**U. S. SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-KSB**

 

 

**(MARK ONE)**

 

**ý****  ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE****SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2002**

 

**o****  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

 

**COMMISSION FILE NUMBER 1-7335**

 

**LEE PHARMACEUTICALS**

(Nameof small business issuer in its charter)

 
| **CALIFORNIA**                                                   |   | **95-2680312**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |   | (I.R.S.  Employer Identification No.) |
|                                                             |   |                                  |
| **1444 SANTA ANITA AVENUE, SOUTH EL MONTE, CALIFORNIA**          |   | **91733**                             |
| (Address  of principal executive offices)                        |   | (Zip  code)                           |
|                                                             |   |                                  |
| ISSUER’S  TELEPHONE NUMBER:  **(626) 442-3141**        |

 

SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT

 

| **Title of  Each Class** |   | **Name of  Each Exchange  on Which Registered** |
|--------------------------|--------|-------------------------------------------------|
|                     |   |                                            |
| None                     |   |                                            |

 

SECURITIES REGISTERED UNDERSECTION 12 (g) OF THE EXCHANGE ACT:  **Common stock, par value $.10 per share**

 

Check whether the issuer (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes    ý            No    o

 

Check if there is nodisclosure of delinquent filers in response to Item 405 of Regulation S-B isnot contained in this form, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB. ý

 

State issuer’s revenues forits most recent fiscal year: $10,154,000 Gross

 

As of the close of businesson November 30, 2002, the aggregate market value of Lee Pharmaceuticals commonstock held by nonaffiliates was $175,843.

 

State the number of sharesoutstanding of each of the issuer’s classes of common equity, as of the latestpracticable date.  Common stock, parvalue $.10; 4,135,162 shares outstanding as of the close of business onNovember 30, 2002.

 

DOCUMENTS INCORPORATED BYREFERENCE:  NONE

 

** **

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**PART I**

 

**ITEM 1.****                                 ****DESCRIPTION OF BUSINESS.**

 

TheCompany is engaged in the development, purchase, manufacture, and marketing ofconsumer personal care products and professional dental products, all of whichare targeted for the improved well-being of the human body.  The Company’s business is directed to twomain areas:  (a) the development andmarketing of a range of consumer products including over-the-counter items,health and beauty aids, cosmetics and prescription drug products containingcontrolled substances and (b) the manufacture and sale of materials andsupplies for use in the professional dental health field.  For all years presented, revenues, operatingresults and identifiable assets of the consumer products group were in excessof 93% of total Company operations.

 

TheCompany’s executive offices are located at 1444 Santa Anita Avenue, South ElMonte, California 91733, and its telephone number is (626) 442-3141. The Company  was incorporated in April 1971 as aCalifornia corporation.

 

**Consumer products segment**

 

TheCompany manufactures and sells lip balm, lip gloss, hair removal products,antacid tablets, nasal care products, artificial fingernail extenders andrelated fingernail products, a variety of over-the-counter items andprescription drug products.  TheCompany’s product lines have been developed internally or by outside productline acquisitions.

 

Infiscal 2000, the Company continued the expansion of the Lee® Lip-Ex® line to include 6 new “fun” flavored SPF 15sticks.  In addition, a new line of 6“fun” flavored sticks called Lee® Sippers® Lip Gloss was introduced.  The target markets include women andteenagers.  On Novemer 15, 1999, theCompany purchased Cope®, a tension headache relief tablet, and Astring-o-Sol®, a concentrated mouthwash, from U.S.Dermatologics, Inc.  In addition, onJanuary 31, 2000, the Company acquired Serutan®, toasted granules, a bulk-forming laxative,from Numark Laboratories, Inc.

 

OnOctober 30, 2000, the Company acquired the Sloans® Liniment hand pain relief medication fromC.B. Fleet Co., Inc.  On February 12,2001, the Company purchased the Black Draught® laxative product line from The MonticelloCompanies, Inc.  On August 22, 2001, theCompany acquired the DeWitt’s® analgesic pills for backache and joint painrelief from The Monticello Companies, Inc. Subsequent to fiscal year end 2001, the Company exercised an option toresell the product line back to The Monticello Companies, Inc.  Also, during fiscal 2001, the Companyexpanded its private label offerings to include several major grocery chains,drug wholesalers and retail chains.

 

TheConsumer Products Division of Lee Pharmaceuticals continues as the majorrevenue contributor to the Company.  Infiscal 2002, the Lee Consumer Products Division generated approximately 95% ofthe Company revenues.  The seniormanagement team envisions the continued growth and importance of this divisionand has put in place resources for further development.

 

Infiscal 2002, the Consumer Products Division continued the emphasis on gainingproduct distribution and product line diversification.  This diversification was twofold.  First, through the development of privatelabel (store brands) for major chain accounts (Wal-Mart, Eckerd, Duane Reade,CDMA) in the USA and ,secondly, through acquisitions of products complementaryto the existing Lee Pharmaceuticals’ products.

 

Theprimary strategy for fiscal 2002 was to continue to establish a solid foundationto further build sales volume in retail establishments.  This was accomplished by targeting new tradeclasses, expanding sales globally and replacing older, lower sales volumeproducts.

 

Infiscal 2002, the Company’s marketing department expanded the following productcategories:

 

**Oral CareProducts**

 

The Company continued theexpansion of the lip care category by providing key chain account retailerswith their own label of lip conditioners. This strategy has allowed the Company to partner with accounts in othercategories.  In addition, the Companyagain promoted two flavors of the Lee®Sippers® Lip Gloss specifically for the Christmas holidayseason.

 

**Cough andCold Products**

 

TheCompany has provided major chain retailers with their own private label ofsaline nasal spray.  The Company willcontinue to pursue this strategy in the future.

 

During fiscal 2002, theCompany once again expanded its over-the-counter category of products by way oftwo acquisitions.  On March 9, 2002, theCompany acquired from Merz Pharmaceuticals the following brands: Cankaid®(oral antiseptic liquid), Medicone® (hemorrhoidal ointment),Medicone® (hemorrhoidal suppository), Sayman®(dry skin bar with lanolin, Sayman® (oily skin bar with witch hazel)and Sayman® (salve).  Also, on April 5, 2002, the Company acquired from NumarkLaboratories, Inc. the following brands: One Step at a Time® (nicotine addiction withdrawalsystem) and lite’n® Up (reusable cigarette filter).

 

On April 23, 2002, theCompany acquired from U.S. Dermatologics, Inc. the following brands: Unguentine®(ointment for burns) and Unguentine® Plus(first aid antiseptic and pain relieving cream).

 

Allof the products within these acquired product lines currently enjoydistribution in retail outlets across the United States, distribution and saleslevels that the Company hopes to expand under the sales and marketing expertiseof Lee Pharmaceuticals.

 

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Internaland external diversification efforts carried out by the Company’s ConsumerProducts Division contributed long term opportunities for the Company duringfiscal 2002.  This effort has addedsales volume in brand categories which were nonexistent in prior Companyhistory, continued expansion efforts into convenience, independent noveltystores and dollar stores, and expanded the Company product line into globalmarkets.

 

TheCompany sold Astring-o-Sol® (concentrated mouthwash) to Oakhurst Productson July 31, 2002.

 

**Domestic consumer products marketing**

 

Consumer products are sold nationally, principallythrough major retail drug, food and discount department store chains.  In addition, the Lee®Lip-Ex® lip balm and Aquafilter® brandshave national distribution in convenience and independent novelty stores.   Retail distribution is primarilyaccomplished through a network of independent general merchandise salesrepresentatives.  All lines areadvertised in a variety of media, including television, magazines andnewspapers.

 

**Consumer products competition**

 

The Consumer ProductsDivision of the Company operates in a highly competitive environment.  In the area of fingernail extension andover-the-counter drugs, the Company competes with many companies, most of whichare larger and with greater financial resources.

 

Competition in the depilatoryproduct category is intense, with competitors even more numerous than in theartificial fingernail field.  Theacquisition of Zip Wax and Bikini Bare brands of hair removal products has giventhe Company two brands in this category.

 

The Company continues toexpand its product line via a combination of acquisitions and in-housedevelopment activity.  The Company’sconsumer products line is no longer restricted solely to the cosmeticsbusiness.

 

**Regulation of consumer products**

 

The Company’s consumerproducts are regulated by the Food and Drug Administration.  The regulations deal principally withconsumer safety and with the effectiveness of the products for the purposes forwhich they are proposed to be used.  Formany years, the regulations were applied only in cases of adulteration ormisbranding.  Under the Fair Packagingand Labeling Act (1966), the FDA has moved to require new labeling data as toingredients for all consumer products.

 

The Company believes that allits consumer products are manufactured and sold in compliance with the laws ofeach state and that no pre-marketing clearance of its products is required fromany state.  The Company maintains acomprehensive data file on each of its consumer products and believes that itwould be able to apply for any required clearances expeditiously if data wereever required for its cosmetic, drug or food products.

 

To the extent the Company’sproducts are marketed in foreign countries, foreign laws are applicable as wellas FDA regulations which control export of cosmetics.  To date, where regulations have been established by foreignministries of health which differ from those established in the United States,the Company has been able to make acceptable substitutions.  As a result, marketing of the products hasnot been significantly impeded by foreign regulations.

 

Material Safety Data Sheets(MSDS) are available on all its consumer finished products.  The MSDSs are supplied to the Company’scustomers upon request.

 

All products for exportshipped by air or sea which contain listed hazardous materials meet UnitedNations Standards as of January 1991. The requirements are based on the U.N.’s performance-oriented packaging(POP) specifications found in the “Transport of Dangerous Goods” commonlycalled “The Orange Book”.

 

**Dental products segment**

 

From its inception in 1971 through 2002, the Company at various timesintroduced dental products designed to satisfy specific material or supplyrequirements of the practicing dental professional and of the orthodonticspecialist.

 

Its dental product line consists of a variety of restorative materials(filling materials, core build up materials), Beta Quartz glass ceramicinserts, splints, orthodontic brackets, Maryland bridge adhesives, and enameland dentin bonding materials and related products.

 

**Dental marketing in the United States**

 

TheCompany markets its dental and orthodontic products in the United Statesthrough telephone solicitation, direct mail, and dental dealers.  The Company plans and executes its ownmarketing programs.

 

**Dental marketing outside the United States**

 

TheCompany markets dental products outside the United States through foreigndental distributors who either solicit individual dentists and orthodontistsand sell the Company’s products to them directly for use in the treatment oftheir patients, or sell through local dealers whom they engage to sell theCompany’s products on their behalf.  TheCompany plans and executes its own international marketing programs and regularlydisplays its dental products at international conventions by way of itsdistributors.

 

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**Dental competition**

 

Thedental preventive and restorative materials industry is highly competitive, andthe Company’s market share in the total industry is insignificant.  The Company competes with largercorporations which have greater financial resources.

 

**Regulation of Dental Products**

 

**Food and Drug Administration**

 

Dental materials areclassified as devices under the Medical Device Amendments of 1976 to theFederal Food, Drug and Cosmetic Act.

 

All the dental deviceproducts marketed by the Company were registered as devices with the FDA at themandatory time (December 31, 1977).  Allnew devices marketed after May 28, 1976, must be processed under the FDApremarketing notification regulation (510 k) for determination of equivalencyto preenactment devices, or the product must be submitted as a new device whichrequires providing considerable extra test data.

 

The Safe Medical Devices Act(SMDA) became law on November 28, 1990, requiring all serious injuries andserious illness contributed to or caused by medical devices to be reported todistributors, manufacturers and the FDA. SMDA also requires all premarket submissions to the FDA to containadequate information on safety and effectiveness.

 

As required by the FDA, theCompany observes certain procedures and policies in the manufacture, qualitycontrol, and after-sale monitoring of performance for its products.  Although the various criteria to be used bythe FDA in regulating devices have not been finalized, the Company believesthat all of its products and procedures comply with all current and anticipateddevice regulations.  Over half theCompany’s products fall into the FDA’s Class II classification which requiresthat those products must meet certain performance standards.  The Company believes that all affectedproducts meet all current performance standards.

 

For those products placed inClass II, final marketing approval from the FDA is contingent on finalacceptance of the Panel’s findings and on development of standards (in largepart being done by the American Dental Association).  It is expected that, based upon current available information,most of the Company’s products will meet the standards currently anticipated;for the products that do not meet the standards, the Company will have tosubmit adequate data directly to the FDA. Failure to gain approval by the FDA could impede the marketing of thesedevices to the point of removal from the market until such time as clearance isobtained.

 

**Other governmental regulations**

 

To the extent the Company’sproducts are marketed in foreign countries, the Company believes it hascomplied with the laws of such countries, and with the FDA regulations whichcontrol export of devices.  In thosecountries which ban use of certain ingredients, the Company has reformulatedcertain of its products to meet the specifications of that particular country.

 

There is generally world widemovement to increase and/or streamline the regulations controlling medicaldevices.  The twenty two countries inEurope have consolidated their regulations into a joint code referred to as ISO9000.  This code regulates themanufacture and distribution of medical devices in Europe.  One of the provisions of the code is thatthe Company maintain a quality control system very much like the FDA system,but with some differences.  It appearsthat these differences are being negotiated so that both regulations will beequivalent.

 

Prior to this time, theCompany generally had to apply to each individual country to obtain permissionto sell in that country.  With theconsolidated regulations, a company needs only to apply to one.  At the moment all test data needed for anapplication must be generated in Europe or validated in Europe.  The resolution of differences between theFDA and the ISO 9000 regulations will probably result in U.S. data beingaccepted in Europe, and vice versa. Whether this consolidation will apply to prescription drugs isuncertain.

 

The Company elected to have two of its major dentalbrands obtain the CE markings in order to continue to distribute those brandsthroughout Europe.  The Company receivedthe CE Markings on Prosthodent® andInsta-Bond®.

 

The Company believes that allits dental products are manufactured and sold in compliance with the laws ofeach state and country to whom the Company exports and that no premarketingclearance of its products is required from any state.

 

**Department of Transportation**

 

TheMaterials Transportation Bureau administers the Hazardous Materials Regulation,effective July 7, 1975.  It has beenascertained that those dental products and components marketed by the Companywhich fall within the provisions of the regulations are brought into complianceby proper labeling and/or filing for exemptions.  The Company believes that it is in full compliance with allbureau regulations applicable to its products and that compliance with theseregulations will not significantly impede the marketing of its products.

 

**Applicableto All Segments**

 

**Foreign and Domestic Operations and Export Sales**

 

|                                            |   | **Year ended  September 30** |   |
|-------------------------------------------------|--------|------------------------------|--------|
|                                            |   | **2002**                     |   | **2001** |   | **2000** |   |
|                                            |   | **(000)**                    |   | **(000)** |   | **(000)** |   |
|                                            |   |                         |   |   |   |   |   |
| United States  export sales (except Canada)     |   | $                            | 253    |   | $ | 224 |   | $ | 276 |   |
| United States domestic sales (including Canada) |   | $                            | 9,901  |   | $ | 9,253 |   | $ | 9,586 |   |

** **

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**Research program**

 

TheCompany focuses on brand acquisitions rather than extensive internal researchand development.  Effective July 1996the Company eliminated its internal research and development department, anddecided that future testing and research, that cannot be absorbed by its qualityassurance and production control departments, will be placed outside theCompany.  The Company follows the policyof expensing all research and development costs when incurred.  The Company did not have any internalresearch and development expenses during fiscal years September 30, 2002 and 2001.

 

**Raw materials**

 

The raw materials used by theCompany in the manufacture of most of its dental and consumer products areobtained from commercial sources where they are presently available insufficient quantities and are refined by the Company as needed for use in itsproducts.  The Company generally carriessufficient amounts of raw materials inventory to meet the delivery requirementsof customers.

 

**Patents and trademarks**

 

The Company has adopted thepolicy of making patent disclosures on its products and of filing applicationsfor patents on the products or on aspects of their manufacture or use whenappropriate.  The Company owns nine U.S.patents, including Dental Restoration System and Method and owns the rights ina number of other U. S. patent applications pending.  The Company believes that, while patent protection is desirablein certain areas, it is not essential; therefore, certain foreign patents havebeen abandoned as not necessary to the interest of the Company.

 

United States trademarks forthe major dental products as well as some consumer products, have beengranted.  Additional trademarks forother products have been applied for, both in the U. S. and in foreigncountries.  Trademarks for certain minorproducts, or in countries with minor market potential, have been abandoned asnot necessary to the interest of the Company.

