UFP Technologies, Inc.

Index

PART I:FINANCIAL INFORMATION

ITEM 1:FINANCIAL STATEMENTS

UFP Technologies, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share data)

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

UFP Technologies, Inc.

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

UFP Technologies, Inc.

Condensed Consolidated Statements of Cash FlowsIncome

(In thousands)thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

UFP Technologies, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

Notes to Interim Condensed Consolidated Financial Statements

(1)      Basis of Presentation

(2)      Supplemental Cash Flow Information

(4)      Share-Based Compensation

Share-based compensation is measured at the grant date based on the fair value of the award and is recognized as an expense over the 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 the notes to the consolidated financial statements for the year ended December 31, 2015. The compensation cost charged against income for those plans is included in selling, general & administrative expenses as follows (in thousands):

Share-based compensation for the three and six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015 includes approximately $105,000, in each period respectively, representing the fair value of the Company’s common stock granted during the periods to the Company’s Board of Directors.

The total income tax benefit recognized in the condensed consolidated statements of income for share-based compensation arrangements was approximately $103,000$67,000 and $135,000, respectively,$63,000, for the three-month periods ended JuneSeptember 30, 2016 and 2015, respectively, and approximately $161,000$264,000 and $193,000, respectively,$256,000, for the six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015, respectively.

The following is a summary of stock option activity under all plans for the three- monthnine-month period ended JuneSeptember 30, 2016:

On June 9, 2016, the Company granted options to its directors for the purchase of 17,184 shares of common stock at that day’s closing price of $22.02. The compensation expense related to these grants was determined as the fair value of the options using the Black Scholes option pricing model based on the following assumptions:

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 calculated based on the simplified method.

During each of the three- and six-monththree-month periods ended JuneSeptember 30, 2016 and 2015, the Company recorded compensation expense related to RSUs of approximately $95,000 and $160,000,$82,000, respectively. TheDuring the nine-month periods ended September 30, 2016 and 2015, the Company recorded compensation expense related to RSUs of approximately $82,000$254,000 and $149,000, respectively, for the same periods in 2015.$231,000, respectively.

At the Company’s discretion, RSU holders are given the option to net-share settle to cover the required minimum withholding tax, and the remaining amount is converted into the equivalent number of common shares. During the six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015, 3,889 and 3,405 shares were surrendered at an average market price of $22.82 and $23.15, respectively.

As of JuneSeptember 30, 2016, the Company had approximately $1.1 million$947,000 of unrecognized compensation expense, which is expected to be recognized over a period of 3.75 years.3.5 years.

The Company’s products are primarily sold to customers within the Medical, Automotive, Consumer, Electronics, Industrial, and Aerospace and Defense markets. Net sales by market for the three- and six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015 are as follows (in thousands):

Note – certain amounts for the three- and nine-months ended September 30, 2015 were reclassified between markets to conform to the current period presentation.

(11)     Plant Consolidations

On July 16, 2014, the Company committed to move forward with a plan to cease operations at its Costa Mesa, California, plant and consolidate operations into its Rancho Dominguez, California, facility and other UFP facilities. The Company’s decision was in response to the December 31, 2014, expiration of the lease on the Costa Mesa facility as well as the close proximity of the two properties. The California consolidation is complete.

The company recorded the following restructuring costs associated with the California consolidation for the three- and six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015 (in thousands):

(12)

(12)	Related Party Transactions

Daniel Croteau, who has been a member of the Company’s board of directors since December 16, 2015, is the Chief Executive Officer of Vention Medical, Inc., a customer of the Company. Sales to Vention for the six-monthsnine-months ended JuneSeptember 30, 2016 were approximately $248,000.$403,000. Open accounts receivable from Vention were approximately $49,000$66,000 at JuneSeptember 30, 2016.

