UFP Technologies Inc: Form 10-Q for the period ended Sep 30, 2024

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, and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Management and representatives of UFP Technologies, Inc. (the “Company”) also may from time to time make forward-looking statements. 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; the demand for its products, the well-being and availability of the Company’s employees, the continuing operation of the Company’s locations, delayed payments by the Company’s customers and the potential for reduced or canceled orders; statements about expectations regarding customer inventory levels; statements about the Company’s acquisition strategies and opportunities and the Company’s growth potential and strategies for growth; expectations regarding customer demand; expectations regarding the Company’s liquidity and capital resources, including the sufficiency of its cash reserves and the availability of borrowing capacity to fund operations and/or potential future acquisitions; anticipated revenues and the timing of such revenues; expectations about shifting the Company’s book of business to higher-margin, longer-run opportunities; anticipated trends and potential advantages in the different markets in which the Company competes, including the medical, aerospace and defense, automotive, consumer, electronics, and industrial markets, and the Company’s plans to expand in certain of its markets; statements regarding anticipated advantages the Company expects to realize from its investments and capital expenditures; statements regarding anticipated advantages to improvements and alterations at the Company’s existing plants; expectations regarding the Company’s manufacturing capacity, operating efficiencies, and new production equipment; statements about new product offerings and program launches; statements about the Company’s participation and growth in multiple markets; statements about the Company’s business opportunities; and any indication that the Company may be able to sustain or increase its sales, earnings or earnings per share, or its sales, earnings or earnings per share growth rates.

Investors are cautioned that such forward-looking statements involve risks and uncertainties that could adversely affect the Company’s business and prospects, and otherwise cause actual results to differ materially from those anticipated by such forward-looking statements, or otherwise, including without limitation: financial condition and results of operations, including risks relating to substantially decreased demand for the Company’s products; risks relating to the potential closure of any of the Company’s facilities or the unavailability of key personnel or other employees; risks that the Company’s inventory, cash reserves, liquidity or capital resources may be insufficient; risks relating to delayed payments by our customers and the potential for reduced or canceled orders; risks related to customer concentration; risks related to global conflict or civil unrest to the efficacy of our manufacturing process; risks associated with the identification of suitable acquisition candidates and the successful, efficient execution of acquisition transactions, the integration of any such acquisition candidates, the value of those acquisitions to our customers and shareholders, and the financing of such acquisitions; risks related to our indebtedness and compliance with covenants contained in our financing arrangements, and whether any available financing may be sufficient to address our needs; risks associated with efforts to shift the Company’s book of business to higher-margin, longer-run opportunities; risks associated with the Company’s entry into and growth in certain markets; risks and uncertainties associated with seeking and implementing manufacturing efficiencies and implementing new production equipment; risks and uncertainties associated with growth of the Company’s business and increases to sales, earnings and earnings per share; risks relating to our ability to achieve our environmental, social and governance (“ESG”) objectives or otherwise meet the expectations of our stakeholders with respect to ESG matters; risks relating to cybersecurity, including cyber-attacks on the Company’s information technology infrastructure, products, suppliers, customers and partners, and cybersecurity-related regulations; and risks associated with new product and program launches. 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 current beliefs, estimates and assumptions and are 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 our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, 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”, “us”, “our”, or “the Company” refer to UFP Technologies, Inc. and its consolidated subsidiaries.

Overview

The Company is a designer and custom manufacturer of comprehensive solutions for medical devices, sterile packaging, and other highly engineered custom products. The Company is an important link in the medical device supply chain and a valued outsource partner to many of the top medical device manufacturers in the world. The Company’s single-use and single-patient devices and components are used in a wide range of medical devices and packaging for minimally invasive surgery, infection prevention, surfaces and support, wound care, wearables, orthopedic soft goods, and orthopedic implants.