 

**Current regulatory registration**

 

The Company has a license tomanufacture and sell two dental products from the American Dental AssociationHealth Research Foundation, which operates a dental research facility in thecomplex of the National Institute of Standards and Technology.

 

The Company is registeredwith the Federal and State of California FDA agencies as a manufacturer anddistributor of Drugs, Medical Devices, Processed Foods and Cosmetics.  The Company is also registered as a wastegenerator with the Environmental Protection Agency (EPA).

 

The Company has CECertifications on two dental products which are distributed in Europe:Prosthodent® Core Build Up Material and Lee Insta-Bond® Orthodontic Bracket Adhesive.

 

Effective November 23, 1998,the Company applied for and was granted a Controlled Substance License with theDrug Enforcement Agency (DEA).  Thelicense is issued for one year and grants the Company the right to distributeprescription drug products containing controlled substance (s).  As of March 26, 2002, the Company’s DEAlicense was renewed.

 

**Environmental protection regulation and litigation**

 

The Company owns amanufacturing facility located in South El Monte, California.  The California Regional Water QualityControl Board (The “RWQCB”) ordered the Company in 1988 and 1989 to investigatethe contamination on its property (relating to soil and groundwater contamination).  The Company engaged a consultant whoperformed tests and reported to the then Chairman of the Company.  The Company resisted further work on itsproperty until the property upgradient was tested in greater detail since two“apparent source” lots had not been tested. On August 12, 1991, the RWQCB issued a “Cleanup and Abatement Order”directing the Company to conduct further testing and cleanup the site.  In October 1991, the Company received froman environmental consulting firm an estimate of $465,200 for investigation andcleanup costs.  The Company believedthat this estimate was inconclusive and overstated the contaminationlevels.  The Company believes thatsubsequent investigations will support the Company’s conclusions  about that estimate.  The Company did not complete the testing forthe reasons listed above as well as “financial constraints”.  In June 1992, the RWQCB requested that theEPA evaluate the contamination and take appropriate action.  At the EPA’s request, Ecology &Environment, Inc. conducted an investigation of soil and groundwater on theCompany’s property.  Ecology &Environment Inc.’s Final Site Assessment Report, which was submitted to the EPAin June 1994, did not rule out the possibility that some of the contaminationoriginated on-site, and resulted from either past or current operations on theproperty.

 

On April 24, 2002, the RWQCB notified the Company that the detection ofemergent chemicals in groundwater, above State and Federal maximum containmentlevels or action levels, has caused the RWQCB and the EPA to reassess thethreat posed to groundwater resources used for domestic supply.  The RWQCB directed the Company to test forthe presence of emergent chemicals in its groundwater monitoring wells.  The groundwater monitoring analyticalresults were due by July 15, 2002.  OnMay 24, 2002, the Company informed RWQCB that it could not comply with therequirement to conduct groundwater sampling due to ongoing financialdifficulties.

 

On July 8, 2002, the RWQCB sent a “Second Notice of Violation” to theCompany directing the Company to comply with the requirement to prepare agroundwater remedial action plan (RAP). The Company previously notified the RWQCB that it could not comply withthe requirement to submit a RAP because of ongoing financial difficulties.  The RWQCB requested that the Company submitcertain financial information by July 29, 2002 to “substantiate any allegedfinancial losses and determine whether any suspension of implementingthe...(Cleanup and Abatement Order) is warranted.”  The Company has received an extension to submit the requiredfinancial information to August 19, 2002. The Company submitted the requestedfinancial information on August 16, 2002. As of the date of the financial statements, no response has beenreceived.  The Company may be liable forall or part of the costs of remediating the contamination on its property andcould be subject to enforcement action by the RWQCB, including injunctive andcivil monetary remedies.  As of the dateof the financial statements, the Company’s share of the costs have not beendetermined.

 

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The Company and nearbyproperty owners, in consort with their comprehensive general liability (CGL)carriers, engaged a consultant to perform a site investigation with respect tosoil and shallow groundwater contamination over the entire city block.  The CGL carriers provided $290,000 infunding which paid for the $220,000 study, $20,000 in legal fees for project oversight,and a $50,000 balance in the operating fund. Earlier the Company had accrued $87,500 as its proportionate share ofthe earlier quote of $175,000. Since that time, the overall scope of theproject was increased to $205,000 plus $15,000 for waste water disposal,bringing the total to the above listed $220,000.  The $87,500 accrual was not spent on this project (as the entirecost was borne by the CGL carriers), but remains on the books as an accrualagainst the cost of remediation of the same site that was included in thestudy.

 

The tenants of nearbyproperties upgradient have sued the Company alleging that hazardous materialsfrom the Company’s property caused contamination on the properties leased bythe tenants.  The case name is DelRay Industrial Enterprises, Inc. v. Robert Malone, et al., LosAngeles County Superior Court, Northwest District, commenced August 21,1991.  In this action, the plaintiffalleges environmental contamination by defendants of its property, and seeks acourt order preventing further contamination and monetary damages.  The Company does not believe there is anybasis for the allegations and is vigorously defending the lawsuit.

 

The Company’s South El Montemanufacturing facility is also located over a large area of possiblycontaminated regional groundwater which is part of the San Gabriel ValleySuperfund Site.  The Company has beennotified that it is a potentially responsible party  (“PRP”)  for thecontamination.   In 1995, the Companywas informed that the EPA estimated the cleanup costs for the South El Monte’sportion of the San Gabriel Valley Superfund Site to be $30 million.  The Company’s potential share of such amounthas not been determined.  Superfund PRPsare jointly and severally liable for superfund site costs, and are responsiblefor negotiating among themselves the allocation of the costs based on, amongother things, the outcome of environmental investigation.

 

In August 1995, the Companywas informed that the EPA entered into an Administrative Order of Consent withCardinal Industrial Finishes (“Cardinal”) for a PRP lead remedial investigationand feasibility study (the “Study”) which, the EPA states, will bothcharacterize the extent of groundwater contamination in South El Monte andanalyze alternatives to control the spread of contamination.  The Company and others entered into theSouth El Monte Operable Unit Site Participation Agreement with Cardinalpursuant to which, among other things, Cardinal contracted with anenvironmental firm to conduct the Study. The Study has been completed. The Company’s share of the cost of the Study was $15,000 and was accruedfor in the financial statements as of September 30, 1995.  The South El Monte Operable Unit (SEMOU)participants developed four remedial alternatives.  The capital cost of the four alternatives range from $0 (noaction) up to $3.49 million.  Theestimated annual operating cost for the four alternatives range from $0 (noaction) to $770,300.  Over a 30-yearperiod, the total cost of the four alternatives range from $0 (no action) up to$13.05 million.  The EPA prefers analternative which estimates the capital cost up to $3.08 million, the annualoperating cost at $.48 million, and the 30-year period total cost up toapproximately $9.09 million.  Theselection of the actual alternative implemented is subject to publiccomment.  At the present time, theCompany does not know what its share of the cost may be, if any.  Therefore, no additional accrual has beenrecognized as a liability on the Company’s books.  The Company requested that the EPA conduct an “ability-to-payevaluation” to determine whether the Company is entitled to an early settlementof this matter based upon a limited ability to pay costs associated with siteinvestigation and remediation.  InAugust 2000, the EPA informed the Company that it does not qualify for an earlysettlement at this time.

 

The EPA has informed theCompany that it has learned that the intermediate zone groundwatercontamination in the western portion of the SEMOU has migrated further west andhas now impacted the City of Monterey Park and Southern California WaterCompany production wells.  The EPAstated that the City of Monterey Park Water Department, San Gabriel ValleyWater Company and Southern California Water Company are planning to buildtreatment facilities for their wells. The EPA stated that these three water purveyors contacted some of theSEMOU PRPs, other than the Company, to seek funding to develop groundwatertreatment facilities for the contaminated wells.  A group of these PRPs calling themselves the “South El MonteCooperative Group” has been formed and purportedly has reached a generalagreement with the water purveyors to fund the development of treatmentfacilities and use the water purveyors’ wells in an attempt to contain thegroundwater contamination to meet EPA’s goals. At this time, the EPA has not reviewed or approved any specific plan toaddress contamination at the purveyor wells, nor has the EPA compromised itsright to recover response costs from any person who is legally responsible forcontamination within the SEMOU.  As ofthe date of this report, the Company has not been contacted by the South ElMonte Cooperative Group in respect to its participation in any proposed cleanupactivity.  As a result, the Company isnot able to determine what contribution, if any, it may be assessed inconnection with this cleanup activity.

 

By letter dated November 13,2000, the Company was notified that the City of Monterey Park, San GabrielValley Water Company and Southern California Water Company intend to bring suitunder the Safe Drinking Water and Toxic Enforcement Act of 1986 alleging thatthe Company has knowingly released volatile organic compounds in the soil andshallow groundwater beneath the Company’s property between at least on orbefore November 8, 1996 and the present and has failed to promptly clean up allof the contamination.  As of the date ofthis report, the Company has not been served with this lawsuit.

 

The City of South El Monte,the city in which the Company has its manufacturing facility, is located in theSan Gabriel Valley.  The San GabrielValley has been declared a Superfund site. The 1995 Water Quality Control Plan issued by the California RegionalWater Quality Control Board states that the primary groundwater basinpollutants in the San Gabriel Valley are volatile organic compounds fromindustry, nitrates from subsurface sewage disposal and past agriculturalactivities.  In addition, the Plan notedthat hundreds of underground storage tanks leaking gasoline and other toxicchemicals have existed in the San Gabriel Valley.  The California Department of Toxic Substance Control has declaredlarge areas of the San Gabriel Valley to be environmentally hazardous andsubject to cleanup work.

 

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The Company believes the Cityof South El Monte does not appear to be located over any of the majorplumes.  However, the EPA has announcedit is studying the possibility that, although the vadose soil and groundwater,while presenting cleanup problems, there may be a contamination by DNAPs (densenon-aqueous phase liquids), i.e., “sinkers”, usually chlorinated organiccleaning solvents.  The EPA has proposedto drill six “deep wells” throughout the City of South El Monte at an estimatedcost of $1,400,000.  The EPA isconferring with SEMPOA (South El Monte Property Owners Association) as to costsharing on this project.  SEMPOA hasobtained much lower preliminary cost estimates.  The outcome cost and exact scope of this are unclear at thistime.

 

The Company and otherproperty owners engaged Geomatrix Consultants, Inc., to do a survey of vadosesoil and shallow groundwater in the “hot spots” detected in the previousstudies.  Geomatrix issued a reportdated December 1, 1997 (the “Report”), on the impact of volatile organiccompounds on the soil and groundwater at the Lidcombe and Santa Anita Avenuesite located in South El Monte, California (which includes the Company’sfacilities).  The Report indicatedgenerally low concentrations of tetrachloroethene, trichloaethene andtrichloroethane in the groundwater of the upgradient neighbor.  The Report was submitted to the RWQCB forits comments and response.  A meetingwith the parties and RWQCB was held on February 10, 1998.  The RWQCB had advised companies that vadosesoil contamination is minimal and requires no further action.  However, there is an area of shallowgroundwater which has a higher than desired level of chlorinated solvents, andthe RWQCB requested a proposed work plan be submitted by Geomatrix.  Geomatrix has submitted a “FocusedFeasibility Study” which concludes that there are five possible methods forcleanup.  The most expensive are for apump and sewer remediation which would cost between $1,406,000 and$1,687,000.  The Company is activelyexploring the less expensive alternative remediation methods, of which the twoproposed alternatives range in cost between $985,000 and $1,284,000.  Since there are four economic entitiesinvolved, the Company’s best estimate at this time, in their judgment, would bethat their forecasted share would be $287,000 less the liability alreadyrecognized on the books of $165,000 thereby requiring an additional $122,000liability.  Accordingly, the Companyrecorded an additional accrual of $122,000 in the third quarter of fiscal1998.  The $122,000 accrual is inaddition to the $79,000 accrual for the Monterey Site as will be explained inthe following paragraph.  The $79,000accrual, in the third quarter of fiscal 1998, related to the Monterey Site isnot included in the $287,000 figure above. In April 2000, the Company received a Notice of Violation from theRWQCB.  The Notice of Violation statesthat the Company and other property owners were required to submit agroundwater remedial action plan by November 1, 1999, and that the RWQCB hasbeen advised that the Company and the other property owners were unable tosubmit the required remedial action plan because the Company and the otherproperty owners could not agree on the allocation of financial responsibilityto prepare the action plan.  The RWQCBstated that it will no longer encourage the cooperative approach among theCompany and the other property owners in completing the cleanup requirements andwill pursue appropriate measures, including when necessary, enforcementactions.  The RWQCB states that it mayimpose civil liability penalties of up to $1,000 per day from November 1, 1999for failure to file the action plan.  Inlight of these events, no assurances can be given that the cleanup costs andpossible penalties will not exceed the amount of the Company’s current accrualsof $287,000 (which includes the $122,000 charge to income in the third quarterof fiscal 1998).

 

In July 2000, the propertyowners formed the Lidcombe & Santa Anita Avenue Work Group (LSAAW) inresponse to the RWQCB request for the preparation of an action plan.  The LSAAW submitted a Focused FeasibilityStudy to the RWQCB for their review and approval of the selected remedialaction method for the site.  After receivingRWQCB approval, LSAAW obtained three cost proposals to implement the RWQCBapproved pump and treat remedial method. According to these cost proposals, the lowest estimated costs for anassumed five (5) years of pump and treat remediation is $600,000.  This cost is lower than the previous costproposed work plan, discussed above, from Geomatrix Consultants, Inc.  The capital costs including contingenciesare approximately $300,000.

 

The LSAAW is hopeful theWater Quality Authority (WQA) is willing and able to reauthorize its grant forone-half (1/2) of the capital costs of its remediation system construction notto exceed $150,000.  It is estimated atthis time that the reserves for the Company’s share of this cost proposal areadequate since its prior accrual was based on the higher cost estimate fromGeomatrix.

 

Without any priorcorrespondence or inkling of the Company’s potential liability, the EPAinformed the Company that the Company may have potential liability for theongoing remediation of Operating Industries, Inc. (as they have gone out ofbusiness) Landfill Superfund Site in Monterey Park, California (the “MontereySite”).  The Monterey Site is a 190 acrelandfill that operated from 1948 to 1984, in which the Company disposed of nontoxic pH balanced waste water on six occasions between 1974 and 1978.  Over 4,000 companies have been identified ashaving contributed waste to the Monterey Site. The EPA has offered to settle the Company’s potential liability withrespect to the Monterey Site for a cost to the Company of $79,233.  The Company accrued a $79,000 charge in thethird quarter of fiscal 1998 with respect to this possible liability.  The Company has elected to file for relieffrom these obligations under the financial hardship option in the EPA’sresponse form.  On June 30, 2000, theEPA informed the Company that the EPA believed the Company is able to pay thefull settlement cost, but offered to reduce the amount of the settlement to$75,271.

 

The Company was notified bythe EPA that the Company may have potential liability for waste material itdisposed of at the Casmalia Disposal Site (“Site”) located on a 252 acre parcelin Santa Barbara County, California. The Site was operational from 1973 to 1989, and over 10,000 separateparties disposed of waste there.  TheEPA stated that federal, state and local governmental agencies along with thenumerous private entities that used the Site for waste disposal will beexpected to pay their share as part of this settlement.  The U.S. EPA is also pursuing theowner(s)/operator(s) of the Site to pay for Site remediation.  The EPA has a settlement offer to theCompany with respect to the Site for a cost of $373,950.  The Company accrued a $374,000 charge in thefirst quarter of fiscal 1999 with respect to this possible liability.  The Company has elected to file for relieffrom these obligations under the financial hardships option in the EPA’sresponse form.  The Company, the EPA andcertain PRPs have entered into an agreement tolling the applicable statutes oflimitation.  The Company has beennotified by the EPA that their request for a waiver, due to financial hardship,was “partially granted.”  Improvementsin the bidding process has lowered the Company’s estimated share down to$245,000 (from $374,000) and of that, the EPA was requesting that the Companypay $113,000, as a result of their findings on the application for waiver dueto financial hardship.  The Company isconsidering the EPA’s request.

