Atrion Corp. Annual Report 2016

Plain-text annual report

ATRION CORPORATION ANNUAL REPORT 2016 2016 ATRION CORPORATION develops and manufactures products primarily for medical applications. Our products advance the standard of care by increasing safety for patients and providers. We target niche markets, with particular emphasis on ﬂuid delivery, cardiovascular and ophthalmology applications. Headquartered in Allen, Texas, Atrion has design and manufacturing facilities in Alabama, Florida and Texas. Contents Letter to Stockholders ............................................ 2 Financial Statements ...................................................4 Management’s Discussion ........................................22 Selected Financial Data ..............................................27 Corporate Information ................................................29 Financial Highlights For the Year Ended December 31 2016 2015 As of December 31 2016 2015 Revenues $ 143,487,000 $ 145,733,000 Total Assets $ 182,593,000 $ 164,336,000 Operating Income 39,126,000 42,510,000 Net Income 27,581,000 28,925,000 Cash and Investments 54,047,000 38,256,000 Income per Diluted Share $ 14.85 $ 15.47 Long-term Debt — — Weighted Average Diluted Shares Outstanding 1,857,000 1,870,000 Stockholders’ Equity $ 162,988,000 $ 144,098,000 2012 2013 2014 2015 2016 $11.66 $13.18 2012 2013 $14.08 2014 $15.47 2015 $14.85 2016 $119 $132 $141 $146 $143 2012 2013 2014 2015 2016 $33.6 $37.9 $40.8 $42.5 $39.1 INCOME PER DILUTED SHARE REVENUES (IN MILLIONS) OPERATING INCOME (IN MILLIONS) Comparison of 5-year cumulative total return Among Atrion Corporation, Russell 2000 Index and SIC Code Index Atrion Corporation Russell 2000 Index SIC Code Index 400 300 s r a l l o D 200 100 0 The graph set forth at left compares the total cumulative return for the ﬁve-year period ended December 31, 2016 on the Company’s common stock, the Russell 2000 Index and SIC Code 3841 Index--Surgical and Medical Instruments (compiled by Zacks Investment Research, Inc.), assuming $100 was invested on December 31, 2011 in our common stock, the Russell 2000 Index and the SIC Code Index and dividends were reinvested 2011 2012 2013 2014 2015 2016 Company/Index Atrion Corporation Russell 2000 Index SIC Code Index 2011 $100.00 $100.00 $100.00 2012 $86.56 $116.35 $118.75 2013 $132.20 $161.52 $166.81 2014 $153.07 $169.42 $192.53 2015 $173.12 $161.95 $206.24 2016 $232.44 $196.45 $239.63 ATRION 2016 ANNUAL REPORT 1 To our stockholders, We ﬁnished 2016 with an after-tax return on equity of 18%, almost 50% higher than the S&P 500. This return is even stronger if you consider that about 30% of our equity was comprised of cash and investments that did not generate signiﬁcant income in this low-interest environment. If we exclude these assets and the income they generated, our after-tax return on equity for the year jumps to 25%. Once again, Atrion provided double-digit increases in the dividend to our stockholders—17% in 2016. We also ﬁnished the year debt-free and with $54 million in cash and investments—40% higher than at the end of 2015. That we achieved these results despite the signiﬁcant headwinds I described in last year’s letter reveals some critical insights about Atrion. We proudly own and operate our manufacturing facilities, all of which are in the United States. We do this to ensure the highest levels of quality, as well as out of mutual loyalty to our employees—many have more than 20 years with us, and more than a few have given us an incredible 30 or more years of their expertise. But, like other U.S.-based manufacturers that export a substantial portion of their products, the strong dollar impacted our revenues and operating income. Even though product volumes actually grew in 2016, we saw a 2% decline in revenues and an 8% decline in operating income. We nevertheless generated strong returns for our investors because we manage the ups and downs of business cycles sensibly. This does not mean we happily accept, let alone excuse, any sort of negative year-over-year comparisons—quite the opposite, in fact. In 2016, we redoubled our efforts to expand our sales. We went back and questioned our processes and production methods to further improve our efﬁciencies. But we also remained focused on our commitment to long-term growth for our stockholders, employees, and customers. This means that making smart investments in people, manufacturing technologies, and future products took precedence over adding a little more to the 2016 year-end numbers. This is how we intend to continue to grow and remain highly proﬁtable over the next decade. Well-prepared for what’s next While 2016 brought us signiﬁcant headwinds in the form of pricing pressure, we are still proud that our products are increasing their share of the marketplace. Our unwavering commitment to consistency, our laser focus on quality, our unfailing dedication to customer service, and our careful attention to hiring and retaining the right people: these are the factors that have long shored up our foundation, and that we are conﬁdent we can rely on going forward. 2 ATRION 2016 ANNUAL REPORT Since last year’s report, global volatility has only increased and it might well continue in that direction. We don’t know what 2017 will bring in terms of macroeconomic factors, but we do recognize that any changes that come our way—for example, corporate tax reform, trade policies, and regulatory requirements —could impact us in ways that might be positive or negative. In the face of this, it is critical that we remain prepared and able to maintain a steady course. Guided by solid business planning, our philosophy has long been to prepare for, and protect against, factors that are beyond our control. Over the years, we have done this by focusing on maintaining a solid ﬁnancial condition, and on growth that is steady and sustainable. A solid ﬁnancial foundation is what allows us to continue investing in what matters. We have no plans to slow the pace of investment in our manufacturing, technology, and people. Of particular focus has been investing in research and development, an area where we hold a signiﬁcant competitive advantage. In 2017, we will maintain the pace of these investments; they have served us well. Atrion’s stability and growth are ﬁrmly rooted in the capabilities of our facilities and equipment, the intellectual property we own, and the people driving our advancements. Our priority is ensuring Atrion’s long-term stability and growth, rather than realizing the kind of short-term outcomes achieved when we react too quickly to events or expectations. You can continue to count on us to focus on the long term, just as you can count on my continued appreciation of your belief in us. I am grateful to all of our investors, and to the many people at Atrion responsible for our steady, strong performance. Respectfully, David A. Battat President and CEO 2016 2016 REVENUES BY PRODUCT LINE Fluid Delivery $ 60,889,000 Cardiovascular $ 47,064,000 Ophthalmology $ 15,427,000 Other $ 20,107,000 42% 33% 11% 14% ATRION 2016 ANNUAL REPORT 3 CONSOLIDATED BALANCE SHEETS As of December 31, 2016 and 2015 Assets: Current Assets: Cash and cash equivalents Short-term investments Accounts receivable, net of allowance for doubtful accounts of $71 and $50 in 2016 and 2015, respectively Inventories Prepaid expenses and other current assets Deferred income taxes Total Current Assets Long-term investments Property, Plant and Equipment Less accumulated depreciation and amortization Other Assets and Deferred Charges: Patents and licenses, net of accumulated amortization of $11,911 and $11,647 in 2016 and 2015, respectively Goodwill Other Total Assets The accompanying notes are an integral part of these statements. 2016 2015 (in thousands) $ 20,022 $ 28,346 24,080 17,166 29,015 3,181 651 94,115 9,945 160,413 95,148 65,265 1,929 9,730 1,609 13,268 44 16,620 29,771 2,934 580 78,295 9,866 150,807 87,493 63,314 2,193 9,730 938 12,861 $ 182,593 $ 164,336 4 ATRION 2016 ANNUAL REPORT Liabilities and Stockholders’ Equity: Current Liabilities: Accounts payable Accrued liabilities Accrued income and other taxes Total Current Liabilities Line of credit Other Liabilities and Deferred Credits: Deferred income taxes Other Total Liabilities Commitments and Contingencies Stockholders’ Equity: Common stock, par value $.10 per share, authorized 10,000 shares, issued 3,420 shares Additional paid-in capital Accumulated other comprehensive income (loss) Retained earnings Treasury shares, 1,596 shares in both 2016 and 2015, at cost Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity The accompanying notes are an integral part of these statements. 2016 2015 (in thousands) $ 4,028 $ 4,635 410 9,073 — 9,404 1,128 10,532 19,605 3,926 5,061 329 9,316 — 9,989 933 10,922 20,238 342 342 37,448 (474) 239,946 (114,274) 162,988 35,945 283 219,516 (111,988) 144,098 $ 182,593 $ 164,336 ATRION 2016 ANNUAL REPORT 5 CONSOLIDATED STATEMENTS OF INCOME For the year ended December 31, 2016, 2015 and 2014 Revenues Cost of Goods Sold Gross Proﬁt Operating Expenses: Selling General and administrative Research and development Operating Income Interest Income Other Income (Expense), net Income before Provision for Income Taxes Provision for Income Taxes Net Income Net Income Per Basic Share Weighted Average Basic Shares Outstanding Net Income Per Diluted Share Weighted Average Diluted Shares Outstanding Dividends Per Common Share 2016 2015 2014 (in thousands, except per share amounts) $ 143,487 $ 145,733 $ 140,762 75,857 67,630 6,611 15,319 6,574 28,504 39,126 448 (308) 39,266 (11,685) 27,581 15.12 1,824 74,752 70,981 6,043 16,082 6,346 28,471 42,510 771 (2,411) 40,870 (11,945) 28,925 15.67 1,846 $ $ $ $ 14.85 $ 15.47 $ 1,857 1,870 3.90 $ 3.30 $ 72,244 68,518 6,210 16,205 5,286 27,701 40,817 1,191 13 42,021 (14,213) 27,808 14.20 1,958 14.08 1,975 2.78 $ $ $ $ The accompanying notes are an integral part of these statements. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the year ended December 31, 2016, 2015 and 2014 Net Income Other Comprehensive Income (Loss), net of tax: Unrealized Gain (Loss) on investments, net of tax beneﬁt of $408 in 2016, net of tax expense of $283 in 2015 and net of tax beneﬁt of $131 in 2014 2016 2015 2014 (in thousands) $ 27,581 $ 28,925 $ 27,808 (757) 528 (245) Comprehensive Income $ 26,824 $ 29,453 $ 27,563 The accompanying notes are an integral part of these statements. 