ITEM 2:MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Statements

Some of the statements contained in this Report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). These statements are subject to known and unknown risks, uncertainties, and other factors, which may cause our or our industry’s actual results, performance, or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements about the Company’s prospects, anticipated trends in the different markets in which the Company competes, including the medical, automotive, consumer, electronics, industrial and aerospace and defense markets, anticipated new customer contracts, statements regarding anticipated advantages relating to the Company’s decisions to consolidate its facilities and the expected cost savings and efficiencies associated therewith, anticipated advantages and the timing associated with requalification of parts, anticipated advantages of maintaining fewer, larger plants, anticipated advantages the Company expects to realize from its investments and capital expenditures, including the development of and investments in its molded fiber product lines, expectations regarding the manufacturing capacity and efficiencies of the Company and the expected timing associated therewith, statements about the Company’s acquisition opportunities and strategies, its participation and growth in multiple markets, its business opportunities, the Company’s growth potential and strategies for growth, anticipated revenues and the timing of such revenues, and any indication that the Company may be able to sustain or increase its sales and earnings or sales and earnings growth rates. Investors are cautioned that such forward-looking statements involve risks and uncertainties, including without limitation risks and uncertainties associated with the identification of suitable acquisition candidates and the successful, efficient execution of acquisition transactions and integration of any such acquisition candidates, risks and uncertainties associated with plant closures and consolidations and expected efficiencies from consolidating manufacturing, risks and uncertainties associated with the requalification of parts, the risk that we may not be able to finalize anticipated new customer contracts, risks associated with the implementation of new production equipment and requalification or recertification of transferred equipment in a timely, cost-efficient manner, and risks that any benefits from such new equipment may be delayed or not fully realized, or that the Company may be unable to fully utilize its expected production capacity. Accordingly, actual results may differ materially.

In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential,” and similar expressions intended to identify forward-looking statements. Our actual results could be different from the results described in or anticipated by our forward-looking statements due to the inherent uncertainty of estimates, forecasts, and projections, and may be materially better or worse than anticipated. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements represent our estimates and assumptions only as of the date of this Report. We expressly disclaim any duty to provide updates to forward-looking statements, and the estimates and assumptions associated with them, after the date of this Report, in order to reflect changes in circumstances or expectations, or the occurrence of unanticipated events, except to the extent required by applicable securities laws. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed above and under “Risk Factors” set forth in Part I Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as well as the risks and uncertainties discussed elsewhere in this Report. We qualify all of our forward-looking statements by these cautionary statements. We caution you that these risks are not exhaustive. We operate in a continually changing business environment and new risks emerge from time to time.

Unless the context requires otherwise, the terms “we”“we”, “us”, “our”, or “the Company” refer to UFP Technologies, Inc. and its consolidated subsidiaries.

Overview

UFP Technologies 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 consists of a single operating and reportable segment.

The Company generated improved operating results in its second quarter ended June 30, 2016 over the same quarter last year, as the manufacturing inefficiencies and extra labor required for plant moves and re-qualifications began to give way to synergies.  The Company expects continued, gradual improvements in manufacturing efficiency as it completes its Northeast consolidation.

Strong secondthird quarter growth in sales to customers in the medical, consumer and consumerautomotive markets were partially offset by weakness in demand from customers in the military and electronics markets. The Company anticipates continued growth in sales to customers in the medical market. Continued manufacturing inefficiencies resulting from recent plant consolidations and the resulting need to requalify parts with many of the Company’s customers in the medical market caused an increase in material and labor costs that negatively impacted gross margins. The Company anticipates that these increases will be temporary and that gross margins will improve as new employees get trained and parts get requalified.

The Company’s current strategy includes organic growth and growth through strategic acquisitions.acquisitions.

