevents including interest rates, return on pensionplan assets, rate of compensation increases, andhealth care cost trend rates. Actual pension planasset performance will either decrease or increaseunamortized pension losses that will affect netearnings in future years. Depending upon theperformance of the equity and bond markets in 2010,the Company could be required to record a charge toequity. In addition, if the discount rate wasdecreased by 25 basis points from 5.5% to 5.25%, theprojected benefit obligation for the defined benefitplan would increase by approximately $2.1 million andresult in an additional after-tax charge toshareholders’ equity of approximately $1.3 million.The discount rate used in measuring the Company’spension and postretirement welfare obligations wasdeveloped by matching yields of actual high-qualitycorporate bonds to expected future pension plan cashflows (benefit payments). Over 400 Aa-rated,non-callable bonds with a wide range of maturitieswere used in the analysis. After using the bondyields to determine the present value of the plancash flows, a single representative rate thatresulted in the same present value was developed.**Other Matters****CONTINGENCIES**As a normal incident of the businesses in which theCompany is engaged, various claims, charges andlitigation are asserted or commenced against theCompany. In the opinion of Management, finaljudgments, if any, which might be rendered againstthe Company are adequately reserved, covered byinsurance, or otherwise are not likely to have amaterial adverse effect on its financial conditionor results of operation.**ESCO TECHNOLOGIES INC.**     18     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**Market risks relating to the Company’s operationsresult primarily from changes in interest rates andchanges in foreign currency exchange rates. TheCompany is exposed to market risk related to changesin interest rates and selectively uses derivativefinancial instruments, including forward contractsand swaps, to manage these risks. During 2009, theCompany entered into two $40 million one-year forwardinterest rate swaps effective October 5, 2009, tohedge some of its exposure to variability in futureLIBOR-based interest payments on variable rate debt.In addition, during 2008, the Company entered into atwo-year amortizing interest rate swap to hedge someof its exposure to variability in future LIBOR-basedinterest payments on variable rate debt. The swapnotional amount for the first year was $175 millionamortizing to $100 million in the second year. Allderivativeinstruments are reported on the balance sheet at fairvalue. The derivative instrument is designated as acash flow hedge and the gain or loss on thederivative is deferred in accumulated othercomprehensive income until recognized in earningswith the underlying hedged item. See furtherdiscussion in “Management’s Discussion and Analysis— Market Risk Analysis” regarding the Company’smarket risks.**CONTROLS AND PROCEDURES**The Company carried out an evaluation under thesupervision of and with the participation ofManagement, including the Company’s Chief ExecutiveOfficer and Chief Financial Officer, of theeffectiveness of the design and operation of theCompany’s disclosure controls and procedures as ofthe end of the period covered by this report. Basedupon that evaluation, the Company’s Chief ExecutiveOfficer and Chief Financial Officer concluded thatthe Company’s disclosure controls and procedures areeffective. Disclosure controls and procedures arecontrols and procedures that are designed to ensurethat information required to be disclosed in Companyreports filed or submitted under the SecuritiesExchange Act of 1934 is recorded, processed,summarized and reported within time periods specifiedin the Securities and Exchange Commission’s rules andforms. There have been no significant changes in theCompany’s internal controls or in other factorsduring the period covered by this report that havematerially affected, or are reasonably likely tomaterially affect, the Company’s internal controlover financial reporting.**New Accounting Pronouncements**In October 2009, the Financial Accounting StandardsBoard (FASB) issued Update No. 2009-13,*Multiple-Deliverable Revenue Arrangements*(ASU2009-13) and Update No. 2009-14, *Certain RevenueArrangements That Include Software Elements*(ASU2009-14) — *consensuses of the FASB Emerging IssuesTask Force*. ASU 2009-13 applies tomultiple-deliverable revenue arrangements that arecurrently within the scope of Subtopic 605-25 andprovides two significant changes: (i) requires anentity to allocate revenue in an arrangement usingestimated selling prices of deliverables if a vendordoes not have vendor-specific objective evidence orthird-party evidence of selling price and (ii)eliminates the residual method to allocate thearrangement consideration. The consensus also expandsthe disclosure requirements for multiple-deliverablerevenue arrangements. ASU 2009-14 removes tangibleproducts from the scope of the software revenueguidance and provides guidance on determining whethersoftware deliverables in an arrangement that includesa tangible product are within the scope of thesoftware revenue guidance. These consensuses shouldbe applied on a prospective basis for revenuearrangements entered into in fiscal years beginningon or after June 15, 2010 with earlier applicationpermitted. The Company is currently assessing theimpact of this new guidance on its ConsolidatedFinancial Statements and related disclosures.On July 1, 2009, the Company adopted FASB ASC105-10 (ASC 105-10) which established the *FASBAccounting Standards Codification*(the“Codification”) as the source of authoritativeaccounting principles recognized by the FASB to beapplied in the preparation of financial statementsin conformity with GAAP. Rules and interpretivereleases of the SEC under authority of Federalsecurities laws are also sources of authoritativeGAAP for nongovernmental entities. The adoption ofthis Statement did not have amaterial impact on the Company’s ConsolidatedFinancial Statements.Effective April 1, 2009, the Company adopted the newaccounting guidance for subsequent events ascodified in FASB ASC 855, *Subsequent Events*. The newguidance establishes general standards of accountingfor and disclosure of events that occur after thebalance sheet date but before financial statementsare issued or are available to be issued. This newguidance was effective for interim and annualfinancial periods ending after June 15, 2009. TheCompany has evaluated subsequent events ortransactions that occurred after the balance sheetdate of September 30, 2009 up through November 30,2009, which is the date the accompanyingConsolidated Financial Statements were issued.**ESCO TECHNOLOGIES INC.**     19     **2009 ANNUAL REPORT**
 

 
