(

)

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, aerospace and defense, consumer, electronics and industrial 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. Dielectrics, 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, 2018

the Company did

not

have any cash equivalents and at

December 31, 2017,

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 amounts contained within the Company’s main operating accounts at Bank of America and TD Bank at

December 31, 2018,

exceed the federal depository insurance limit by approximately

$3.8

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, 2018.

(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, 2018.

(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.

events or changes in circumstances arose during the year ended

December 31, 2018

which required management to perform an impairment analysis.

(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. In testing goodwill for impairment at

December 31, 2018,

the Company primarily 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 in size and market capitalization to each other and to the Company.

As of

December 31, 2018,

based on our calculations under the above noted approach, the fair value of the reporting unit significantly exceeded the carrying value of the reporting unit. 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 net carrying amounts of goodwill for the years ended

December 31, 2018

and

2017

are as follows (in thousands):

	Goodwill

December 31, 2017	$	7,322
Acquired in Dielectrics business combination (See Note 22)		44,516
December 31, 2018	$	51,838

Approximately

$47.9

million of goodwill is deductible for tax purposes.

(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.

events or changes in circumstances arose during the year ended

December 31, 2018

which required management to perform an impairment analysis.

(k)

Revenue Recognition

Beginning in

2018,

the Company recognizes revenue when a customer obtains control of a promised good or service. The amount of revenue recognized reflects the consideration that the Company expects to be entitled to in exchange for promised goods or services. The Company recognizes revenue in accordance with the core principles of ASC

606

which include (

) identifying the contract with a customer, (

) identifying separate performance obligations within the contract, (

) determining the transaction price, (

) allocating the transaction price to the performance obligations, and (

) recognizing revenue. The Company recognizes all but an immaterial portion of its product sales upon shipment. The Company recognizes revenue from the sale of tooling and machinery primarily upon customer acceptance, with the exception of certain tooling where control does

not

transfer to the customer, which results in revenue being recognized over the estimated time for which parts are produced with the use of each respective tool. The Company recognizes revenue from engineering services as the services are performed. Although only applicable to an insignificant number of transactions, the Company has elected to exclude sales taxes from the transaction price. The Company has elected to account for shipping and handling activities for which the Company is responsible under the terms and conditions of the sale

not

as performance obligations but rather as fulfillment costs. These activities are required to fulfill the Company’s promise to transfer the good and are expensed when revenue is recognized.

For the years

2017

and

2016,

prior to ASC

606,

the Company recognized 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). Forfeitures are expensed as they occur.

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

12.

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

	Years Ended December 31,
	2018		2017		2016
Share-based compensation expense	$	1,212	$	1,068	$	1,056

The compensation expense for stock options granted during the

three

-year period ended

December

31,

2018,

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

	Years Ended December 31,
	2018			2017				2016
Expected volatility		27.7	%		27.4%	-	29.1%		29.7	%
Expected dividends		None				None			None
Risk-free interest rate		2.7	%		1.56%	-	1.84%		0.9	%
Exercise price	$	31.20			$27.05	–	$28.70	$	22.02
Expected term (in years)		6.0			2.7	to	5.8		5.0
Weighted-average grant-date fair value	$	10.15			5.59	-	$8.51	$	6.11

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

$544,000,

$525,000

and

$318,000

for the years ended

December 31, 2018,

2017

and

2016,

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)

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 or 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.

(p)

Segments and Related Information

The Company follows the provisions of Accounting Standards Codification (ASC)

280,

Segment Reporting

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

(q)

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 years ended

December 31, 2018

and

2017.

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 was subsequently updated (“Accounting Standards Codification (ASC)

606”

). The Company adopted ASC

606

January 1, 2018.

See Note

for further details.

February 2016,

the FASB issued ASU

No.

2016

02,

“

Leases (ASC

842

” and issued subsequent amendments to the initial guidance in

January 2018

within ASU

No.

2018

and in

July 2018

within ASU Nos.

2018

and

2018

11.

The standard requires lessees to recognize leases on the balance sheet as a right-of-use (“ROU”) asset and a lease liability, other than leases that meet the definition of a short-term lease. The liability will be equal to the present value of the lease payments. The asset will be based on the liability, subject to adjustment. Currently, under existing U.S. generally accepted accounting principles, the Company does

not

recognize on the balance sheet a right-of-use asset or lease liability related to its operating leases. For income statement purposes, the leases will continue to be classified as either operating or finance. Operating leases will result in straight-line expense (similar to current operating leases) and finance leases will result in a front-loaded expense pattern (similar to current capital leases). The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after

December

15,

2018.

Early adoption is permitted. The standard allows an entity to elect to have a date of initial application as of the beginning of the period of adoption. The standard provides for the option to elect a package of practical expedients upon adoption.

The Company adopted ASC

842

as of

January 1, 2019,

using a modified retrospective approach and applying the standard’s transition provisions at

January 1, 2019,

the effective date. The Company elected the package of practical expedients permitted under the transition guidance, which among other things, allows us to carryforward the historical lease classification. In addition, the Company elected to combine the lease and non-lease components into a single lease component for its leases and is making an accounting policy election to exclude from balance sheet reporting those leases with initial terms of

months or less. The Company estimates that adoption of the standard will result in recognition of operating lease ROU assets and lease liabilities of approximately

$4.0

million and

$4.1

million, respectively, with the difference due to deferred rent that will be reclassified to the ROU asset value. We do

not

expect adoption of the standard to materially affect our results of operations or cash flows.

January 2017,

the FASB issued ASU

No.

2017

04,

Intangibles—Goodwill and Other (ASC

350

), Simplifying the Test for Goodwill Impairment

. The guidance removes Step

of the goodwill impairment test and eliminates the need to determine the fair value of individual assets and liabilities to measure goodwill impairment. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value,

not

to exceed the carrying amount of goodwill. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The guidance will be applied prospectively and is effective for annual and interim goodwill impairment tests in fiscal years beginning after

December

15,

2019.

Early adoption is permitted for any impairment tests performed on testing dates after

January

2017.

The Company does

not

believe adoption will have a material impact on its financial condition or results of operations.

Revisions

Certain revisions have been made to the

December 31, 2017

Condensed Consolidated Balance Sheet to conform to the current year presentation relating to a reclassification of deferred revenue. The reclassification resulted in an increase in deferred revenue and a decrease in accrued expenses in the amount of approximately

$297,000.

In addition, certain revisions have been made to the Condensed Consolidated Statements of Cash Flows for the years ended

December 31, 2017

and

2016,

also due to a reclassification of deferred revenue. The reclassification resulted in an increase to the change in deferred revenue and a decrease in the change in accrued expenses in the amount of approximately

$91,000

and

$206,000

for the years ended

December 31, 2017

and

2016,

respectively. These revisions had

impact on previously reported net income and are deemed immaterial to the previously issued financial statements.