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

The Company completed four strategic acquisitions in the nine-month period ended September 30, 2024. The acquired operations primarily serve the medical market and contributed to an overall 20.7% increase in net sales for this period. Organic sales grew 9.1%, fueled by strong sales in the robotic surgery and infection prevention markets. Net sales relating to our largest customer, Intuitive Surgical SARL, were 30.3% of our net sales in the nine-month period ended September 30, 2024. As a result of the four acquisitions largely all in the third quarter, it is anticipated that this concentration will decrease going forward. This increase in sales as well as strong margins and the leverage of relatively fixed SG&A costs allowed the Company to generate a 30.5% increase in operating income for the nine-month period ended September 30, 2024.

Results of Operations

Net Sales

Net sales for the three-month period ended September 30, 2024 increased approximately 44.0% to $145.2 million from sales of $100.8 million for the same period in 2023. The increase in net sales is primarily due to increased sales to customers in the medical market of 52.2%, primarily led by increased sales from the Company’s recent acquisitions as well as 7.9% increased organic sales fueled by increases in the robotic surgery and infection prevention markets.

Net sales for the nine-month period ended September 30, 2024 increased approximately 20.7% to $360.4 million from sales of $298.6 million for the same period in 2023. The increase in net sales is primarily due to increased sales to customers in the medical market of 23.7%, primarily led by increased sales from the Company’s recent acquisitions as well as 7.1% increased organic sales fueled by increases in the robotic surgery and infection prevention markets.

Gross Profit

Gross margin increased to 28.6% for the three-month period ended September 30, 2024, from 27.5% for the same period in 2023. As a percentage of sales, material and overhead costs collectively decreased 3.2% while labor costs increased 2.1%. The increase in gross margin is primarily due to the accretive margins from the Company’s recent acquisitions as well as increased manufacturing efficiencies and the containment of fixed overhead costs.

Gross margin increased to 29.0% for the nine-month period ended September 30, 2024, from 28.8% for the same period in 2023. As a percentage of sales, material costs decreased 1.1% while overhead and labor costs collectively increased 0.8%. The increase in gross margin is primarily due to the accretive margins from the Company’s recent acquisitions as well as increased manufacturing efficiencies and the containment of fixed overhead costs. The gross margin increases for both the three- and nine-month periods ended September 30 were achieved despite the absorption of approximately $1 million in purchase accounting one-time costs.

Selling, General and Administrative Expenses

Selling, general, and administrative expenses (“SG&A”) increased approximately 26.6% to $15.8 million for the three-month period ended September 30, 2024, from $12.5 million for the same period in 2023, largely due to SG&A from the Company’s recent acquisitions as well as increased performance-based compensation and professional fees. As a percentage of sales, SG&A decreased to 10.9% for the three-month period ended September 30, 2024, from 12.4% for the same three-month period in 2023 reflecting the leverage of the sales increase over relatively fixed SG&A

SG&A increased approximately 21.5% to $43.6 million for the nine-month period ended September 30, 2024, from $37.8 million for the same period in 2023, largely due to SG&A from the Company’s recent acquisitions as well as increased performance-based compensation and professional fees. As a percentage of sales, SG&A decreased to 12.1% for the nine-month period ended September 30, 2024, from 12.7% for the same nine-month period in 2023 reflecting the leverage of the sales increase over relatively fixed SG&A.

Acquisition Costs

The Company incurred approximately $0.7 million and $1.7 million in costs associated with acquisition related activities which were charged to expense for the three- and nine-month periods ended September 30, 2024, respectively These costs were primarily for legal, due diligence and valuation services and are reflected on the face of the income statement.