**MANAGEMENT’S DISCUSSION AND ANALYSIS****Forward-Looking Information**Statements regarding future events and the Company’sfuture results that are based on currentexpectations, estimates, forecasts and projectionsabout the Company’s performance and the industries inwhich the Company operates, 2010 revenues, EBIT, EPS,adequacy of the Company’s credit facilities andfuture cash flows, estimates of anticipated contractcosts and revenues, the anticipated total value ofthe Aclara RF Contract with PG&E and with the City ofNew York, the anticipated total value of Aclara PLS’scontract with Idaho Power Company, the anticipatedtotal value of TekPackaging’s recently received fiveyear production contract, the outcome of currentlitigation, claims and charges, the anticipatedtiming and amount of lost deferred tax assets,continued reinvestment of foreign earnings, thetiming, total value and period of performance ofcontracts awarded to the Company, the accuracy of theCompany’s estimates utilized in software revenuerecognition, the accuracy of the Company’s estimatesutilized to project costs at completion in the Testsegment and Filtration segment, income taxliabilities, the effective tax rate, the amount,timing and ability to use net research tax credits,the timing and amount of the reduction ofunrecognized tax benefits, repayment of debt withinthe next twelve months, the recognition of costsrelated to share-based compensation arrangements,future costs relating to environmental matters, sharerepurchases, investments, sustained performanceimprovement, performance improvement initiatives,growth opportunities, new product development, theCompany’s ability to increase shareholder value,acquisitions, and the beliefs and assumptions ofManagement contained in the letter To OurShareholders (pages 1-2), and Management’s DiscussionandAnalysis and other statements contained herein whichare not strictly historical are considered“forward-looking statements” within the meaning ofthe safe harbor provisions of the Federal securitieslaws. Words such as expects, anticipates, targets,goals, projects, intends, plans, believes,estimates, variations of such words, and similarexpressions are intended to identify suchforward-looking statements. Investors are cautionedthat such statements are only predictions, speakonly as of the date of this report, and the Companyundertakes no duty to update. The Company’sactual results in the future may differ materiallyfrom those projected in the forward-lookingstatements due to risks and uncertainties that existin the Company’s operations and business environmentincluding, but not limited to those described under“Item 1A. Risk Factors” in the Company’s AnnualReport on Form 10-K for the fiscal year endedSeptember 30, 2009 and the following: the timing andcontent of purchase order releases under the PG&Econtract; termination for convenience of customercontracts; timing and magnitude of future contractawards; weakening of economic conditions in servedmarkets; the success of the Company’s competitors;changes in customer demands or customerinsolvencies; competition; intellectual propertyrights; technical difficulties; the availability ofselected acquisitions; delivery delays or defaultsby customers; performance issues with key customers,suppliers and subcontractors; material changes inthe costs of certain raw materials; labor disputes;changes in laws and regulations including but notlimited to changes in accounting standards andtaxation requirements; costs relating toenvironmental matters; litigation uncertainty; andthe Company’s successful execution of internaloperating plans.**ESCO TECHNOLOGIES INC.**     20     **2009 ANNUAL REPORT**
 

 
**CONSOLIDATED STATEMENTS OF OPERATIONS**             (Dollars in thousands, except per share amounts)         Years ended September 30, **2009**  2008  2007  Net sales **$****619,064**   613,566   437,375              Costs and expenses:            Cost of sales  **372,351**   367,951   278,108 Selling, general and administrative expenses  **152,397**   147,324   108,207 Amortization of intangible assets  **19,214**   17,044   10,243 Interest expense (income), net  **7,450**   9,808   (677)Other expenses, net  **4,480**   161   2,834  Total costs and expenses  **555,892**   542,288   398,715  Earnings before income tax  **63,172**   71,278   38,660 Income tax expense  **13,867**   23,709   7,854  Net earnings from continuing operations **$****49,305**   47,569   30,806  Earnings (loss) from discontinued operations, net of tax of$568 in 2009, $229 in 2008 and $1,161 in 2007  **135**   (282)  2,907 Loss on sale of discontinued operations, net of tax of $905 in 2009,$157 in 2008  **(32****)**  (576)  —  Net earnings (loss) from discontinued operations  **103**   (858)  2,907  Net earnings **$****49,408**   46,711   33,713               Earnings (loss) per share:            Basic:            Continuing operations **$****1.88**   1.84   1.19 Discontinued operations  —   (0.04)  0.11  Net earnings **$****1.88**   1.80   1.30  Diluted:            Continuing operations  **1.86**   1.81   1.17 Discontinued operations  **—**   (0.03)  0.11  Net earnings **$****1.86**   1.78   1.28               Average common shares outstanding (in thousands):            Basic  **26,216**   25,909   25,865 Diluted  **26,560**   26,315   26,387  See accompanying Notes to Consolidated Financial Statements.**ESCO TECHNOLOGIES INC.