6 ATRION 2016 ANNUAL REPORT CONSOLIDATED STATEMENTS OF CASH FLOWS For the year ended December 31, 2016, 2015 and 2014 Cash Flows From Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Deferred income taxes Stock-based compensation Impairment of investment Net change in accrued interest, premiums, and discounts on investments Other Changes in operating assets and liabilities: Accounts receivable Inventories Prepaid expenses and other current assets Other non-current assets Accounts payable and accrued liabilities Accrued income and other taxes Other non-current liabilities Cash Flows From Investing Activities: Property, plant and equipment additions Purchase of investments Proceeds from sale of investments Proceeds from maturities of investments Cash Flows From Financing Activities: Shares tendered for employees’ withholding taxes on stock-based compensation Tax beneﬁt related to stock-based compensation Purchase of treasury stock Dividends paid Net change in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Cash paid for: Income taxes The accompanying notes are an integral part of these statements. $ $ 2016 2015 2014 (in thousands) $ 27,581 $ 28,925 $ 27,808 8,953 (247) 1,566 8,823 (1,431) 1,841 345 2,413 (37) — 100 17 8,723 2 2,209 — 340 29 38,161 40,688 39,111 (546) 756 (247) (673) (324) 81 195 371 (1,749) 1,786 (103) (492) (128) 54 (2,798) (1,756) (3,117) (22) 968 (396) (767) 37,403 40,427 31,223 (10,639) (30,799) 210 5,000 (36,228) (1,112) — (1,276) (7,111) (9,499) (8,324) 28,346 (9,323) (168) — 13,400 3,909 (154) 156 (30,698) (6,069) (36,765) 7,571 20,775 20,022 $ 28,346 $ (12,671) (33,115) — 35,975 (9,811) (376) 168 (23,556) (5,432) (29,196) (7,784) 28,559 20,775 10,750 $ 12,900 $ 17,475 ATRION 2016 ANNUAL REPORT 7 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY For the year ended December 31, 2016, 2015 and 2014 (in thousands) Common Stock Treasury Stock Shares Outstanding Amount Shares Amount Additional Paid-in Capital Accumulated Other Comprehensive Income (loss) Retained Earnings Total Balances, January 1, 2014 1,985 $ 342 1,435 $ (57,302) $ 31,592 $ — $ 174,362 $ 148,994 Net income Other comprehensive income Tax beneﬁt from stock-based compensation Stock-based compensation transactions Shares surrendered in stock transactions Purchase of treasury stock Dividends 3 (1) (74) (3) 1 74 61 (376) (23,556) (245) 168 2,180 27,808 27,808 (245) 168 2,241 (376) (23,556) (5,464) (5,464) Balances, December 31, 2014 1,913 342 1,507 (81,173) 33,940 (245) 196,706 149,570 Net income Other comprehensive income Tax beneﬁt from stock-based compensation Stock-based compensation transactions Shares surrendered in stock transactions Purchase of treasury stock Dividends 1 (1) (89) (1) 1 89 37 (154) (30,698) 528 156 1,849 28,925 28,925 528 156 1,886 (154) (30,698) (6,115) (6,115) Balances, December 31, 2015 1,824 342 1,596 (111,988) 35,945 283 219,516 144,098 Net income Other comprehensive income Stock-based compensation transactions Shares surrendered in stock transactions Purchase of treasury stock Dividends 7 (3) (4) (7) 3 4 102 (1,112) (1,276) (757) 1,503 27,581 27,581 (757) 1,605 (1,112) (1,276) (7,151) (7,151) Balances, December 31, 2016 1,824 $ 342 1,596 $ (114,274) $ 37,448 $ (474) $ 239,946 $ 162,988 The accompanying notes are an integral part of this statement. 8 ATRION 2016 ANNUAL REPORT ATRION CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of the Company’s cash and cash equivalents and our short and long-term investments as of December 31, 2016 and 2015 are as follows (in thousands): Cash and Cash Equivalents: Cash deposits Money market funds Total cash and cash equivalents Short-term investments: December 31, 2016 2015 $ $ 10,724 $ 16,015 9,298 12,331 20,022 $ 28,346 Certiﬁcates of deposit (held-to-maturity) $ 24,000 Corporate bonds (held-to-maturity) 80 Total short-term investments Long-term investments: Corporate bonds (held-to-maturity) Equity securities (available-for-sale) Total long-term investments Total cash, cash equivalents and short and long-term investments $ $ $ $ 24,080 $ 5,000 $ 4,945 9,945 $ — 44 44 5,555 4,311 9,866 54,047 $ 38,256 Trade Receivables Trade accounts receivable are recorded at the original sales price to the customer. We maintain an allowance for doubtful accounts to reﬂect estimated losses resulting from the failure of customers to make required payments. On an ongoing basis, the collectability of accounts receivable is assessed based upon historical collection trends, current economic factors and the assessment of the collectability of speciﬁc accounts. We evaluate the collectability of speciﬁc accounts and determine when to grant credit to our customers using a combination of factors, including the age of the outstanding balances, evalua- tion of customers’ current and past ﬁnancial condition, recent payment history, current economic environment, and discus- sions with appropriate Company personnel and with the customers directly. Accounts are written off when we determine the receivable will not be collected. (1) Summary of Signiﬁcant Accounting Policies Atrion Corporation and its subsidiaries (“we,” “our,” “us,” “Atrion” or the “Company”) develop and manufacture products primarily for medical applications. We market our products throughout the United States and internationally. Our customers include physicians, hospitals, distributors, and other manufacturers. Atrion Corporation’s principal subsidiaries through which these operations are conducted are Atrion Medical Products, Inc., Halkey-Roberts Corporation and Quest Medical, Inc. Principles of Consolidation The consolidated ﬁnancial statements include the accounts of Atrion Corporation and its subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. Estimates The preparation of the 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 and disclosures of contingent assets and liabilities at the dates of the ﬁnancial statements and the reported amount of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Cash and Cash Equivalents and Investments Cash and cash equivalents include cash on hand and in the bank as well as money market accounts and debt securities with maturities at the time of purchase of 90 days or less. Our investments consist of taxable corporate bonds, certiﬁcates of deposit and equity securities. We classify our investment securities in one of two categories: held-to-maturity or available- for-sale. Securities that we have the positive intent and ability to hold to maturity are reported at amortized cost and classiﬁed as held-to-maturity securities. If we do not have the intent and ability to hold a security to maturity, we report the investment as available-for-sale securities. We report available-for-sale securities at fair value, based on quoted market prices, with unrealized gains and, to the extent deemed temporary, unrealized losses recorded in stockholders’ equity as accumulated other comprehensive income (loss). We consider investments which will mature in the next 12 months as current assets. The remaining investments are considered non-current assets including our investment in equity securities which we intend to hold longer than 12 months. We periodically evaluate our investments for impairment. Notes to Consolidated Financial Statements ATRION 2016 ANNUAL REPORT 9 Inventories Inventories are stated at the lower of cost (including materials, direct labor and applicable overhead) or market. Cost is determined by using the ﬁrst-in, ﬁrst-out method. The following table details the major components of inventory (in thousands): December 31, 2016 2015 Raw materials Work in process Finished goods Total inventories $ $ 12,984 $ 6,230 9,801 29,015 $ 12,775 6,557 10,439 29,771 Accounts Payable We reﬂect disbursements as trade accounts payable until such time as payments are presented to our bank for payment. At December 31, 2016 and 2015, disbursements totaling approximately $624,000 and $636,000, respectively, had not been presented for payment to our bank. Income Taxes We account for income taxes utilizing Accounting Standards Codiﬁcation (ASC 740), Income Taxes, or ASC 740. ASC 740 requires the asset and liability method for the recording of deferred income taxes, whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the ﬁnancial statement and the tax bases of assets and liabilities, as measured at current enacted tax rates. When appropriate, we evaluate the need for a valuation allowance to reduce deferred tax assets. ASC 740 also requires the accounting for uncertainty in income taxes recognized in an enterprise’s ﬁnancial statements and prescribes a recognition threshold and measurement attributes of income tax positions taken or expected to be taken on a tax return. Under ASC 740, the impact of an uncertain tax position taken or expected to be taken on an income tax return must be recognized in the ﬁnancial statements at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized in the ﬁnancial statements unless it is more-likely-than-not of being sustained. Our uncertain tax positions are recorded as “Other non-current liabilities.” We classify interest expense on underpayments of income taxes and accrued penalties related to unrecognized tax beneﬁts in the income tax provision. During the years ended December 31, 2016 and 2015, we made quarterly payments in excess of federal income taxes due of approximately $920,000 and $1.2 million, respectively. These amounts are recorded in Prepaid expenses and other current assets on our Consolidated Balance Sheets. Property, Plant and Equipment Property, plant and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the related assets. Additions and improvements are capitalized, including all material, labor and engineering costs to design, install or improve the asset. Expenditures for repairs and maintenance are charged to expense as incurred. The following table represents a summary of property, plant and equipment at original cost (in thousands): December 31, 2016 2015 Useful Lives $ 5,260 $ 5,260 — 32,321 31,914 30-40 yrs 122,832 113,633 3-15 yrs $ 160,413 $ 150,807 Land Buildings Machinery and equipment Total property, plant and equipment Depreciation expense of $8,689,000, $8,478,000 and $8,454,000 was recorded for the years ended December 31, 2016, 2015 and 2014, respectively. Depreciation expense is recorded in either cost of goods sold or operating expenses based on the associated assets’ usage. Patents and Licenses Costs for patents and licenses acquired are determined at acquisition date. Patents and licenses are amortized over the useful lives of the individual patents and licenses, which are from seven to 20 years. Patents and licenses are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Goodwill Goodwill represents the excess of cost over the fair value of tangible and identiﬁable intangible net assets acquired. Annual impairment testing for goodwill is done using a qualitative assessment on goodwill impairment to determine whether it is necessary to perform the two-step goodwill impairment test. Goodwill is also reviewed whenever events or changes in circumstances indicate a change in value may have occurred. We have identiﬁed three reporting units where goodwill was recorded for purposes of testing goodwill impairment annually: (1) Atrion Medical Products, Inc., (2) Halkey-Roberts Corporation and (3) Quest Medical, Inc. The total carrying amount of goodwill in each of the years ended December 31, 2016 and 2015 was $9,730,000. Our evaluation of goodwill during each year resulted in no impairment losses. 