Change in fair value of contingent consideration

In connection with the acquisitions of Welch and Marble in 2024, and DAS Medical in 2021, the Company is required to make contingent payments, subject to the entities achieving certain financial performance thresholds. The contingent consideration payments for the Welch, Marble and the DAS Medical acquisitions are up to $6 million, $500 thousand and $20 million, respectively. The fair value of the liability for the contingent consideration payments recognized upon the acquisition as part of the purchase accounting opening balance sheets totaled approximately $800 thousand, $400 thousand and $5.2 million for the Welch, Marble and the DAS Medical acquisitions, respectively, and was estimated by discounting to present value the probability-weighted contingent payments expected to be made. Assumptions used in the initial calculation were management’s financial forecasts, discount rate and various volatility factors. The ultimate settlement of contingent consideration could deviate from current estimates based on the actual results of these financial measures. Contingent consideration is considered to be a Level 3 financial liability that is re-measured each reporting period. The fair value of the liability for the contingent consideration payments recognized at September 30, 2024 totaled approximately $10.0 million out of the remaining potential payments of $16.5 million. The change in fair value of contingent consideration for the acquisitions for the three- and nine-month periods ended September 30, 2024, resulted in an expense of approximately $0.2 million and $0.7 million, respectively, and is included in change in fair value of contingent consideration in the condensed consolidated statements of comprehensive income.

Interest expense, net

Net interest expense was approximately $3.5 million and $0.9 million for the three-month periods ended September 30, 2024 and 2023, respectively. The increase in net interest expense for the three-month period ended September 30, 2024 was primarily due to higher debt related to 2024 acquisitions. Interest income was immaterial.

Net interest expense was approximately $4.7 million and $2.9 million for the nine-month periods ended September 30, 2024 and 2023, respectively. The increase in net interest expense for the nine-month period ended September 30, 2024 was primarily due to higher debt related to 2024 acquisitions. Interest income was immaterial.

Income Taxes

The Company recorded income tax expense of approximately 22.9% and 17.3% of income before income tax expense, for the three-month periods ended September 30, 2024 and 2023, respectively. The increase in the effective tax rate for the current period as compared to the prior period is largely due to the difference in discrete items during the two periods.

The Company recorded income tax expense of approximately 21.0% and 20.7% of income before income tax expense, for the nine-month periods ended September 30, 2024 and 2023, respectively. The increase in the effective tax rate for the current period as compared to the prior period is largely due to the difference in discrete items during the two periods as well as more anticipated US based income in 2024 as a result of the recent acquisitions.

Liquidity and Capital Resources

The Company generally funds its operating expenses, capital requirements, and growth plan through internally generated cash and bank credit facilities.

Cash Flows

Net cash provided by operations for the nine-month period ended September 30, 2024 was approximately $42.2 million and was primarily a result of net income generated of approximately $42.6 million, depreciation and amortization of approximately $10.1 million, share-based compensation of approximately $4.8 million, a change in the fair value of contingent consideration of approximately $0.7 million, a decrease in deferred taxes of approximately $0.8 million, and a decrease in accounts payable of approximately $0.7 million due to the timing of vendor payments in the ordinary course of business.

These cash inflows and adjustments to income were partially offset by an increase in accounts receivable of approximately $2.9 million resulting primarily from an increase in sales from the last 60 days of Q3 2024 as compared to Q4 2023, partially offset by the collection of an escrow receivable, an increase in inventory of approximately $5.6 million due to inventory build for upcoming demand, an increase in prepaid expenses of approximately $0.9 million primarily due to the payment of current year insurance policies, an increase in refundable income taxes of $0.8 million due to the timing of payment of tax estimates, an increase in other assets of approximately $0.5 million, a decrease in accrued expenses of approximately $0.6 million due primarily to the net payment of accrued compensation, a decrease in deferred revenue of approximately $0.8 million due to the recognition of deferred tooling and development revenue, and a decrease in other long-term liabilities of approximately $5.4 million due primarily to non-compete payments and payments of contingent consideration.

Net cash used in investing activities during the nine-month period ended September 30, 2024 was approximately $206.3 million and was primarily the result of the acquisition of Marble Medical, AJR Enterprises, Welch Fluorocarbon, and AQF Medical, and the additions of manufacturing machinery and equipment and various building improvements across the Company.

Net cash provided by financing activities was approximately $175.1 million during the nine-month period ended September 30, 2024 and was primarily the result of borrowings under the Company’s Third Amended and Restated Credit Agreement of approximately $240.2 million to recent acquisitions. These borrowings were partially offset by payments on the revolving line of credit of approximately $28.2 million, principal payments of long-term debt of approximately $32.0 million, payments of contingent consideration of approximately $0.2 million and payments of statutory withholding for stock options exercised and restricted stock units vested of approximately $4.7 million.