**     21     **2009 ANNUAL REPORT**
 

 
**CONSOLIDATED BALANCE SHEETS**         (Dollars in thousands)      Years ended September 30, **2009**  2008           **ASSETS**                 **Current assets:**        Cash and cash equivalents **$****44,630**   28,667 Accounts receivable, less allowance for doubtful accounts of$1,457 and $1,050 in 2009 and 2008, respectively  **108,620**   134,710 Costs and estimated earnings on long-term contracts, less progressbillings of $19,861 and $34,978 in 2009 and 2008, respectively  **10,758**   9,095 Inventories  **82,020**   65,019 Current portion of deferred tax assets  **20,417**   15,368 Other current assets  **13,750**   14,888 Current assets from discontinued operations  **—**   2,889  Total current assets  **280,195**   270,636           **Property, plant and equipment:**        Land and land improvements  **4,996**   5,342 Buildings and leasehold improvements  **49,181**   47,829 Machinery and equipment  **71,773**   63,995 Construction in progress  **2,290**   2,344     **128,240**   119,510          Less accumulated depreciation and amortization  **58,697**   47,157  Net property, plant and equipment  **69,543**   72,353 Goodwill  **330,719**   328,878 Intangible assets, net  **221,600**   236,192 Other assets  **21,630**   17,665 Other assets from discontinued operations  **—**   2,349    **$****923,687**   928,073  See accompanying Notes to Consolidated Financial Statements.**ESCO TECHNOLOGIES INC.**     22     **2009 ANNUAL REPORT**
 

 
**CONSOLIDATED BALANCE SHEETS**         (Dollars in thousands)      Years ended September 30, **2009**  2008           **LIABILITIES AND SHAREHOLDERS’ EQUITY**                 **Current liabilities:**        Current maturities of long-term debt **$****50,000**   50,000 Accounts payable  **47,218**   48,982 Advance payments on long-term contracts, less costs incurredof $17,484 and $7,880 in 2009 and 2008, respectively  **2,840**   7,467 Accrued salaries  **20,465**   20,409 Current portion of deferred revenue  **20,215**   18,226 Accrued other expenses  **23,247**   22,058 Current liabilities from discontinued operations  **—**   1,541  Total current liabilities  **163,985**   168,683  Pension obligations  **27,483**   12,172 Deferred tax liabilities  **78,471**   83,515 Other liabilities  **5,941**   11,816 Long-term debt  **130,467**   183,650  Total liabilities  **406,347**   459,836           **Shareholders’ equity:**        Preferred stock, par value $.01 per share, authorized 10,000,000 shares  **—**   — Common stock, par value $.01 per share, authorized 50,000,000 shares;Issued 29,771,103 and 29,465,154 shares in 2009 and 2008, respectively  **298**   295 Additional paid-in capital  **265,794**   254,240 Retained earnings  **322,878**   273,470 Accumulated other comprehensive (loss) income, net of tax  **(11,598****)**  556     **577,372**   528,561          Less treasury stock, at cost (3,357,046 and 3,375,106 common shares in2009 and 2008, respectively)  **(60,032****)**  (60,324) Total shareholders’ equity  **517,340**   468,237    **$****923,687**   928,073  See accompanying Notes to Consolidated Financial Statements.**ESCO TECHNOLOGIES INC.**     23     **2009 ANNUAL REPORT**
 

 
**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**                                               Accumulated                 Additional      Other         Common Stock  Paid-In  Retained  Comprehensive  Treasury    (In thousands) Shares  Amount  Capital  Earnings  Income (Loss)  Stock  Total  Balance, September 30, 2006  29,031  $290   236,390   193,046   (2,070)  (51,222)  376,434                             Comprehensive income:                            Net earnings  —   —   —   33,713   —   —   33,713 Translation adjustments  —   —   —   —   4,252   —   4,252 Minimum pension liability,net of tax of $(1,622)  —   —   —   —   3,558   —   3,558                             Comprehensive income                          41,523                             SFAS 158 adjustment, net of tax of $(358)  —   —   —   —   563   —   563 Stock options and stock compensationplans, net of tax benefit of $(828)  129   2   6,741   —   —   227   6,970 Purchases into treasury  —   —   —   —   —   (10,007)  (10,007) Balance, September 30, 2007  29,160   292   243,131   226,759   6,303   (61,002)  415,483                             Comprehensive income:                            Net earnings  —   —   —   46,711   —   —   46,711 Translation adjustments  —   —   —   —   (869)  —   (869)Net unrecognized actuarial loss,net of tax of $2,506  —   —   —   —   (4,043)  —   (4,043)Interest rate swap, net of tax of $512                  (835)      (835)                            Comprehensive income                          40,964                             Stock options and stock compensationplans, net of tax benefit of $(845)  305   3   11,109   —   —   678   11,790  Balance, September 30, 2008  29,465   295   254,240   273,470   556   (60,324)  468,237                             Comprehensive income:                            Net earnings  **—**   **—**   **—**   **49,408**   **—**   **—**   **49,408** Translation adjustments  **—**   **—**   **—**   **—**   **(707****)**  **—**   **(707****)**Net unrecognized actuarial loss,net of tax of $7,488  **—**   **—**   **—**   **—**   **(11,393****)**  **—**   **(11,393****)**Interest rate swap, net of tax of $62  **—**   **—**   **—**   **—**   **(54****)**  **—**   **(54****)**                            Comprehensive income                          **37,254**                             Stock options and stock compensationplans, net of tax benefit of $(325)  **306**   **3**   **11,554**   **—**   **—**   **292**   **11,849**  Balance, September 30, 2009  **29,771**  **$****298**   **265,794**   **322,878**   **(11,598****)**  **(60,032****)**  **517,340**  See accompanying Notes to Consolidated Financial Statements.**ESCO TECHNOLOGIES INC.**     24     **2009 ANNUAL REPORT**
 

 
**CONSOLIDATED STATEMENTS OF CASH FLOWS**             (Dollars in thousands)         Years ended September 30, **2009**  2008  2007  Cash flows from operating activities:            Net earnings **$****49,408**   46,711   33,713 Adjustments to reconcile net earnings to net cash provided by operating activities:            Net (earnings) loss from discontinued operations, net of tax  **(103****)**  858   (2,907)Depreciation and amortization  **30,267**   27,067   16,308 Stock compensation expense  **4,866**   3,990   4,834 Changes in current assets and liabilities  **1,566**   (12,154)  (26,384)Effect of deferred taxes on tax provision  **(2,543****)**  12,349   13,759 Change in deferred revenue and costs, net  **1,781**   (3,284)  9,339 Pension contributions  **(1,997****)**  (531)  — Change in uncertain tax positions  **(5,700****)**  2,335   (1,281)Other  **(71****)**  (270)  (2,158) Net cash provided by operating activities — continuing operations  **77,474**   77,071   45,223 Net earnings (loss) from discontinued operations, net of tax  **103**   (858)  2,907 Net cash provided (used) by discontinued operations  **39**   673   (5,564) Net cash provided (used) by operating activities — discontinued