ALPHA PRO TECH LTD — Regulatory Filings 1998

Mar 31, 1998

SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 10549 FORM 10-K (Mark One) / X / ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from__to____ Commission file number--019893 ----------------- ALPHA PRO TECH, LTD. (exact name of registrant as specified in its charter) ----------------- Delaware 63-1009183 - ------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No. incorporation or organization Suite 112, 60 Centurian Drive Markham, Ontario L3R 9R2 - ------------------------------ ----------------------------------- Address of principal offices Zip Code Registrant's telephone number including area code: 905-479-0654 Securities registered pursuant to Section 12(g) of the Act: Common Shares Par Value $.01 Per Share ------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- The number of registrants's Common Shares outstanding as of March 25, 1998 was 24,112,449. The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 25, 1998 was $ 22,225,642 based on the average bid and asked price on that date. Documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated are as follows: Registrant's definitive proxy statement for its 1998 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission on or before April 30, 1998 (incorporated by reference under Part III). Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 or Regulation S-K (Sec. 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X --- PART I ITEM 1. BUSINESS GENERAL ALPHA PRO TECH, LTD. (referred to herein as the "Company") was incorporated on February 17, 1983 pursuant to the British Columbia Company Act R.S.B.C. 1979, Chapter 59 (the "Company Act (British Columbia)" under the name Princeton Resources Corp. The Company subsequently changed its name to Canadian Graphite Ltd. on July 27, 1988 and further changed its name to BFD Industries Inc. on July 4, 1989. Effective July 1, 1994, the Company changed its corporate domicile from Canada to the State of Delaware in the United States and changed its name to Alpha Pro Tech, Ltd. At that time, all of the Company's operating assets were transferred to its wholly owned subsidiary Alpha Pro Tech, Inc. The Company's executive offices are located at 60 Drive, Suite 112, Markham Ontario, Canada L3R 9R2, and its telephone number is (905) 479-0654. BUSINESS The Company develops, manufactures and markets disposable protective apparel, food industry, infection control, extended care and consumer products for the cleanroom, food services, industrial, medical, dental and consumer markets. The Company operates through four divisions: apparel; food industry; mask and shield; and extended care. The Company's products are primarily sold under the "Alpha Pro Tech" brand names, but are also sold for use under private label. The Company's products are classified into five groups: Disposable protective apparel consisting of a complete line of shoecovers, headcovers, gowns, coveralls and labcoats; food industry apparel consisting of a line of automated shoecovers, sleeve protectors, aprons, coveralls and bus boy jackets; Infection control products consisting of a line of facial masks and facial shields, extended care products consisting of a line of mattress overlays, wheelchair covers, geriatric chair surfaces, operating room table surfaces and pediatric surfaces; consumer products consisting of a line of pet bedding and pet toys. The Company's current strategy is to not only grow its cleanroom business through its exclusive agreement with VWR Scientific Products, but to refocus on its other core businesses which include medical, dental and pet markets. As part of its current strategy emphasis is being placed on developing innovative products and processes which are expected to increase gross margins. The Company will continue to pursue the food service industry with its proprietary shoecover, which helps prevent employees from slipping and falling on slippery surfaces, found in restaurants, supermarkets and food processing facilities. 2 The Company's products are used primarily in hospitals, clean rooms, laboratories industrial and dental offices and are distributed principally in the United States through a network presently consisting of three purchasing groups, ten major distributors, approximately 200 additional distributors, approximately 10 independent sales representatives and a Company sales force of 8 people. HISTORICAL DEVELOPMENT In April, 1989, the Company purchased all the assets, patents, trade secrets, inventory, goodwill and other properties to manufacture, among other items, certain transparent eye protection products utilizing optical-grade polyester film from John Russell (the inventor of certain products currently being manufactured, marketed and distributed by the Company), Al Millar (currently president and a director of the Company), Sheldon Hoffman (currently chief executive officer and a director of the Company), Robert Isaly, (currently a director of the Company), and Irving Bronfman, (a former director of the Company), BFD Inc. (an Alabama corporation), 779177 Ontario Inc. (a corporation owned by Messrs. Hoffman and Bronfman), Milmed International Distributors Limited (a company owned by Al Millar). None of the persons of entities referred to above were officers, directors or affiliated with the Company in any way prior to the transaction. From April 1, 1990 to August 30, 1991, the business currently being carried on by the Company, was operated by the BFD Industries Limited Partnership, an Ontario limited partnership (the "BFD Limited Partnership"), of which a wholly-owned subsidiary of the Company was the general partner, and of which there was only one limited partner. Pursuant to an agreement between the Company and the sole limited partner of the Company's Limited Partnership dated June 21, 1991, the Company purchased the limited partner's 50% interest in the BFD Limited Partnership for a purchase price of $1,000,000.00 The BFD Limited Partnership was dissolved on August 30, 1991 and the business and operations have continued to be carried on by the Company directly. Prior to its acquisition of the business currently being conducted, the Company was involved in mining and exploration. PRODUCTS The Company's product groups and products include the following: DISPOSABLE PROTECTIVE APPAREL * Shoecovers * Headcovers * Gowns * Coveralls * Lab Coats 3 FOOD INDUSTRY * Automated Shoecovers * Sleeve Protectors * Aprons * Coveralls * Bus Boy Jackets INFECTION CONTROL * Face Masks * Face Shields EXTENDED CARE * Unreal Lambswool * Medi-Pads * Hospital Pads * Wheelchair accessories * Bedrail Pads * Knee and Elbow protectors CONSUMER PRODUCTS * Pet Bedding * Pet Toys DISPOSABLE PROTECTIVE APPAREL The Apparel division was established April 1, 1994, for the acquisition of the assets of DMPI. The products manufactured include many different styles of shoecovers, headcovers, gowns, coveralls, lab coats, and other miscellaneous products. These are manufactured in Mexico. FOOD INDUSTRY Through the acquisition of Gem Nonwovens, Inc. a patented automated shoe cover machine was acquired. This prototype machine has been replaced with an improved new machine which in combination with a patent pending, laminated material produced by Ludan allowed the Company to develop a shoecover that to date is being tested by a number of restaurant chains with favorable results and is to be marketed on an exclusive basis by Chicopee, Inc. The balance of the food industry products are to be manufactured by the apparel division. 