(1)

Summary of Significant Accounting Policies

UFP Technologies, Inc. (“the Company”) is an innovative designer and custom converter of foams, plastics, composites and natural fiber products principally serving the medical, automotive, consumer, electronics, industrial and aerospace and defense markets. The Company was incorporated in the State of Delaware in

1993.

(a)

Principles of Consolidation

The consolidated financial statements include the accounts and results of operations of UFP Technologies, Inc., its wholly-owned subsidiaries, Moulded Fibre Technology, Inc., Simco Industries, Inc. and Stephenson & Lawyer, Inc. and its wholly-owned subsidiary, Patterson Properties Corporation. All significant intercompany balances and transactions have been eliminated in consolidation. The Company has evaluated all subsequent events through the date of this filing.

(b)

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including allowance for doubtful accounts and the net realizable value of inventory, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

(c)

Fair Value Measurement

The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurement or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions, and credit risk.

The Company has not elected fair value accounting for any financial instruments for which fair value accounting is optional.

(d)

Fair Value of Financial Instruments

Cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other liabilities are stated at carrying amounts that approximate fair value because of the short maturity of those instruments. The carrying amount of the Company’s long-term debt approximates fair value as the interest rate on the debt approximates the Company’s current incremental borrowing rate.

(e)

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of

three

months or less to be cash equivalents. At

December

31,

2016

and

2015,

cash equivalents primarily consisted of money market accounts and certificates of deposit that are readily convertible into cash.

The Company maintains its cash in bank deposit accounts, money market funds, and certificates of deposit that at times exceed federally insured limits. The Company periodically reviews the financial stability of institutions holding its accounts, and does not believe it is exposed to any significant custodial credit risk on cash. The Company’s main operating account with Bank of America exceeds federal depository insurance limit by approximately

$17.6

million.

(f)

Accounts Receivable

The Company periodically reviews the collectability of its accounts receivable. Provisions are recorded for accounts that are potentially uncollectable. Determining adequate reserves for accounts receivable requires management’s judgment. Conditions impacting the realizability of the Company’s receivables could cause actual asset write-offs to be materially different than the reserved balances as of

December

31,

2016.

(g)

Inventories

Inventories include material, labor, and manufacturing overhead and are valued at the lower of cost or net realizable value. Cost is determined using the

first

-in,

first

-out (FIFO) method.

The Company periodically reviews the realizability of its inventory for potential excess or obsolescence. Determining the net realizable value of inventory requires management’s judgment. Conditions impacting the realizability of the Company’s inventory could cause actual asset write-offs to be materially different than the Company’s current estimates as of

December

31,

2016.

(h)

Property, Plant, and Equipment

Property, plant, and equipment are stated at cost and are depreciated or amortized using the straight-line method over the estimated useful lives of the assets or the related lease term, if shorter.

Estimated useful lives of property, plant, and equipment are as follows:

Leasehold improvements	Shorter of estimated useful life or remaining lease term
Buildings and improvements (in years)	20	-	40
Machinery & Equipment (in years)	7	-	15
Furniture, fixtures, computers & software (in years)	3	-	7

Property, plant, and equipment amounts are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset

may

not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess of the asset’s carrying value over its fair value.

(i)

Goodwill

Goodwill is tested for impairment annually, and will be tested for impairment between annual tests if an event occurs or circumstances change that would indicate that the carrying amount

may

be impaired. Impairment testing for goodwill is done at a reporting unit level. Reporting units are

one

level below the business segment level, but can be combined when reporting units within the same segment have similar economic characteristics. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The Company consists of a single reporting unit. We last performed “step

1”

of the goodwill impairment test as of

September

30,

2014.

We utilized the guideline public company (“GPC”) method under the market approach and the discounted cash flows method (“DCF”) under the income approach to determine the fair value of the reporting unit for purposes of testing the reporting unit’s carrying value of goodwill for impairment. The GPC method derives a value by generating a multiple of EBITDA through the comparison of the Company to similar publicly traded companies. The DCF approach derives a value based on the present value of a series of estimated future cash flows at the valuation date by the application of a discount rate,

one

that a prudent investor would require before making an investment in our equity securities. The key assumptions used in our approach included:

The reporting unit’s estimated financials and

five

-year projections of financial results, which were based on our strategic plans and long-range forecasts. Sales growth rates represent estimates based on current and forecasted sales mix and market conditions. The profit margins were projected based on historical margins, projected sales mix, current expense structure and anticipated expense modifications.