operations  **142**   (185)  (2,657) Net cash provided by operating activities  **77,616**   76,886   42,566  Cash flows from investing activities:            Acquisition of businesses, net of cash acquired  **(6,442****)**  (345,395)  (8,250)Proceeds from sale of marketable securities  **—**   4,966   — Change in restricted cash (acquisition escrow)  **2,189**   (6,841)  — Capital expenditures  **(9,255****)**  (16,669)  (12,408)Additions to capitalized software  **(5,004****)**  (10,488)  (28,555) Net cash used by investing activities — continuing operations  **(18,512****)**  (374,427)  (49,213)Capital expenditures — discontinued operations  **—**   (1,140)  (7,095)Proceeds from divestiture of business, net — discontinued operations  **3,100**   74,370   —  Net cash provided (used) by investing activities — discontinued operations  **3,100**   73,230   (7,095) Net cash used by investing activities  **(15,412****)**  (301,197)  (56,308) Cash flows from financing activities:            Proceeds from long-term debt  **32,000**   304,157   — Principal payments on long-term debt  **(85,183****)**  (71,197)  — Debt issuance costs  **—**   (2,965)  — Net (decrease) increase in short-term borrowings — discontinued operations  **—**   (2,844)  2,844 Purchases of common stock into treasury  **—**   —   (10,007)Excess tax benefit from stock options exercised  **782**   737   73 Proceeds from exercise of stock options  **6,621**   6,384   1,843 Other  **247**   338   (173) Net cash (used) provided by financing activities  **(45,533****)**  234,610   (5,420) Effect of exchange rate changes on cash and cash equivalents  **(708****)**  (270)  981 Net increase (decrease) in cash and cash equivalents  **15,963**   10,029   (18,181)Cash and cash equivalents at beginning of year  **28,667**   18,638   36,819  Cash and cash equivalents at end of year **$****44,630**   28,667   18,638  Changes in current assets and liabilities:            Accounts receivable, net **$****26,090**   (32,688)  (15,424)Costs and estimated earnings on long-term contracts, net  **(1,663****)**  2,425   (10,175)Inventories  **(17,001****)**  443   (12,007)Other current assets  **(714****)**  4,777   (4,926)Accounts payable  **(1,764****)**  1,163   13,050 Advance payments on long-term contracts, net  **(4,627****)**  3,716   (3,959)Accrued expenses  **1,245**   8,010   7,057    **$****1,566**   (12,154)  (26,384) Supplemental cash flow information:            Interest paid **$****7,425**   9,233   109 Income taxes paid (including state, foreign & AMT)  **22,144**   7,004   3,731  See accompanying Notes to Consolidated Financial Statements.**ESCO TECHNOLOGIES INC.**     25     **2009 ANNUAL REPORT**
 

 
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****1. Summary of Significant Accounting Policies****A. PRINCIPLES OF CONSOLIDATION**The Consolidated Financial Statementsinclude the accounts of ESCO Technologies Inc.(ESCO) and its wholly owned subsidiaries (theCompany). All significant intercompanytransactions and accounts have been eliminated inconsolidation.**B. BASIS OF PRESENTATION**Fair values of the Company’s financialinstruments are estimated by reference to quotedprices from market sources and financialinstitutions, as well as other valuationtechniques. The estimated fair value of each classof financial instruments approximated the relatedcarrying value at September 30, 2009 and 2008.The business and most of the assets of ComtrakTechnologies, LLC (Comtrak) were sold during thesecond quarter of fiscal 2009. In addition, theFiltertek businesses (excluding TekPackaging LLC)were sold during fiscal 2008. Comtrak and Filtertekare accounted for as discontinued operations inaccordance with accounting principles generallyaccepted in the United States of America (GAAP).**C. NATURE OF OPERATIONS**The Company has three reportable segments:Utility Solutions Group (USG), RF Shielding and Test(Test), and Filtration/Fluid Flow (Filtration).***USG:***The Aclara Group is a proven supplier of specialpurpose fixed-network communications systems forelectric, gas and water utilities, including hardwareand software to support advanced meteringapplications. Doble provides high-end, intelligent,diagnostic test solutions for the electric powerdelivery industry.***Test:***The EMC Group is an industryleader in providing its customers with the ability toidentify, measure and contain magnetic,electromagnetic and acoustic energy.***Filtration:***The companies within this segmentdesign and manufacture specialty filtrationproducts including hydraulic filter elements usedin commercial aerospace applications, unique filtermechanisms used in micro propulsion devices forsatellites and custom designed filters for mannedand unmanned aircraft.**D. USE OF ESTIMATES**The preparation of financial statements inconformity with GAAP requires Management to makeestimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of thefinancial statements and the reported amounts ofrevenues and expenses during the reporting periods.The Company regularly evaluates the estimates andassumptions related to the allowance for doubtfultrade receivables, inventory obsolescence, warrantyreserves, value of equity-based awards, goodwill andpurchased intangible asset valuations, assetimpairments, employee benefit plan liabilities,income tax liabilities and assets and relatedvaluation allowances, uncertain tax positions, andlitigation and other loss contingencies. Actualresults could differ from those estimates.**E. REVENUE RECOGNITION*****USG Segment:***Within the USG segment,approximately 96% of the segment’s revenuearrangements (approximately 60% of consolidatedrevenues) contain software components. Revenue underthese arrangements is recognized in accordance withFASB ASC Subtopic 985-605, *Software — RevenueRecognition*. The segment’s software revenuearrangements within the Aclara Group generallyinclude multiple products and services, or “elements”consisting of meter and substation hardware, meterreading system software, program management supportduring the deployment period and software support(post-contract customer support, “PCS”). Thesearrangements typically require the Company to deliversoftware at the inception of the arrangement whilethe hardware and program management support aredelivered over the contractual deployment period.Software support is provided during deployment andsubsequent thereto. The software element included insuch arrangements is essential to the