Outstanding and Available Debt

On June 27, 2024, the Company, as the borrower, entered into a secured $275 million Amended and Restated Credit Agreement (the “Third Amended and Restated Credit Agreement”) with certain of the Company’s subsidiaries (the “Subsidiary Guarantors”) and Bank of America, N.A., in its capacity as the initial lender, Administrative Agent, Swingline Lender and L/C Issuer, and certain other lenders from time-to-time party thereto. The Third Amended and Restated Credit Agreement amends and restates the Company’s prior credit agreement, originally dated as of December 22, 2021.

The credit facilities under the Third Amended and Restated Credit Agreement consist of a secured term loan to the Company of$125 million and a secured revolving credit facility, under which the Company may borrow up to $150 million. The Third Amended and Restated Credit Facilities mature on June 27, 2029. This maturity date is subject to acceleration and the Company could be subject to additional fees and expenses in certain circumstances should one or more events of default described in the Third Amended and Restated Credit Agreement occur. The secured term loan requires quarterly principal payments of $3,125,000 that commence on December 31, 2024. The proceeds of the Third Amended and Restated Credit Agreement may be used for general corporate purposes, including funding the acquisition of AJR Enterprises, LLC, as well as certain other permitted acquisitions. The Company’s obligations under the Third Amended and Restated Credit Agreement are guaranteed by Subsidiary Guarantors and secured by substantially all assets of the Company.

The Third Amended and Restated Credit Facilities call for interest of SOFR plus a margin that ranges from 1.25% to 2.25% or, at the discretion of the Company, the bank’s prime rate plus a margin that ranges from .25% to 1.25%. In both cases the applicable margin is dependent upon Company performance. Under the Third Amended and Restated Credit Agreement, the Company is subject to a minimum fixed-charge coverage financial covenant as well as a maximum total funded debt to EBITDA financial covenant. The Third Amended and Restated Credit Agreement contains other covenants customary for transactions of this type, including restrictions on certain payments, permitted indebtedness and permitted investments.

At September 30, 2024, the Company had approximately $212 million in outstanding borrowings under the Third Amended and Restated Credit Agreement, and also had approximately $0.7 million in standby letters of credit outstanding, drawable as a financial guarantee on worker’s compensation insurance policies. At September 30, 2024, the applicable interest rate was approximately 6.5% and the Company was in compliance with all covenants under the Third Amended and Restated Credit Agreement.

Long-term debt consists of the following (in thousands):

Future maturities of long-term debt at September 30, 2024 are as follows (in thousands):

Future Liquidity

The Company requires cash to pay its operating expenses, purchase capital equipment, and to service its contractual obligations. The Company’s principal sources of funds are its operations and its Third Amended and Restated Credit Agreement. The Company generated cash of approximately $42.2 million from operations during the nine-month period ended September 30, 2024. The Company cannot guarantee that its operations will generate cash in future periods. The Company’s longer-term liquidity is contingent upon future operating performance and availability of draws on its revolving credit facility. Further, the economic uncertainty resulting from events including inflation, bank failures, and other factors beyond the control of the Company could affect the Company’s long-term ability to access the public markets and obtain necessary capital in order to properly capitalize and continue operations.

The Company plans to continue to add capacity to enhance operating efficiencies in its manufacturing plants and accommodate anticipated growth in demand. The Company may consider additional acquisitions of companies, technologies, or products that are complementary to its business. The Company believes that its existing resources, including its revolving credit facility, together with cash expected to be generated from operations, will be sufficient to fund its cash flow requirements, including capital asset acquisitions, through the next twelve months.

The Company may also require additional capital in the future to fund capital expenditures, acquisitions, or other investments. These capital requirements could be substantial. The Company anticipates that any future expansion of its business will be financed through existing resources, cash flow from operations, the Company's revolving credit facility, or other new financing. The Company cannot guarantee that it will be able to meet existing financial covenants or obtain other new financing on favorable terms, if at all. The Company's liquidity will be impacted to the extent additional stock repurchases are made under the Company's stock repurchase program.