4 MASKS AND FACE SHIELDS The facemasks come in a wide variety of filtration efficiencies and styles. The Company's patented Positive Facial Lock-Registration Mark- feature that provides a custom fit to the face to prevent blow-by for better protection. Combine this feature with the Magic Arch-Registration Mark-, that holds the mask away from the nose and mouth and creates a breathing chamber, and you have a quality disposable facemask. The term "blow-by" is used to describe the potential for infectious material entering or escaping a facemask without going through the filter as a result of gaps or openings in the face mask. All of the face shields are made from an optical-grade, polyester film, and have a permanent anti-fog feature. This provides the wearer with extremely light weight, distortion-free protection that can be worn for hours and will not fog up from humidity and/or perspiration. An important feature of all eye and face shields is that they are disposable. This eliminates a chance of cross infection between patients and saves hospitals the expense of sterilization after every use. EXTENDED CARE The Extended Care Division began with the Company's Unreal Lambswool pressure sore and bed patient monitoring system product lines. The Unreal Lambswool is used to prevent decubitus ulcers or bedsores on long term care patients. The bed patient monitoring system offers nurses an alarm system that tell when patients try to get out of bed. This helps nursing and other extended and long term care facilities to comply with the Omnibus Reconciliation Act (OBRA) of 1987 mandate to work towards using no restraints to control residents or patients in these facilities. CONSUMER PRODUCTS The Consumer Product Division uses the Company's existing medical products and technologies for general consumer purposes. The Unreal Lambswool is being packaged for the retail pet bed market and pet toys. MARKETS The Company's products are sold to the following markets: Infection Control Products, (Masks and Shields) and disposable protective apparel are sold to the Medical and Dental market and the Industrial and Cleanroom markets; Unreal Lambswool and Medi-Pads are sold to the Extended Care market; Pet Bedding and Pet Toys are sold to the consumer market; and Automated Shoe Covers are sold to the Food Industry, Medical, Industrial and Cleanroom market. The Company intends to expand its marketing efforts for the Food Industry to include apparel, such as sleeve protectors, aprons, coveralls and bus boy jackets as well as shields, although no sales of such products to the food industry have been made to date. 5 DISTRIBUTION The Company relies primarily on a network of independent distributors for the sale of its products including the following: * VWR Scientific * Allegiance Healthcare * General Medical * Medline Industries * ABCO * Texwipe * Owens and Minor * Astra Pharmaceutical * Cottrell, Ltd. * Henry Schein, Inc. Of the ten major distributors in the United States to the best of the Company's knowledge, all sell competing products. In 1994, the Company entered into an exclusive five year agreement to supply Baxter Scientific Products, a division of Baxter Healthcare Corporation, with eye and face shields, masks and disposable apparel for sale to the Industrial/Cleanroom market place. The distribution calls for Baxter to purchase a minimum of $1 million during the first year to retain exclusive distribution rights. This minimum figure has been attained for 1994 and 1995. During 1995, Baxter Scientific Products was sold to VWR Scientific Products who has continued to honor the Agreement. In 1996, a new agreement was entered into with VWR Scientific Products with required minimum purchases of $ 5,000,000 annually to retain exclusive distribution rights which was attained for 1996 and 1997. In April, 1996, the Company entered into a three year distribution agreement with Chicopee, Inc. of Dayton, New Jersey with respect to the distribution of the Company's line of Aqua Trak black shoe covers. Chicopee was granted exclusive distribution rights for the restaurant, food service, food processing and related businesses in the United State, Canada and Mexico. In order to maintain this exclusivity, Chicopee must purchase $ 11 Million of products during the 18 month period, beginning April 8, 1996. Failure to meet such minimum purchases could result in termination of exclusivity. The contract also allows for new products to be added to the agreement with their own agreed upon minimum purchase amounts in return for similar exclusivity. Although minimum purchase requirements were not met for 1996 and 1997, Chicopee retained exclusivity. Sales to VWR Scientific Products, the successor to Baxter Scientific Products represented 42.9% of total sales for 1996, and 50.7% for 1997. The loss of this customer would have a material adverse effect on the Company's business. The Company does not generally have backlog orders, as orders are usually placed for immediate shipment and contract for shipment over a period time. The Company anticipates no problems in fulfilling orders as they are placed. 6 MANUFACTURING The Company's mask production, shield production and automated shoecover facility is located in a leased 26,800 square foot building at 903 West Center Street, Bldg. E, North Salt Lake, Utah. Approximately 3,000 square feet of this building is used for corporate offices. A 25,000 square foot facility is located at 615 North Parker Drive, Janesville, Wisconsin 53595 is used for the manufacture of the Company's real lambskin products. The Company's disposable protective apparels production is located in three facilities, a 45,000 sq. ft. facility is located at 1180 West Industrial Park Drive in Nogales, Arizona which is used for cutting, warehousing and shipping, a 33,000 square foot facility is located at Bustamonte Drive, Nogales, Mexico which is used for assembly of shields and sewing, and a 30,000 sq. ft. facility located at Ave. Abolardo L. Rodriguez y Novena, Benjamin Hill, Sonora 83900, is used for sewing. As a result of the March, 1995 acquisition of Ludan Corporation, the Company has a material coating and automated shoe cover facility of 16,000 square feet located at 2224 Cypress Street, Valdosta, Georgia 31602. The Company has multiple suppliers of the materials used to produce its products. In that regard, the Company currently has no problems, and does not anticipate any problems, with respect to the sources and availability of the materials needed to produce its products. The business of the Company is not subject to seasonal considerations. It is necessary for the Company to have adequate finished inventory in stock, and the Company generally maintains a one to two-month supply of product. With respect to the optical grade polyester film used in its products, it generally must be ordered two months in advance, and the Company generally carries a three-month supply of film. COMPETITION The Company faces substantial competition from numerous other companies, including some companies with greater marketing and financial resources. The Company's major competitor in the medical and dental markets is Technol, Inc. of Fort Worth, Texas. Other large competitors would include Minnesota Mining and Manufacturing Corporation (3M), Johnson & Johnson, and Isolyser, Inc., American Threshold and Maxium. The Company's major competitors in the industrial and cleanroom market are Technol, Inc., 3M, Isolyser, Inc., Kimberly Clark, Kappler USA, and Allegiance Health Care. In the extended care market, Texten Corp., Glenoit Mills and Hudson Industries are the principal competitors, and in the consumer products market, principal competitors include Flexmat Corporation, Lazy Pet Company and Dogloo, Inc. The Company has entered the food service market with a new type of product, and expects competition from companies who provide floor treatment and manufacturers of safety boots such as Weinbrenner, Inc. However, the Company believes that the quality of its products, along with the price and service provided, will allow it to remain competitive in the disposable apparel market. 