functionalityof the hardware and, therefore, the hardware isconsidered to be software-related. Hardware isconsidered a specified element in the softwarearrangement and vendor-specific objective evidence offair value (“VSOE”) has been established for thiselement. VSOE for the hardware element is determinedbased on the price when sold separately to customers.These revenue arrangements are divided into separateunits of accounting if the delivered item(s) hasvalue to the customer on a stand-alone basis, thereis objective and reliable evidence of the fair valueof the undelivered item(s) and delivery/performanceof the undelivered item(s) is probable. For multipleelement arrangements, revenue is allocated to theindividual elements based on VSOE of the individualelements.The application of these principlesrequires judgment, including the determination ofwhether a software arrangement includes multipleelements and estimates of the fair value of theelements. The VSOE of the fair value of undeliveredelements is determined based on the historicalevidence of stand-alone sales of these elements tocustomers. Hardware revenues are generally recognizedat the time of shipment or receipt by customerdepending upon contract terms. VSOE generally doesnot exist for the software element; therefore, theCompany uses the residual method to recognize revenuewhen VSOE exists for all other undelivered elements.Under the residual method, the fair value of theundelivered elements is deferred and the remainingportion of the arrangement fee is recognized asrevenue.**ESCO TECHNOLOGIES INC.**     26     **2009 ANNUAL REPORT**
 

 
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**The applicable guidance requires the sellerof software that includes post-contract customersupport (PCS) to establish VSOE of the undeliveredelement of the contract in order to accountseparately for the PCS revenue. The Companydetermines VSOE by a consistent pricing of PCS andPCS renewals as a percentage of the softwarelicense fees or by reference to contractualrenewals, when the renewal terms are substantive.Revenues for PCS are recognized ratably over themaintenance term specified in the contract(generally in 12 monthly increments). Revenues forprogram management support are recognized whenservices have been provided. The Company determinesVSOE for program management support based on hourlyrates when services are performed separately.Approximately 4% of segment revenues are recognizedwhen services are performed for unaffiliatedcustomers or when products are delivered (when titleand risk of ownership transfers).***Test Segment:***Within the Test segment, approximately40% of revenues (approximately 10% of consolidatedrevenues) are recognized when products are delivered(when title and risk of ownership transfers) or whenservices are performed for unaffiliated customers.Certain arrangements contain multiple elements whichare accounted for under the provisions of FASB ASCSubtopic 605-25, *Revenue Recognition:Multiple-Element Arrangements*. The multiple elementsgenerally consist of materials and installationservices used in the construction and installation ofstandard shielded enclosures to measure and containmagnetic and electromagnetic energy. The installationprocess does not involve changes to the features orcapabilities of the equipment and does not requireproprietary information about the equipment in orderfor the installed equipment to perform tospecifications. There is objective and reliableevidence of fair value for each of the units ofaccounting, and as a result, the arrangement revenueis allocated to the separate units of accountingbased on their relative fair values. Typically, fairvalue is the price of the deliverable when it isregularly sold on a stand-alone basis.Approximately 60% of the segment’s revenues(approximately 15% of consolidated revenues) arerecorded under the percentage-of-completionprovisions of FASB ASC Subtopic 605-35, *RevenueRecognition: Construction-Type and Production-TypeContracts*due to the complex nature of the enclosuresthat are designed and produced under these contracts.Products accounted for under this Subtopic includethe construction and installation of complex testchambers to a buyer’s specifications that provide itscustomers with the ability to measure and containmagnetic, electromagnetic and acoustic energy. Asdiscussed above, for arrangements that are accountedfor under this Subtopic, the Company estimates profitas the difference between total estimated revenue andtotal estimated cost of a contract and recognizesthese revenues and costs based on either (a) unitsdelivered or (b) contract milestones.If a reliable measure of output cannot be established(which applies in less than 10% of Test segmentrevenues or 2% of consolidated revenues), inputmeasures (e.g., costs incurred) are used to recognizerevenue. Given the nature of the Company’s operationsrelated to these contracts, costs incurred representan appropriate measure of progress towardscompletion.The percentage-of-completion method of accountinginvolves the use of various techniques to estimateexpected costs at completion. These estimates arebased on Management’s judgment and the Company’ssubstantial experience in developing these types ofestimates.***Filtration Segment:***Within the Filtration segment,approximately 60% of revenues (approximately 10% ofconsolidated revenues) are recognized when productsare delivered (when title and risk of ownershiptransfers) or when services are performed forunaffiliated customers.Approximately 40% of segment revenues (approximately5% of consolidated revenues) are recorded under thepercentage-of-completion provisions of FASB ASCSubtopic 605-35, *Revenue Recognition: Construction-Type andProduction-Type Contracts*. Products accounted forunder this Subtopic include the design, developmentand manufacture of complex fluid control products,quiet valves, manifolds and systems primarily for theaerospace and military markets. For arrangements thatare accounted for under this Subtopic, the Companyestimates profit as the difference between totalestimated revenue and total estimated cost of acontract and recognizes these revenues and costsbased on units delivered. Thepercentage-of-completion method of accountinginvolves the use of various techniques to estimateexpected costs at completion.**F. CASH AND CASH EQUIVALENTS**Cash equivalents include temporaryinvestments that are readily convertible intocash, such as money market funds.**G. ACCOUNTS RECEIVABLE**Accounts receivable have been reduced by anallowance for amounts that the Company estimates areuncollectible in the future. This estimatedallowance is based on Management’s evaluation of thefinancial condition of the customer and historicalwrite-off experience.**H. COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS**Costs and estimated earnings on long-termcontracts represent unbilled revenues, includingaccrued profits, accounted for under thepercentage-of-completion method, net of progressbillings.**ESCO TECHNOLOGIES INC.**     27     **2009 ANNUAL REPORT**
 

 