 

7

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The total amount ofenvironmental investigation and cleanup costs that the Company may incur withrespect to the foregoing is not known at this time.  However, based upon information available to the Company at thistime, the Company has expensed since 1988 a total of $860,000, of which $89,000were legal fees, exclusive of legal fees expended in connection with the SECenvironmental investigation.  The actualcosts could differ materially from the amounts expensed for environmentalinvestigation and cleanup costs to date.

 

As of September 30, 2002, noadditional amounts have been incurred and no settlements have been reached.

 

**Other regulations**

 

During the last severalyears, several state, local and federal agencies have finalized or proposedregulations relating to hazardous materials. These include Los Angeles CountyHazardous Materials Business Plan, California and federal OSHA “right to know”laws, EPA “community right to know” laws and Extremely Hazardous SubstanceRegulations, Los Angeles County’s program for monitoring and closingunderground tanks, the California Safe Drinking and Toxic Enforcement Act of1986 (Prop 65), California Connelly-Sterling Toxic Hot Spots InformationAct  and AQMD’s New Source ofCarcinogenic Air Contaminants (Rule 1401). The Company believes it is in compliance with these regulations that arein effect and is anticipating it will be in compliance with those of these actsyet to be finalized.

 

The Internal StandardsOrganization in September 1996 released specifications (ISO 14000) forcompanies to use as guidelines in reducing worldwide contamination andimproving on recycling operations.  TheCompany believes that demonstrating that the Company meets these specificationsis good citizenship and also in time will be necessary for internationaltrade.  The Company has not yet appliedfor an ISO 14000 rating due to the burden of other environmental mattersoutlined above.

 

**Employees**

 

The Company’s work force of102 presently includes 34 permanent employees, both salaried and hourly, and 68personnel leased through employment agencies.

 

**Other**

 

The Company is not dependentupon any one supplier for any important raw material item.  Most raw material items are commodities andreadily available in the market.  Inmost instances, the Company utilizes two or more suppliers to furnish rawmaterials as needed.  Sources arebelieved to be sufficient to satisfy current and anticipated needs.

 

Demand for some of theCompany’s principal product lines is not seasonal.  The depilatory line of products is, however, generally seasonal,with demand significantly higher during the spring and summer months.

 

Although the Company does notbelieve that it is dependent upon any one customer or distributor, a customeraccounted for 12% and 10% of the Company’s net revenues during fiscal 2002 and2001, respectively.  No other customeraccounted for 6% or more of the Company’s net revenues for those fiscal years.

 

Backlog is not a significantfactor in the Company’s business.  Mostorders are filled immediately and in any event, are cancelable under certainconditions.  There are no materialcontracts with distributors.

 

Consumer Products Divisionreturns must include proof of purchase, sales receipt and a written explanationof the reason for the return.  TheCompany generally provides credits for replacement of product, however, onoccasion it may provide a cash refund.

 

In addition, discontinued oroverstocked items may be returned once the customer receives a computer printed“return authorization” and “shipping labels” for full case stock of factoryfresh product to be sent freight prepaid to the Company’s warehouse.  The customer will not receive credit foradditional merchandise that may have been added to the return.

 

The Company’s sales returnpolicy for the Dental Division, is as follows: “products returned to LeePharmaceuticals for credit must be sent postage paid and within 90 days ofpurchase”.  Defective merchandise can bereplaced free of charge at any time prior to the date of expiration.  Excessively used or improperly storedmerchandise is not eligible for replacement.

 

**ITEM 2.****                                 ****DESCRIPTION OF PROPERTY.**

 

The Company occupies, throughownership or lease, seven buildings on contiguous lots in South El Monte,California. The Company owns the following:

 
| **Address**             |   | **Approximate  square  footage** |       | **Usage**                        |       |
|-------------------------|--------|----------------------------------|------------|----------------------------------|------------|
|                    |   |                             | ** ** |                             | ** ** |
| 1428 Santa Anita Avenue |   | 10,400                           |       | Chemical processing and  filling |       |

 

8

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The Company leases the following:

 

 
| **Address**                  |   | **Approximate  square  footage** |   | **Aggregate  annual  rental** |    | **Lease  expiration  date** |       | **Usage**                                                                             |                                                                                                      |
|------------------------------|--------|----------------------------------|--------|-------------------------------|---------|-----------------------------|------------|---------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1434 Santa Anita Avenue      |   | 11,200                           |   | $                             | 62,748  | *                           | 11/30/2005 |                                                                                  | Inventory control,  personnel, data processing,   accounting offices and dental production/shipping. |   |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1460 Santa Anita Avenue (1)  |   | 14,560                           |   | 81,576                        |  * | 11/30/2005                  |       | Effective January 15, 1996,  the building was subleased.                              |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1470 Santa Anita Avenue (2)  |   | 8,400                            |   | 47,062                        | *  | 11/30/2005                  |       | Effective July 16, 1996,  the building was subleased.                                 |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1500 Santa Anita Avenue      |   | 17,600                           |   | 98,604                        | *       | 11/30/2005                  |       | Warehouse, consumer  packaging operations, injection molding and corrugated printing. |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1516 Santa Anita Avenue      |   | 17,600                           |   | 98,604                        | *  | 11/30/2005                  |       | Sales/marketing offices,  purchasing, consumer shipping, and warehouse.               |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1444 Santa Anita Avenue (3)  |   | 9,800                            |   | 73,800                        | *  | 11/30/2005                  |       | Executive office, consumer  production, quality control and bottle printing.          |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1427 Lidcombe Avenue         |   | 6,000                            |   | 33,616                        | *  | 11/30/2005                  |       | Maintenance and chemical  processing (rear building).                                 |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1425 Lidcombe Avenue         |   | 6,000                            |   | 33,616                        | *  | 11/30/2005                  |       | Chemical processing and  packaging.                                                   |                                                                                                      |
|                         |   |                             |   |                          |    |                        |       |                                                                                  |                                                                                                      |
| 1445 Lidcombe Avenue (3) (4) |   | 9,200                            |   | 69,288                        | *  | 11/30/2005                  |       | Manufacturing and  packaging.                                                         |                                                                                                      |
|                              |        |                                  |        |                               |         |                             |            |                                                                                       |                                                                                                           |  |

 

----

*                 Revised biannually for consumer price indexchange.

 

(1)          The Company entered into a sublease agreement, effective December 1,2000, which expires November 30, 2002. The gross annual rental income is $87,360.  This lease has been extended for one year and will expireNovember 30, 2003.

 

(2)          The Company entered into a sublease agreement, effective April 1, 2001,which expires November 30, 2005.  Thegross annual rental income is $49,392. This new sublease replaces the sublease which expired November 30, 2000.

 

(3)          This property is treated as a sale leaseback agreement between theCompany and Ronald G. Lee, President. The monthly lease payments were set at the prevailing rates in the areaat the time the leases were written.

 

(4)          Effective June 7, 2002, the month-to-month sublease which had been ineffect was terminated, and the Company began using the building for its ownoperations.

 

All of the Company’s business segments use the properties owned orleased by the Company except for 1470 Santa Anita Avenue (sublease expiresNovember 30, 2005)and1460 Santa Anita Avenue (subleaseexpires November 30, 2003).

 

The Company has a right of first refusal to acquire most of thebuildings which it leases.

 

The Company believes that its existing facilities are adequate to enableit to continue to produce its products at their present volume together withany moderate increases thereto.

 

**ITEM 3.****                                 ****LEGAL PROCEEDINGS.**

 

TheCompany is a party to an action entitled Carma Laboratories, Inc. v. LeePharmaceuticals filed in the United States District Court for the EasternDistrict of Wisconsin.  Plaintiff claimsthat lip balm products sold by the Company under the names Lip-Ex® and Equate® Lip Balm are sold in jars with trade dressthat infringes plaintiff’s trade dress on its Carmex® brand lip balm sold in white jars with yellowlids.  Plaintiff claims unfaircompetition and trademark infringement under the federal Landham Act andcommon. law.  Plaintiff seeks injunctiverelief against the continued selling by the Company of lip balm whichincorporates trade dress which plaintiff claims to be confusingly similar toits white jar with yellow lid and also seeks other equitable relief.  Plaintiff seeks damages in an unstatedamount and the Company’s profits on the allegedly infringing merchandise.  The Company has answered the complaint,denied the material allegations thereof, and asserted affirmative defenses andtwo counterclaims.  The firstcounterclaim seeks to invalidate Carma’s alleged trademark for its trade dress(i.e., white jar with a yellow lid). The second counterclaim seeks to hold the plaintiff’s alleged trademarkfor its trade dress to be unenforceable. The Company intends vigorously to defend this action and pursue itscounterclaims.

 

9

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Inaddition, in the ordinary course of its business, the Company is involved fromtime to time in litigation.  In theopinion of management of the Company none of that litigation currently pendingwill have a material effect on its business or financial condition.  See Item I – “Applicable to All Segments -Environmental protection regulation and litigation” for additional informationconcerning certain environmental litigation.

 

**ITEM 4.****                                 ****SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

Notapplicable.

 

**PART II**

 

**ITEM 5.****                                 ****MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS.**

 

The Company’s Common Stock trades on the electronic over-the-counterbulletin board under the trading symbol LPHM. For the two most recent fiscal years, its shares have closed at high andlow trading prices as follows:

 

|        |   | **QTR** |   | **High** |   | **Low** |   |
|-------------|--------|---------|--------|----------|--------|---------|--------|
| **FY 2002** |   | 1Q      |   | $        | .1600  |    | $      | .1100 |   |
|        |   | 2Q      |   | .2400    |   | .1700   |   |
|        |   | 3Q      |   | .2400    |   | .1200   |   |
|        |   | 4Q      |   | .2400    |   | .0800   |   |
| **FY 2001** |   | 1Q      |   | $        | .2100  |    | $      | .1575 |   |
|        |   | 2Q      |   | .2000    |   | .1500   |   |
|        |   | 3Q      |   | .1800    |   | .1300   |   |
|        |   | 4Q      |   | .1600    |   | .1300   |   |

 

There were approximately 721 shareholders of record of the Company’sCommon Stock as of the close of business on September 30, 2002.

 

The Company has not paid any cash dividends and has no present intentionof paying cash dividends in the foreseeable future.

 

**ITEM 6.****                                 ****MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.**

 

**Fiscal years ended September 30, 2002, and September30, 2001**

 

In fiscal 2002, net revenues increased 9% to$9,226,000 from $8,469,000 in fiscal 2001. The increase in net revenues was primarily attributed to higher salesvolume associated with the Lee® Lip-Ex®lip balm ($415,000) along with the volume from the private label ($492,000)segment.  In addition, the Companyexperienced added volume from the newly acquired brands such as:  One Step at a Time®,Medicone®, Cankaid® andSayman® (totaling $456,000).  The increase in net revenues was partially offset by lower salesvolume generated from depilatories ($143,000), Nosebetter®($167,000), Take-Off® ($115,000) and other over-the-counteritems ($246,000).  The  Company’s sales returns decreasedapproximately $80,000 or 8% when comparing fiscal years 2002 and 2001.  The Company continued to experience thediscontinuance of a few of the Company’s SKUs (stock keeping units) at the retail store level.  The expansion into the private labelbusiness segment along with the continued growth of the convenience storedistributors and dollar stores has been positive.

 

Cost of sales as a percentageof gross revenues for fiscal 2002 and 2001 was 49% and 46%, respectively.  The higher cost of sales percentage infiscal 2002 was due to a change in the product mix and lower pricedcommodity-type goods with an accompanying higher cost of goods attached tothem, thereby generating lower gross margins on sales of these relatedproducts.  The lower gross margin goodsinclude, but are not limited to, the Lee® Lip-Ex® lip balm category plus private labelbusiness.  In addition, the Companyincurred increased direct labor costs as a result of a rise in the minimumhourly wage ($6.75 effective January 1, 2002 versus $6.25).

 

Selling and advertisingexpenses increased $399,000 or 17% when comparing fiscal years 2002 and2001.  The increased expenses were primarilydue to the following factors: (1) higher salesmen salaries and related fringebenefits due to the hiring of a higher salaried salesman who replaced lowersalaried sales personnel plus added temporary help ($98,000), (2) increasedsalaries and wages along with related fringe benefits, the result of overallmerit raises ($26,000), (3) higher sales force commissions/bonuses resultingfrom increased sales to convenience store accounts and private label business($62,000), (4) added commissions ($57,000) due to added manufacturerrepresentatives covering territories that were previously open, (5) increasedfreight costs ($68,000), (6) increased bad debt expense ($138,000), (7)increased convention/show expense ($23,000), (8) higher premiums related to insurancecoverage ($22,000), (9) added royalty expense from new product lineacquisitions ($80,000) and (10) higher sales aids and materials/suppliesexpenses ($27,000).  The above increaseswere partially offset by lower amortization expense ($238,000) due to a newaccounting pronouncement requiring only intangible assets with finite usefullives to continue to be amortized over their useful lives.

 

10

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General and administrativeexpenses increased $14,000 or 1% when comparing fiscal years 2002 and2001.  This increase was principally dueto higher MIS (Management Information Systems) expenses for consulting services($60,000).  This was partially offset bylower legal fees ($34,000).

 

Financial Accounting StandardsNo. 142 (FAS-142) became effective for the Company on October 1, 2001.  FAS-142 requires goodwill and otherintangible assets that have indefinite useful lives to no longer be amortized;however, these assets must be tested at least annually for impairment.  FAS-142 also requires an evaluation ofexisting acquired goodwill and other intangible assets for properclassification under the new requirements. In connection with the adoption of FAS-142, the impairment test requiredthe Company to record an impairment charge of $659,000 for the year endedSeptember 30, 2002.

 

Interest expense decreased$13,000 or 2% when comparing fiscal years 2002 and 2001.  The decrease was due to a lower averageprime rate (4.83% versus 8.08%) in reference to certain loans which are tied toprime.  Although the interest expensedecreased from fiscal 2001 to fiscal 2002, there were four new loans at ahigher interest rate which are not tied to prime.  Also, the Company’s overall borrowings level increased duringfiscal 2002 when compared to fiscal 2001.

 

Other income increased$94,000 or 134% to $164,000 when comparing fiscal years 2002 and 2001,respectively.  This significant increasewas attributed to the deferred income recognized from the sale of two of theCompany’s prior (November 1999 and September 1997) product line acquisitionsalong with property tax refunds.

** **

**Liquidity and capital resources**

 

Working capital was anegative $l,883,000 at September 30, 2002, as compared with a negative$1,750,000 at September 30, 2001.  Thedecrease in working capital of $133,000 was basically due to an increase incurrent liabilities of $405,000 (accounts payable).  This increase was partially offset by a $207,000 increase inaccounts receivable.  The ratio ofcurrent assets to current liabilities was .7 to 1 at September 30, 2002 andSeptember 30, 2001.

 

In comparing fiscal years2002 and 2001, accounts receivable turnover increased (10.1 versus 9.2) and thenumber of day’s sales were in average accounts receivable improved (30 daysversus 33 days).  This data wasrelatively constant during fiscal years 2002 and 2001 due to continuedcollection efforts.  Accounts payable asa percentage of total costs and expenses was 14% in fiscal 2002 versus 12% infiscal 2001.

 

Effective April 23, 2002, theCompany renewed its accounts receivable financing, maturing May 2004, whereby70% of the eligible domestic accounts receivable, not to exceed the greater of$1,400,000 or $1,400,000 less amounts advanced on inventory, can be advanced.  The agreement is renewable for successiveone year periods thereafter.  Also, theagreement requires minimum monthly interest of $3,000 with an interest rate of8% above Union Bank of California’s prime rate.  The financing agreement includes a $300,000 term loan oninventory which is incorporated in the working capital line of creditabove.  The inventory term loan requiresmonthly payments of $5,000 with an interest rate of 8% above Union Bank ofCalifornia’s prime rate.  As ofSeptember 30, 2002, the inventory term loan principal balance was $215,000 andis being paid down to $100,000 at the rate of $5,000 per month.  The $100,000 will be due when the financingagreement matures.  Additionally, thereis a separate $400,000 term loan on the Company’s equipment.  As monthly payments are made to reduce theequipment term loan balance, the Company, from time to time, as needed, canrequest additional financing for new and used equipment at 80% of the purchaseprice.  As of September 30, 2002, theequipment term loan balance was $362,000. This equipment financing is secured by a security interest in all of theCompany’s assets and requires monthly payments of $19,166 plus interest atUnion Bank of California’s prime rate plus 8%. The continuing personal guarantee by the Company’s President, ofobligations of the Company, remains in force.