The projected terminal value which reflects the total present value of projected cash flows beyond the last period in the DCF. This value reflects a growth rate for the reporting unit, which is approximately the same growth rate of expected inflation into perpetuity.

The discount rate determined using a Weighted Average Cost of Capital method (“WACC”), which considered market and industry data as well as Company-specific risk factors.

Selection of guideline public companies which are similar to each other and to the Company.

As of

September

30,

2014,

based on our calculations under the above noted approach, the fair value of the reporting unit exceeded its carrying value by approximately

$69

million or

74%.

In performing these calculations, management used its most reasonable estimates of the key assumptions discussed above. If our actual operating results and/or the key assumptions utilized in management’s calculations differ from our expectations, it is possible that a future impairment charge

may

be necessary.

The Company’s annual impairment testing date is

December

31.

The Company performed a qualitative assessment (“step

0”)

as of

December

31,

2016,

and determined that it was more likely than not that the fair value of its reporting unit exceeded its carrying amount. As a result, the Company is not required to proceed to a “step

1”

impairment assessment. Factors considered included the

2014

step

analysis and the calculated excess fair value over carrying amount, financial performance, forecasts and trends, market cap, regulatory and environmental issues, macro-economic conditions, industry and market considerations, raw material costs and management stability.

(j)

Intangible Assets

Intangible assets with a definite life are amortized on a straight-line basis, with estimated useful lives ranging from

years. Intangible assets with a definite life are tested for impairment whenever events or circumstances indicate that their carrying values

may

not be recoverable.

(k)

Revenue Recognition

The Company recognizes revenue at the time of shipment when title and risk of loss have passed to the customer, persuasive evidence of an arrangement exists, performance of its obligation is complete, its price to the buyer is fixed or determinable, and the Company is reasonably assured of collection. Determination of these criteria, in some cases, requires management’s judgment.

(l)

Share-Based Compensation

When accounting for equity instruments exchanged for employee services, share-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant).

The Company issues share-based awards through several plans that are described in detail in Note

11.

The compensation cost charged against income for those plans is included in selling, general & administrative expenses as follows (in thousands):

	Year Ended December 31,
	2016		2015		2014
Share-based compensation expense	$	1,056	$	1,069	$	1,119

The compensation expense for stock options granted during the

three

-year period ended

December

31,

2016,

was determined as the fair value of the options using the Black Scholes valuation model. The assumptions are noted as follows:

	Year Ended December 31,
	2016			2015			2014
Expected volatility		29.7	%	31.5%	-	32.3%	32.8%	-	37.9%
Expected dividends		None			None			None
Risk-free interest rate		0.9	%	1.0%	-	1.2%	0.7%	-	0.9%
Exercise price	$	22.02		$19.97	-	$22.36	$22.55	-	$25.48
Expected term (in years)		5.0			5.0		3.8	to	5.0
Weighted-average grant-date fair value	$	6.11			$6.04			$7.24

The stock volatility for each grant is determined based on a review of the experience of the weighted average of historical daily price changes of the Company’s common stock over the expected option term, and the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected term of the option. The expected term is estimated based on historical option exercise activity.

The total income tax benefit recognized in the consolidated statements of income for share-based compensation arrangements was approximately

$318,000,

$312,000

and

$320,000

for the years ended

December

31,

2016,

2015

and

2014,

respectively.

(m)

Deferred Rent

The Company accounts for escalating rental payments on a straight-line basis over the term of the lease.

(n)

Shipping and Handling Costs

Costs incurred related to shipping and handling are included in cost of sales. Amounts charged to customers pertaining to these costs are included in net sales.

(o)

Research and Development

On a routine basis, the Company incurs costs related to research and development activity. These costs are expensed as incurred. Approximately

$1.3

million,

$1.3

million, and

$1.4

million were expensed in the years ended

December

31,

2016,

2015

and

2014,

respectively.