10 ATRION 2016 ANNUAL REPORT Notes to Consolidated Financial Statements Current Accrued Liabilities The items comprising current accrued liabilities are as follows (in thousands): December 31, 2016 2015 Accrued payroll and related expenses $ 3,661 $ 4,206 Accrued vacation Other accrued liabilities Total accrued liabilities 265 709 245 610 $ 4,635 $ 5,061 Revenues We recognize revenue when our products are shipped to our customers, provided an arrangement exists, the fee is ﬁxed and determinable and collectability is reasonably assured. All risks and rewards of ownership pass to the customer upon shipment. Net sales represent gross sales invoiced to customers, less certain related charges, including discounts, returns and other allowances. Revenues are recorded exclusive of sales and similar taxes. Returns, discounts and other allowances have been insigniﬁcant historically. Shipping and Handling Policy Shipping and handling fees charged to customers are reported as revenue and all shipping and handling costs incurred related to products sold are reported as cost of goods sold. Research and Development Costs R&D costs relating to the development of new products and improvements of existing products are expensed as incurred. Stock-Based Compensation We have stock-based compensation plans covering certain of our ofﬁcers, directors and key employees. As explained in detail in Note 8, we account for stock-based compensation utilizing the fair value recognition provisions of ASC 718, Compensation- Stock Compensation, or ASC 718. New Accounting Pronouncements In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). This amendment simpliﬁes the accounting for some aspects of share-based payment transactions, including the income tax treatment of excess tax beneﬁts and deﬁciencies, forfeitures, classiﬁcation of share-based awards as either equity or liabilities, and classiﬁcation in the statement of cash ﬂows for certain share-based transactions related to tax beneﬁts and payments. Under this guidance all excess tax beneﬁts (“windfalls”) and deﬁciencies (“shortfalls”) related to employee stock compensation are recognized within income tax expense. Under prior guidance windfalls were recognized in paid-in capital and shortfalls were only recognized to the extent they exceeded the pool of windfall tax beneﬁts. ASU 2016-09 also requires companies to classify cash ﬂows resulting from excess tax beneﬁts and deﬁciencies from employee share-based payments as cash ﬂows from operating activities. These items were previously included as cash ﬂows from ﬁnancing activities. ASU 2016-09 is effective for ﬁscal years beginning after December 15, 2016, including interim periods within those ﬁscal years. Early adoption is permitted. The Company early adopted this guidance in the second quarter of 2016 effective January 1, 2016. The Company elected to account for forfeitures as they occur and to use a prospective transition method for the presentation of excess tax beneﬁts on the statement of cash ﬂows. As a result of the adoption, a tax beneﬁt of $687,000 was recorded in 2016 reﬂecting the excess tax beneﬁts resulting from the vesting of restricted stock and restricted stock units. Prior to adoption, this amount would have been recorded as additional paid-in capital. This change could create future volatility in our effective tax rate depending upon the amount of exercise or vesting activity from our stock based awards. This adoption also impacted the computation of diluted shares outstanding for all 2016 reporting periods as we excluded the excess tax beneﬁts from the assumed proceeds available to repurchase shares in the computation of our diluted earnings per share. The effect of this change on our diluted earnings per share was not signiﬁcant. The excess tax beneﬁt recorded in 2016 was included in our consolidated statements of cash ﬂows as an operating activity rather than as a ﬁnancing activity as was done in prior years. There were no restatements of cash ﬂows from operating activities or cash ﬂows from ﬁnancing activities for the years 2015 and 2014 because we elected to adopt this change on a prospective basis. ASU 2016-09 also requires the presentation of employee taxes paid by the Company through the withholding of shares as a ﬁnancing activity on the statement of cash ﬂows, which is how we had previously reﬂected these items. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The main objective of this update is to enhance the reporting model for ﬁnancial instruments in order to provide users of ﬁnancial statements with more decision-useful information. The new guidance addresses certain aspects of recognition, measurement, presentation, and disclosure of ﬁnancial instruments. This ASU is effective for ﬁscal years beginning after December 15, 2017, including interim periods within those ﬁscal years. We are currently evaluating the new guidance to determine the impact it may have on our consolidated ﬁnancial statements. In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classiﬁcation of Deferred Taxes (ASU 2015-17) which requires that deferred tax liabilities and assets be classiﬁed as noncurrent on the balance sheet. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by this guidance. ASU 2015-17 is effective for annual Notes to Consolidated Financial Statements ATRION 2016 ANNUAL REPORT 11 and interim periods beginning after December 15, 2016 but early application is permitted and the guidance may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company does not anticipate a material impact on its consolidated ﬁnancial statements at the time of adoption of this new standard. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-09). ASU 2014-09 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. ASU 2014-09 will replace most existing revenue recognition guidance in United States Generally Accepted Accounting Principles when it becomes effective. In July 2015, the FASB voted to delay the effective date of ASU 2014-09 by one year, making it effective for ﬁscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted as of the original effective date. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We plan on adopting the ASU in the ﬁrst quarter of the year ended December 31, 2018. The Company has not yet selected a transition method and is currently evaluating the effect that our pending adoption for the guidance will have on our consolidated ﬁnancial statements and related disclosures. We anticipate our assessment to be completed by December 31, 2017. Based on our existing evaluation process, we have not identiﬁed any revenue stream that would be impacted. From time to time, new accounting pronouncements applicable to us are issued by the FASB, or other standards setting bodies, which we will adopt as of the speciﬁed effective date. Unless otherwise discussed, we believe the impact of recently issued standards that are not yet effective will not have a material impact on our consolidated ﬁnancial statements upon adoption. Fair Value Measurements Accounting standards use a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. These tiers are: Level 1, deﬁned as observable inputs such as quoted prices in active markets; Level 2, deﬁned as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, deﬁned as unobservable inputs in which little or no market data exists therefore requiring an entity to develop its own assumptions. As of December 31, 2016 and 2015, we held certain investments in corporate and government debt securities, certiﬁcates of deposit, and certain equity securities. These investments are all considered Level 2 assets and the fair value of our investments were estimated using recently executed transactions and market price quotations (see Note 2). The carrying values of our other ﬁnancial instruments including cash and cash equivalents, money market accounts, accounts receivable, accounts payable, accrued liabilities, and accrued income and other taxes approximated fair value due to their liquid and short-term nature. Concentration of Credit Risk Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, certiﬁcates of deposit, investments and accounts receivable. Our cash and cash equivalents and certiﬁcates of deposit are held in accounts with ﬁnancial institutions that we believe are creditworthy. Certain of these amounts at times may exceed federally-insured limits. At December 31, 2016, approximately 89 percent of our cash and cash equivalents and all of our certiﬁcates of deposit were uninsured. We have not experienced any credit losses in such accounts and do not believe we are exposed to any signiﬁcant credit risk on these funds. We have investments in corporate bonds. As a result, we are exposed to potential loss from market risks that may occur as a result of changes in interest rates, changes in credit quality of the issuer and otherwise. These securities have a higher degree of credit or default risk and a greater exposure to credit risk and may be less liquid in times of economic weakness or market disruptions. For accounts receivable, we perform ongoing credit evaluations of our customers’ ﬁnancial condition and generally do not require collateral. We maintain reserves for possible credit losses. As of December 31, 2016 and 2015, we had allowances for doubtful accounts of approximately $71,000 and $50,000, respectively. The carrying amount of the receivables approximates their fair value. No customer exceeded 10 percent of our accounts receivable as of December 31, 2016 or 2015. (2) Investments As of December 31, 2016 and 2015, we held certain investments that were required to be measured for disclosure purposes at fair value on a recurring basis. These investments were considered Level 2 investments. We consider as current assets those investments which will mature in the next 12 months including interest receivable on long-term bonds. The remaining investments are considered non-current assets including our investment in equity securities which we intend to hold longer than 12 months. The amortized cost and fair value of our investments and the related gross unrealized gains and losses, were as follows as of the dates shown below (in thousands): 12 ATRION 2016 ANNUAL REPORT Notes to Consolidated Financial Statements Gross Unrealized (3) Patents and Licenses Cost Gains Losses As of December 31, 2016 Fair Value Short-term Investments: Certiﬁcates of deposit $ 24,000 $ 9 $ — $ 24,009 Corporate bonds $ 80 $ — $ — $ 80 Long-term Investments: Corporate bonds $ 5,000 $ Equity Investments $ 5,675 $ — — ($287) $ 4,713 ($730) $ 4,945 As of December 31, 2015 Short-term Investments: Corporate bonds $ 44 $ — $ — $ 44 Long-term Investments: Corporate and government bonds $ 5,555 $ — ($30) $ 5,525 Equity Investments $ 3,876 $ 435 $ — $ 4,311 The above long-term corporate bonds represent an investment in one issuer at December 31, 2016. The unrealized loss for this investment relates to a rise in interest rates which resulted in a lower market price for that security. This investment has not been in a loss position for more than 12 months. In 2015, one of our bonds experienced a signiﬁcant decline in market value over a 12-month period due to a changed outlook for the issuer resulting from a major economic decline in its industry. In the fourth quarter of 2015, we determined based upon disclosures by the issuer, that more likely than not, we would be required to sell or exchange the bond before recovery of its amortized cost. Therefore, we recorded an impairment loss on this bond of $2.4 million in 2015, reducing the carrying value of the bond to its market value at December 31, 2015. In 2016 after the issuer declared bankruptcy, we sold this bond that was previously intended to be held to maturity. We recorded an additional net loss of $311,000 on this bond in 2016 prior to and including its sale. These losses in 2015 and 2016 are reported as other income (loss) on our Consolidated Statements of Income. The carrying value of our investments is reviewed quarterly for changes in circumstance or the occurrence of events that suggest an investment may not be recoverable. At December 31, 2016, the length of time until maturity of the corporate bond we currently own is 53.5 months and the length of time until maturity of the certiﬁcates of deposit ranged from 1.5 to 9.7 months. Our accumulated other comprehensive income (loss) is comprised solely of unrealized losses on our above equity investments, net of tax. These equity securities are treated as available-for-sale securities. Purchased patents and licenses paid for the use of other entities’ patents are amortized over the