 

During fiscal 2002, theCompany financed the acquisition of three new product lines.  The debt incurred for the financing of theseproduct lines was $1,100,000 at an interest rate ranging from 20% to 24%.

 

See “Business - Applicable toAll Segments - Environmental protection regulation and litigation” for adescription of certain environmental matters relating to the Company.

 

The Company has anaccumulated deficit of $8,123,000.  The Company’spast recurring losses and fiscal 2001 and 2000’s nominal profits fromoperations and inability to generate sufficient cash flow from normaloperations to meet its obligations as they come due raise substantial doubtabout the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due.

 

The Company does not believethat inflation had a significant impact on its operations during fiscal years2002 and 2001.

 

11

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**ITEM 7.****                                 ****FINANCIAL STATEMENTS.**

 
| **Index to Financial Statements**  | **Page**

**number**                                                                                       |
|------------------------------------|------------------------------------------------------------------------------------------------------------|
|                               |
| Independent Auditor’s  Report | 13                                                                                                         |
|                               |                                                                                                       |
| Financial Statements:              |                                                                                                       |
|                               |                                                                                                       |   |
|                               | Balance sheet as of September 30, 2002                                                                     | 14 |
|                               |                                                                                                       |   |
|                               | Statements  of operations for the years ended  September 30, 2002 and September 30, 2001                   | 15 |
|                               |                                                                                                       |   |
|                               | Statements of  stockholders’ (deficit) for the years ended  September 30, 2002 and September 30, 2001 | 16 |
|                               |                                                                                                       |   |
|                               | Statements  of cash flows for the years ended  September 30, 2002 and September 30, 2001                   | 17 |
|                               |                                                                                                       |   |
|                               | Notes to financial  statements                                                                             | 18-31 |

 

All schedules not filed orincluded herein are omitted either because they are not applicable or notrequired, or the required information is included in the financial statementsor notes thereto.

 

12

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***CALDWELL,******BECKER,DERVIN, PETRICK & CO.,******L.L.P.***

***CERTIFIED PUBLIC ACCOUNTANTS***

 

 

INDEPENDENT AUDITOR’S REPORT

 

 

To the Board ofDirectors and Stockholders

of LeePharmaceuticals

 

We have auditedthe accompanying balance sheet of Lee Pharmaceuticals (a Californiacorporation) as of September 30, 2002, and the related statements ofoperations, stockholders’ (deficit), and cash flows for each of the years inthe two-year period then ended.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audit.

 

We conducted ouraudit in accordance with auditing standards generally accepted in the UnitedStates of America.  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includes assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audit provides areasonable basis for our opinion.

 

In our opinion,the financial statements referred to above present fairly, in all materialrespects, the financial position of Lee Pharmaceuticals as of September 30,2002, and the results of its operations and its cash flows for each of theyears in the two-year period then ended, in conformity with accountingprinciples generally accepted in the United States of America.

 

The accompanyingfinancial statements have been prepared assuming that the Company will continueas a going concern.  As discussed inNote 1 to the financial statements, the Company has not shown a trend forgenerating sufficient net income and cash flow from normal operations.  Those conditions raise substantial doubtabout its ability to continue as a going concern.  Management’s plans regarding those matters are also described inNote 1.  The financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.

 

As discussed inNote 12 to the financial statements, the Company is named in severalenvironmental remediation actions.  Although the Company has accrued a liability in the amount of$740,000, the total costs of these actions cannot be presently determined.  The total amount of expense relating to thisissue is $860,000.

 

 

CALDWELL, BECKER,DERVIN, PETRICK & CO., L.L.P.

 

Caldwell, Becker,Dervin, Petrick & Co., L.L.P.

Woodland Hills,California

December 12, 2002

 

20750 Venura Boulevard, Suite 140 • WoodlandHills, CA 91364

(818) 704-1040 • (323) 873-1040 • FAX (818)704-5536

 

13

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**LEE PHARMACEUTICALS**

 

**BALANCE SHEET**

(roundedto thousands)

 

**SEPTEMBER 30, 2002**

 
| **ASSETS**                                                                                                    |   |       |      |
|---------------------------------------------------------------------------------------------------------------|--------|------------|-----------|
|                                                                                                          |   |       |      |
| **CURRENT ASSETS:**                                                                                           |   |       |      |
| Cash                                                                                                          |   | $          | 26,000    |   |
| Accounts receivable, less allowance for doubtful accounts of $40,000  and sales returns allowance of $158,000 |   | 1,086,000  |      |
| Inventories                                                                                                   |   | 2,418,000  |      |
| Deposits                                                                                                      |   | 321,000    |      |
| Other current assets                                                                                          |   | 183,000    |      |
| **Total current assets**                                                                                      |   | 4,034,000  |      |
|                                                                                                          |   |       |      |
| **Property,  plant and equipment, at cost:**                                                                  |   |       |      |
| Land                                                                                                          |   | 49,000     |      |
| Building                                                                                                      |   | 217,000    |      |
| Machinery and equipment                                                                                       |   | 5,197,000  |      |
| Leasehold improvements                                                                                        |   | 377,000    |      |
|                                                                                                          |   | 5,840,000  |      |
| Less accumulated depreciation and amortization                                                                |   | (5,322,000 | )         |
| **Net property, plant and  equipment**                                                                        |   | 518,000    |      |
| **Other assets:**                                                                                             |   |       |      |
| Intangible assets, net of accumulated amortization of $1,957,000 and  impairment of $659,000                  |   | 2,290,000  |      |
| Non-current deposits                                                                                          |   | 46,000     |      |
| **Total other assets**                                                                                        |   | 2,336,000  |      |
|                                                                                                          |   |       |      |
| **Total**                                                                                                     |   | $          | 6,888,000 |   |
|                                                                                                          |   |       |      |
| **LIABILITIES  AND STOCKHOLDERS’ (DEFICIT)**                                                             |   |       |      |
|                                                                                                          |   |       |      |
| **Current  liabilities:**                                                                                     |   |       |      |
| Bank overdraft                                                                                                |   | $          | 73,000    |   |
| Notes payable - finance company                                                                               |   | 947,000    |      |
| Current portion  - notes payable, other                                                                       |   | 1,014,000  |      |
| Current portion- note payable related party                                                                   |   | 790,000    |      |
| Accounts payable                                                                                              |   | 1,316,000  |      |
| Accrued liabilities                                                                                           |   | 358,000    |      |
| Environmental cleanup liability                                                                               |   | 366,000    |      |
| Due to related parties - accrued interest                                                                     |   | 902,000    |      |
| Deferred income                                                                                               |   | 151,000    |      |
| **TOTAL CURRENT LIABILITIES**                                                                                 |   | 5,917,000  |      |
|                                                                                                          |   |       |      |
| **Long-term  notes payable - finance company**                                                                |   | 287,000    |      |
| **Long-term  notes payable to related parties**                                                               |   | 1,889,000  |      |
| **Long-term  notes payable, other**                                                                           |   | 1,734,000  |      |
| **Environmental cleanup  liability - casmalia site**                                                          |   | 374,000    |      |
| **Deferred income**                                                                                           |   | 175,000    |      |
| **Total liabilities**                                                                                         |   | 10,376,000 |      |
|                                                                                                          |   |       |      |
| **Commitments  and contingencies**                                                                            |   |       |      |
|                                                                                                          |   |       |      |
| **Stockholders’ (deficit)****:**                                                                         |   |       |      |
| Common stock, $.10 par value; authorized 7,500,000 shares; issued and  outstanding, 4,135,162 shares          |   | 413,000    |      |
| Additional paid-in capital                                                                                    |   | 4,222,000  |      |
| Accumulated (deficit)                                                                                         |   | (8,123,000 | )         |
| **Total stockholders’  (deficit)**                                                                       |   | (3,488,000 | )         |
|                                                                                                          |   |       |      |
| **Total**                                                                                                     |   | $          | 6,888,000 |   |

 

The accompanying notes are an integral part of the financial statements.

 

14

----

 

**LEE PHARMACEUTICALS**

 

**STATEMENTS OF OPERATIONS**

(roundedto thousands)

 

**FOR THE YEARS ENDED SEPTEMBER 30,**

 
|                                             |   | **2002**  |       | **2001**   |   |
|--------------------------------------------------|--------|-----------|------------|------------|--------|
|                                             |   |      |       |       |   |
| **Gross revenues**                               |   | $         | 10,154,000 |       | $      | 9,477,000 |   |
| Less: Sales returns, discounts and allowances    |   | (928,000  | )          | (1,008,000 | )      |
|                                             |   |      |       |       |   |
| **Net revenues**                                 |   | 9,226,000 |       | 8,469,000  |   |
|                                             |   |      |       |       |   |
| **Costs and expenses:**                          |   |      |       |       |   |
| Cost of sales                                    |   | 4,999,000 |       | 4,386,000  |   |
| Selling and advertising                          |   | 2,711,000 |       | 2,312,000  |   |
| General and administrative                       |   | 1,156,000 |       | 1,142,000  |   |
| Intangible impairment loss                       |   | 659,000   |       | —     |   |
|                                             |   |      |       |       |   |
| **Total  costs and expenses**                    |   | 9,525,000 |       | 7,840,000  |   |
|                                             |   |      |       |       |   |
| **Operating income (loss)**                      |   | (299,000  | )          | 629,000    |   |
| **Interest expense**                             |   | (777,000  | )          | (790,000   | )      |
| **Gain on sale of fixed assets**                 |   | 1,000     |       | 14,000     |   |
| **OTHER INCOME**                                 |   | 164,000   |       | 70,000     |   |
|                                             |   |      |       |       |   |
| **NET (LOSS) BEFORE EXTRAORDINARY  ITEM**        |   | (911,000  | )          | (77,000    | )      |
| **Extraordinary item**                           |   | —    |       | 124,000    |   |
|                                             |   |      |       |       |   |
| **Net income (loss)**                            |   | $         | (911,000   | )          | $      | 47,000 |   |
|                                             |   |      |       |       |   |
| **Per share:**                                   |   |      |       |       |   |
| Basic (loss) per share before extraordinary item |   | $         | (.22       | )          | $      | (.02 | ) |
| Extraordinary item                               |   | —    |       | .03        |   |
| Basic (loss) income per share                    |   | $         | (.22       | )          | $      | .01 |   |

 

The accompanying notes are an integral part of the financial statements.

 

15

----

 

**LEEPHARMACEUTICALS**

 

**STATEMENTS OF STOCKHOLDERS’ (DEFICIT)**

(roundedto thousands)

 

**FOR THE YEARS ENDED SEPTEMBER 30,**

 
|                          |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |    | **(Accumulated  Deficit)** |   | **Total**  |   |
|-------------------------------|--------|-------------------|--------|----------------------------------|---------|----------------------------|--------|------------|--------|
| **Number of  Shares**         |   | **Amount**        |   |
|                          |   |              |   |                             |    |                       |   |       |   |   |   |
| Balance at September 30, 2000 |   | 4,135,162         |   | $                                | 413,000 |                       | $      | 4,222,000  |   | $ | (7,259,000 | ) | $ | (2,624,000 | ) |
|                          |   |              |   |                             |    |                       |   |       |   |   |   |
| Net income                    |   |              |   |                             |    |                       |   | 47,000     |   | 47,000 |   |
|                          |   |              |   |                             |    |                       |   |       |   |   |   |
| Balance at September 30, 2001 |   | 4,135,162         |   | 413,000                          |    | 4,222,000                  |   | (7,212,000 | )      | (2,577,000 | ) |
|                          |   |              |   |                             |    |                       |   |       |   |   |   |
| Net (loss)                    |   |              |   |                             |    |                       |   | (911,000   | )      | (911,000 | ) |
|                          |   |              |   |                             |    |                       |   |       |   |   |   |
| Balance at September 30, 2002 |   | 4,135,162         |   | $                                | 413,000 |                       | $      | 4,222,000  |   | $ | (8,123,000 | ) | $ | (3,488,000 | ) |

 

The accompanying notes are an integral part of the financial statements.

 

16

----

 

**LEE PHARMACEUTICALS**

 

**STATEMENTS OF CASH FLOWS**

(roundedto thousands)

 

**FOR THE YEARS ENDED SEPTEMBER 30,**

 
|                                                                               |   | **2002**   |     | **2001**   |   |
|------------------------------------------------------------------------------------|--------|------------|----------|------------|--------|
| CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:                                       |   |       |     |       |   |
| Net income  (loss)                                                                 |   | $          | (911,000 | )          | $      | 47,000 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |       |     |       |   |
| Depreciation                                                                       |   | 170,000    |     | 170,000    |   |
| Amortization of  intangibles                                                       |   | 231,000    |     | 487,000    |   |
| Intangible  impairment loss                                                        |   | 659,000    |     | —     |   |
| (Gain) on disposal  of property, plant, and equipment                              |   | (1,000     | )        | (14,000    | )      |
| Other loss                                                                         |   | —     |     | 1,000      |   |
| Change in operating assets and liabilities:                                        |   |       |     |       |   |
| (Increase)  decrease in accounts receivable                                        |   | (208,000   | )        | 365,000    |   |
| (Decrease) in  allowance for doubtful accounts and sales returns and allowances    |   | (129,000   | )        | (17,000    | )      |
| Decease  (increase) in inventories                                                 |   | 201,000    |     | (191,000   | )      |
| (Decrease)  increase in inventory reserve                                          |   | (210,000   | )        | 69,000     |   |
| (Increase)  decrease in deposits                                                   |   | (42,000    | )        | 112,000    |   |
| (Increase)  decrease in other current assets                                       |   | (140,000   | )        | 60,000     |   |
| Increase in  accounts payable and accrued liabilities                              |   | 330,000    |     | 25,000     |   |
| Increase in due  to related parties-accrued interest                               |   | 48,000     |     | 121,000    |   |
| (Decrease) in  accrued royalties                                                   |   | —     |     | (39,000    | )      |
| (Decrease)  increase in deferred income and advance payment                        |   | (119,000   | )        | 294,000    |   |
|                                                                               |   |       |     |       |   |
| Net cash (used  in) provided by operating activities                               |   | (121,000   | )        | 1,490,000  |   |
|                                                                               |   |       |     |       |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |   |       |     |       |   |
| Additions to  property, plant and equipment                                        |   | (125,000   | )        | (201,000   | )      |
| Proceeds from  sale of equipment                                                   |   | 1,000      |     | 7,000      |   |
| Proceeds from  sale of product brand                                               |   | 565,000    |     | —     |   |
| Acquisition of product brands  and covenants not to compete                        |   | (646,000   | )        | (463,000   | )      |
| Increase in  non-current deposit                                                   |   | —     |     | (11,000    | )      |
|                                                                               |   |       |     |       |   |
| Net cash (used  in) investing activities                                           |   | (205,000   | )        | (668,000   | )      |
|                                                                               |   |       |     |       |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |   |       |     |       |   |
| Proceeds from  notes payable to related party                                      |   | 120,000    |     | 44,000     |   |
| (Payments on)  notes payable to related party                                      |   | (244,000   | )        | (155,000   | )      |
| Decrease in due  from related party                                                |   | —     |     | 25,000     |   |
| (Decrease) in  notes payable                                                       |   | (116,000   | )        | (74,000    | )      |
| Proceeds from  notes payable, other                                                |   | 1,960,000  |     | 1,070,000  |   |
| (Payments on)  notes payable, other                                                |   | (1,361,000 | )        | (1,474,000 | )      |
| (Decrease)  increase in bank overdraft                                             |   | (12,000    | )        | (265,000   | )      |
|                                                                               |   |       |     |       |   |
| Net cash  provided by (used in) financing activities                               |   | 347,000    |     | (829,000   | )      |
|                                                                               |   |       |     |       |   |
| NET INCREASE (DECREASE) IN CASH                                                    |   | 21,000     |     | (7,000     | )      |
| Cash, beginning of year                                                            |   | 5,000      |     | 12,000     |   |
|                                                                               |   |       |     |       |   |
| Cash, end of year                                                                  |   | $          | 26,000   |       | $      | 5,000 |   |
|                                                                               |   |       |     |       |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                |   |       |     |       |   |
|                                                                               |   |       |     |       |   |
| Cash paid during the year for:                                                     |   |       |     |       |   |
| Interest                                                                           |   | $          | 717,000  |       | $      | 676,000 |   |
| Taxes                                                                              |   | $          | 1,000    |       | $      | 1,000 |   |

 

The accompanying notes are an integral part of the financial statements.