Results of Operations

Sales

Sales for the three-month period ended JuneSeptember 30, 2016 increased approximately 3.8%8.1% to $37.9$37.2 million from sales of $36.5$34.4 million for the same period in 2015. The increase in sales for the three-month period ended JuneSeptember 30, 2016 was primarily a result of increases in sales to customers in the medical, consumer and consumerautomotive markets of approximately 12.1%19.4%, 18.5% and 24.7%11.0%, respectively, partially offset by decreases in sales to customers in the aerospace & defense market of approximately 31.5% due to continued cuts in government spending and decreases in sales to customers in the electronics markets of approximately 20.5%.28.7% and 12.7%, respectively. The increase in sales to customers in the medical market was largely due to a new five-year contract with one of the Company’s larger customers in this market.market as well as an overall increase in demand from other medical customers. The increase in sales to customers in the consumer market was largely due to increased demand for molded fiber protective packaging.packaging for consumer products. The increase in sales to customers in the automotive market was primarily due to increased demand for interior trim parts from a customer in the southeast, resulting from the customer resolving certain production issues. The reduction in sales to customers in the aerospace and defense market was largely due to continued cuts in government spending. The decrease in sales to customers in the electronics market was primarily due to a temporary spike in demand for packaging at one of our larger customers in 2015.

Sales for the six-monthnine-month period ended JuneSeptember 30, 2016 increased approximately 2.7%4.5% to $72.4$109.6 million from sales of $70.5$104.9 million for the same period in 2015. The increase in sales for the six-monthnine-month period ended JuneSeptember 30, 2016 was primarily a result of increases in sales to customers in the medical and consumer markets of approximately 12.7%14.9% and 25.0%22.9%, respectively, partially offset by decreases in sales to customers in the aerospace & defense market of approximately 24.5% due to continued cuts in government spending and decreases in sales to customers in the electronicsconsumer markets of approximately 15.0%.25.9% and 14.1%, respectively. The increase in sales to customers in the medical market was largely due to a new five-year contract with one of the Company’s larger customers in this market.market as well as an overall increase in demand from other medical customers. The increase in sales to customers in the consumer market was largely due to increased demand for molded fiber protective packaging.packaging for consumer products. The reduction in sales to customers in the aerospace and defense market was largely due to continued cuts in government spending. The decrease in sales to customers in the electronics market was primarily due to general softness in demand for protective packaging.packaging.

Gross Profit

Gross profit as a percentage of sales (“gross margin”) decreased to 27.1%22.7% for the three-month period ended JuneSeptember 30, 2016, from 28.2%27.6% for the same period in 2015. As a percentage of sales, material and labor costs collectively increased 0.9%2.9%, while overhead increased 0.2%2.0%. The increase in collective material and labor costs as a percentage of sales is primarily due to manufacturing inefficiencies resulting from recent plant consolidations as well asand the one-time write-offresulting need to requalify parts with many of the Company’s customers in the medical market. The increase in overhead is primarily due to an increase in indirect labor costs of approximately $288,000$635,000 due largely to temporary hires to assist in obsolete toolingthe requalification of parts, an increase in plant and inventory. equipment maintenance costs of approximately $365,000 due largely to one-time costs associated with the plant consolidations and an increase in depreciation of approximately $164,000 due largely to depreciation on the Company’s new building in Newburyport.

Gross profit as a percentage of sales decreased to 24.9%24.1% for the six-monthnine-month period ended JuneSeptember 30, 2016, from 26.9%27.1% for the same period in 2015. As a percentage of sales, material and labor costs collectively increased 2.2%2.4%, while overhead decreased 0.2%increased 0.6%. The increase in collective material and labor costs as a percentage of sales is primarily due to manufacturing inefficiencies resulting from recent plant consolidations and the resulting need to requalify parts with many of the Company’s customers in the medical market, as well as the one-timea non-recurring write-off of approximately $288,000 in obsolete tooling and inventory.

Selling, General and Administrative Expenses

Selling, general, and administrative expenses (“SG&A”) decreased approximately 4.5% to $6.5 million for the three-month period ended June 30, 2016, from $6.8 million for the same period in 2015. As a percentage of sales, SG&A

decreased to 17.1% for the three-month period ended June 30, 2016, from 18.6% for the same three-month period in 2015. The decrease in SG&A and SG&A as a percentage of sales for the three-month period ended June 30, 2016, is primarily due to lower salaries, benefits and commissions expense resulting largely from recent plant consolidations.