useful life of the patent or license. The following tables provide information regarding patents and licenses (dollars in thousands): December 31, 2016 Weighted Average Original Life (years) Gross Carrying Amount Accumulated Amortization 15.67 $ 13,840 $ 11,911 December 31, 2015 Weighted Average Original Life (years) Gross Carrying Amount Accumulated Amortization 15.67 $ 13,840 $ 11,647 Aggregate amortization expense for patents and licenses was $264,000, $345,000 and $269,000 for 2016, 2015 and 2014, respectively. Estimated future amortization expense for each of the years set forth below ending December 31 is as follows (in thousands): 2017 2018 2019 2020 2021 $ $ $ $ $ 151 119 119 119 119 (4) Line of Credit As of December 31, 2016 we had a $40.0 million revolving credit facility with a money center bank pursuant to which the lender was obligated to make advances until October 1, 2021. The credit facility was secured by substantially all our inventories, equipment and accounts receivable. Interest under the credit facility was assessed at 30-day, 60-day or 90-day LIBOR, as selected by us, plus one percent (1.76 percent at December 31, 2016) and was payable monthly. We had no outstanding borrowings under the credit facility at December 31, 2016 or 2015. Our ability to borrow funds under the credit facility from time to time was contingent on meeting certain covenants in the loan agreement, the most restrictive of which was the ratio of total debt to earnings before interest, income tax, depreciation and amortization. At December 31, 2016, we were in compliance with all of those covenants. On February 28, 2017 we replaced the revolving credit facility with a new $75.0 million revolving credit facility with the same bank. The new credit facility has similar operational, covenant and collateral characteristics as the prior facility. Interest under the new credit facility is assessed at one, two, three or six-month LIBOR, as selected by us, plus .875 percent. The new credit facility provides for advances until February 28, 2022. Notes to Consolidated Financial Statements ATRION 2016 ANNUAL REPORT 13 (5) Income Taxes The items comprising income tax expense are as follows (in thousands): Year ended December 31, 2016 2015 2014 Current — Federal $ 10,706 $ 11,848 $ 12,626 — State Deferred — Federal — State 1,226 11,932 (92) (155) (247) 1,528 13,376 (1,364) (67) (1,431) 1,585 14,211 31 (29) 2 Provision for Income Taxes $ 11,685 $ 11,945 $ 14,213 Temporary differences and carryforwards which have given rise to deferred income tax assets and liabilities as of December 31, 2016 and 2015 are as follows (in thousands): Deferred tax assets: Beneﬁt plans Inventories Other Total deferred tax assets Deferred tax liabilities: Property, plant and equipment Patents and goodwill Other Total deferred tax liabilities Net deferred tax liability Balance Sheet classiﬁcation: Non-current deferred income tax liability Current deferred income tax asset Net deferred tax liability $ $ $ $ $ $ 2016 2015 $ 1,819 $ 1,958 519 1,292 473 733 3,630 $ 3,164 9,550 $ 2,833 — 12,383 8,753 $ $ 9,585 2,897 91 12,573 9,409 9,404 $ 9,989 651 580 8,753 $ 9,409 Total income tax expense differs from the amount that would be provided by applying the statutory federal income tax rate to pretax earnings as illustrated below (in thousands): Income tax expense at the statutory federal income tax rate Increase (decrease) resulting from: State income taxes Section 199 manufactur- ing deduction R&D tax credits Excess tax beneﬁt from stock compensation Other, net Year ended December 31, 2016 2015 2014 $ 13,743 $ 14,304 $ 14,707 730 882 934 (1,165) (1,070) (687) 134 (1,383) (2,254) — 396 (1,290) (393) — 255 An excess tax beneﬁt is the realized tax beneﬁt related to the amount of deductible compensation cost reported on an employer’s tax return for equity instruments in excess of the compensation cost for those instruments recognized for ﬁnancial reporting purposes. The Company adopted ASU-2016-09 (see Note 1) effective January 1, 2016 eliminating the requirement for excess tax beneﬁts to be recorded as additional paid-in capital when realized. Excess tax beneﬁts in the amount of $156,000 and $168,000 were recognized as additional paid-in capital during 2015 and 2014, respectively, resulting from the vesting of restricted stock and restricted stock units. With the adoption of ASU 2016-09, excess tax beneﬁts of $687,000 were recognized as a component of income tax expense in 2016 for these types of transactions. We recorded tax credits for our R&D expenditures totaling $2.3 million in 2015. This amount included an adjustment for recalculation of our R&D tax credits from prior years resulting from a new regulation issued by the Treasury Department which favorably impacted the beneﬁts provided to the Company under these rules. A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax beneﬁts as required by ASC 740 is as follows (in thousands): Gross unrecognized tax beneﬁts at January 1, 2014 $ 346 Increase in tax positions for prior years Increase in tax positions for current year Lapse in statutes of limitation Gross unrecognized tax beneﬁts at December 31, 2014 $ Increase in tax positions for prior years Increase in tax positions for current year Lapse in statutes of limitation Gross unrecognized tax beneﬁts at December 31, 2015 $ Decrease in tax positions for prior years Increase in tax positions for current year Lapse in statutes of limitation Gross unrecognized tax beneﬁts at December 31, 2016 $ 6 0 (223) 129 122 0 (131) 120 (120) 0 0 0 We are subject to United States federal income tax as well as to income tax of multiple state jurisdictions. We have concluded all United States federal income tax matters for years through 2011. The audit of our federal income tax returns for 2011, 2012 and 2013 was completed in 2016 with no changes. All material state and local income tax matters have been concluded for years through 2012. We recognize interest and penalties, if any, related to unrecognized tax beneﬁts in income tax expense. Tax expense for the year ended December 31, 2016, 2015 and 2014 included a net interest beneﬁt of $0, $9,000 and $12,000, respectively. Provision for Income Taxes $ 11,685 $ 11,945 $ 14,213 14 ATRION 2016 ANNUAL REPORT Notes to Consolidated Financial Statements (6) Stockholders’ Equity Our Board of Directors has at various times authorized repurchases of our stock in open-market or privately-negotiated transactions at such times and at such prices as management may from time to time determine. On August 16, 2011, our Board of Directors adopted a stock repurchase program pursuant to which we repurchased 200,000 shares of our common stock from time to time in open market or privately- negotiated transactions, which was the maximum number of shares that could be repurchased. On May 21, 2015 our Board of Directors adopted a new stock repurchase program pursuant to which we can repurchase up to 250,000 shares of our common stock from time to time in open market or privately- negotiated transactions. This program has no expiration date but may be terminated by the Board of Directors at any time. As of December 31, 2016, 231,765 shares remained available for repurchase under this program. We repurchased 3,427, 89,452 and 73,379 shares during 2016, 2015 and 2014, respectively. We increased our quarterly cash dividend payments in September of each of the past three years. The quarterly dividend was increased to $.75 per share in September 2014, to $.90 per share in September 2015 and to $1.05 per share in September 2016. Holders of our stock units earned non-cash dividend equivalents of $40,000 in 2016, $46,000 in 2015 and $33,000 in 2014. (7) Income Per Share The following is the computation of basic and diluted income per share: Year ended December 31, 2016 2015 2014 (in thousands, except per share amounts) Net Income $ 27,581 $ 28,925 $ 27,808 Weighted average basic shares outstanding Add: Effect of dilutive securities Weighted average diluted shares outstanding Net Income Per Share 1,824 1,846 1,958 33 24 17 1,857 1,870 1,975 Basic Diluted $ $ 15.12 14.85 $ $ 15.67 15.47 $ $ 14.20 14.08 As required by ASC 260, Earnings per Share, unvested share- based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are considered participating securities and, therefore, are included in the computation of basic income per share pursuant to the two-class method. Incremental shares from stock options and restricted stock units were included in the calculation of weighted average diluted shares outstanding using the treasury stock method. Dilutive securities representing eight shares of common stock for the year ended December 31, 2014 were excluded from the computation of weighted average diluted shares outstanding because their effect would have been anti-dilutive. (8) Stock Plans At December 31, 2016, we had three stock-based compensation plans which are described more fully below. We account for our plans under ASC 718, and the disclosures that follow are based on applying ASC 718. Our Amended and Restated 2006 Equity Incentive Plan, or 2006 Plan, provides for awards to key employees, non-employee directors and consultants of incentive and nonqualiﬁed stock options, restricted stock, restricted stock units, deferred stock units, stock appreciation rights, performance shares and other stock-based awards. Under the 2006 Plan, 200,000 shares, in the aggregate, of common stock have been reserved for awards. The purchase price of shares issued on the exercise of options must be at least equal to the fair market value of such shares on the date of grant. The options granted become exercisable and expire as determined by the Compensation Committee. As of December 31, 2016, there remained 52,248 shares reserved for future stock-based awards under the 2006 Plan. In May 2007, we adopted our Deferred Compensation Plan for Non-Employee Directors (as amended, the “Deferred Compensation Plan”), and 2,500 shares of our common stock were initially reserved for issuance thereunder. This plan allows our non-employee directors to elect to receive stock units in lieu of all or part of the cash fees they are receiving for their services as directors. On the ﬁrst business day of each calendar year, each participating non-employee director is credited with a number of stock units determined on the basis of the foregone cash fees and the closing price of our common stock on the next preceding date on which shares of our stock were traded. The stock units are converted to shares of our common stock on a one-for-one basis at a future date as elected in advance by the director, but no later than the January following the year in which the director ceases to serve on the Board of Directors, and the shares are delivered to the director. As of December 31, 2016, there remained 1,559 shares of common stock reserved for issuance upon the conversion of stock units which may be credited in the future to non-employee directors. In May 2007, we also adopted our Non-Employee Director Stock Purchase Plan, (as amended, the “Director Stock Purchase Plan”), and 2,500 shares of our common stock were initially reserved for issuance thereunder. Under this plan, our non- employee directors may elect to receive on the ﬁrst business day of the calendar year fully-vested stock and restricted stock in lieu of some or all of their fees payable to them during such year. The foregone fees are converted into shares of fully-vested stock and restricted stock on the ﬁrst business day of such calendar