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****I. INVENTORIES**Inventories are valued at the lower of cost(first-in, first-out) or market value. Inventoriesunder long-term contracts reflect accumulatedproduction costs, factory overhead, initial toolingand other related costs less the portion of suchcosts charged to cost of sales and any unliquidatedprogress payments. In accordance with industrypractice, costs incurred on contracts in progressinclude amounts relating to programs havingproduction cycles longer than one year, and a portionthereof will not be realized within one year.**J. PROPERTY, PLANT AND EQUIPMENT**Property, plant and equipment are recorded atcost. Depreciation and amortization are computedprimarily on a straight-line basis over theestimated 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 theremaining term of the applicable lease or theirestimated useful lives, whichever is shorter.**K. GOODWILL AND OTHER LONG-LIVED ASSETS**Goodwill represents the excess of purchasecosts over the fair value of net identifiable assetsacquired in business acquisitions. The Companyaccounts for goodwill as required by FASB ASC Topic350, *Intangibles — Goodwill & Other*. Managementannually reviews goodwill and other long-lived assetswith indefinite useful lives for impairment orwhenever events or changes in circumstances indicatethe carrying amount may not be recoverable. If theCompany determines that the carrying value of thelong-lived asset may not be recoverable, a permanentimpairment charge is recorded forthe amount by which the carrying value of thelong-lived asset exceeds its fair value.Fair value is measured based on a discounted cashflow method using a discount rate determined byManagement to be commensurate with the riskinherent in the Company’s current business model.Other intangible assets represent costs allocatedto identifiable intangible assets, principallycapitalized software, patents, trademarks, andtechnology rights. See Note 4 regarding goodwilland other intangible assets activity.**L. CAPITALIZED SOFTWARE**The costs incurred for the development ofcomputer software that will be sold, leased, orotherwise marketed are charged to expense whenincurred as research and development untiltechnological feasibility has been established forthe product. Technological feasibility is typicallyestablished upon completion of a detailed programdesign. Costs incurred after this point arecapitalized on a project-by-project basis inaccordance with FASB ASC Topic 985, *Software*.Capitalized costs primarily consist of externaldevelopment costs. Upon general release of theproduct to customers, the Company ceasescapitalization and begins amortization, which iscalculated on a project-by-project basis as thegreater of (1) the ratio of current gross revenuesfor a product to the total of current andanticipated future gross revenues for the productor (2) the straight-line method over the estimatedeconomic life of the product. The Company generallyamortizes the software development costs over athree-to-seven year period based upon the estimatedfuture economic life of the product. Factorsconsidered in determining the estimated futureeconomic life of the product include anticipatedfuture revenues, and changes in software andhardware technologies. Management annually reviewsthe carrying values of capitalized costs forimpairment or whenever events or changes incircumstances indicate the carrying amount may notbe recoverable. If expected cash flows areinsufficient to recover the carrying amount of theasset, then an impairment loss is recognized tostate the asset at its net realizable value.**M. IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETSTO BE DISPOSED OF**Recoverability of assets to be held and used ismeasured by a comparison of the carrying amount of anasset to future cash flows expected to be generatedby the asset. If such assets are considered to beimpaired, the impairment to be recognized is measuredby the amount by which the carrying amount of theassets exceeds the fair value of the assets. Assetsto be disposed of are reported at the lower of thecarrying amount or fair value less costs to dispose.**N. INCOME TAXES**Income taxes are accounted for under the assetand liability method. Deferred tax assets andliabilities are recognized for the future taxconsequences attributable to differences between thefinancial statement carrying amounts of existingassets and liabilities and their respective taxbases. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply totaxable income in the years in which those temporarydifferences are expected to be recovered or settled.Deferred tax assets may be reduced by a valuationallowance if it is more likely than not that someportion or all of the deferred tax assets will not berealized. The effect on deferred tax assets andliabilities of a change in tax rates isrecognized in income in the period that includes theenactment date. The Company regularly reviews itsdeferred tax assets for recoverability andestablishes a valuation allowance when Managementbelieves it is more likely than not such assets willnot be recovered, taking into considerationhistorical operating results, expectations of futureearnings, tax planning strategies, and the expectedtiming of the reversals of existing temporarydifferences.**ESCO TECHNOLOGIES INC.**     28     **2009 ANNUAL REPORT**
 

 