7 The Company is not required to obtain regulatory approval from the U.S. Food and Drug Administration ("FDA") with respect to the sale of its products. The Company's products are however, subject to prescribed "good manufacturing practices" as defined by the FDA and its manufacturing facilities are inspected by the FDA every two years to assure compliance with such "good manufacturing practices." The Company is marketing a Particulate Respirator that meets the new O.S.H.A. respirator guidelines and which has been approved by the National Institute for Safety and Health (NIOSH). This product is designed to help prevent the breathing in of the tuberculosis virus. The Company does not anticipate that any federal, state and local provisions which have been or may be enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have any material effect upon the capital expenditures, earnings and competitive position of its business. PATENTS AND TRADEMARKS PATENTS The Company's policy is to protect its intellectual property rights, products, designs and processes through the filing of patents in the United States and where appropriate in Canada and other foreign countries. At present, the Company has 13 United States patents relating to its MEDS, Add-A-Mask, Coverall, 1/2 Coverall, Combo Cone, Combo, Positive Facial Lock and Shieldmate products and a U.S. patent on the automated shoecover and the shoecover process. The Company also has a U.S. patent pending on a fluid impervious and non-slip fabric for the Company's Aqua-Trak shoe cover. The Company has foreign patents either issued or pending for its MEDS, 1/2 Coverall, Combo Cone and Combo products but doe not intend to maintain those foreign patents on products whose sales do not justify the maintenance expense. The Company believes that its patents may offer a competitive advantage, but there can be no assurance that any patents, issued or in process, will not be circumvented or invalidated. The Company also intends to rely on trade secrets and proprietary know how to maintain and develop its commercial position. The various United States patents issued have remaining durations of approximately 9 to 14 years before expiry. TRADEMARKS Many of the Company products are sold under various trademarks and trade names including Alpha Pro Tech and others. The Company believes that many of its trademarks and trade names have significant recognition in its principal markets and takes customary steps to register or otherwise protect its rights in its trademarks and trade names. 8 EMPLOYEES As of February 1, 1998, the Company had 594 employees, including eight persons at its head office in Markham, Ontario, Canada; 40 persons at its facemask production facility in Salt Lake City, Utah and 20 persons at its Extended Care production facility in Janesville, Wisconsin; 25 persons at its cutting, warehouse and shipping facility in Nogales, Arizona; 200 persons at its shield assembly and sewing operation in Nogales, Mexico; 280 at its sewing operation in Benjamin Hill, Mexico; and 21 persons at its coating and automated shoe cover facility in Valdosta, Georgia. None of the Company's employees in the United States and Canada are subject to collective bargaining agreements. However, a collective bargaining agreement with the Confederation of Mexican Workers, exists for its Mexican employees. Benefits are reviewed annually by May and the 1998 agreement was signed with moderate benefit increases. Wages are set by the Government of Mexico. The Company considers its relations with the union and its employees to be good. ITEM 2. PROPERTIES The Companies' Head Office is located at 60 Centurian Drive, Suite 112, Markham, Ontario L3R 9R2. The approximate monthly costs are $2,500 under a lease expiring January 31, 1999. Eight (8) employees of the Company, including the President, Alexander Millar, Chief Executive Officer, Sheldon Hoffman and Vice President and Controller, Lloyd Hoffman work out of this head office. The Company manufactures its surgical face masks at 903 West Center Street, Building C, North Salt Lake, Utah 84054. The monthly rental is $6,413 for 32,000 square feet. This lease expires July 1, 1998 with successive 2-year renewal options at rents based on the U.S. Consumer Price Index. A second manufacturing facility is located at 615 North Parker Drive, Janesville, Wisconsin. These premises of 25,000 square feet are leased for $5,600.00 monthly. The lease expires August 15, 2002. The Company's line of Extended Care products are manufactured in these facilities. The Apparel division has its cutting operation, warehousing, and shipping facility at 1140 West Industrial Park Drive, Nogales, Arizona. The monthly rental is $15,476.00 for 45,000 square feet. This lease expires July 31, 1999. Shield assembly and sewing is done at Bustamonte Drive in Sonora, Mexico. The monthly rental is $9,900 for 33,000 square feet. This lease expires july 31, 1999. Sewing is done at Ave. Abelardo L. Rodriguez Y. Novena, Benjamin Hill, Sonora, Mexico. The monthly rental is $ 8,500 for 30,000 square feet. This lease expires January 31, 1999. The Coating Division has its facility at 2224 Cypress Street, Valdosta, Georgia. The monthly rental is $3,600 for 16,000 square feet. The Company believes that these arrangements are adequate for its present needs and that other premises, if required, are readily available. 9 ITEM 3. LEGAL PROCEEDINGS In June, 1996, an action was commenced against the Company in the Superior Court of the State of Arizona, in and for the County of Maricopa by New-Invest, Inc., an Arizona Corporation (the "Plaintiff"). This action involved a claim by the Plaintiff for the breach of an alleged contract to sell stock units consisting of Common Stock and Warrants in the Company to the Plaintiff through an alleged private offering. The lawsuit was originally filed in the Maricopa County (Arizona) Superior Court. Thereafter, the action was removed to the United States District Court for the District of Arizona. In November 1997, the lawyers for the Plaintiff withdrew as counsel of record. The District Court ordered that the Plaintiff secure replacement counsel for the reason that a corporation cannot appear in court on its own behalf. Upon failure to comply with this order, the District Court entered its Amended Judgment on December 4, 1997 dismissing the lawsuit with prejudice. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of 1997. PART II ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF SECURITIES From January 1, 1991 through July 16, 1993 the Common Shares were traded on the Vancouver Stock Exchange under the symbol BFI, at which time the Common Shares were de-listed from the Vancouver Stock Exchange at the Company's request. On March 8, 1993 the Common Shares of the Company were cleared for quotation on the National Association of Securities Dealers (NASD) Over the Counter (OTC) Bulletin Board under the symbol "BFDIF." When the Company changed its name to Alpha Pro Tech Ltd. on July 1, 1994, its symbol was changed to APTD. The high and low range of bids prices for the Common Shares of the Company for the quarters indicated as reported by the NASD were as follows:

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Such over the counter market quotations reflect interdealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. As at March 25, 1998 there were approximately 613 shareholders of record, and 3,500 beneficial owners. DIVIDEND POLICY The holders of the Company's Common Shares are entitled to receive such dividends as may be declared by the directors of the Company from time to time to the extent that funds are legally available for payment thereof. The Company has never declared nor paid any dividends on any of its Common Shares. It is the current policy of the Board of Directors to retain any earnings to provide for the development and growth of the Company. Consequently, the Company has no intention to pay cash dividends in the foreseeable future. 11 ITEM 6. SELECTED FINANCIAL DATA ALPHA PRO TECH, LTD. SELECTED FINANCIAL DATA

(1) Includes the operations of Ludan Corporation which was acquired April 1, 1995. See footnote 12 in Notes to the Consolidated Financial Statements. (2) Includes the operations of Disposable Medical Products, Inc. which was acquired on March 25, 1994. See footnote 12 in Notes to Consolidated Financial Statements. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Fiscal 1997 compared to fiscal 1996 Alpha Pro Tech, Ltd. ("Alpha" or the "Company") reported a net loss for the year ended December 31, 1997 of $929,000 as compared to a net loss of $2,145,000 for the year ended December 31, 1996 representing an improvement of $1,216,000. The net loss is attributable primarily to costs associated with Alpha's efforts to restructure into a more customer-driven, innovative operation and entering into an unprofitable venture into contract manufacturing of reusable apparel products that was discontinued in August 1997. SALES Consolidated net sales for the year ended December 31, 1997 increased to $17,823,000 from $14,863,000 in 1996, representing an increase of $2,960,000 or 19.9%. Net sales for the Apparel Division for the year ended December 31, 1997 were $10,969,000 as compared to $7,475,000 for the same period of 1996. The Apparel Division sales increase of $3,494,000 or 46.7% was primarily due to increased sales to the Company's largest distributor which is expected to continue growing as a result of the Company's strategy toward developing innovative solutions to meet this and other customers needs. Net sales to this distributor were 50.7% and 42.9% of total net revenue for 1997 and 1996 respectively. Mask and eye shield sales decreased by 13.5%, to $4,354,000 in 1997 from $5,035,000 in 1996. This decrease is primarily the result of a drop in shield/mask combination product sales. Sales of mask and eye shield should strengthen in 1998 with the introduction of a new line of masks and shields. Sales from the Company's Extended Care Unreal Lambskin and other related products which includes a line of pet beds increased by 6.2% to $2,500,000 in 1997 compared to $2,353,000 in the same period in 1996. An increase in sales of Alpha's line of pet beds & related products is primarily responsible for the increase. The Company's line of pet products is expected to improve in the future. Alpha has recently restructured its business around a new strategy of innovation that will enable it to develop custom products to meet its customers needs in a very timely manner. This new approach is to satisfy customer requirements in a way that the Company's larger competitors are unable to match. The Company has a profit sharing agreement with its largest distributor. Goods shipped at cost to this distributor are to fill orders already received from the distributor's end users. Revenue for goods shipped to this distributor which includes goods shipped at cost as well as the Company's share of the profits, are recognized at the time of shipping. 13 COST OF GOODS SOLD Cost of goods sold increased to $11,594,000 for the year ended December 31,1997 from $9,665,000 for the same period in 1996. As a percentage of net sales, cost of goods sold remained flat at 65.0% for both 1997 and 1996. Gross profit margin also remained constant at 35.0% for the year ended December 31, 1997 and 1996 respectively. Management expects the gross profit margin to improve through its new strategic emphasis of developing innovative products and processes but there can be no assurance that these margin improvements will be attained. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses increased by $1,921,000 to $6,531,000 for the year ended December 31, 1997 from $4,610,000 for the year ended December 31, 1996. As a percentage of net sales, selling, general and administrative expenses increased to 36.6% in 1997 from 31.0% in 1996. The increase in selling, general and administrative expenses primarily consists of increased payroll related costs of $886,000; increased marketing, commissions and travel expenses of $560,000; increased expense related to options/warrants issued for services of $98,000; increased public company expenses of $96,000 including investor relations, annual report and annual meeting costs, stock transfer costs, and costs associated with SEC reporting requirements; increased professional fee expenses of $104,000; increased rent of $47,000; increased telecommunications expense of $41,000 and increased general office and factory expenses of $79,000. Of the increases in payroll related costs, $637,000 is due to increases in factory indirect expenses of which the majority is attributable to the Apparel Division which had an increase in sales of 46.7%. As a percentage of Apparel Division sales, selling, general and administrative expenses for the Apparel division decreased slightly to 20.6% in 1997 as compared to 20.9% in 1996. The 1997 increase in selling, general and administrative expenses are primarily as a result of Alpha's new innovative and customer-driven strategy. DEPRECIATION & AMORTIZATION Depreciation and amortization expense increased by $65,000 to $319,000 for the year ended December 31, 1997 from $254,000 for the same period in 1996. This increase is primarily attributable to an increase in the purchase of equipment through capital leases and amortization of goodwill on the acquisition of Ludan Corporation. NET INTEREST Interest expense increased by $29,000, to $308,000 for the year ended December 31, 1997 from $279,000 for the year ended December 31, 1996. The 14 increase in interest expense is due to interest on the additional capital leases acquired. In December 1997, the Company entered into a new three-year $2,900,000 credit facility with an asset-based lendor at prime plus 2%. Alpha's previous credit facility was at prime plus 5%. LOSS FROM OPERATIONS Loss from operations decreased by $1,249,000 to a loss of $621,000 for the year ended December 31, 1997 as compared to a loss from operations of $1,870,000 for the year ended December 31, 1996. The decreased loss from operations of $1,249,000 is due to an increase in gross profit of $1,031,000 ; a decrease of $2,204,000 on the 1996 non cash transaction of the exchange of escrow shares offset by an increase in selling, general and administrative expenses of $1,921,000; and an increase in depreciation and amortization of $65,000. NET LOSS The net loss for the year ended December 31, 1997 was $929,000 compared to a net loss of $2,145,000 for the year ended December 31, 1996, an improvement of $1,216,000 . The net loss decrease of $1,216,000 is comprised primarily of a decrease in loss from operations of $1,249,000 offset by an increase in interest expense of $29,000. The Company does not have any pension, profit sharing or similar plans established for its employees, however, the chief executive officer and president are entitled to a combined bonus equal to 10% of the pre-tax profits of the company. No bonus was earned in 1997 or 1996. FISCAL 1996 COMPARED TO FISCAL 1995 Alpha Pro Tech, Ltd. ("Alpha" or the "Company") reported a net loss for the year ended December 31, 1996 of $2,145,000 as compared to a net loss of $5,971,000 for the year ended December 31, 1995, representing an improvement of $3,826,000. The 1996 loss was attributable to a $2,204,000 non cash charge to earnings resulting from the issuance of 2,475,000 shares of Common Stock in exchange for a like amount of shares of the Company's Common Stock held in escrow. Simultaneously, there was an increase to paid in capital resulting in shareholders equity remaining unchanged. The net income for 1996, excluding the non-cash escrow share exchange valued at $2,204,000 was $59,000, as compared to a net loss of $1,049,000 for 1995, excluding an impairment loss on intangible assets of $4,922,000. This represents an improvement of $1,108,000, excluding the above mentioned items. 15 SALES Consolidated net sales for the year ended December 31, 1996 increased to $14,863,000 from $13,031,000 in 1995, representing an increase of $1,832,000 or 14.1%. Net sales for the Apparel Division for the year ended December 31, 1996 were $7,475,000 as compared to $4,953,000 for the same period of 1995. The Apparel Division sales increase of $2,522,000 or 50.9% was primarily due to increased sales to its largest customer which was made possible by the completion in the first quarter of 1996 of the new manufacturing facility in Nogales, Mexico. Mask, and eye shield sales decreased by 3.3%, to $5,035,000 in 1996 from $5,205,000 in 1995. Mask, and eye shield sales to dentists were virtually unchanged while the decrease can be attributed to lower medical sales. Sales from the Company's Unreal Lambskin and other related products which includes a line of pet beds, decreased by 18.1% to $2,353,000 in 1996 from $2,873,000 in 1995. The decrease in the Unreal Lambskin sales is the result of a decline in medical pad sales combined with the loss of a major pet bed distributor and the loss of business due to competitive pricing of rolled good products. The Company's Unreal Lambskin line of products is a mature line which is no longer an area for significant growth. COST OF GOODS SOLD Cost of goods sold increased to $9,665,000 for the year ended December 31, 1996 from $8,562,000 for the same period in 1995. As a percentage of net sales, cost of goods sold decreased to 65% from 65.7%. Gross profit margin increased slightly to 35.0% for the year ended December 31, 1996 from 34.3% for the year ended December 31, 1995. Management expects the gross profit margin to continue to improve through the streamlining of its manufacturing facilities but there can be no assurance that these improvements will be attained. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses increased by $268,000 to $4,610,000 for the year ended December 31, 1996 from $4,342,000 for the year ended December 31, 1995. As a percentage of net sales, selling, general and administrative expenses decreased to 31% in 1996 from 33% in 1995. The increase in selling, general and administrative expenses is primarily in the areas of payroll related costs of $311,000; tradeshows expenses of $36,000 and travel expenses of $32,000 offset by decreases in commission expenses of $46,000 and professional fees of $45,000. Of the $311,000 increase in payroll related costs, $296,000 is due to the Apparel Division which had an increase in sales of 50.9%. As a percentage of net Apparel Division sales, selling, general and administrative expenses for the Apparel division remained constant at 20% for 1996 and 1995. DEPRECIATION & AMORTIZATION Depreciation and amortization expense decreased by $364,000, to $254,000 for the year ended December 31, 1996 from $618,000 for the 16 same period in 1995. This decrease is primarily attributable to the write off at the end of 1995 of the remaining intangible assets acquired on the acquisition of its wholly-owned subsidiary, Alpha Pro Tech Inc. This is partially offset by Apparel Division fixed asset additions in 1996 and the amortization of goodwill recorded in connection with the Ludan acquisition. IMPAIRMENT LOSS ON INTANGIBLES At the end of 1995, the Company decided to write off the remaining intangible assets of $4,922,000 acquired on the acquisition of its wholly-owned subsidiary, Alpha ProTech, Inc. During the fourth quarter of 1995, it became apparent to management that cash flows from the mask, shield, and wound care products manufactured and distributed through Alpha ProTech, Inc. had declined for each of the past four years and would decline in the future. Dramatic changes have taken place in the health care market with downsizing, cost containment pressure and changing of buying practices for medical products. A significant investment would have to be made to change the Company's manufacturing equipment and facilities to continue to aggressively attack these markets. As a result, the Company has modified its strategy in order to maximize sales and profit by focusing on increased demand for its apparel cleanroom products and food service industry products. EXCHANGE OF ESCROW SHARES Pursuant to an agreement dated April 5, 1989, the Company purchased all of the assets of BFD Inc. from certain individuals. The purchase price of $625,000 Canadian was settled by the issuance of 3,500,000 common shares and the assumption of liabilities of $520,000 Canadian. Of the shares issued, 3,150,000 were subject to an escrow agreement. On December 30, 1996, all of the escrowed shares, except for the shares canceled in connection with the settlement with John P. Russell, were exchanged for new shares. The 2,475,000 new shares were valued at the fair market value of the shares on the date of the exchange which resulted in a $2,204,000 charge to earnings that was recorded during the fourth quarter of 1996. Additionally, the paid in capital increase $2,204,000 resulted in no net change to stockholders equity. The 2,475,000 shares held in escrow were canceled effective December 30, 1996. Net Interest Interest expense decreased by $284,000, to $279,000 for the year ended 17 December 31, 1996 from $563,000 for the year ended December 31, 1995. This decrease is primarily due to the following factors: a reduction in the interest paid on notes payable of $50,000; costs related to financing through Allstate at higher interest rates of $52,000 and the termination costs of Allstate at $45,000 in the first quarter of 1995; costs of $63,000 in 1995 in relation to recording the fair value of options and warrants granted to third parties; and in 1996, the Company earned an additional $40,000 in interest revenue. LOSS FROM OPERATIONS Loss from operations decreased by $3,543,000 to a loss of $1,870,000 for the year ended December 31, 1996 from a loss from operations of $5,413,000 for the year ended December 31, 1995. The decreased loss from operations is primarily due to the increase in gross profit of $729,000; the decrease in depreciation and amortization of $364,000; the increased selling, general and administrative expenses of $268,000 and the non cash transactions of the exchange of escrow shares of $2,204,000 in 1996 offset by the impairment loss on intangible assets of $4,922,000 in 1995. Income from operations excluding the 1996 and 1995 non cash transactions was $334,000 in 1996 compared to a loss of $491,000 in 1995, a net increase in income from operations of $825,000. NET LOSS Net Loss for the year ended December 31, 1996 was $2,145,000 compared to a net loss of $5,971,000 for the year ended December 31, 1995, a decrease $3,826,000. The net loss decrease of $3,826,000 is comprised of a decreased loss from operations of $3,543,000 as described above, and a decrease in interest expense of $284,000. Excluding the escrow shares exchange, net income for the year ended December 31, 1996 was $59,000 as compared to a net loss in 1995 of $1,049,000 excluding the impairment loss on intangible assets, an increase in net income of $1,108,000. The Company does not have any pension, profit sharing or similar plans established for its employees, however, the chief executive officer and president are entitled to a combined bonus equal to 10% of the pre-tax profits of the company. No bonus was earned in 1996 or 1995. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, the Company had cash of $490,000 and working capital of 18 $3,612,000. During the year ended December 31, 1997, cash increased by $215,000 and accounts payable and accrued liabilities increased by $389,000. The improvement of the company's cash and working capital is primarily due to the exercise of warrants and options for a total equity infusion of $2,463,000. The Company currently has secured a new asset based lender's line of credit of $2,900,000, based upon the level of eligible accounts receivable, inventory and equipment which expires in December 2000. At December 31, 1997, the maximum line of credit available was $2,144,000 for accounts receivable, inventory and equipment of which $773,000 remained available at December 31, 1997. Net cash used for operations was $1,973,000 for the year ended December 31, 1997 and $298,000 for the same period of 1996. The Company's use of cash from operations for the year ended December 31, 1997 is due primarily to increases in accounts receivable, inventories, prepaids and other assets offset by an increase in accounts payable and accrued liabilities. The Company's investing activities have consisted primarily of expenditures for fixed assets and intangible assets of $534,000, $70,000 for business acquisition offset by $18,000 for the sale of marketable securities for a total of $586,000 for the year ended December 31, 1997. The Company anticipates that its mask manufacturing capabilities are to be improved based on customer demands at an estimated cost of $225,000. Depending on the success of the automated shoe cover approximately $350,000 of additional equipment could be required. The Company intends to lease equipment whenever possible. During the year ended December 31, 1997, the Company's financing activities consisted primarily of the exercise of warrants and options for $2,463,000, increases in the asset based loan of $179,000, offset by principle payment on capital leases of $71,000 and repayments of borrowings totaling $50,000 which resulted in the net cash provided by financing activities of $2,521,000. Management believes that it has available cash and borrowings to finance all known financial commitments for at least 12 months and also expects to show positive cash flow for 1998. NEW ACCOUNTING STANDARDS The financial accounting standards board has issued statement of financial accounting 19 standards (SFAS) No. 128, "Earnings Per Share," which became effective after December 15, 1997. SFAS 128 requires the computation of "basic" earnings per share, which utilizes the weighted average number of common shares outstanding without regard to potential common shares, and "diluted" earnings per share, which includes all such shares if dilutive. Potential common shares for all years were anti-dilutive and accordingly were excluded from the loss per share calculations. CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 ("Act) provides a safe harbor for forward-looking information made on behalf of the Company. All statements, other than statements of historical facts which address the Company's expectations of sources of capital or which express the Company's expectation for the future with respect to financial performance or operating strategies can be identified as forward-looking statements. Such statements made by the Company are based on knowledge of the environment in which it operates, but because of the factors previously listed, as well as other factors beyond the control of the Company, actual results may differ materially from the expectations expressed in the forward-looking statements. 20 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated financial statements and the Report of Independent Auditors thereon are set forth under Item 134 (a) (1) of this Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III The information pursuant to Items 10, 11, 12 and 13 is omitted from this report (in accordance with Federal Instruction G for Form 10-K), since the Company is filing with the Commission (by no later than April 30, 1998), a definitive proxy statement pursuant to Regulation 14A, which involves the election of directors at the annual shareholders' meeting of the Company is expected to be held on June 19, 1998. 21 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1 and 2 Financial Statement and Financial Statement Schedules SEE INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES APPEARING ON PAGE F-1 OF THIS FORM 10-K (b) Exhibit Index ITEM 16. EXHIBITS