 

17

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**LEE PHARMACEUTICALS**

**NOTESTO FINANCIAL STATEMENTS**

 

 

**NOTE 1 -****                         ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Description of business**

 

The Company is engaged in thedevelopment, purchase, manufacture, and marketing of consumer personal careproducts and professional dental products, all of which are targeted for theimproved well-being of the human body. The Company’s business is directed to two main areas:  (a) the development and marketing of a rangeof consumer products including over-the-counter items, health and beauty aids,cosmetics and prescription drug products containing controlled substances and(b) the manufacture and sale of materials and supplies for use in theprofessional dental health field.  Forall years presented, revenues, operating results and identifiable assets of theconsumer products group were in excess of 93% of total Company operations.

 

**Continuedexistence**

 

The financial statements havebeen prepared assuming the Company will continue as a going concern.  The Company has an accumulated deficit of$8,123,000.  The Company’s recurringlosses from operations and inability to generate sufficient cash flow fromnormal operations to meet its obligations as they come due raise substantialdoubt about the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due. Management’s plans in regard to these matters are to increaseprofitability by increasing sales, control expenses and seek additionalfinancing from outside lenders.  Thefinancial statements do not include any adjustments to reflect the possiblefuture effects of the recoverability and classification of assets or theamounts and classification of liabilities that may result from the possibleinability of the Company to continue as a going concern.

 

**Reclassifications**

 

Certain reclassificationshave been made to the prior year financial statements to be consistent with the2002 presentation.

 

**Cash andcash equivalents**

 

For purposes of thestatements of cash flows, the Company considers cash and cash equivalents to includecash on hand, bank balances, money markets and short-term investments with amaturity of three months or less.

 

**Accountsreceivable**

 

The Company provides anallowance for doubtful accounts and reserve for returned merchandise.  The Company’s estimates are based onhistorical collection and return experience and a review of the current statusof trade accounts receivable.  It isreasonably possible that the Company’s estimate of the allowance for doubtfulaccounts will change.

 

**Inventories**

 

Inventories are stated at thelower of average cost or market using the first-in, first-out method.

 

**Depreciationand amortization**

 

Propertyand Equipment

 

Property and equipment arerecorded at cost.  Expenditures formajor additions and improvements are capitalized, and minor replacements,maintenance, and repairs are charged to expense as incurred.  When property and equipment are retired orotherwise disposed of, the cost and accumulated depreciation are removed fromthe accounts and any resulting gain or loss is included in the results ofoperations for the respective period. Amortization and depreciation are computed on the straight line methodsused for financial reporting purposes using the following lives:

 

| Building                |   | 31  years  |
|-------------------------|--------|------------|
| Machinery and equipment |   | 5-7  years |
| Leasehold improvements  |   | 39  years  |

 

Depreciation expense was $170,000 and $170,000 for theyears ended September 30, 2002 and 2001, respectively.

 

Intangibles

 

Intangible assets are being amortized under thestraight-line method using the following lives:

 

| Covenants not to compete |   | 60  months - 120 months |
|--------------------------|--------|-------------------------|
| Distribution rights      |   | 56  months              |

 

Amortization expense was$231,000 and $487,000 for the years ended September 30, 2002 and 2001,respectively.

 

18

----

 

**Environmentalexpenditures**

 

Environmental expendituresthat relate to an existing condition caused by past operations, and which donot contribute to current or future revenue generation, are expensed.  The Company’s proportionate share of theliabilities are recorded when environmental remediation and/or cleanups areprobable, and the costs can be reasonably estimated.  Management believes that the total amount provided at September30, 2002 for remedial cost studies is adequate based on current information available.  (See Note 12 - “Assessment for environmentalcleanup.”)

 

**Majorcustomer and vendors**

 

The Company had one majorcustomer with sales volume approximating 12% and 10% of the Company’s netrevenues for the years ending September 30, 2002, and 2001, respectively.  The amount due from the customer was$248,000 and $102,000 at September 30, 2002, and 2001, respectively, and isincluded in accounts receivable in these financial statements.  The Company has five vendors that accountedfor 25% of the total inventory purchased for the fiscal year ended September30, 2002.

 

**Revenue andexpense recognition**

 

Income and expenses arerecorded on the accrual basis of accounting. The Company recognizes revenues from sales when goods have been shipped,there are no material uncertainties regarding customer acceptance, collectionof the resulting receivable is deemed probable, and no other significant vendorobligations exist.  Expenses arerecognized when services have been performed or inventory items have been used.  Chemical items are recognized as inventoryonce Quality Control testing is in compliance with the Companyspecifications.  Adoption of SAB 101 hashad no effect on the way the Company recognizes revenue.  The Company has not had to change theiraccounting policies to comply with SAB 101.

 

**Concentrationof credit risk**

 

Financial instruments whichpotentially subject the Company to concentrations of credit risk consist ofcash and trade receivables.  The Companyplaces its cash with high credit quality financial institutions.  At times such investments may be in excessof the FDIC limit.  In regards to tradereceivables, the risk is limited due to the large number of customers comprisingthe customer base, and the dispersion in different industries and geographies.  Generally, the Company does not requirecollateral for its trade receivables.

 

**Deferredincome tax accounts**

 

Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases.  Deferred tax assets, including tax loss and credit carryforwards,and liabilities are measured using enacted tax rates expected to apply totaxable income in the years in which those temporary differences are expectedto be recovered or settled.  The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin income in the period that includes the enactment date.  Deferred income tax expense represents thechange during the period in the deferred tax assets and deferred taxliabilities.  The components of thedeferred tax assets and liabilities are individually classified as current andnon-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in theopinion of management, it is more likely than not that some portion or all ofthe deferred tax assets will not be realized.

 

**Use ofestimates**

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosures of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

**Fair valueof financial instruments**

 

Based on borrowing ratescurrently available to the Company for bank loans with similar terms andmaturities, the fair value of the Company’s long-term debt approximates thecarrying value.  Furthermore, thecarrying value of all other financial instruments potentially subject tovaluation risk (principally consisting of accounts receivable and accountspayable) also approximates fair value.

 

**Impairmentof long-lived assets and long-lived assets to be disposed of**

 

The Company evaluates itslong-lived assets, including goodwill (product line) and certain identifiableintangibles, for impairment whenever events or changes in circumstancesindicate that the carrying amount of such assets or intangibles may not berecoverable.  Recoverability of assetsto be held and used is measured by a comparison of the carrying amount of anasset to future undiscounted net cash flows expected to be generated by theasset.  If such assets are considered tobe impaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceed the fair value of the assets.  If an asset is to be disposed of, it isreported at the lower of the carrying amount or fair value less costs tosell.   (See Note 4 - “IntangibleAssets.”)

 

**Advertisingcosts**

 

Advertising costs areexpensed as incurred.  Advertising costsfor fiscal years ended September 30, 2002 and 2001 were $160,000 and $194,000,respectively.

 

19

----

 

**Stock optionplan**

 

The Company applies theintrinsic value-based method of accounting prescribed by Accounting PrinciplesBoard (“ABP”) Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations, in accounting for its outstanding stockoptions.  As such, deferred compensationexpense would generally be recorded on the date of grant only if the currentmarket price of the underlying stock exceeded the exercise price.  Such deferred compensation is expensedpro-rata over the vesting period of the stock option.  Repriced stock options are accounted for using variable planaccounting which requires periodic re-measurement of the intrinsic value of therelated stock option until its exercise, forfeiture or cancellation. (See Note12 - “Stock Options.”)

 

**Segmentreporting**

 

In June 1997, the FASB issuedStatement of Financial Accounting Standards (“SFAS”) No. 131, *Disclosuresabout Segments of an Enterprise and Related Information*.  SFAS No. 131 establishes standards for themanner in which public companies report information about operating segments inannual and interim financial statements. It also establishes standards for related disclosures about products andservices, geographic areas and major customers.  The method for determining what information to report is based onthe way management organizes the operating segments within the Company formaking operating decisions and assessing financial performance.  The Company’s chief operating decision-makeris considered to be the Company’s chief executive officer (“CEO”).

 

Information available onreportable segments is as follows:

 
|                                         |   | **For Year  Ended September 30** |      |
|----------------------------------------------|--------|----------------------------------|-----------|
|                                         |   | **2002**                         |      | **2001** |   |
|                                         |   |                             |      |   |   |
| Revenue from consumer personal care products |   | $                                | 9,906,214 |   | $ | 9,183,489 |   |
|                                         |   |                             |      |   |   |
| Revenue from professional dental products    |   | $                                | 248,137   |   | $ | 293,524 |   |

 

The Company does not identifyor allocate assets by operating segment and does not allocate cost of sales,operating profits, depreciation or other expenses by operating segments.

 

**Newaccounting pronouncement**

 

In June 2001, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 142 (FAS-142), *Goodwill and Other Intangible Assets*.  FAS-142 supersedes Accounting PrinciplesBoard Opinion No. 17, *Intangible Assets*, and requires goodwilland other intangible assets that have indefinite useful lives to no longer beamortized; however, these assets must be tested at least annually forimpairment.  FAS-142 also requires anevaluation of existing acquired goodwill and other intangible assets for properclassification under the new requirements. In addition, intangible assets (other than goodwill) that have finiteuseful lives will continue to be amortized over their useful lives; however,the amortization period of such intangible assets will no longer be limited to40 years.  In connection with theadoption of this standard, the Company’s unamortized goodwill balance will nolonger be amortized over its estimated useful life; rather, it will be subjectto at least an annual assessment for impairment by applying a fair-value-basedtest.

 

FAS-142 became effective forthe Company on October 1, 2001.  TheCompany is still assessing the impact of all the Statement’s provisions on itsfinancial position and results of operations. However, based on its review to date, the Company expects the followingsignificant impacts:

 

•    Uponadoption, the balance of product line is expected to be $1,068,225, and theCompany will discontinue amortizing these assets at that time.  The resulting reduction in amortizationexpense is estimated at approximately $220,000 for each of the years 2003 and2004.  In the prior years, product lineswere called goodwill.

 

•    TheCompany is required to perform a transitional impairment test as of September30, 2002.  This impairment test willrequire the Company to (1) identify its reporting units, (2) determine thecarrying value of each reporting unit by assigning assets and liabilities,including existing product line and intangible assets, to those reportingunits, and (3) determine the fair value of each reporting unit.  If the carrying value of any reporting unitexceeds its fair value, then the amount of any product line impairment will bedetermined through a fair value analysis of each of the assigned assets(excluding product line) and liabilities.

 

•    Followingthe transitional impairment test, the Company’s product line balances will besubject to annual impairment tests using the same process described above.  If any impairment is indicated as a resultof the annual test, an impairment charge would be recorded as part of incomefrom operations.

 

20

----

 

**NOTE 2 -****                         ****NET INCOME (LOSS) PER SHARE**

 

Basic net income per share iscomputed using the weighted-average number of shares of common stockoutstanding.  Diluted net income pershare is computed using the weighted-average number of shares of common stockoutstanding and, when dilutive, potentially dilutive shares from restrictedstock and options to purchase common stock using the treasury stock method.

 

The following is areconciliation of the shares used in the computation of basic and diluted netincome per share:

 
|                                                                                  |   | **For Year  Ended September 30** |   |
|---------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                  |   | **2002**                         |   | **2001** |   |
| Basic net income  per share - weighted average number of common shares outstanding    |   | 4,135,162                        |   | 4,135,162 |   |
|                                                                                  |   |                             |   |   |   |
| Effect of  potentially dilutive securities outstanding - restricted stock and options |   | —                           |   | — |   |
|                                                                                  |   |                             |   |   |   |
| Shares used in  diluted net income per share computation                              |   | 4,135,162                        |   | 4,135,162 |   |

 

Options to purchase shares ofcommon stock at an average share price which is greater than the average marketprice of the shares are not included in the computation of diluted earnings pershare, or EPS, because the effect of their inclusion would have beenanti-dilutive.  For the years ended September 30, 2002 and2001, 212,000 options and 1,130,000 options, respectively, to purchase shares ofcommon stock were excluded from the computation of diluted earnings per share.

 

**NOTE 3 -****                         ****INVENTORIES**

 

Inventories consist of thefollowing at September 30, 2002:

 

| Raw materials              |   | $         | 2,170,000 |   |
|----------------------------|--------|-----------|-----------|--------|
| Work-in-process            |   | 279,000   |      |
| Finished goods             |   | 345,000   |      |
|                       |   | 2,794,000 |      |
| Allowance for obsolescence |   | (376,000  | )         |
| Total                      |   | $         | 2,418,000 |   |

 

**NOTE 4 -****                         ****INTANGIBLE ASSETS**

 

The Company acquired certainproduct lines in 2002 (see Note 17) and in prior years.  Amounts related to these acquisitions areallocated to intangible assets. Included in intangible assets, which have not been fully amortized atSeptember 30, 2002, are the following:

 
|                     |   | **Cost**  |      | **Accumulated  Amortization  at 10/1/01** |   | **Acquisitions  (Sales)  Current Year** |   | **Current  Year  Amortization** |    | **Current  Year  Impairment** |   | **Net  Unamortized  at 9/30/02** |   |
|--------------------------|--------|-----------|-----------|-------------------------------------------|--------|-----------------------------------------|--------|---------------------------------|---------|-------------------------------|--------|----------------------------------|--------|
|                     |   |      |      |                                      |   |                                    |   |                            |    |                          |   |                             |   |
| Product lines            |   | $         | 2,340,000 |                                      | $      | (1,150,000                              | )      | $                               | 537,000 |                          | $      | —                           |   | $ | (659,000 | ) | $ | 1,068,000 |   |
| Covenants not to compete |   | 2,142,000 |      | (521,000                                  | )      | (183,000                                | )      | (216,000                        | )       | —                        |   | 1,222,000                        |   |
| Distribution rights      |   | 70,000    |      | (55,000                                   | )      | —                                  |   | (15,000                         | )       | —                        |   | —                           |   |
|                     |   |      |      |                                      |   |                                    |   |                            |    |                          |   |                             |   |
| Total                    |   | $         | 4,552,000 |                                      | $      | (1,726,000                              | )      | $                               | 354,000 |                          | $      | (231,000                         | )      | $ | (659,000 | ) | $ | 2,290,000 |   |

 

**Productlines**

 

Since the acquisition, profitmargins for certain of the products have been below management’s expectations principallyas a result of lower than expected sales levels.  During 2002, the Company performed a detailed evaluation of theproduct lines which took into consideration estimated future cash flows of theindividual brands based on the brands’ projected sales and the direct costsassociated with manufacturing and selling the brands.  Where the individual brands’ undiscounted cash flow projectionswere less than the carrying value, an impairment loss was calculated andrecognized.  In determining the amount ofimpairment loss, the value of each product line was calculated using thediscounted future estimated annual cash flows. A discount rate of 33.3%, which represents an estimated risk-adjustedcost of capital, was used in the calculation. This evaluation resulted in a noncash charge to earnings for the yearended September 30, 2002 of $659,000, and reduced the carrying value of theproduct lines from $1,727,000 to $1,068,000. This remaining carrying value of $1,068,000 at September 30, 2002 doesnot necessarily represent the amount that could be obtained by a sale of any orall brands to a third party.

 

21

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**Covenant notto compete**

 

Covenant not to competeagreements (net) of $1,222,000 at September 30, 2002, represents the portion ofthe purchase price associated with the acquisition of ten different productlines allocated to noncompetition agreements. Under these agreements, the former companies agreed not to compete withthe Company for periods ranging from five to ten years.  The related cost is being amortized on thestraight-line method over the terms of the agreements.