year based on the closing price of our common stock on the Notes to Consolidated Financial Statements ATRION 2016 ANNUAL REPORT 15 or the termination is in connection with a change in control. A summary of changes in nonvested restricted stock for the year ended December 31, 2016 is presented below: Nonvested Shares Shares Weighted Average Award Date Fair Value Per Share Restricted stock at December 31, 2015 4,500 $ 212.53 Granted in 2016 Vested in 2016 — $ — (3,000) $ 204.76 Restricted stock at December 31, 2016 1,500 $ 228.08 All shares of nonvested restricted stock outstanding at December 31, 2016 are expected to vest. The total fair value of restricted stock vested during 2016, 2015 and 2014 was $1,177,000, $1,086,000 and $1,372,000, respectively. During 2016 there were no restricted stock units awarded under the 2006 Plan. All of our restricted stock units are convertible to shares of stock on a one-for-one basis when the restrictions lapse, which is generally after a ﬁve-year period. Nonvested stock units are generally forfeited on termination of employment unless the termination is in connection with a change in control. During the vesting period, holders of all restricted stock units earn dividends in the form of additional units. During 2016, one non-employee director elected to receive stock units in lieu of a portion of his cash fees for his services as a member of the Board of Directors. A summary of changes in stock units for the year ended December 31, 2016, is presented below: Weighted Average Award Date Fair Value Per Unit Restricted Stock Units Director’s Stock Units Weighted Average Award Date Fair Value Per Unit 15,428 88 (6,128) $ $ $ 229.02 431.74 186.49 — 25 $ 390.43 (25) $ 390.43 9,388 $ 258.69 — Nonvested Stock Units Nonvested at December 31, 2015 Granted Vested Nonvested at December 31, 2016 next preceding date on which shares of our stock were traded. The restricted stock vests in equal amounts on the ﬁrst day of the next three succeeding calendar quarters provided the non- employee director is then serving on our Board of Directors. As of December 31, 2016, there remained 1,126 shares reserved for issuance under such plan. A summary of stock option transactions for the year ended December 31, 2016 is presented below: Options Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term Outstanding at December 31, 2015 Granted Exercised Outstanding at December 31, 2016 Exercisable at December 31, 2016 50,000 $ 204.76 — — — — 50,000 45,000 $ $ 204.76 1.9 years 202.17 1.8 years All nonvested options outstanding at December 31, 2016 are expected to vest. We estimate the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. None of our grants includes performance-based or market-based vesting conditions. The expected life represents the period that our stock-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The fair value of stock-based payments, funded with options, is valued using the Black-Scholes valuation method with a volatility factor based on our historical stock trading history. We base the risk-free interest rate using the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury securities with an equivalent term. We base the dividend yield used in the Black-Scholes valuation method on our dividend history. There were no options granted in 2016, 2015 or 2014. There were no options exercised in 2016 or 2015. The total intrinsic values of options outstanding and options currently exercisable at December 31, 2016, were $15.1 million and $13.7 million, respectively. During 2016, no shares of restricted stock were awarded under the 2006 Plan. Under the terms of our restricted stock awards, the restrictions usually lapse over a ﬁve-year period. During the vesting period, holders of restricted stock have voting rights and earn dividends, but the shares may not be sold, assigned, transferred, pledged or otherwise encumbered. Nonvested shares are generally forfeited on termination of employment unless otherwise provided in the participant’s employment agreement 16 ATRION 2016 ANNUAL REPORT Notes to Consolidated Financial Statements All nonvested restricted stock units at December 31, 2016 are expected to vest. The total intrinsic value of all outstanding stock units which were not convertible at December 31, 2016, including 457 stock units held for the accounts of non-employee directors, was $4,994,000. The total fair value of directors’ stock units that vested was $10,000 during 2016, $5,000 during 2015 and $8,000 during 2014. Stock awards that vested immediately were awarded under the 2006 Plan to non-employee directors totaling $240,000 in value in each of 2016, 2015 and 2014. Compensation related to stock awards, restricted stock and stock units is based on the fair market value of the stock on the date of the award. These fair values are then amortized on a straight-line basis over the requisite service periods of the entire awards, which is generally the vesting period. Compensation related to stock options is based on the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. For the years ended December 31, 2016, 2015 and 2014, we recorded stock-based compensation expense as a G&A expense in the amount of $1,566,000, $1,841,000 and $2,209,000, respectively, for all of the above mentioned stock-based compensation arrangements. The total tax beneﬁt recognized in the income statement from stock-based compensation arrangements for the years ended December 31, 2016, 2015 and 2014, was $1,235,000, $644,000 and $773,000, respectively. The 2016 tax beneﬁt amount includes $687,000 of excess tax beneﬁts within income tax expense as a result of the adoption of ASU 2016-09. Excess tax beneﬁts of $156,000 and $168,000 were recognized during 2015 and 2014, respectively, as additional paid-in capital and are shown as a ﬁnancing activity in our consolidated statements of cash ﬂows for such years. Unrecognized compensation cost information for our various stock-based compensation types is shown below as of December 31, 2016: Unrecognized Compensation Cost Weighted Average Remaining Years in Amortization Period Stock options Restricted stock Restricted stock units Total $ $ 76,000 128,000 622,000 826,000 0.4 0.4 2.5 We have a policy of utilizing treasury shares to satisfy stock option exercises, stock unit conversions and restricted stock awards. (9) Industry Segment and Geographic Information We operate in one reportable industry segment: developing and manufacturing products primarily for medical applications and have no foreign operating subsidiaries. We have other product lines which include pressure relief valves and inﬂation systems, which are sold primarily to the aviation and marine industries. Due to the similarities in product technologies and manufacturing processes, these products are managed as part of our medical products segment. Our revenues from sales to customers outside the United States totaled approximately 37, 35 and 42 percent of our net revenues in 2016, 2015 and 2014, respectively. In 2015, we saw a shift in the percentage of our international sales that was driven in large part by a customer’s decision to build a new facility in the United States. We have no assets located outside the United States. A summary of revenues by geographic area, based on shipping destination, for 2016, 2015 and 2014 is as follows (in thousands): Year ended December 31, 2016 2015 2014 United States $ 91,092 $ 94,840 $ 81,971 Canada 2,041 2,062 11,655 Other countries less than 10% of revenues 50,354 48,830 47,136 Total $ 143,487 $ 145,733 $ 140,762 A summary of revenues by product line for 2016, 2015 and 2014 is as follows (in thousands): 2016 2015 2014 Fluid Delivery $ 60,889 $ 60,630 $ 57,905 Cardiovascular Ophthalmology Other Total 47,064 15,427 20,107 46,463 18,253 20,387 43,001 19,329 20,527 $ 143,487 $ 145,733 $ 140,762 (10) Employee Retirement and Beneﬁt Plans We sponsor a deﬁned contribution 401(k) plan for all employees. Each participant may contribute certain amounts of eligible compensation. We make a matching contribution to the plan. Our contributions under this plan were $667,000, $645,000 and $600,000 in 2016, 2015 and 2014, respectively. Notes to Consolidated Financial Statements ATRION 2016 ANNUAL REPORT 17 (11) Commitments and Contingencies From time to time and in the ordinary course of business, we may be subject to various claims, charges and litigation. In some cases, the claimants may seek damages, as well as other relief, which, if granted, could require signiﬁcant expenditures. We accrue the estimated costs of settlement or damages when a loss is deemed probable and such costs are estimable, and accrue for legal costs associated with a loss contingency when a loss is probable and such amounts are estimable. Otherwise, these costs are expensed as incurred. If the estimate of a probable loss or defense costs is a range and no amount within the range is more likely, we accrue the minimum amount of the range. As of December 31, 2016, the Company had no ongoing litigation or arbitration for such matters. (12) Quarterly Financial Data (Unaudited) We had a dispute which was favorably settled in the third quarter of 2007. This settlement was amended in December 2008. The amended settlement agreement provides that we may receive annual payments from 2009 through 2024. We have not recorded $4.0 million in potential future payments under this settlement as of December 31, 2016 due to the uncertainty of payment. We have arrangements with three of our executive ofﬁcers pursuant to which the termination of their employment under certain circumstances would result in lump sum payments to them. Termination under such circumstances at December 31, 2016 could have resulted in payments aggregating $6.0 million. Quarter Ended Operating Revenue Operating Income Net Income (in thousands, except per share amounts) Income Per Basic Share Income Per Diluted Share $ $ 03/31/16 06/30/16 09/30/16 12/31/16 03/31/15 06/30/15 09/30/15 12/31/15 36,215 $ 10,465 $ 6,945 $ 3.81 $ 36,143 37,835 33,294 10,074 10,976 7,611 7,450 7,614 5,571 4.09 4.17 3.05 38,324 $ 11,486 $ 7,602 $ 4.05 $ 37,655 37,381 32,372 11,120 11,573 8,330 7,474 7,799 6,050 4.04 4.25 3.32 3.76 4.02 4.10 3.00 4.01 3.99 4.19 3.27 The quarterly information presented above reﬂects, in the opinion of management, all adjustments necessary for a fair presentation of the results for the interim periods presented. 