22

• ------------------------ Unless otherwise noted, all of the foregoing exhibits are incorporated by reference to Form 10 Registration Statement (File No. 0-1983) filed on February 25, 1992. * Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 019893) ** Incorporated by reference to Registration Statement on Form S-1, (File No. 33-93894) which became effective August 10, 1995 *** Incorporated by reference to Post-Effective Amendment No. 1 filed January 30, 1997 to Registration Statement on Form S-1 (File No. 33-93894) 23 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has fully caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ALPHA PRO TECH, LTD. Date: March 27, 1998 By: S/SHELDON HOFFMAN -------------- ------------------------------- Sheldon Hoffman Chief Executive Officer, Principal Financial Officer and Director Date: March 27, 1998 By: S/LLOYD HOFFMAN -------------- ------------------------------- Lloyd Hoffman Vice President, Controller and Principal Accounting Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registration and in the capacities indicated on March 27, 1998. S/DONALD E. BENNETT, JR. ---------------------------------- Donald E. Bennett, Jr. Director S/SHELDON HOFFMAN ---------------------------------- Sheldon Hoffman, Director S/ROBERT H. ISALY ---------------------------------- Robert H. Isaly, Director S/ALEXANDER W. MILLAR ---------------------------------- Alexander W. Millar, Director S/ DR. JOHN RITOTA ---------------------------------- Dr. John Ritota, Director 24 Alpha Pro Tech, Ltd. Report and Consolidated Financial Statements December 31, 1997, 1996 and 1995 Index to Consolidated Financial Statements - -------------------------------------------------------------------------------- Page Financial Statements: Report of Independent Accountants.......................................F-2 Consolidated Balance Sheets at December 31, 1997 and 1996...............F-3 Consolidated Statements of Operations for each of the three years ended December 31, 1997...............................................F-4 Consolidated Statements of Shareholders' Equity for the three years ended December 31, 1997...................................F-5 Consolidated Statements of Cash Flows for the three years ended December 31, 1997.....................................................F-6 Notes to Consolidated Financial Statements..............................F-8 Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 1997..............................................F-22 All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. F-1 Report of Independent Accountants To the Board of Directors and Shareholders of Alpha Pro Tech, Ltd. In our opinion, the consolidated financial statements listed in the index on page F-1 present fairly, in all material respects, the financial position of Alpha Pro Tech, Ltd. and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Price Waterhouse LLP Salt Lake City, Utah February 24, 1998 F-2 Consolidated Balance Sheets - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. F-3 Consolidated Statements of Operations - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. F-4 Consolidated Statements of Shareholders' Equity - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. F-5 Consolidated Statements of Cash Flows - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. F-6 ALPHA PRO TECH, LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) - ------------------------------------------------------------------------------