 

**NOTE 5 -**                          **NOTESPAYABLE - FINANCE COMPANY**

 
| Note payable (accounts  receivable financing), secured by accounts receivable, equipment, inventories,  and certain other assets, maximum revolving advance is $1,400,000 (based on  domestic accounts receivable as defined in the agreement less amounts loaned  on inventory, not to exceed $300,000, can be advanced), requires minimum  monthly interest of $3,000, interest rate is 8% above Union Bank of  California’s prime rate.  The  agreement matures May 2004 and is renewable annually.  The continuing personal guarantee by the  Company’s President, of the obligations of the Company, remains in force. |   | $         | 657,000 |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|---------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |      |    |
| Note payable, secured by  inventory, maximum amount of term loan is the lessor of $300,000 or 25% of  the amount of eligible inventory, requires monthly payments of $5,000 plus  interest at Union Bank of California’s prime rate plus 8%, maturing May 2004.                                                                                                                                                                                                                                                                                                                                                                            |   | 215,000   |    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |      |    |
| Note payable, maximum  amount of term loan is $400,000, secured by the Company’s machinery and  equipment, requires monthly payments of $10,000 plus interest at Union Bank  of California’s prime rate plus 8%, maturing May 2004.                                                                                                                                                                                                                                                                                                                                                                                                   |   | 221,000   |    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |      |    |
| Note payable, maximum  amount of term loan is $134,000, secured by the Company’s machinery and  equipment, requires monthly payments of $5,166 plus interest at Union Bank of  California’s prime rate plus 8%, maturing May 2004.                                                                                                                                                                                                                                                                                                                                                                                                    |   | 65,000    |    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |      |    |
| Note payable, maximum  amount of term loan is $50,000, secured by the Company’s machinery and  equipment, requires monthly payments of $2,000 plus interest at Union Bank of  California’s prime rate plus 8%, maturing May 2004.                                                                                                                                                                                                                                                                                                                                                                                                     |   | 42,000    |    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   |      |    |
| Note payable, maximum amount  of term loan is $50,000, secured by the Company’s machinery and equipment,  requires monthly payments of $2,000 plus interest at Union Bank of  California’s prime rate plus 8%, maturing May 2004.                                                                                                                                                                                                                                                                                                                                                                                                     |   | 34,000    |    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | 1,234,000 |    |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | (947,000) |    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | $         | 287,000 |   |

 

Interest expense onthe above notes was $182,000 for the year ended September 30, 2002.

 

**NOTE 6 -**                          **ACCRUEDLIABILITIES**

 

For the year ended September30, 2002, accrued liabilities consisted of the following:

 

| Payroll taxes         |   | $       | 15,803  |   |
|-----------------------|--------|---------|---------|--------|
| Royalties             |   | 58,084  |    |
| Commissions           |   | 43,124  |    |
| Customer deposits     |   | 54,000  |    |
| Rental deposits       |   | 23,201  |    |
| Salaries and vacation |   | 107,108 |    |
| Professional fees     |   | 22,105  |    |
| Other                 |   | 34,575  |    |
| Total                 |   | $       | 358,000 |   |

 

**NOTE 7 -****                         ****RELATED PARTY TRANSACTIONS**

 

In 1991 the Company sold andleased back two of its operating facilities in a transaction with its formerChairman.  An initial gain wasrecognized and a deferred gain was recorded which is being amortized over theterm of the two leases which expired November 2000.  The amount of deferred gain realized in 2001 was $11,000.  There was no deferred gain realized in 2002because the two leases expired in November 2000.  (See Note 12 - “Lease commitments.”)

 

The amounts of rents paid torelated parties were $143,000 for September 30, 2002 and $139,000 for September30, 2001.

 

During the fiscal year endingSeptember 30, 2002, the total interest expensed to related parties (Note 9) was$130,000 of which $59,000 was paid. Included in due to related parties, as of September 30, 2002, was accruedinterest of $902,000.

 

During the fiscal year endingSeptember 30, 2001, the total interest expensed to related parties was $223,000of which $109,000 was paid.

 

22

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**NOTE 8 -****                         ****NOTES PAYABLE - OTHER**

 
| Note payable to a company,  secured by product brand, payable in monthly installments of $12,000, plus  interest, commencing July 25, 2001, until and including September 25,  2001.  Thereafter, monthly installment  payments will be $22,000.  The  interest rate is the highest prime rate published by Citibank, N.A., during  the preceding month.                                    |   | $          | 212,000   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|-----------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Notes payable to bank, secured by a deed on land and  building, requires monthly  payments of $4,200, including interest at the bank’s reference rate plus 4%, maturing  January 2006.  The note is guaranteed  by the President and former Chairman of the Company.                                                                                                                   |   | 129,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable to a company,  secured by product brand, payable in monthly installments of $3,000, plus  interest, commencing June 15, 2002, until January 15, 2004.  The interest rate is the highest prime  rate in the Wall Street Journal during the previous month.  The interest rate at September 30, 2002,  was 4.75%.  The note is guaranteed by  the President of the Company. |   | 48,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| The following notes are due  to two individuals.                                                                                                                                                                                                                                                                                                                                                      |   |       |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, bearing interest at 20%.   The note, as renewed, matures December 1, 2002.  Interest only payments are made monthly.                                                                                                                                                                                                                               |   | 50,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, unsecured,  payable in monthly installments of $10,000, plus interest at 20%, commencing  June 20, 2000.                                                                                                                                                                                                                                                                                |   | 20,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, unsecured,  payable in monthly installments of $6,000, plus interest at 20% commencing  January 10, 2001.                                                                                                                                                                                                                                                                               |   | 224,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $4,000, plus interest at  20%, commencing April 10, 2001.                                                                                                                                                                                                                                                                 |   | 128,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $6,000, plus interest at  20%, commencing September 15, 2001.                                                                                                                                                                                                                                                             |   | 322,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $5,000, plus interest at  20%, commencing December 25, 2001.                                                                                                                                                                                                                                                              |   | 250,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $15,000, plus interest at  24%, commencing March 15, 2002.                                                                                                                                                                                                                                                                |   | 255,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $10,000, plus interest at  24%, commencing March 20, 2002.                                                                                                                                                                                                                                                                |   | 170,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $5,000, plus interest at  24%, commencing May 25, 2002.                                                                                                                                                                                                                                                                   |   | 75,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $5,000, plus interest at  24%, commencing June 25, 2002.                                                                                                                                                                                                                                                                  |   | 80,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, secured by  product brand, payable in monthly installments of $5,000, plus interest at  20%, commencing August 1, 2002.                                                                                                                                                                                                                                                                 |   | 185,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |       |      |
| Note payable, unsecured,  with interest only payments at 10%, commencing August 20, 2002.  The due date of the note is October 1,  2004, or later, and is guaranteed by the President of the Company.  After two years from July 1, 2002, either  party can give 90 days written notice to pay off in full.                                                                                 |   | 600,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   | 2,748,000  |      |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                                  |   | (1,014,000 | )         |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   | $          | 1,734,000 |   |

 

Interest expense on the above notes was $419,000 forthe year ended September 30, 2002.

 

23

----

 

**NOTE 9 -**                          **NOTESPAYABLE - RELATED PARTIES (LEE FAMILY MEMBERS)**

 
| Notes payable to related  parties, unsecured, bearing interest at bank’s prime rate (4.75% at September  30, 2002), maturing January 2005.   Payable interest only.                                                                                                         |   | $         | 40,000    |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|-----------|--------|
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Note payable to related  party, unsecured, bearing interest at bank’s prime rate (4.75% at September  30, 2002), principal and accrued interest is payable in January 2005.                                                                                                      |   | 372,000   |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Notes payable to related  party (Lee Foundation), secured by product brand, bearing interest at bank’s  prime rate (4.75% at September 30, 2002), principal and accrued interest is  payable in January 2005.                                                                    |   | 400,000   |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Note payable to related  party, unsecured, bearing interest at bank’s prime rate (4.75% at September  30, 2002), and principal payable based on a twelve (12) year fully amortized  schedule commencing March 15, 1997.  Monthly  payments are not being made on this note. |   | 1,440,000 |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Notes payable to related  party, secured by product brand, bearing interest at bank’s prime rate (4.75%  at September 30, 2002), principal and accrued interest is payable in January  2005.                                                                                     |   | 7,000     |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Note payable to related  party, secured by product brand, bearing interest at bank’s prime rate (4.75%  at September 30, 2002), principal and accrued interest is payable in January  2005.                                                                                      |   | 100,000   |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Note payable to related  party, unsecured, bearing interest at bank’s prime rate (4.75% at September  30, 2002), principal and accrued interest is payable in January 2005.                                                                                                      |   | 250,000   |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Note payable to officer, unsecured, bearing interest  at 1.7%.  Monthly payments are based  on credit card minimum, no due date stated.                                                                                                                                          |   | 68,000    |      |
|                                                                                                                                                                                                                                                                                  |   |      |      |
| Note payable to officer, unsecured, bearing interest  at 12.84%.  Monthly payments are based  on credit card minimum, no due date stated.                                                                                                                                        |   | 2,000     |      |
|                                                                                                                                                                                                                                                                                  |   | 2,679,000 |      |
| Less current portion ($735,000 in arrears)                                                                                                                                                                                                                                            |   | (790,000  | )         |
|                                                                                                                                                                                                                                                                                  |   | $         | 1,889,000 |   |

 

Interest expense onthe above notes was $130,000 for the year ended September 30, 2002.

 

**NOTE 10 -****                  ****LONG-TERM DEBT MATURITIES**

 

At September 30, 2002, theCompany was committed to the following minimum principal payments.

 
| **Year ending  September 30,** |   | **Notes  payable  finance company** |      | **Related  parties** |   | **Other** |   | **Total** |      |
|--------------------------------|--------|-------------------------------------|-----------|----------------------|--------|-----------|--------|-----------|-----------|
| 2003                           |   | $                                   | 947,000   |                 | $      | 790,000   |   | $         | 1,014,000 |   | $ | 2,751,000 |   |
| 2004                           |   | 287,000                             |      | 120,000              |   | 568,000   |   | 975,000   |      |
| 2005                           |   | —                              |      | 120,000              |   | 920,000   |   | 1,040,000 |      |
| 2006                           |   | —                              |      | 1,357,000            |   | 169,000   |   | 1,526,000 |      |
| 2007                           |   | —                              |      | 120,000              |   | 68,000    |   | 188,000   |      |
| Thereafter                     |   | —                              |      | 172,000              |   | 9,000     |   | 181,000   |      |
| Total                          |   | $                                   | 1,234,000 |                 | $      | 2,679,000 |   | $         | 2,748,000 |   | $ | 6,661,000 |   |

 

**NOTE 11 -****                  ****DEFERRED INCOME**

 

The deferred income consistsof six assistance agreements paid for in advance by the purchaser of theproduct lines Klutch® and Astring-o-Sol® (see Note 18). The original agreements vary in length from thirty-sixto forty-eight months.  At September 30,2002, the income earned per the agreement is as follows:

 

| **Year ending  September 30,** |   | **Amount** |    |
|--------------------------------|--------|------------|---------|
| 2003                           |   | $          | 151,000 |   |
| 2004                           |   | $          | 115,000 |   |
| 2005                           |   | $          | 46,000  |   |
| 2006                           |   | $          | 14,000  |   |
|                           |   |       |    |   |
| Total                          |   | $          | 326,000 |   |
|                                |        |            |         |  |  |  |

 

24

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**NOTE 12 -****               ****COMMITMENTS AND CONTINGENCIES**

 

**Leasecommitments**

 

At September 30, 2002, theCompany was committed to its Chairman and to others under noncancelableoperating leases for land and buildings requiring minimum annual rentals asfollows:

 
| **Year ending  September 30,** |   | **Others** |      | **Chairman** |   | **Total** |   |
|--------------------------------|--------|------------|-----------|--------------|--------|-----------|--------|
|                           |   |       |      |         |   |      |   |
| 2003                           |   | $          | 456,000   |         | $      | 143,000   |   | $ | 599,000 |   |
| 2004                           |   | 456,000    |      | 143,000      |   | 599,000   |   |
| 2005                           |   | 456,000    |      | 143,000      |   | 599,000   |   |
| 2006                           |   | 76,000     |      | 24,000       |   | 100,000   |   |
| 2007                           |   | —     |      | —       |   | —    |   |
| Total                          |   | $          | 1,444,000 |         | $      | 453,000   |   | $ | 1,897,000 |   |

 

The leases expire November30, 2005.  The renewal calls forConsumer Price Index (based on Los Angeles - Riverside - Orange County: Allitems - All Urban Consumers) adjustments on December 1, 2002 and December 1,2004 pertaining to the leases above (Others) and adjustments on April 1, 2003and April 1, 2005 for the Chairman’s leases. The lessee has an option to renew at the end of all lease terms.

 

Generally, the leases providethat maintenance, insurance and a portion of property taxes are to be paid bythe Company.  The Company also has aright of first refusal to acquire most of the buildings which it leases.  The Company’s rental expense for the yearsended September 30, 2002, and 2001, was $596,000 and $596,000, respectively.

 

At the beginning of fiscalyear 2002, there were three subleases. The leases are subleased to other companies.  Sublease income was $178,000 and $178,000 for fiscal years endedSeptember 30, 2002 and 2001, respectively. Effective June 7, 2002, the one sublease which was month-to-month wasterminated.  The Company currentlyoccupies the building.  Another subleasewas renewed December 1, 2000 for $7,280 per month for twenty-four months.  The other sublease for $4,116 per month wassigned April 1, 2001.  It will expireNovember 30, 2005.

 
| **Year ending  September 30,** |   | **Sublease  revenues** |    |
|--------------------------------|--------|------------------------|---------|
|                           |   |                   |    |
| 2003                           |   | $                      | 63,952  |   |
| 2004                           |   | $                      | 49,392  |   |
| 2005                           |   | $                      | 49,392  |   |
| 2006                           |   | $                      | 8,232   |   |
| 2007                           |   | $                      | —  |   |
|                           |   |                   |    |
| Total                          |   | $                      | 170,968 |   |

 

**Assessmentfor environmental cleanup**

 

The Company owns a manufacturing facility located in South El Monte,California.  The California RegionalWater Quality Control Board (The “RWQCB”) ordered the Company in 1988 and 1989to investigate the contamination on its property (relating to soil andgroundwater contamination).  The Companyengaged a consultant who performed tests and reported to the then Chairman ofthe Company.  The Company resistedfurther work on its property until the property upgradient was tested ingreater detail since two “apparent source” lots had not been tested.  On August 12, 1991, the RWQCB issued a“Cleanup and Abatement Order” directing the Company to conduct further testingand cleanup the site.  In October 1991,the Company received from an environmental consulting firm an estimate of$465,200 for investigation and cleanup costs. The Company believed that this estimate was  inconclusive and overstated the contamination levels.  The Company believes that subsequentinvestigations will support the Company’s conclusions  about that estimate.  TheCompany did not complete the testing for the reasons listed above as well as“financial constraints”.  In June 1992,the RWQCB requested that the EPA evaluate the contamination and takeappropriate action.  At the EPA’srequest, Ecology & Environment, Inc. conducted an investigation of soil andgroundwater on the Company’s property. Ecology & Environment Inc.’s Final Site Assessment Report, which wassubmitted to the EPA in June 1994, did not rule out the possibility that someof the contamination originated on-site, and resulted from either past orcurrent operations on the property.

 

On April 24, 2002, the RWQCB notified the Company that the detection ofemergent chemicals in groundwater, above State and Federal maximum containmentlevels or action levels, has caused the RWQCB and the EPA to reassess thethreat posed to groundwater resources used for domestic supply.  The RWQCB directed the Company to test forthe presence of emergent chemicals in its groundwater monitoring wells.  The groundwater monitoring analyticalresults were due by July 15, 2002.  OnMay 24, 2002, the Company informed RWQCB that it could not comply with therequirement to conduct groundwater sampling due to ongoing financialdifficulties.

 

25

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On July 8, 2002, the RWQCB sent a “Second Notice of Violation” to theCompany directing the Company to comply with the requirement to prepare agroundwater remedial action plan (RAP). The Company previously notified the RWQCB that it could not comply withthe requirement to submit a RAP because of ongoing financial difficulties.  The RWQCB requested that the Company submitcertain financial information by July 29, 2002 to “substantiate any allegedfinancial losses and determine whether any suspension of implementingthe...(Cleanup and Abatement Order) is warranted.”  The Company has received an extension to submit the requiredfinancial information to August 19, 2002. The Company submitted the requested financial information on August 16,2002.  As of the date of the financial statements,no response has been received.  TheCompany may be liable for all or part of the costs of remediating thecontamination on its property and could be subject to enforcement action by theRWQCB, including injunctive and civil monetary remedies.  As of the date of the financial statements,the Company’s share of the costs have not been determined.