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****O. RESEARCH AND DEVELOPMENT COSTS**Company-sponsored research and developmentcosts include research and development and bid andproposal efforts related to the Company’s productsand services. Company-sponsored product developmentcosts are charged to expense when incurred.Customer-sponsored research and development costsincurred pursuant to contracts are accounted forsimilar to other program costs. Customer-sponsoredresearch and development costs refer to certainsituations whereby customers provide funding tosupport specific contractually defined research anddevelopment costs.**P. FOREIGN CURRENCY TRANSLATION**The financial statements of the Company’sforeign operations are translated into U.S. dollarsin accordance with FASB ASC Topic 830, *ForeignCurrency Matters*. The resulting translationadjustments are recorded as a separate component ofaccumulated other comprehensive income.**Q. EARNINGS PER SHARE**Basic earnings per share is calculated usingthe weighted average number of common sharesoutstanding during the period. Diluted earnings pershare is calculated using the weighted average numberof common shares outstanding during the period plusshares issuable upon the assumed exercise of dilutivecommon share options and vesting ofperformance-accelerated restricted shares using thetreasury stock method.The number of shares used in the calculation ofearnings per share for each year presented is asfollows:             (In thousands) **2009** 2008 2007 Weighted Average SharesOutstanding — Basic  **26,216**   25,909   25,865 Dilutive Options and Performance-Accelerated Restricted Stock  **344**   406   522  Adjusted Shares — Diluted  **26,560**   26,315   26,387  Options to purchase 605,186 shares at pricesranging from $35.69-$54.88 were outstanding duringthe year ended September 30, 2009, but were notincluded in the respective computation of diluted EPSbecause the options’ exercise price was greater thanthe average market price of the common shares.Options to purchase 542,689 shares at prices rangingfrom $35.69-$54.88 were outstanding during the yearended September 30, 2008, but were not included inthe respective computation of diluted EPS because theoptions’ exercise price was greater than the averagemarket price of the common shares. Options topurchase 602,731 shares at prices ranging from$36.07-$54.88 were outstandingduring the year ended September 30, 2007, but werenot included in the respective computation of dilutedEPS because the options’ exercise price was greaterthan the average market price of the common shares.These options expire in various periods through 2013.Approximately 180,000, 140,000 and 76,000 restrictedshares were outstanding but unearned at September 30,2009, 2008 and 2007, respectively, and, therefore,were not included in the respective years’computations of diluted EPS.**R. SHARE-BASED COMPENSATION**The Company provides compensation benefits tocertain key employees under several share-basedplans providing for employee stock options and/orperformance-accelerated restricted shares(restricted shares), and to non-employee directorsunder a non-employee directors compensation plan.**S. COMPREHENSIVE INCOME (LOSS)**Accumulated other comprehensive loss of$(11.6) million at September 30, 2009 as shown onthe consolidated balance sheet, net of tax,consisted of $(17.9) million related to a pensionnet actuarial loss; $7.2 million related tocurrency translation adjustments; and $(0.9)million related to interest rate swaps. Accumulatedother comprehensive income of $0.6 million atSeptember 30, 2008 consisted of $7.9 millionrelated to currency translation adjustments; $(6.5)million related to the pension net actuarial loss;and $(0.8) million related to interest rate swaps.**T. DEFERRED REVENUE AND COSTS**Deferred revenue and costs are recorded forproducts or services that have not been provided buthave been invoiced under contractual agreements orpaid for by a customer, or when products or serviceshave been provided but the criteria for revenuerecognition have not been met. If there is a customeracceptance provision or there is uncertainty aboutcustomer acceptance, revenue and costs are deferreduntil the customer has accepted the product orservice.**U. DERIVATIVE FINANCIAL INSTRUMENTS**All derivative financial instruments arereported on the balance sheet at fair value. Theaccounting for changes in fair value of aderivative instrument depends on whether it hasbeen designated and qualifies as a hedge and on thetype of hedge. For each derivative instrumentdesignated as a cash flow hedge, the effectiveportion of the gain or loss on the derivative isdeferred in accumulated other comprehensive incomeuntil recognized in earnings with the underlyinghedged item. For each derivative instrumentdesignated as a fair value hedge, the gain or losson the derivative and the offsetting gain or losson the hedged item are recognized immediately inearnings. Regardless of type, a fully effectivehedge will result in no net earnings impact whilethe derivative is outstanding. To the extent thatany hedge is ineffective at offsetting cash flow orfair value changes in the underlying hedged item,there could be a net earnings impact.**ESCO TECHNOLOGIES INC.**     29     **2009 ANNUAL REPORT**
 

 
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****V. NEW ACCOUNTING STANDARDS**In October 2009, the Financial AccountingStandards Board (FASB) issued Update No. 2009-13,*Multiple-DeliverableRevenue Arrangements*(ASU 2009-13) and Update No.2009-14, *Certain Revenue Arrangements That IncludeSoftware Elements*(ASU 2009-14) — *consensuses of theFASB Emerging Issues Task Force*. ASU 2009-13 appliesto multiple-deliverable revenue arrangements that arecurrently within the scope of Subtopic 605-25 andprovides two significant changes: (i) requires anentity to allocate revenue in an arrangement usingestimated selling prices of deliverables if a vendordoes not have vendor-specific objective evidence orthird-party evidence of selling price and (ii)eliminates the residual method to allocate thearrangement consideration. The consensus also expandsthe disclosure requirements for multiple-deliverablerevenue arrangements. ASU 2009-14 removes tangibleproducts from the scope of the software revenueguidance and provides guidance on determining whethersoftware deliverables in an arrangement that includesa tangible product are within the scope of thesoftware revenue guidance. These consensuses shouldbe applied on a prospective basis for revenuearrangements entered into in fiscal years beginningon or after June 15, 2010 with earlier applicationpermitted. The Company is currently assessing theimpact of this new guidance on its ConsolidatedFinancial Statements and related disclosures.On July 1, 2009, the Company adopted FASB ASC105-10 (ASC 105-10) which established the *FASBAccounting Standards Codification*(the“Codification”) as the source of