Non-cash investing and financing activity: 1997 The Company incurred capital lease obligations for machinery and equipment of $270,000. 1996 Effective June 1996, the Company acquired the remaining 20% minority interest in Ludan Corporation for a $68,000 note payable of which $19,000 was unpaid at December 31, 1996. The Company incurred capital lease obligations for machinery and equipment of $105,000. 1995 Effective April 1995, the Company acquired an 80% interest in Ludan Corporation for $35,000 in cash including $6,000 of direct acquisition costs, plus assumption of net liabilities of $23,000. In addition, a note payable in the amount of $20,000 owed by LC to a third party was converted to 20,000 shares of the Company's common stock. Notes payable of $830,000 were converted to 1,106,999 shares of common stock in 1995. The Company incurred capital lease obligations for office equipment and machinery and equipment of $83,000. The accompanying notes are an integral part of these financial statements. F-7 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 1. THE COMPANY Alpha Pro Tech, Ltd. (the Company) manufactures and distributes a variety of disposable mask, shield, shoe cover and apparel products and woundcare products. Through its 1992 acquisition of Alpha Pro Tech, Inc. (APT), a wholly-owned subsidiary, the Company began manufacturing and distributing its line of disposable mask and shield products and woundcare products. In 1994, APT acquired all of the assets of Disposable Medical Products, Inc. (DMP). DMP manufactures and distributes the Company's disposable apparel products and has become the primary division of the Company. In April 1995, the Company, through APT, acquired an 80% interest in Ludan Corporation (LC). In June 1996, the Company acquired the minority shareholders 20% interest in LC (Note 12). Through this acquisition, the Company has developed other applications for existing products, particularly disposable apparel and automated shoe cover products, to market to the food service and other industries. Most of the Company's disposable apparel, mask and shield products and woundcare products are distributed to medical, dental, industrial and clean room markets, predominantly in the United States. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiary, Alpha Pro Tech, Inc. (APT) as well as APT's wholly-owned subsidiary (80% owned from April 1995 to June 1996), Ludan Corporation (LC), and 96.8% owned subsidiary DPI De Mexico (DPI). All significant intercompany accounts and transactions have been eliminated. Certain prior year balances have been reclassified to conform with the current period presentation. USE OF ESTIMATES The preparation of these financial statements in conformity with generally accepted accounting principles required management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. REVENUE RECOGNITION Revenue is generally recognized when goods are shipped to the customers. The Company has an agreement with its largest customer whereby revenue is recognized at cost when goods are shipped. When this customer sells goods to third parties, the resulting profits are then recorded by the Company. Revenues are reduced for anticipated sales returns and allowances. MARKETABLE SECURITIES The Company complies with Statement of Financial Accounting Standards No. 115 (SFAS 115) "Accounting for Certain Investments in Debt and Equity Securities" which requires investment securities to be classified as either held to maturity, trading or available for sale. At December 31, 1997, the marketable security is a restricted certificate of deposit held by a financial institution that serves as a compensating balance for lines of credit relating to the Company's credit cards. The Company has classified its short-term security as available for sale and appropriately recorded it at its fair market value of $21,000. F-8 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. ADVERTISING Advertising costs consist primarily of catalog preparation and printing costs which are charged to expense when shipped. Catalog costs expensed in 1997, 1996 and 1995 were $16,000, $0 and $41,000, respectively. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation and are depreciated on a straight-line basis over their estimated useful lives as follows:

INTANGIBLE ASSETS The excess of purchase price over the estimated fair value of assets acquired and liabilities assumed has been recorded as goodwill and is being amortized using the straight-line method over 8 years. Patent rights are recorded at cost and are amortized on a straight-line basis over their estimated useful lives of 8-17 years. During 1995, the Company reduced the useful lives of mask and shield patents from 17 years to 8 years and the useful life of the APT goodwill from 20 years to 8 years. These changes in estimate were based on the Company's analysis that future sales from masks, shields and woundcare products will decrease over the next five years as the Company continues to focus its efforts to manufacture and promote its automated shoe cover and disposable apparel products. Because the useful lives of the APT goodwill and the majority of the Company's patents were based on mask, shield and woundcare products, which are declining areas of the Company's business, the Company determined the change in useful lives was appropriate. At each balance sheet date, the Company reviews its intangible assets and determines whether an impairment has occurred by evaluating whether the carrying value of intangible assets exceed their respective future undiscounted cash flows, excluding interest. If an impairment has occurred, the Company evaluates the expected fair value of the assets based upon expectations of future discounted cash flows. As of December 31, 1995, the Company concluded that an impairment of $4,922,000 existed and recorded that amount during the fourth quarter of 1995 (Note 5). INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes". This statement requires an asset and liability approach for accounting for income taxes. TRANSLATION OF FOREIGN CURRENCIES During 1992, the Company adopted the United States dollar as the functional currency. Prior to 1992, the Canadian dollar was the functional currency. Prior to December 31, 1995, the difference of $139,000 in translation for periods prior to the change in functional currency has been recorded as the cumulative translation adjustment in shareholders' equity. At December 31, 1995, the Company reclassified the cumulative translation adjustment account to accumulated deficit as the balance is F-9 ALPHA PRO TECH, LTD. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ immaterial to overall shareholders' equity and the account will not change in future years. Transactions in foreign currencies during the reporting periods are translated into the functional currency at the exchange rate prevailing at the transaction date. Monetary assets and liabilities in foreign currencies at each period end are translated at the exchange rate in effect at that date and are immaterial in amount. Transaction gains or losses on foreign exchange are reflected in net loss for the periods presented and are immaterial in amount. LOSS PER SHARE Earnings per share "EPS" have been computed pursuant to the provisions of Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share" which became effective after December 15, 1997. All periods prior to December 15, 1997 have been restated to conform with the provisions SFAS 128. The following table provides a reconciliation of both the net loss and the number of common shares used in the computations of "basic" EPS, which utilizes the weighted average number of common shares outstanding without regard to potential common shares, and "diluted" EPS, which includes all such shares.

For 1995, the basic and diluted common share calculations (denominator) exclude 2,475,000 shares held in escrow. Such shares were issued to management on December 30, 1996 (Note 9) and have been included in basic and diluted common shares thereafter. Potential common shares for all years were anti-dilutive and accordingly were excluded from the loss per share calculations. MAJOR CUSTOMER AND CONCENTRATION OF CREDIT RISK With the acquisition of the assets and business of DMP in 1994, the Company sells significant amounts of product to a large distributor on credit terms. Net sales to this distributor were 50.7%, 42.9% and 28.2% of total net revenue for 1997, 1996 and 1995, respectively. Trade receivables from this distributor were 42.3% and 33.7% of total trade receivables for 1997 and 1996, respectively. Management believes that adequate provision has been made for risk of loss on all credit transactions. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of financial instruments including cash, accounts receivable, accounts payable, accrued professional fees, other accrued liabilities, due to related parties, notes payable and loans payable approximate their respective book values at December 31, 1997 and 1996. F-10 ALPHA PRO TECH, LTD. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ STOCK FOR SERVICES Common stock, stock options to purchase common stock and warrants to purchase common stock that are granted to third parties in exchange for services are valued at their estimated fair value at the date of grant and are expensed over the period the services are rendered. STOCK BASED COMPENSATION In accordance with Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-based Compensation," which establishes an accounting method based on the fair value of equity instruments awarded to employees to account for its stock-based compensation, the Company applies the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" to account for its stock-based compensation. The company also provides pro forma disclosure in the notes to the financial statements of the differences between the fair value method and the intrinsic value method (Note 9). 3. INVENTORIES Inventories consist of the following:

1. PROPERTY AND EQUIPMENT Property and equipment consist of the following:

F-11 ALPHA PRO TECH, LTD. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ Included in the above amounts are the following assets under capital lease obligations:

1. INTANGIBLE ASSETS Intangible assets consist of the following:

IMPAIRMENT LOSS The Company acquired all of the common stock of APT in May 1992 for $7,307,000 including direct acquisition costs of $107,000. The acquisition was accounted for as a purchase and the purchase price was ultimately allocated as follows:

F-12 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ As noted in Note 1, the Company manufactures and distributes its line of disposable mask and shield products and woundcare products through its wholly-owned subsidiary, APT. Due to declining sales of these product lines since the 1992 APT acquisition and due to recent changes in the health care market, the Company has modified its strategy to focus on increased demand for its disposable apparel and automated shoe cover products. The above changes resulted in the Company revising the estimated useful lives of intangible assets recorded from the APT acquisition (Note 2). Additionally, the Company conducted an impairment analysis that determined the fair value of the assets based on discounted cash flows. From the analysis, the Company determined that the carrying value of the APT goodwill and patents related to the Company's line of disposable mask and shield products and woundcare products should be reduced by $4,922,000 at December 31, 1995. At December 31, 1995, the impairment loss has been recorded in the 1995 statement of operations and relates to the carrying value of the following assets:

1. ACCRUED LIABILITIES Accrued liabilities consist of the following:

F-13 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ 7. NOTES PAYABLE Notes payable consist of the following:

1. LOANS PAYABLE In December 1997, the Company, through its wholly owned subsidiary APT, entered into a three-year credit facility with an asset-based lender. Loans payable at December 31, 1997 represent outstanding amounts against the facility. Pursuant to the terms of the credit agreement, the Company has a $2,500,000 line of credit and a $400,000 term loan secured by accounts receivable, inventory, trademarks, patents, property and equipment, and 66.67% of the issued and outstanding shares of DPI. The credit facility bears interest at prime plus 2% which was 10.5% at December 31, 1997. The Company paid $29,000 in loan origination fees to obtain the credit facility. Under the terms of the agreement, the Company pays a 0.5% loan fee annually and is subject to certain other minimum loan fees, unused line fees and prepayment penalties if the line of credit is repaid early. The Company used certain of the proceeds of its new facility to repay its previous asset-based loan. Loans payable at December 31, 1996 represent outstanding amounts against this previous facility. Additionally, under the terms of the previous facility, the Company paid $63,000, $84,000 and $76,000 in loan and unused line of credit fees for the years ended December 31, 1997, 1996 and 1995, respectively. F-14 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Future maturities for loans payable are as follows:

2. SHAREHOLDERS' EQUITY ESCROWED SHARES Pursuant to an agreement dated April 5, 1989, the Company purchased all of the assets and business of BFD Inc. from certain individuals. The purchase price of $625,000 Canadian was settled by the issuance of 3,500,000 shares of common stock and the assumption of liabilities of $520,000 Canadian. Of the shares issued, 3,150,000 were subject to an escrow agreement. On December 30, 1996, all of the escrowed shares, except for 675,000 shares which were canceled in connection with a legal settlement with a former stockholder, were exchanged for new shares. The 2,475,000 new shares were valued at fair market value on the date of the exchange which resulted in a $2,204,000 charge to earnings that was recorded during the fourth quarter of 1996. As a result of the related paid-in capital increase of $2,204,000, the transaction resulted in no net change to stockholders equity. The 2,475,000 shares held in escrow were canceled effective December 30, 1996. SHARES ISSUED FOR SERVICES During 1995, the Company issued 16,949 shares valued at $13,000 for services performed relating to the Company's private placement. No shares were issued for services in 1997 or 1996. PRIVATE PLACEMENT ACTIVITY During 1995, the Company received subscriptions for 1,802,649 common shares under private placements for $1,352,000. Costs relating to the private placements were $426,000 for 1995. F-15 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- WARRANT ACTIVITY Warrant activity for the three years ended December 31, 1997 is as follows:

The warrants outstanding at December 31, 1997 are currently exerciseable and entitle the holders to purchase one common share for the stated price and expire July 1, 1999. OPTION ACTIVITY During 1993, the Company adopted stock option plans for employees and directors of the Company. As of December 31, 1997, 3.6 million shares were reserved for issuance under these plans, of which 3.0 million have been granted. The exercise price of the options is determined based on the fair market value of the stock on the date of grant, and the options generally vest immediately. F-16 Alpha Pro Tech NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Option activity for the three years ended December 31, 1997 is as follows:

All options are fully exerciseable. The following summarizes information about stock options outstanding at December 31, 1997:

F-17 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Had compensation cost for the Company's employee/director options been determined based on the fair value at the grant date the Company's pro forma net loss, pro forma basic loss, and pro forma diluted loss per share would have been as follows:

For the purpose of the above pro forma disclosures, the fair value of each employee/director stock option was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

The weighted-average grant date fair values of employee/director options granted during 1997 and 1996 were $0.38 and $0.72, respectively. 10. INCOME TAXES The provision (benefit) for income taxes consists of the following:

No current benefit for income taxes has been recorded in the 1997 statement of operations since the Company's history of recurring losses precludes anticipation of the benefit of the 1997 loss. F-18 ALPHA PRO TECH NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Deferred tax assets (liabilities) are comprised of the following at December 31.

The provision for income taxes differs from the amount that would be obtained by applying the United States statutory rate to the loss before income taxes as a result of the following:

At December 31, 1997, the Company has net operating losses for United States and Canadian tax purposes available to reduce future United States and Canadian taxable income amounting to approximately $6.5 million and $3.1 million, respectively. F-19 NOTES TO FINANCIAL STATEMENTS For United States tax purposes, these losses will expire as follows:

For Canadian income tax purposes, these losses will expire as follows:

In the event of changes in ownership, IRS regulations may limit net operating losses available to the Company. 11. LEASE COMMITMENTS AND OBLIGATIONS The Company leases manufacturing facilities under non-cancelable operating leases expiring between June 1998 and January 2001. The Company also leases certain manufacturing and office equipment under capital leases expiring between June 1998 and June 2000. F-20 NOTES TO FINANCIAL STATEMENTS The following summarizes future minimum lease payments required under capital and non-cancelable operating leases:

Total rent expense incurred by the Company under operating leases for the year ended December 31, 1997, 1996 and 1995 was $588,000, $599,000 and $447,000, respectively. 12. ACQUISITION OF LUDAN CORPORATION Effective April 1995, the Company acquired an 80% interest in Ludan Corporation, a Georgia based materials laminating company, for $35,000 in cash including $6,000 of direct acquisition costs, plus assumption of net liabilities of $23,000. In addition, a note payable owed by LC to a third party of $20,000 was converted to 20,000 shares of the Company's common stock. The Company recorded $78,000 of goodwill in connection with the acquisition which is being amortized over 8 years. In June 1996, the Company acquired the remaining 20% interest in LC for a $68,000 note payable of which $49,000 was paid in 1996 and the $19,000 remaining at December 31, 1996 was paid in 1997. The Company recorded an additional $58,000 of goodwill which is being amortized over 8 years. During 1997 the Company through its wholly-owned subsidiary Disposable Medical Products, Inc. acquired the remaining 3.2% of the shares in DPI, for $70,000. The Company recorded $70,000 of goodwill in connection with the acquisition which is being amortized over 8 years. F-21 Alpha Pro Tech, Ltd. And Subsidiaries Schedule II--Valuation and Qualifying Accounts

F-22