 

The Company and nearbyproperty owners, in consort with their comprehensive general liability (CGL)carriers, engaged a consultant to perform a site investigation with respect tosoil and shallow groundwater contamination over the entire city block.  The CGL carriers provided $290,000 infunding which paid for the $220,000 study, $20,000 in legal fees for projectoversight, and a $50,000 balance in the operating fund.  Earlier the Company had accrued $87,500 asits proportionate share of the earlier quote of $175,000.  Since that time, the overall scope of theproject was increased to $205,000 plus $15,000 for waste water disposal,bringing the total to the above listed $220,000.  The $87,500 accrual was not spent on this project (as the entirecost was borne by the CGL carriers), but remains on the books as an accrualagainst the cost of remediation of the same site that was included in thestudy.

 

The tenants of nearbyproperties upgradient have sued the Company alleging that hazardous materialsfrom the Company’s property caused contamination on the properties leased bythe tenants.  The case name is DelRay Industrial Enterprises, Inc. v. Robert Malone, et al., LosAngeles County Superior Court, Northwest District, commenced August 21,1991.  In this action, the plaintiffalleges environmental contamination by defendants of its property, and seeks acourt order preventing further contamination and monetary damages.  The Company does not believe there is anybasis for the allegations and is vigorously defending the lawsuit.

 

The Company’s South El Montemanufacturing facility is also located over a large area of possiblycontaminated regional groundwater which is part of the San Gabriel ValleySuperfund Site.  The Company has beennotified that it is a potentially responsible party  (“PRP”)  for thecontamination.   In 1995, the Companywas informed that the EPA estimated the cleanup costs for the South El Monte’sportion of the San Gabriel Valley Superfund Site to be $30 million.  The Company’s potential share of such amounthas not been determined.  Superfund PRPsare jointly and severally liable for superfund site costs, and are responsiblefor negotiating among themselves the allocation of the costs based on, amongother things, the outcome of environmental investigation.

 

In August 1995, the Companywas informed that the EPA entered into an Administrative Order of Consent withCardinal Industrial Finishes (“Cardinal”) for a PRP lead remedial investigationand feasibility study (the “Study”) which, the EPA states, will bothcharacterize the extent of groundwater contamination in South El Monte andanalyze alternatives to control the spread of contamination.  The Company and others entered into theSouth El Monte Operable Unit Site Participation Agreement with Cardinalpursuant to which, among other things, Cardinal contracted with anenvironmental firm to conduct the Study. The Study has been completed.  TheCompany’s share of the cost of the Study was $15,000 and was accrued for in thefinancial statements as of September 30, 1995. The South El Monte Operable Unit (SEMOU) participants developed fourremedial alternatives.  The capital costof the four alternatives range from $0 (no action) up to $3.49 million.  The estimated annual operating cost for thefour alternatives range from $0 (no action) to $770,300.  Over a 30-year period, the total cost of thefour alternatives range from $0 (no action) up to $13.05 million.  The EPA prefers an alternative whichestimates the capital cost up to $3.08 million, the annual operating cost at$.48 million, and the 30-year period total cost up to approximately $9.09million.  The selection of the actualalternative implemented is subject to public comment.  At the present time, the Company does not know what its share ofthe cost may be, if any.  Therefore, noadditional accrual has been recognized as a liability on the Company’sbooks.  The Company requested that the EPAconduct an “ability-to-pay evaluation” to determine whether the Company is entitledto an early settlement of this matter based upon a limited ability to pay costsassociated with site investigation and remediation.  In August 2000, the EPA informed the Company that it does notqualify for an early settlement at this time.

 

The EPA has informed theCompany that it has learned that the intermediate zone groundwatercontamination in the western portion of the SEMOU has migrated further west andhas now impacted the City of Monterey Park and Southern California WaterCompany production wells.  The EPAstated that the City of Monterey Park Water Department, San Gabriel ValleyWater Company and Southern California Water Company are planning to buildtreatment facilities for their wells. The EPA stated that these three water purveyors contacted some of theSEMOU PRPs, other than the Company, to seek funding to develop groundwatertreatment facilities for the contaminated wells.  A group of these PRPs calling themselves the “South El MonteCooperative Group” has been formed and purportedly has reached a generalagreement with the water purveyors to fund the development of treatmentfacilities and use the water purveyors’ wells in an attempt to contain thegroundwater contamination to meet EPA’s goals. At this time, the EPA has not reviewed or approved any specific plan toaddress contamination at the purveyor wells, nor has the EPA compromised itsright to recover response costs from any person who is legally responsible forcontamination within the SEMOU.  As ofthe date of this report, the Company has not been contacted by the South ElMonte Cooperative Group in respect to its participation in any proposed cleanupactivity.  As a result, the Company isnot able to determine what contribution, if any, it may be assessed inconnection with this cleanup activity.

 

26

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By letter dated November 13,2000, the Company was notified that the City of Monterey Park, San GabrielValley Water Company and Southern California Water Company intend to bring suitunder the Safe Drinking Water and Toxic Enforcement Act of 1986 alleging thatthe Company has knowingly released volatile organic compounds in the soil andshallow groundwater beneath the Company’s property between at least on orbefore November 8, 1996 and the present and has failed to promptly clean up allof the contamination.  As of the date ofthis report, the Company has not been served with this lawsuit.

 

The City of South El Monte,the city in which the Company has its manufacturing facility, is located in theSan Gabriel Valley.  The San GabrielValley has been declared a Superfund site. The 1995 Water Quality Control Plan issued by the California RegionalWater Quality Control Board states that the primary groundwater basinpollutants in the San Gabriel Valley are volatile organic compounds fromindustry, nitrates from subsurface sewage disposal and past agriculturalactivities.  In addition, the Plan notedthat hundreds of underground storage tanks leaking gasoline and other toxicchemicals have existed in the San Gabriel Valley.  The California Department of Toxic Substance Control has declaredlarge areas of the San Gabriel Valley to be environmentally hazardous andsubject to cleanup work.

 

The Company believes the Cityof South El Monte does not appear to be located over any of the majorplumes.  However, the EPA has announcedit is studying the possibility that, although the vadose soil and groundwater,while presenting cleanup problems, there may be a contamination by DNAPs (densenon-aqueous phase liquids), i.e., “sinkers”, usually chlorinated organiccleaning solvents.  The EPA has proposedto drill six “deep wells” throughout the City of South El Monte at an estimatedcost of $1,400,000.  The EPA isconferring with SEMPOA (South El Monte Property Owners Association) as to costsharing on this project.  SEMPOA hasobtained much lower preliminary cost estimates.  The outcome cost and exact scope of this are unclear at thistime.

 

The Company and otherproperty owners engaged Geomatrix Consultants, Inc., to do a survey of vadosesoil and shallow groundwater in the “hot spots” detected in the previousstudies.  Geomatrix issued a reportdated December 1, 1997 (the “Report”), on the impact of volatile organiccompounds on the soil and groundwater at the Lidcombe and Santa Anita Avenuesite located in South El Monte, California (which includes the Company’sfacilities).  The Report indicatedgenerally low concentrations of tetrachloroethene, trichloaethene andtrichloroethane in the groundwater of the upgradient neighbor.  The Report was submitted to the RWQCB forits comments and response.  A meetingwith the parties and RWQCB was held on February 10, 1998.  The RWQCB had advised companies that vadosesoil contamination is minimal and requires no further action.  However, there is an area of shallowgroundwater which has a higher than desired level of chlorinated solvents, andthe RWQCB requested a proposed work plan be submitted by Geomatrix.  Geomatrix has submitted a “FocusedFeasibility Study” which concludes that there are five possible methods forcleanup.  The most expensive are for apump and sewer remediation which would cost between $1,406,000 and$1,687,000.  The Company is activelyexploring the less expensive alternative remediation methods, of which the twoproposed alternatives range in cost between $985,000 and $1,284,000.  Since there are four economic entitiesinvolved, the Company’s best estimate at this time, in their judgment, would bethat their forecasted share would be $287,000 less the liability alreadyrecognized on the books of $165,000 thereby requiring an additional $122,000liability.  Accordingly, the Companyrecorded an additional accrual of $122,000 in the third quarter of fiscal1998.  The $122,000 accrual is in additionto the $79,000 accrual for the Monterey Site as will be explained in thefollowing paragraph.  The $79,000accrual, in the third quarter of fiscal 1998, related to the Monterey Site isnot included in the $287,000 figure above. In April 2000, the Company received a Notice of Violation from theRWQCB.  The Notice of Violation statesthat the Company and other property owners were required to submit agroundwater remedial action plan by November 1, 1999, and that the RWQCB hasbeen advised that the Company and the other property owners were unable tosubmit the required remedial action plan because the Company and the otherproperty owners could not agree on the allocation of financial responsibilityto prepare the action plan.  The RWQCBstated that it will no longer encourage the cooperative approach among theCompany and the other property owners in completing the cleanup requirementsand will pursue appropriate measures, including when necessary, enforcementactions.  The RWQCB states that it mayimpose civil liability penalties of up to $1,000 per day from November 1, 1999for failure to file the action plan.  Inlight of these events, no assurances can be given that the cleanup costs andpossible penalties will not exceed the amount of the Company’s current accrualsof $287,000 (which includes the $122,000 charge to income in the third quarterof fiscal 1998).

 

In July 2000, the propertyowners formed the Lidcombe & Santa Anita Avenue Work Group (LSAAW) inresponse to the RWQCB request for the preparation of an action plan.  The LSAAW submitted a Focused FeasibilityStudy to the RWQCB for their review and approval of the selected remedialaction method for the site.  After receivingRWQCB approval, LSAAW obtained three cost proposals to implement the RWQCBapproved pump and treat remedial method. According to these cost proposals, the lowest estimated costs for anassumed five (5) years of pump and treat remediation is $600,000.  This cost is lower than the previous costproposed work plan, discussed above, from Geomatrix Consultants, Inc.  The capital costs including contingenciesare approximately $300,000.

 

The LSAAW is hopeful theWater Quality Authority (WQA) is willing and able to reauthorize its grant forone-half (1/2) of the capital costs of its remediation system construction notto exceed $150,000.  It is estimated atthis time that the reserves for the Company’s share of this cost proposal areadequate since its prior accrual was based on the higher cost estimate fromGeomatrix.

 

27

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Without any priorcorrespondence or inkling of the Company’s potential liability, the EPAinformed the Company that the Company may have potential liability for theongoing remediation of Operating Industries, Inc. (as they have gone out ofbusiness) Landfill Superfund Site in Monterey Park, California (the “MontereySite”).  The Monterey Site is a 190 acrelandfill that operated from 1948 to 1984, in which the Company disposed of nontoxic pH balanced waste water on six occasions between 1974 and 1978.  Over 4,000 companies have been identified ashaving contributed waste to the Monterey Site. The EPA has offered to settle the Company’s potential liability withrespect to the Monterey Site for a cost to the Company of $79,233.  The Company accrued a $79,000 charge in thethird quarter of fiscal 1998 with respect to this possible liability.  The Company has elected to file for relieffrom these obligations under the financial hardship option in the EPA’sresponse form.  On June 30, 2000, theEPA informed the Company that the EPA believed the Company is able to pay thefull settlement cost, but offered to reduce the amount of the settlement to$75,271.

 

The Company was notified bythe EPA that the Company may have potential liability for waste material itdisposed of at the Casmalia Disposal Site (“Site”) located on a 252 acre parcelin Santa Barbara County, California. The Site was operational from 1973 to 1989, and over 10,000 separateparties disposed of waste there.  TheEPA stated that federal, state and local governmental agencies along with thenumerous private entities that used the Site for waste disposal will beexpected to pay their share as part of this settlement.  The U.S. EPA is also pursuing the owner(s)/operator(s)of the Site to pay for Site remediation. The EPA has a settlement offer to the Company with respect to the Sitefor a cost of $373,950.  The Companyaccrued a $374,000 charge in the first quarter of fiscal 1999 with respect tothis possible liability.  The Companyhas elected to file for relief from these obligations under the financialhardships option in the EPA’s response form. The Company, the EPA and certain PRPs have entered into an agreementtolling the applicable statutes of limitation. The Company has been notified by the EPA that their request for awaiver, due to financial hardship, was “partially granted.”  Improvements in the bidding process haslowered the Company’s estimated share down to $245,000 (from $374,000) and ofthat, the EPA was requesting that the Company pay $113,000, as a result oftheir findings on the application for waiver due to financial hardship.  The Company is considering the EPA’srequest.

 

The total amount ofenvironmental investigation and cleanup costs that the Company may incur withrespect to the foregoing is not known at this time.  However, based upon information available to the Company at thistime, the Company has expensed since 1988 a total of $860,000, of which $89,000were legal fees, exclusive of legal fees expended in connection with the SECenvironmental investigation.  The actualcosts could differ materially from the amounts expensed for environmentalinvestigation and cleanup costs to date.

 

As of September 30, 2002, nosettlements have been reached.  Thetotal amount expensed in prior years relating to this environmental issue is$860,000.  For the year ended September30, 2002, no additional amounts have been expensed or accrued.  The Company has an accrued liability on thebooks at September 30, 2002 of $740,000 for the environmental cleanup.

 

**NOTE 13 -****                  ****STOCK OPTIONS**

 

The 1997 Employee IncentiveStock Option Plan was adopted by the Board of Directors on January 20, 1997,and was approved by the Company’s shareholders on March 11, 1997.  The Employee Incentive Stock Option Planprovides for the granting of options to selected officers and key employees ofthe Company for the purchase of a total of 980,000 shares of common stock ofthe Company at a price per share equal to the fair market value on the date ofthe grant.  The options expire fiveyears from the date of the grant.  Forthe year ended September 30, 2002, 768,000 options expired.

 

An additional 1997 StockOption Plan was adopted by the Board of Directors on January 20, 1997, and wasapproved by the Company’s shareholders on March 11, 1997.  This Stock Option Plan provides for thegranting of options to the Company’s outside directors for the purchase of150,000 shares of common stock of the Company at a price per share equal to thefair market value on the date of the grant. These options expired during the current year.

 

Only incentive stock optionsmay be granted under the Employee Incentive Stock Option Plan and onlynonqualified stock options may be granted under the 1997 Stock Option Plan.

 

Under both plans, the priceper share of the shares subject to each option shall not be less than 100% ofthe fair market value of such stock on the date the stock option isgranted.  Stock options shall not beexercisable until one and one-half years from the date of the grant.  Commencing eighteen (18), thirty (30), andforty-two (42) months, respectively, after the date of the grant, an option maybe exercised to the extent of one third of the total number of shares to whichit relates.  Upon a change in control ofthe Company (as defined), all stock options granted to any optionee will becomefully exercisable.  Any stock optiongranted to an employee who at the time the option is granted, owns stock representingmore than ten percent (10%) of the total combined voting power of all classesof stock of the Company, will be granted at a price equal to one hundred andten percent (110%) of the fair market value determined as of the date the stockoption is granted.  Both plans willexpire on December 31, 2006.