Selling, general, and administrative expenses (“SG&A”) decreasedincreased approximately 3.3%7.5% to $12.4$6.0 million for the six-monththree-month period ended JuneSeptember 30, 2016, from $12.8$5.6 million for the same period in 2015. As a percentage of sales, SG&A decreased to 17.1%16.2% for the six-monththree-month period ended JuneSeptember 30, 2016, from 18.2%16.3% for the same six-monththree-month period in 2015. The decreaseincrease in SG&A for the three-month period ended September 30, 2016, is primarily due to one-time consulting and recruiting costs associated with filling open positions and company-wide training. The decrease in SG&A as a percentage of sales for the six-monththree-month period ended JuneSeptember 30, 2016, is primarilylargely due to lower salaries, benefits and commissions expense resulting largely from recent plant consolidations.the leveraging of relatively fixed SG&A expenses against the increase in sales.

Selling, general, and administrative expenses (“SG&A”) was unchanged at $18.4 million for the nine-month period ended September 30, 2016, as compared to the same nine-month period in 2015. As a percentage of sales, SG&A decreased to 16.8% for the nine-month period ended September 30, 2016, from 17.5% for the same nine-month period in 2015. The decrease in SG&A as a percentage of sales for the nine-month period ended September 30, 2016, is largely due to the leveraging of relatively fixed SG&A expenses against the increase in sales.

Restructuring Costs

For the three- monththree-month period ended JuneSeptember 30, 2016, the Company incurred restructuring costs of approximately $55,000,$25,000, compared to approximately $30,000$851,000 for the same period in 2015.

For the six-monthnine-month period ended JuneSeptember 30, 2016, the Company incurred restructuring costs of approximately $178,000,$203,000, compared to approximately $108,000$1.0 million for the same period in 2015.

Additional information regarding restructuring costs can be found in Note 11 of the Notes to Interim Condensed Consolidated Financial Statements.

Material Overcharge Settlement

The Company was a participant in a class action lawsuit against a number of polyurethane foam suppliers (“Defendants”) that recently reached settlement. The suit was filed to recover damages and obtain injunctive relief for Defendants’ alleged violations of the federal antitrust laws with respect to the fixing of prices of polyurethane foam sold from January 1, 1999 through August 2010. The Company received a settlement amount of approximately $432,000 during the three-month period ended June 30, 2016.  The Company received an additional settlement amountrecorded gains of approximately $1.7 million in July, 2016, which will be recorded inand $2.1 million during the three-month period endingthree- and nine-month periods ended September 30, 2016, andrespectively, which isrepresents the final payment the Company will receive for this settlement.full settlement amount received. The settlement amount for the current quarter is recorded as “Material overcharge settlement” in the operating income section of the Condensed Consolidated Statements of Income.

Interest Income and Expense

The Company had net interest income of approximately $15,000$25,000 and $8,000$9,000 for the three-month periods ended JuneSeptember 30, 2016 and 2015, respectively. The Company had net interest income of approximately $26,000$51,000 and net interest expense of approximately $15,000$7,000 for the six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015, respectively. The increase in net interest income is primarily due to an increase in interest earned on money market accounts and certificates of deposit and decreasing interest costs on ourthe Company’s term loans.

Income Taxes

The Company’s effective tax rate was approximately 35.0%, for each of the three-month periods ended JuneSeptember 30, 2016 and 2015. The Company’s effective tax rate was approximately 35.7%35.4% and 35.0%, for the six-monthnine-month periods ended JuneSeptember 30, 2016 and 2015, respectively. The increase in the effective tax rate for the six-monthnine-month period ended JuneSeptember 30, 2016 is due to a tax assessment of approximately $40,000 from one jurisdiction recorded in the first quarter of 2016. The Company has deferred tax assets on its books associated with net operating losses generated in previous years. The Company has considered both positive and negative available evidence in its determination that the deferred tax assets are more likely than not to be realized, and has not recorded a tax valuation allowance at JuneSeptember 30, 2016. The Company will continue to assess whether the deferred tax assets will be realizable and, when appropriate, will record a valuation allowance against these assets. The amount of the net deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry-forward period are reduced.