(p)

Income Taxes

The Company’s income taxes are accounted for under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax expense (benefit) results from the net change during the year in deferred tax assets and liabilities. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

The Company evaluates the need for a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. Should the Company determine that it would not be able to realize all or part of its deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than

50%

likelihood of being realized upon settlement. The Company recognizes interest and penalties accrued related to unrecognized tax benefits in tax expense.

(q)

Segments and Related Information

The Company follows the provisions of ASC

280,

Segment Reporting

, which establish standards for the way public business enterprises report information and operating segments in annual financial statements (see Note

17).

(r) Treasury Stock

The Company accounts for treasury stock under the cost method, using the

first

-in,

first

out flow assumption, and we include treasury stock as a component of stockholders’ equity. The Company did

not

repurchase any shares of common stock during the year ended

December

31,

2016.

During the year ended

December

31,

2015,

the Company repurchased

29,559

shares of common stock at a cost of approximately

$587,000.

Recent Accounting Pronouncements

May

2014,

the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No.

2014

09,

Revenue from Contracts with Customers

, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard will replace most existing revenue recognition guidance when it becomes effective. The standard permits the use of either the full retrospective or modified retrospective transition methods. In

August

2015,

the FASB issued an update to defer the effective date of this update by

one

year. The updated standard becomes effective for the Company in the

first

quarter of

2018,

but allows the Company to adopt the standard

one

year earlier if it so chooses. The Company expects to adopt the standard in the

first

quarter of

2018

using the modified retrospective transition method. The Company is continuing to evaluate its revenue sources for potential impact. Based on the work completed to date, the Company expects that for a significant majority of our business, the recognition of revenue under the updated standard will occur at a point in time, which is consistent with current practice.

February

2016,

the FASB issued ASU No.

2016

02,

Leases.

The guidance in this ASU supersedes the leasing guidance in Topic

840,

Leases

. Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for those leases previously classified as operating leases. The amendments in ASU No.

2016

are effective for annual reporting periods beginning after

December

15,

2018,

including interim periods within that reporting period with early adoption permitted. The Company is evaluating the impact of adopting this ASU on its consolidated financial position and results of operations.

March

2016,

the FASB issued ASU No.

2016

09,

Improvements to Employee Share Based Payment Accounting

. This ASU simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards, forfeitures and classification on the statement of cash flows. The provisions of this ASU are effective for fiscal years beginning after

December

15,

2016,

and interim periods within those fiscal years. The Company will adopt the new standard in the

first

quarter of

2017.

Although the impact of adopting this update to the Company’s Consolidated Financial Statements is not expected to have a material effect, the impact will depend on market factors and the timing and intrinsic value of future share-based compensation award vests and exercises. The Company has elected to account for forfeitures as they occur, rather than estimate expected forfeitures. Subsequent to adoption, the Company notes the potential for volatility in its effective tax rate as any windfall or shortfall tax benefits related to its share-based compensation plans will be recorded directly into results of operations.

Revisions

Certain revisions have been made to the

2015

Consolidated Balance Sheet and

2015

Consolidated Statement of Cash Flows to conform to the current year presentation relating to presentation of a reserve for uncertain tax positions. The impact on the

2015

Consolidated Balance Sheet was a decrease in the amount of

$315,000

to both refundable income taxes and accrued expenses. The impact on the

2015

Consolidated Statement of Cash Flows (cash provided by operating activities) was an increase to the change in refundable income taxes of

$315,000

and a decrease to the change in accrued expenses of

$315,000.

These revisions had no impact on previously reported net income and are deemed immaterial to the previously issued financial statements.

Certain revisions have been made to the

2015

Consolidated Balance Sheet,

2015

Consolidated Statement of Operations and

2015

Consolidated Statement of Stockholders’ Equity to conform to the current year presentation relating to the presentation of common shares outstanding. The impact to the Consolidated Balance Sheet was a decrease of

29,559

in the number of common shares outstanding. The impact to the Statements of Operations was a decrease of approximately

13,000

shares in basic and diluted weighted average common shares outstanding. The impact to the Consolidated Statement of Stockholders’ Equity was a decrease of approximately

30,000

in common shares outstanding (repurchase of common stock line). These revisions had no impact on previously reported net income, earnings per share or cash flows and are deemed immaterial to the previously issued financial statements.