Stock Repurchase Program

The Company accounts for treasury stock under the cost method, using the first-in, first-out cost flow assumption, and includes treasury stock as a component of stockholders’ equity. On June 16, 2015, the Company announced that its Board of Directors authorized the repurchase of up to $10.0 million of the Company’s outstanding common stock. Under the program, the Company is authorized to repurchase shares through Rule 10b5-1 plans, open market purchases, privately negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934. The stock repurchase program will end upon the earlier of the date on which the plan is terminated by the Board or when all authorized repurchases are completed. The timing and amount of stock repurchases, if any, will be determined based upon our evaluation of market conditions and other factors. The stock repurchase program may be suspended, modified or discontinued at any time, and the Company has no obligation to repurchase any amount of its common stock under the program. There were no share repurchases during the nine-month periods ended September 30, 2024 and 2023. At September 30, 2024, approximately $9.4 million was available for future repurchases of the Company’s common stock under this authorization.

Critical Accounting Estimates

There have been no material changes to the Company’s Critical Accounting Estimates, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023, with the exception of the item noted below:

The Company believes the following critical accounting policy necessitates that significant judgments and estimates be used in the preparation of its consolidated financial statements.

The Company has reviewed this policy with its Audit Committee.

Valuation of Intangible Assets and Contingent Consideration Liability

We base the fair value of identifiable intangible assets acquired in a business combination on detailed valuations that use information and assumptions provided by management, which consider management’s best estimates of inputs and assumptions that a market participant would use. Further, for those arrangements that involve potential future contingent consideration, we record on the date of acquisition a liability equal to the fair value of the estimated additional consideration we may be obligated to pay in the future. We re-measure this liability each reporting period and record changes in the fair value through a separate line item within our consolidated statements of operations. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount rates, periods, timing and amount of projected revenue or timing or likelihood of achieving regulatory, revenue or commercialization-based milestones. The use of alternative valuation assumptions, including estimated revenue projections, growth rates, cash flows, discount rates, useful life or probability of achieving clinical, regulatory or revenue-based milestones could result in different purchase price allocations and recognized amortization expense and contingent consideration expense or benefit in current and future periods.

Commitments and Contractual Obligations

There have been no material changes outside the ordinary course of business to our contractual obligations and commitments, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023.

There have been no material changes in our market risks as previously disclosed in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2023.

As of the end of the period covered by this report (the “Evaluation Date”), the Company’s management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rule 13a-15(e) or 15d-15(e)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is (i) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

The Company closed the acquisition of Marble in June 2024 and closed on the acquisitions of AJR, Welch and AQF all in the third quarter of 2024. The new acquisitions’ total assets and revenues constituted approximately 33.9% and 10%, respectively, of the Company’s consolidated total assets and year-to-date revenues as shown on our condensed consolidated financial statements as of and for the period ended September 30, 2024. As the acquisitions occurred in the second and third quarters of fiscal 2024, the Company excluded all of the acquired businesses internal control over financial reporting from the scope of the assessment of the effectiveness of the Company’s disclosure controls and procedures. This exclusion is in accordance with the general guidance issued by the Staff of the Securities and Exchange Commission that an assessment of a recently acquired business may be omitted from the scope within the first year of acquisition if specified conditions are satisfied.

An evaluation was also performed under the supervision and with the participation of our management, including the Company’s Chief Executive Officer and Chief Financial Officer, of any change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Except as described above, that evaluation did not identify any change in the Company’s internal control over financial reporting that occurred during our latest fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Company faces a number of uncertainties and risks that are difficult to predict and many of which are outside of the Company's control. For a detailed discussion of the risks that affect our business, you should consider carefully the risks and uncertainties described below, in addition to other information described in this Quarterly Report on Form 10-Q as well as our other public filings with the SEC including Part I, Item IA, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2024.