18 ATRION 2016 ANNUAL REPORT Notes to Consolidated Financial Statements REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Atrion Corporation We have audited the accompanying consolidated balance sheets of Atrion Corporation and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash ﬂows for each of the three years in the period ended December 31, 2016. Our audits of the basic consolidated ﬁnancial statements included the ﬁnancial statement schedule (not presented separately herein) listed in the index appearing under Item 15, Exhibits and Financial Statement Schedules. These ﬁnancial statements and ﬁnancial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these ﬁnancial statements and ﬁnancial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated ﬁnancial statements referred to above present fairly, in all material respects, the ﬁnancial position of Atrion Corporation and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash ﬂows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related ﬁnancial statement schedule, when considered in relation to the basic consolidated ﬁnancial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over ﬁnancial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2017 expressed an unqualiﬁed opinion. Grant Thornton LLP Dallas, Texas March 14, 2017 Report of Independent Registered Public Accounting Firm ATRION 2016 ANNUAL REPORT 19 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management assessed the effectiveness of our internal control over ﬁnancial reporting as of December 31, 2016 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in the 2013 Internal Control–Integrated Framework. Based on this assessment, our management concluded that, as of December 31, 2016, our internal control over ﬁnancial reporting was effective. Our management, including our Chief Executive Ofﬁcer and Chief Financial Ofﬁcer, is responsible for establishing and maintaining adequate internal control over ﬁnancial reporting as deﬁned in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control system is designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent limitations. A system of internal control may become inadequate over time because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to ﬁnancial statement preparation and presentation. 20 ATRION 2016 ANNUAL REPORT Management’s Report on Internal Control Over Financial Reporting REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Atrion Corporation We have audited the internal control over ﬁnancial reporting of Atrion Corporation and subsidiaries (the “Company”) as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over ﬁnancial reporting and for its assessment of the effectiveness of internal control over ﬁnancial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over ﬁnancial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁnancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over ﬁnancial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over ﬁnancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁnancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the ﬁnancial statements. Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over ﬁnancial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated ﬁnancial statements of the Company as of and for the year ended December 31, 2016, and our report dated March 14, 2017, expressed an unqualiﬁed opinion on those ﬁnancial statements. Grant Thornton LLP Dallas, Texas March 14, 2017 Report of Independent Registered Public Accounting Firm ATRION 2016 ANNUAL REPORT 21 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the year ended December 31, 2016, we reported revenues of $143.5 million, operating income of $39.1 million and net income of $27.6 million. Results of Operations Our net income was $27.6 million, or $15.12 per basic and $14.85 per diluted share, in 2016 compared to $28.9 million, or $15.67 per basic and $15.47 per diluted share, in 2015 and net income of $27.8 million, or $14.20 per basic and $14.08 per diluted share, in 2014. Revenues were $143.5 million in 2016 compared with $145.7 million in 2015 and $140.8 million in 2014. Our 2016 revenues were negatively impacted by the strong U. S. dollar in our international markets and lower sales prices in certain markets. The four percent revenue increase in 2015 over 2014 was generally attributable to higher sales volumes. Annual revenues by product lines were as follows (in thousands): Fluid Delivery Cardiovascular Ophthalmology Other Total 2016 2015 2014 $ 60,889 $ 60,630 $ 57,905 47,064 15,427 20,107 46,463 18,253 20,387 43,001 19,329 20,527 $ 143,487 $ 145,733 $ 140,762 Overview We develop and manufacture products primarily for medical applications. We market components to other equipment manufacturers for incorporation in their products and sell ﬁnished devices to physicians, hospitals, clinics and other treatment centers. Our medical products primarily serve the ﬂuid delivery, cardiovascular, and ophthalmology markets. Our other medical and non-medical products include valves and inﬂation devices used in marine and aviation safety products. In 2016, approximately 37 percent of our sales were outside the United States. Our products are used in a wide variety of applications by numerous customers. We encounter competition in all of our markets and compete primarily on the basis of product quality, price, engineering, customer service and delivery time. Our strategy is to provide a broad selection of products in the areas of our expertise. R&D efforts are focused on improving current products and developing highly-engineered products that meet customer needs and serve niche markets with meaningful sales potential. Proposed new products may be subject to regulatory clearance or approval prior to commercialization and the time period for introducing a new product to the marketplace can be unpredictable. We also focus on controlling costs by investing in modern manufacturing technologies and controlling purchasing processes. We have been successful in consistently generating cash from operations and have used that cash to reduce or eliminate indebtedness, to fund capital expenditures, to make investments, to repurchase stock and to pay dividends. Our strategic objective is to further enhance our position in our served markets by: Focusing on customer needs; Expanding existing product lines and developing new products; Maintaining a culture of controlling cost; and Preserving and fostering a collaborative, entrepreneurial management structure. 22 ATRION 2016 ANNUAL REPORT Management’s Discussion and Analysis of Financial Condition and Results of Operations Our cost of goods sold was $75.9 million in 2016, $74.8 million in 2015 and $72.2 million in 2014. Increased compensation costs, depreciation and repair costs partially offset by reduced utilities and reduced supplies were the primary contributors to the increase in cost of goods sold in 2016 over 2015. Higher sales volume along with increased compensation costs, supplies and utilities partially offset by improved manufacturing efﬁciencies were the primary contributors to the increase in cost of goods sold in 2015 over 2014. Gross proﬁt in 2016 was $67.6 million compared with $71.0 million in 2015 and $68.5 million in 2014. Our gross proﬁt was 47 percent of revenues in 2016 and 49 percent of revenues in both 2015 and 2014. The decrease in gross proﬁt percentage in 2016 from 2015 was primarily related to reduced sales, lower sales prices and increased manufacturing costs. Operating expenses were $28.5 million in both 2016 and 2015 and $27.7 million in 2014. R&D expenses increased $228,000 in 2016 as compared to 2015 primarily as a result of increased costs for supplies and travel partially offset by reduced outside services. R&D expenses consist primarily of salaries and other related expenses of our R&D personnel as well as costs associated with regulatory matters. In 2016, selling expenses increased $568,000 as compared with 2015 primarily as a result of increased travel, outside services, compensation and trade shows. Selling expenses consist primarily of salaries, commissions and other related expenses for sales and marketing personnel, marketing, advertising and promotional expenses. General and administrative, or G&A, expenses decreased $763,000 in 2016 as compared to 2015 primarily as a result of reduced compensation and beneﬁts. G&A expenses consist primarily of salaries and other related expenses of administrative, executive and ﬁnancial personnel and outside professional fees. R&D expenses increased $1.1 million in 2015 as compared to 2014 primarily as a result of increased costs for outside services and supplies. In 2015, selling expenses decreased $167,000 as compared with 2014 primarily as a result of decreased promotional costs partially offset by increased commissions. G&A expenses decreased $123,000 in 2015 as compared to 2014 primarily as a result of reduced outside services partially offset by increased amortization. Our operating income for 2016 was $39.1 million compared with $42.5 million in 2015 and $40.8 million in 2014. Operating income was 27 percent of revenues for 2016 and 29 percent of revenues for both 2015 and 2014. Decreases in 2016 gross proﬁt was the major contributor to the decrease in operating income for 2016 as compared to the previous year. Increases in gross proﬁt partially offset by increases in operating expenses described above were the major contributors to the operating income increase in 2015 as compared to the previous year. We expect modest growth in our operating income during 2017 as compared to 2016, reﬂecting the volatility of our ophthalmic sales as well as the signiﬁcant impact of the strong U. S. dollar on sales to our international markets. Interest income for 2016 was $448,000, compared with $771,000 in 2015 and $1.2 million in 2014. Lower interest rates were the primary reason for the reductions in 2016. Reduced levels of investments and lower interest rates were the primary reasons for the reductions in 2015. Other income (expense) in 2015 is primarily related to an impairment loss on one of our long-term corporate bonds which experienced a signiﬁcant decline in market value due to a changed outlook for the issuer resulting from a major economic decline in its industry. In the fourth quarter of 2015, we determined, based upon disclosures by the issuer, that more likely than not we would be required to sell or exchange the bond before recovery of its amortized cost. Therefore, we recorded an impairment loss on this bond of $2.4 million reducing the carrying value of the bond to its market value at December 31, 2015. In 2016 after the issuer declared bankruptcy, we sold this bond that was previously intended to be held to maturity. We recorded an additional net loss of $311,000 on this bond in 2016 prior to and including its sale. Income tax expense in 2016 totaled $11.7 million, compared with $11.9 million in 2015 and $14.2 million in 2014. The effective tax rates for 2016, 2015 and 2014 were 29.8 percent, 29.2 percent and 33.8 percent, respectively. The effective tax rate for 2016 beneﬁtted by $687,000 from the early adoption of ASU 2016-09 regarding the accounting for employee share-based compensation. The adoption was on a prospective basis and therefore had no impact on prior years. The effective tax rate for 2015 beneﬁtted from tax credits totaling $2.3 million for our R&D expenditures. These credits reﬂected amounts for the full year 2015 following the extension of the R&D tax credit in December 2015. This amount also included an adjustment for recalculation of these tax credits from prior years resulting from a new regulation issued by the Treasury Department which favorably impacted the beneﬁts provided to the Company under these rules. Beneﬁts from R&D tax credits totaled $1.1 million in 2016, $2.3 million in 2015 and $393,000 in 2014. Beneﬁts from tax incentives for domestic production totaled $1.2 million in 2016, $1.4 million in 2015 and $1.3 million in 2014. Beneﬁts from changes in uncertain tax positions totaled $120,000 in 2016, $9,000 in 2015 and $217,000 in 2014. We expect our effective tax rate for 2017 to be approximately 33.0 percent. Accounting for stock based awards could create volatility in our effective tax rate depending upon the amount of exercise or vesting activity from these activities. Management’s Discussion and Analysis of Financial Condition and Results of Operations ATRION 2016 ANNUAL REPORT 23 Liquidity and Capital Resources At December 31, 2016, we had a $40.0 million revolving credit facility with a money center bank that could be utilized for the funding