authoritativeaccounting principles recognized by the FASB to beapplied in the preparation of financial statementsin conformity with GAAP. Rules and interpretivereleases of the SEC under authority of Federalsecurities laws are also sources of authoritativeGAAP for nongovernmental entities. The adoption ofthis Statement did not have a material impact onthe Company’s Consolidated Financial Statements.Effective April 1, 2009, the Company adopted the newaccounting guidance for subsequent events ascodified in FASB ASC 855, *Subsequent Events*. The newguidance establishes general standards of accountingfor and disclosure of events that occur after thebalance sheet date but before financial statementsare issued or are available to be issued. This newguidance was effective for interim and annualfinancial periods ending after June 15, 2009. TheCompany has evaluated subsequent events ortransactions that occurred after the balance sheetdate of September 30, 2009 up through November 30,2009, which is the date the accompanyingConsolidated Financial Statements were issued.**2. Divestitures**On March 13, 2009, the Company completed thesale of the business and most of the assets ofComtrak Technologies, LLC (Comtrak) for $3.1 million,net, of cash (referred to as the “Comtrak sale”).This business is reflected as a discontinuedoperation in the financial statements and relatednotes for all periods presented. Comtrak’s operationswere previously included within the Company’s UtilitySolutions Group segment. A pretax loss of $1.2million related to the sale and its 2009 results ofoperations are reflected in the Company’s fiscal 2009results in discontinued operations. Comtrak’s netsales were $3.4 million, $10.3 million, and $7.3million for the years ended September 30, 2009, 2008and 2007, respectively. The pretax loss fromComtrak’s operations was $0.3 million and $0.6million for the years ended September 30, 2008 and2007, respectively.On November 25, 2007, the Company completed the saleof the filtration portion of Filtertek Inc.(Filtertek) to Illinois Tool Works Inc. for $74.4million, net. The TekPack division of Filtertek wasnot included in the transaction. Accordingly, theFiltertek businesses are reflected as discontinuedoperations in the financial statements and relatednotes for all periods presented. A pretax loss of$0.2 million related to Filtertek is reflected in theCompany’s fiscal 2008 results in discontinuedoperations. Filtertek’s net sales were $13.7 millionfor the two-month period ended November 25, 2007.Filtertek’s net sales and pretax earnings were $82.8million and $4.7 million, respectively, for the yearended September 30, 2007. Filtertek’s operations wereincluded within the Company’s Filtration segmentprior to divestiture. The operations of the TekPackbusiness are reflected in continuing operations andcontinue to be included in the Filtration segment.**3. Acquisitions****2009**On September 21, 2009, the Company acquireda minority equity interest in Firetide, Inc. for$4 million in cash. Firetide, Inc. is a providerof wireless infrastructure mesh network managementsystems which will enable communications withother Smart Grid assets and this technology willbe used in Aclara’s Smart Communications Networksolution. This investment is accounted for underthe cost method and is classified as a long-termother asset on the Company’s consolidated balancesheet as of September 30, 2009.On July 2, 2009, the Company acquired certain assets of Complus Systems Pvt Ltd. (Complus) in Indiafor approximately $1.2 million in cash and formed a new Indian entity. The entity will operate asETS-India and its operating results, since the date of acquisition, are included within the Testsegment.**ESCO TECHNOLOGIES INC.**     30     **2009 ANNUAL REPORT**
 

 
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****2008**On November 30, 2007, the Company acquired thecapital stock of Doble for a purchase price ofapproximately $328 million, net of cash acquired.Doble, headquartered in Watertown, Massachusetts, isa worldwide leader in providing high-end intelligentdiagnostic test solutions for the electric utilityindustry. The acquisition aligns with the Company’slong-term growth strategy of expanding its productsand services in the utility industry. The operatingresults for Doble, since the date of acquisition, areincluded within the USG segment.The purchase price allocation was as follows:(In thousands)     Net tangible assets **$****44,498** Identifiable intangible assets:    Trade names  **112,290** Customer relationships  **52,510** Software and databases  **3,790**  Total identifiable intangible assets  **168,590** Goodwill  **192,203** Long-term deferred tax liabilities  **(67,830****)** Total cash consideration **$****337,461**       Reconciliation of purchase price:    Total cash consideration **$****337,461** Less: cash acquired  **(9,639****)** Purchase price **$****327,822**  The identifiable intangible assets consistingof customer relationships will be amortized on astraight-line basis over twenty years and thesoftware and databases will be amortized on astraight-line basis over five years. Theidentifiable intangible asset consisting of tradenames has an indefinite life and is not subject toamortization.**Pro Forma Results**The following pro forma financial informationfor the years ended September 30, 2008 and 2007presents the combined results of operations of ESCOand Doble as if the acquisition had occurred onOctober 1, 2006. The pro forma financial informationfor the periods presented excludes the Comtrakbusiness which was sold in March 2009 and theFiltertek business which was sold in November 2007.The combined results of operations have beenadjusted for the impact of certainacquisition-related items, including additionalamortization of identifiable intangible assets,additional financing expenses and other directcosts. The impact of pro forma adjustments aretax-effected at the expected future consolidatedcorporate tax rate.The unaudited pro forma financial information is notintended to represent, or be indicative of, theCompany’s consolidated results of operations orfinancial condition that would have been reportedhad the acquisition been completed as of thebeginning of each of the periods presented. Thisinformation is provided for illustrative purposesonly and is not necessarily indicative of theCompany’s future consolidated results of operationsor financial condition.(In millions, except per share data)