of operations and for major capital projects or acquisitions, subject to certain limitations and restrictions. Interest under the credit facility was assessed at 30-day, 60-day or 90-day LIBOR, as selected by us, plus one percent and was payable monthly. We had no outstanding borrowings under our credit facility at December 31, 2016 or 2015. The credit facility contained various restrictive covenants, none of which was expected to impact our liquidity or capital resources. At December 31, 2016, we were in compliance with all ﬁnancial covenants. On February 28, 2017 we replaced the revolving credit facility with a new $75.0 million revolving credit facility with the same bank. The new credit facility has similar operational, covenant and collateral characteristics as the prior facility. Interest under the new credit facility is assessed at one, two, three or six-month LIBOR, as selected by us, plus .875 percent. The new credit facility allows us to make advances until February 28, 2022. We believe the bank providing the credit facility is highly-rated and that the entire $75.0 million under the credit facility is currently available to us. At December 31, 2016, we had a total of $54.0 million in cash and cash equivalents, short-term investments and long-term investments, an increase of $15.8 million from December 31, 2015. The principal contributor to this increase was operational results. Cash ﬂows provided by operations of $37.4 million in 2016 were primarily comprised of net income plus the net effect of non-cash expenses. At December 31, 2016, we had working capital of $85.0 million, including $20.0 million in cash and cash equivalents and $24.1 million in short-term investments. The $16.1 million increase in working capital during 2016 was primarily related to increases in short-term investments. This increase was partially offset by decreases in cash and cash equivalents. The increase in short-term investments was primarily a result of operational results partially offset by purchases of treasury stock under our stock repurchase program, purchases of property, plant and equipment and payment of dividends. Working capital items consisted primarily of cash, accounts receivable, short-term investments, inventories and other current assets minus accounts payable and other current liabilities. Capital expenditures for property, plant and equipment totaled $10.6 million in 2016, compared with $9.3 million in 2015 and $12.7 million in 2014. These expenditures were primarily for machinery and equipment. We expect 2017 capital expenditures, primarily machinery and equipment, to be greater than the average of the levels expended during each of the past three years. We paid cash dividends totaling $7.1 million, $6.1 million and $5.4 million during 2016, 2015 and 2014, respectively. We expect to fund future dividend payments with cash ﬂows from operations. We purchased treasury stock totaling $1.3 million, $30.7 million and $23.6 million during 2016, 2015 and 2014, respectively The table below summarizes debt, lease and other contractual obligations outstanding at December 31, 2016: Payments Due by Period Contractual Obligations Total 2017 2018– 2019 2020 and thereafter (in thousands) Purchase Obligations $ 11,863 $ 11,643 $ Total $ 11,863 $ 11,643 $ 220 $ 220 $ — — We believe our cash, cash equivalents, short-term investments and long-term investments, cash ﬂows from operations and available borrowings of up to $75.0 million under our credit facility will be sufﬁcient to fund our cash requirements for at least the foreseeable future. We believe our strong ﬁnancial position would allow us to access equity or debt ﬁnancing should that be necessary. Additionally, we expect our cash and cash equivalents and investments, as a whole, will continue to increase in 2017. Off-Balance Sheet Arrangements We have no off-balance sheet ﬁnancing arrangements. Impact of Inﬂation We experience the effects of inﬂation primarily in the prices we pay for labor, materials and services. Over the last three years, we have experienced the effects of moderate inﬂation in these costs. At times, we have been able to offset a portion of these increased costs by increasing the sales prices of our products. However, competitive pressures have not allowed for full recovery of these cost increases. New Accounting Pronouncements In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09, Stock Compensation (Topic718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). This amendment simpliﬁes the accounting for some aspects of share-based payment transactions, including the income tax treatment of excess tax beneﬁts and deﬁciencies, forfeitures, classiﬁcation of share-based awards as either equity or liabilities, and classiﬁcation in the statement of cash ﬂows for certain share-based transactions related to tax beneﬁts and payments. Under this guidance all excess tax beneﬁts (“windfalls”) and deﬁciencies (“shortfalls”) related to employee stock compensation are recognized within income tax expense. 24 ATRION 2016 ANNUAL REPORT Management’s Discussion and Analysis of Financial Condition and Results of Operations Under prior guidance windfalls were recognized in paid-in capital and shortfalls were only recognized to the extent they exceeded the pool of windfall tax beneﬁts. ASU 2016-09 also requires companies to classify cash ﬂows resulting from excess tax beneﬁts and deﬁciencies from employee share-based payments as cash ﬂows from operating activities. These items were previously included as cash ﬂows from ﬁnancing activities. ASU 2016-09 is effective for ﬁscal years beginning after December 15, 2016, including interim periods within those ﬁscal years. Early adoption is permitted. The Company early adopted this guidance in the second quarter of 2016 effective January 1, 2016. The Company elected to account for forfeitures as they occur and to use a prospective transition method for the presentation of excess tax beneﬁts on the statement of cash ﬂows. As a result of the adoption, a tax beneﬁt of $687,000 was recorded in 2016 reﬂecting the excess tax beneﬁts resulting from the vesting of restricted stock and restricted stock units. Prior to adoption, this amount would have been recorded as additional paid-in capital. This change could create future volatility in our effective tax rate depending upon the amount of exercise or vesting activity from our stock based awards. This adoption also impacted the computation of diluted shares outstanding for all 2016 reporting periods as we excluded the excess tax beneﬁts from the assumed proceeds available to repurchase shares in the computation of our diluted earnings per share. The effect of this change on our diluted earnings per share was not signiﬁcant. The excess tax beneﬁt recorded in 2016 was included in our consolidated statements of cash ﬂows as an operating activity rather than as a ﬁnancing activity as was done in prior years. There were no restatements of cash ﬂows from operating activities or cash ﬂows from ﬁnancing activities for the years 2015 and 2014 because we elected to adopt this change on a prospective basis. ASU 2016-09 also requires the presentation of employee taxes paid by the Company through the withholding of shares as a ﬁnancing activity on the statement of cash ﬂows, which is how we had previously reﬂected these items. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The main objective of this update is to enhance the reporting model for ﬁnancial instruments in order to provide users of ﬁnancial statements with more decision-useful information. The new guidance addresses certain aspects of recognition, measurement, presentation, and disclosure of ﬁnancial instruments. This ASU is effective for ﬁscal years beginning after December 15, 2017, including interim periods within those ﬁscal years. We are currently evaluating the new guidance to determine the impact it may have on our consolidated ﬁnancial statements. In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classiﬁcation of Deferred Taxes (ASU 2015-17) which requires that deferred tax liabilities and assets be classiﬁed as noncurrent on the balance sheet. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by this guidance. ASU 2015-17 is effective for annual and interim periods beginning after December 15, 2016 but early application is permitted and the guidance may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company does not anticipate a material impact on its consolidated ﬁnancial statements at the time of adoption of this new standard. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-09). ASU 2014-09 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. ASU 2014-09 will replace most existing revenue recognition guidance in United States Generally Accepted Accounting Principles when it becomes effective. In July 2015, the FASB voted to delay the effective date of ASU 2014-09 by one year, making it effective for ﬁscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted as of the original effective date. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We plan on adopting the ASU in the ﬁrst quarter of the year ended December 31, 2018. The Company has not yet selected a transition method and is currently evaluating the effect that our pending adoption of this guidance will have on our consolidated ﬁnancial statements and related disclosures. We anticipate our assessment to be completed by December 31, 2017. Based on our existing evaluation process, we have not identiﬁed any revenue stream that would be materially impacted. From time to time, new accounting standards updates applicable to us are issued by the FASB which we will adopt as of the speciﬁed effective date. Unless otherwise discussed, we believe the impact of recently issued standards updates that are not yet effective will not have a material impact on our consolidated ﬁnancial statements upon adoption. Critical Accounting Policies The discussion and analysis of our ﬁnancial condition and results of operations are based on our consolidated ﬁnancial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In the preparation of these ﬁnancial statements, we make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We believe the following discussion addresses our most critical accounting policies and estimates, which are those that are most important to the portrayal of our ﬁnancial condition and results and require management’s most difﬁcult, subjective and complex judgments, often as a result of the need to make estimates Management’s Discussion and Analysis of Financial Condition and Results of Operations ATRION 2016 ANNUAL REPORT 25 about the effect of matters that are inherently uncertain. Actual results could differ signiﬁcantly from those estimates under different assumptions and conditions. From time to time, we accrue legal costs associated with certain litigation. In making determinations of likely outcomes of litigation matters, we consider the evaluation of legal counsel knowledgeable about each matter, case law and other case- speciﬁc issues. We believe these accruals are adequate to cover the legal fees and expenses associated with litigating these matters. However, the time and cost required to litigate these matters as well as the outcomes of the proceedings may vary signiﬁcantly from what we have projected. We maintain an allowance for doubtful accounts to reﬂect estimated losses resulting from the failure of customers to make required payments. On an ongoing basis, the collectability of accounts receivable is assessed based upon historical collection trends, current economic factors and the assessment of the collectability of speciﬁc accounts. We evaluate the collectability of speciﬁc accounts and determine when to grant credit to our customers using a combination of factors, including the age of the outstanding balances, evaluation of customers’ current and past ﬁnancial condition, recent payment history, current economic environment, and discussions with our personnel and with the customers directly. Accounts are written off when it is determined the receivable will not be collected. If circumstances change, our estimates of the collectability of amounts could be changed by a material amount. We are required to estimate our provision for income taxes and uncertain tax positions in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the balance sheet. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is more likely than not, do not establish a valuation allowance. In the event that actual results differ from these estimates, the provision for income taxes could be materially impacted. We assess the impairment of our long-lived identiﬁable assets, excluding goodwill which is tested for impairment as explained below, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. This review is based upon projections of anticipated future cash ﬂows. Although we believe that our estimates of future cash ﬂows are reasonable, different assumptions regarding such cash ﬂows or changes in our business plan could materially affect our evaluations. No such changes are anticipated at this time. We assess goodwill for impairment pursuant to Accounting Standards Codiﬁcation, or ASC, 350, Intangibles—Goodwill and Other, which requires that goodwill be assessed whenever events or changes in circumstances indicate that the carrying value may not be recoverable, or, at a minimum, on an annual basis by applying a qualitative assessment on goodwill impairment to determine whether it is necessary to perform the two-step goodwill impairment test. We assess the total carrying value for each of our investments on a quarterly basis for changes in circumstance or the occurrence of events that suggest our investment may not be recoverable. If an investment is considered impaired, we must determine whether the impairment is other than temporary. If it is determined to be other than temporary, the impairment must be recognized in our ﬁnancial statements. During 2016, 2015 and 2014, none of our critical accounting policy estimates, with the exception of the previously mentioned impairment loss on one of our long-term corporate bonds, required signiﬁcant adjustments. We did not note any material events or changes in circumstances indicating that the carrying value of long-lived assets were not recoverable. Quantitative and Qualitative Disclosures About Market Risks Foreign Exchange Risk We are not exposed to material ﬂuctuations in currency exchange rates because the payments from our international customers are received primarily in United States dollars. However, ﬂuctuations in exchange rates may affect the prices that our international customers are willing to pay and may put us at a price disadvantage compared to other customers. Increases in the value of the United States dollar relative to foreign currencies could make our products less competitive or less affordable and therefore adversely affect our sales in international markets. Market Risk and Credit Risk The Company’s cash and cash equivalents are held in accounts with ﬁnancial institutions that we believe are creditworthy. Certain of these accounts at times may exceed federally-insured limits. We have not experienced any credit losses in such accounts and do not believe we are exposed to any signiﬁcant credit risk on these funds. We have investments in taxable corporate bonds, certiﬁcates of deposit and equity securities. As a result, we are exposed to potential loss from market risks that may occur as a result of changes in interest rates, changes in credit quality of the issuer and otherwise. These securities have a higher degree of credit or default risk and a greater exposure to credit risk and may be less liquid in times of economic weakness or market disruptions. We have also invested a portion of our available funds in common 26 ATRION 2016 ANNUAL REPORT Management’s Discussion and Analysis of Financial Condition and Results of Operations stock. The value of these securities ﬂuctuates due to changes in the equity and credit markets along with other factors. In times of economic weakness, the market value and liquidity of these assets may decline and may negatively impact our ﬁnancial condition. Forward-looking Statements Statements in this Management’s Discussion and Analysis and elsewhere in this Annual Report to Stockholders that are forward looking are based upon current expectations, and actual results or future events may differ materially. Therefore, the inclusion of such forward-looking information should not be regarded as a representation by us that our objectives or plans will be achieved. Such statements include, but are not limited to, our growth in operating income in 2017, our 2017 effective tax rate, the impact of the restrictive covenants in our credit facility on our liquidity and capital resources, our earnings in 2017, our 2017 capital expenditures, funding future dividend payments with cash ﬂows from operations, availability of equity and debt ﬁnancing, our ability to meet our cash requirements for the foreseeable future, the impact on our consolidated ﬁnancial statement of recently issued accounting standards when we adopt those standards, the pace of investments in manufacturing, technology, people, and R&D in 2017, and increases in 2017 in cash, cash equivalents and investments. Words such as “expects,” “believes,” “anticipates,” “intends,” “should,” “plans,” and variations of such words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements contained herein involve numerous risks and uncertainties, and there are a number of factors that could cause actual results or future events to differ materially, including, but not limited to, the following: changing economic, market and business conditions; acts of war or terrorism; the effects of governmental regulation; the impact of competition and new technologies; slower-than-anticipated introduction of new products or implementation of marketing strategies; implementation of new manufacturing processes or implementation of new information systems; our ability to protect our intellectual property; changes in the prices of raw materials; changes in product mix; intellectual property and product liability claims and product recalls; the ability to attract and retain qualiﬁed personnel and the loss of any signiﬁcant customers. In addition, assumptions relating to budgeting, marketing, product development and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic review which may cause us to alter our marketing, capital expenditures or other budgets, which in turn may affect our results of operations and ﬁnancial condition. SELECTED FINANCIAL DATA (in thousands, except per share amounts) Operating Results for the Year ended December 31, Revenues Operating income Net income Depreciation and amortization Per Share Data: Net income per diluted share Cash dividends per common share Average diluted shares outstanding Financial Position at December 31, Total assets Long-term debt 2016 2015 2014 2013 2012 $ 143,487 $ 145,733 $ 140,762 $ 131,993 $ 119,062 39,126 27,581 8,953 42,510 28,925 8,823 40,817 27,808 8,723 37,944 26,582 8,592 $ $ 14.85 $ 3.90 $ 1,857 $ $ 15.47 3.30 1,870 $ $ 14.08 2.78 1,975 $ $ 13.18 2.40 2,017 33,626 23,629 7,610 11.66 12.10 2,027 $ 182,593 $ 164,336 $ 171,514 $ 172,066 $ 155,810 — — — — — Selected Financial Data ATRION 2016 ANNUAL REPORT 27 NON-GAAP FINANCIAL MEASURES RECONCILIATION (Dollars in thousands) Included in our Annual Report is a non-GAAP ﬁnancial measure that is calculated by excluding certain income and assets that are included in ﬁnancial measures determined in accordance with GAAP. We have provided this non-GAAP measure as an additional tool for investors to evaluate the Company’s performance. This measure should be considered in addition to, rather than as a substitute for, GAAP measures of the Company’s performance. The table below provides a reconciliation of this non-GAAP ﬁnancial measure with the most directly comparable GAAP ﬁnancial measure. 2016 net income A Equity at December 31, 2015 Equity at December 31, 2016 Average equity B Return on equity (A/B) 1) 2016 after tax interest income. Adjustments 291 1 $ $ $ 38,256 2 54,047 3 $ $ $ $ GAAP 27,581 144,098 162,988 153,543 4 18% Non-GAAP $ $ $ $ 27,290 105,842 108,941 107,392 5 25% 2) Cash, cash equivalents and investments at December 31, 2015. 3) Cash, cash equivalents and investments at December 31, 2016. 4) GAAP equity at December 31, 2015 plus GAAP equity at December 31, 2016 divided by 2. 5) Adjusted equity at December 31, 2015 plus adjusted equity at December 31, 2016 divided by 2. 28 ATRION 2016 ANNUAL REPORT Non-GAAP Financial Measures Reconciliation Leadership Board of Directors Emile A Battat Chairman of the Board Atrion Corporation Preston G. Athey Private Investor Former Portfolio Manager T. Rowe Price Small Cap Value Fund T. Rowe Price Associates, Inc. Baltimore, Maryland Hugh J. Morgan, Jr. Private Investor Former Chairman of the Board National Bank of Commerce of Birmingham Morganton, North Carolina Ronald N. Spaulding Private Investor Former President of Worldwide Commercial Operations Abbott Vascular Miami, Florida Roger F. Stebbing President and Chief Executive Ofﬁcer Stebbing and Associates, Inc. Signal Mountain, Tennessee John P. Stupp, Jr. President and Chief Executive Ofﬁcer Stupp Bros., Inc. St. Louis, Missouri Executive Ofﬁcers Emile A Battat Chairman of the Board David A. Battat President and Chief Executive Ofﬁcer Jeffery Strickland Vice President and Chief Financial Ofﬁcer, Secretary and Treasurer Corporate Information Corporate Ofﬁce Atrion Corporation One Allentown Parkway Allen, Texas 75002 (972) 390-9800 www.atrioncorp.com Registrar and Transfer Agent American Stock Transfer and Trust Company, LLC Attn: Shareholder Services 6201 15th Avenue Brooklyn, NY 11219 Form 10-K A copy of the Company’s 2016 Annual Report on Form 10-K/A, as ﬁled with the Securities and Exchange Commission, may be obtained by any stockholder without charge by written request to: Corporate Secretary Atrion Corporation One Allentown Parkway Allen, Texas 75002 Stock Information The Company’s common stock is traded on the NASDAQ Global Select Market (Symbol: ATRI). As of February 21, 2017, we had 262 record holders, and approximately 4,500 beneﬁcial owners, of our common stock. The table below sets forth the high and low sales prices as reported by NASDAQ and the quarterly dividends per share declared by the Company for each quarter of 2015 and 2016. 2015 Quarter Ended High Low Dividends March 31 June 30 September 30 December 31 2016 Quarter Ended March 31 June 30 September 30 December 31 $ 355.62 $ 315.01 $ 396.00 428.85 423.00 High 316.25 365.00 343.50 Low $ 415.00 $ 350.00 $ 442.50 490.45 522.05 385.00 393.96 418.00 0.75 0.75 0.90 0.90 Dividends 0.90 0.90 1.05 1.05 The Company presently plans to pay quarterly cash dividends in the future. ATRION 2015 ANNUAL REPORT 29 ATRION CORPORATION One Allentown Parkway Allen, Texas 75002 972.390.9800 www.atrioncorp.com

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