 

28

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The following is a status ofthe stock options outstanding at September 30, 2002 and 2001 and the changesduring the years then ended:

 
|                                           |   | **2002**    |   | **2001**                              |   |
|------------------------------------------------|--------|-------------|--------|---------------------------------------|--------|
|                                           |   | **Options** |   | **Weighted  average  exercise price** |   | **Options** |   | **Weighted  average  exercise price** |   |
|                                           |   |        |   |                                  |   |   |   |   |   |
| Outstanding, beginning of year                 |   | 1,130,000   |   | $                                     | 0.18   |   | 1,130,000 |   | $ | 0.18 |   |
|                                           |   |        |   |                                  |   |   |   |   |   |
| Granted                                        |   | —      |   | —                                |   | — |   | — |   |
| Exercised                                      |   | —      |   | —                                |   | — |   | — |   |
| Expired/Forfeited                              |   | (918,000    | )      | $                                     | 0.18   |   | — |   | — |   |
|                                           |   |        |   |                                  |   |   |   |   |   |
| Outstanding, end of year                       |   | 212,000     |   | $                                     | 0.22   |   | 1,130,000 |   | $ | 0.18 |   |
|                                           |   |        |   |                                  |   |   |   |   |   |
| Exercisable at end of year                     |   | 212,000     |   | $                                     | 0.22   |   | 1,059,334 |   | $ | 0.18 |   |
|                                           |   |        |   |                                  |   |   |   |   |   |
| Weighted average fair value of options granted |   |        |   | $                                     | 0.22   |   |   |   | $ | 0.18 |   |

 

The following tablesummarizes information about stock options outstanding at September 30, 2002:

 
|                |   | **Options  Outstanding** |    | **Options  Exercisable**                          |       |
|---------------------|--------|--------------------------|---------|---------------------------------------------------|------------|
| **Exercise  price** |   | **Number  of shares**    |    | **Weighted  average remaining  contractual life** |       | **Weighted  average  exercise price** |   | **Number  of shares** |   | **Weighted  average  exercise price** |   |
|                |   |                     |    |                                              |       |   |   |   |   |   |   |
| $                   | 0.22   |                     | 212,000 |                                              | .33  years |   | $ | 0.22 |   | 212,000 |   | $ | 0.22 |   |
|                     |        |                          |         |                                                   |            |  |  |  |  |  |  |  |  |  |

 

For purposes of pro forma disclosures, we estimated fair value of eachoption grant and Employee Stock Option Plan grant on the date of the grantusing the Black-Scholes single option pricing model with the followingassumptions:

 
|                     |   | **For Year  Ended September 30** |   |
|--------------------------|--------|----------------------------------|--------|
|                     |   | **2002**                         |   | **2001** |   |
|                     |   |                             |   |   |   |
| Expected life of options |   | 5  years                         |   | 5  years |   |
| Volatility               |   | 62                               | %      | 35 | % |
| Risk free interest rate  |   | 4                                | %      | 5 | % |
| Dividend yield           |   | -0-                              |   | -0- |   |

 

The pro forma effect on netincome for 2002 and 2001 is not representative of the pro forma effect on netincome in future years because it does not take into consideration pro formacompensation expense related to grants made prior to 1995.  Pro forma information in future years willreflect the amortization of a larger number of stock options granted in severalsucceeding years.  The Company’s proforma information is as follows (in thousands except share data):

 
|                              |   | **For Year  Ended September 30** |   |
|-----------------------------------|--------|----------------------------------|--------|
|                              |   | **2002**                         |   | **2001** |   |
|                              |   |                             |   |   |   |
| Pro forma income (loss)           |   | $                                | (911   | ) | $ | 47 |   |
| Pro forma income (loss) per share |   | $                                | (0.22  | ) | $ | 0.01 |   |

 

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**NOTE 14 -****                  ****DEFERRED INCOME TAXES**

 

The net deferred tax amounts included in the accompanying balance sheetcontain the following amounts of deferred tax assets and liabilities:

 
| Deferred tax asset - current         |   | $          | 138,000   |   |
|--------------------------------------|--------|------------|-----------|--------|
| Deferred tax liability - current     |   | —     |      |
|                                 |   | 138,000    |      |
| Less valuation allowance             |   | (138,000   | )         |
| Net deferred tax asset - current     |   | $          | —    |   |
|                                 |   |       |      |
| Deferred tax asset - non-current     |   | $          | 1,946,000 |   |
| Deferred tax liability - non-current |   | —     |      |
|                                 |   | 1,946,000  |      |
| Less valuation allowance             |   | (1,946,000 | )         |
| Net deferred tax asset - non-current |   | $          | —    |   |

 

The deferred tax asset - current, results from an allowance for baddebts and inventory reserves, for financial statement purposes not allowed forincome tax purposes.

 

The deferred tax asset - non-current, results from an estimated netoperating loss carryforward for federal and state income tax purposes, and frombook depreciation and amortization in excess of tax amounts.

 

The Company has recorded a valuation allowance to reflect the estimatedamount of deferred asset, which may not be realized.  Since the Company had net operating loss (NOL) carryforwards ofapproximately $10,951,000 for Federal, the tax rate used to calculate thedeferred tax asset for Federal had been decreased from 34% to 15%.  There is no effect on the financialstatements for the change of tax rate. For the year ended September 30, 2002, the valuation allowance decreasedby $2,213,000 due to the change of tax rate.

 

Significant components of the Company’s deferred tax assets andliabilities are as follows:

 
| Deferred tax assets - current:                     |   |       |   |
|----------------------------------------------------|--------|------------|--------|
| Accrued vacation                                   |   | $          | 19,000 |   |
| Allowance for bad debts and returned merchandise   |   | 47,000     |   |
| Inventory reserve                                  |   | 72,000     |   |
| Total deferred tax assets - current                |   | 138,000    |   |
|                                               |   |       |   |
| Deferred tax assets - non-current:                 |   |       |   |
| Depreciation, amortization and impairment          |   | 155,000    |   |
| Net operating loss carryforward                    |   | 1,791,000  |   |
| Total deferred tax assets - non-current            |   | 1,946,000  |   |
|                                               |   |       |   |
| Net deferred tax assets before valuation allowance |   | 1,808,000  |   |
| Valuation allowance                                |   | (1,808,000 | )      |
| Net deferred tax asset                             |   | $          | — |   |

 

**NOTE 15 -****                  ****INCOME TAXES**

 

As of September 30, 2002, the Company had net operating loss (NOL)carryforwards of approximately $10,951,000 for Federal and $1,674,000 forCalifornia which for tax purposes can be used to offset future Federal andCalifornia income taxes.  Thedifferences in the state carryforwards relate primarily to the treatment ofloss carryforwards and depreciation of property, plant and equipment.  The Federal carryforwards expire from 2005through 2022; California carryforwards expire from 2002 through 2006.   California has temporarily suspended netoperating losses. The Company has provided an allowance for the entire amountof the deferred asset applicable to the NOL.

 

**NOTE 16 -****                  ****EMPLOYEE BENEFIT PLANS**

 

TheCompany has a 401(k) Profit Sharing Plan (the “Plan”) available to allemployees who meet the Plan’s eligibility requirements.  Under the Plan, participating employees maydefer a percentage (not to exceed 50%) of their eligible pretax earnings up tothe Internal Revenue Service’s annual contribution limit.   However, employees deemed to be highlycompensated employees (HCE) for the Plan year may defer a percentage (not toexceed 20%) of their eligible pretax earnings up to the Internal RevenueService’s annual contribution limit. Participants who have attained the age of fifty by the end of thecalendar year, and have contributed the maximum amount permitted, are alsoeligible to make an additional contribution (catch-up contribution) up to$1,000 for calendar year 2002.   Companycontributions are not required. To date, the Company has not made anycontributions to the Plan.

 

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**NOTE 17 -****                  ****ACQUISITIONS**

 

On October 30, 2000, theCompany purchased certain assets of the Sloans® product line from C.B. Fleet Co., Inc. for$50,000 plus approximately $600 of inventory. The Company remitted the full $50,000 at closing.  The balance of $50,000 is for a five yearcovenant not to compete.

 

On February 12, 2001, the Company purchased certain assets of the BlackDraught® product line from The Monticello Companies, Inc. for $185,000.  This amount includes approximately $37,000of inventory and was remitted in full at closing.  The balance of $148,000 is for a five year covenant not tocompete.

 

On August 22, 2001, the Company purchased certainassets of the DeWitt’s® Pillsproduct line from The Monticello Companies, Inc. for $265,000.  The Company remitted the full $265,000 atclosing.  On October 16, 2001, theCompany exercised their option to resell certain assets of DeWitt’s®Pills product line back to The Monticello Companies, Inc.  The Company received $265,000 related to theresell of DeWitt’s® Pills.

 

On March 9, 2002, the Companypurchased certain assets of product lines from Merz Pharmaceuticals LLC for$225,000 plus approximately $63,000 for inventory.  The purchase price of $225,000 includes $200,000 for product lineand $25,000 for a covenant not to compete. The full $225,000 was remitted at closing.  In addition, the Company is obligated to pay a royalty asfollows:  for the first twelve-monthperiod following closing (i) twenty-five percent (25%) of the net sales ofMedicone® and Sayman®; (ii) twenty-five percent (25%) of the net sales of the first 4,800dozen sold of Cankaid®, and (iii) forty percent (40%) of the Cankaid® sold in excess of the first 4,800 dozen.  For the next two 12-month periods afterclosing (8 consecutive quarters), the royalty payments will be (i) twentypercent (20%) of the net sales of Medicone® and Sayman®; (ii) twenty percent (20%) of the net salesof the first 4,800 dozen sold per 12-month period of Cankaid®, and (iii) forty percent (40%) of the Cankaid® units sold in excess of the first 4,800 dozenper 12-month period.  Notwithstandingthe above, no royalty shall be due on Lee’s sales of Cankaid® inventory with 10/02 or 11/02 expirations tocloseout/dollar store/off-price retailers at wholesale prices of less thanseventy cents ($.70).  The minimumroyalty due is $75,000 per year for the next three years.

 

On April 5, 2002, the Companypurchased certain assets of the One Step at a Time® and lite’n® Up product lines from Category One Products,L.L.C., for $350,000 plus inventory. The full $350,000 was remitted at the closing.  The $350,000 has been recorded as product line and is included inintangible assets.  A clause in theagreement stipulates that if certain customers delete one of the product lines,the purchase price will be adjusted downward. Subsequent to the payment of the $350,000, a customer did delete aproduct line and the purchase price was reduced by $14,000.  This amount was refunded to the Company byCategory One Products, L.L.C.  TheCompany also acquired the rights to a royalty agreement for $100,000.  The Company is paying $4,000 per week forthis royalty obligation.

 

On April 23, 2002, theCompany purchased certain assets of product lines Unguentine® and Unguentine® Plus from U.S. Dermatologics, Inc.  The purchase price is $85,000 for a covenantnot to compete and $12,000 for inventory. A cash payment of $25,000 was paid at closing and a Promissory note wassigned for the remaining $60,000.  Thenote is payable in monthly installments of $3,000 plus interest at the highestprime rate published in the Wall Street Journal the prior month beginning June15, 2002.  The inventory was paid for incash at the time of receipt.  Thisagreement also calls for the Company to pay a 20% royalty annually, for aperiod of three years, on net sales of one of the products, with a minimum paymentof $6,000.

 

 

**NOTE 18 -****                  ****OTHER INCOME**

 

For the year ended September30, 2002, the Company realized gains of approximately $11,000 related to thesale of the Astring-o-Sol® product line and approximately $108,000related to the sale of the Klutch® product line.  The realized gains pertain to the recognition of the earnedportion of the deferred income of the consulting agreements arising from thesale of the Astring-o-Sol® and Klutch® brands.  Also included in otherincome is $15,000 in property tax refunds paid in prior years.  These amounts are included in other incomeon the statement of operations.

 

**NOTE 19 -****                  ****EXTRAORDINARY ITEM**

 

For the year ended September30, 2001, the Company reported $124,000 of extraordinary income related to theextinguishment of debt associated with note payable - related party andrenegotiation of two notes payable pertaining to prior product lineacquisitions.  The extraordinary itemhas no income tax effect.

 

**NOTE 20 -****                  ****SUBSEQUENT EVENTS (UNAUDITED)**

 

In December 2002, The Companyadvanced $430,000 to The Monticello Companies, Inc. in exchange for a 40%ownership in an over-the-counter product that The Monticello Companies, Inc. ispurchasing from a large pharmaceutical concern.  There is a transition services agreement with the seller thatexpires in mid 2003.  At that time, theCompany will take over the sales, marketing, warehouse, shipping, invoicing andcollection of the brand after receiving a 7% fee.  The net earnings of the brand will be split 60% to The MonticelloCompanies, Inc. and 40% to the Company.

 

**ITEM 8.****                                 ****CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGAND FINANCIAL DISCLOSURE.**

 

Not applicable.

 

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**PART III**

 

**ITEM 9.****                                 ****DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT.**

 

Directors are elected toserve until the next annual stockholders’ meeting or until their respectivesuccessors have been elected and qualified or as otherwise provided in thebylaws.  Set forth below for the currentdirectors and executive officers are their ages, principal occupations duringthe past five years, and the period during which they have served as a directoror officer of the Company.

 
| **Name**               |   | **Age** |   | **Positions  held  with Company**                   |   | **A director  or officer  since** |   | **Principal  occupation  during the past five years(1)**                                                                                          |   |
|------------------------|--------|---------|--------|-----------------------------------------------------|--------|-----------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                   |   |    |   |                                                |   |                              |   |                                                                                                                                              |   |
| Dr. Henry L. Lee       |   | 76      |   | Director                                            |   | 1971                              |   | Chairman of the Board of  Lee Pharmaceuticals through April 1995 when he retired, available as a  consultant, currently a Director of the Company |   |
|                   |   |    |   |                                                |   |                              |   |                                                                                                                                              |   |
| Ronald G. Lee          |   | 50      |   | President, Chairman  and Director                   |   | 1977                              |   | President and since April  1995, Chairman of the Board of the Company                                                                             |   |
|                   |   |    |   |                                                |   |                              |   |                                                                                                                                              |   |
| Michael L. Agresti     |   | 60      |   | Vice President -  Finance, Treasurer and  Secretary |   | 1977                              |   | Vice President - Finance,  Treasurer and Secretary of the Company                                                                                 |   |
|                   |   |    |   |                                                |   |                              |   |                                                                                                                                              |   |
| William M. Caldwell IV |   | 55      |   | Director                                            |   | 1987                              |   | President of CAIS Internet,  an internet infra-structure solutions company, and  President of Union Jack Group, a merchant banking firm.     |   |

 

(1) None of the companies named, other than the Company, is a parent,subsidiary or other affiliate of the Company.

 

**FamilyRelationships**

 

Ronald G. Lee is the son of Dr. Henry L. Lee.

 

**ITEM 10.****                          ****EXECUTIVE COMPENSATION.**

 

The following table setsforth information with respect to remuneration paid by the Company to theexecutive officers of the Company with total annual salary and bonus of atleast $100,000 for services in all capacities while acting as officers anddirectors of the Company during the fiscal years ended September 30, 2002,2001, and 2000.

 

**SUMMARY COMPENSATION TABLE**

 
|                             |   |     |   | **Annual  Compensation** |   | **Long Term  Compensation  Awards** |   |             |   |
|----------------------------------|--------|----------|--------|--------------------------|--------|-------------------------------------|--------|------------------|--------|
| **Name and  Principal Position** |   | **Year** |   | **Salary ($)**           |   | **Other  Annual  Compensation ($)** |   | **Options  (#)** |   | **All Other  Compensation ($)** |   |
|                             |   |     |   |                     |   |                                |   |             |   |   |   |
| Ronald G. Lee                    |   | 2002     |   | 217,907                  |   | 3,732                               | (1)    | —           | (2)    | — |   |
| President, Chairman              |   | 2001     |   | 221,777                  |   | 4,634                               | (1)    | —           | (2)    | — |   |
| (since April 26, 1995)           |   | 2000     |   | 230,241                  |   | 9,098                               | (1)    | —           | (2)    | — |   |
| & Director                   |   |     |   |                     |   |                                |   |             |   |   |   |

 

(1)              Includes reimbursement of medical and dentalexpenses not covered by the Company’s insurance plan.

 

(2)              No stock options were granted during fiscalyear’s 2002, 2001 and 2000.

 

Each of the directors of theCompany who is not employed by the Company receives a director’s fee of $750for each quarter and $500 for each meeting of the Board of Directors attended,except Dr. Henry L. Lee.  As holder ofthe honorary title of Founder Chairman, Dr. Lee waived his fees.

 

**AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR**

**AND FISCAL YEAR END OPTION VALUES**

 
|          |   | **Number of  Unexercised Options  at Fiscal Year End (#)** |   |
|---------------|--------|------------------------------------------------------------|--------|
| **Name**      |   | **Exercisable/Unexercisable**                              |   |
|          |   |                                                       |   |
| Ronald G. Lee |   | 212,000/0                                                  |   |

 

The stock options were deemed not in the money since the market pricewas less than the option price at September 30, 2002.

 

32

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**ITEM 11.****                          ****SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT.**

 

The following table setsforth the persons who, as of November 30, 2002, were known to the Company to bebeneficial owner of more than five percent of the Company’s Common Stock:

 
| **Title of class** |   | **Name and  address  of beneficial owner** |   | **Amount and  nature  of beneficial ownership** |   | **Percentage  of class** |   |
|--------------------|--------|--------------------------------------------|--------|-------------------------------------------------|--------|--------------------------|--------|
|               |   |                                       |   |                                            |   |                     |   |
| Common Stock       |   | Ronald G. Lee                              |   | 1,903,726  shares                               | (1)    | 44                       | %      |
|               |   | 1444 Santa Anita Avenue                    |   |                                            |   |                     |   |
|               |   | South El Monte, CA 91733                   |   |                                            |   |                     |   |
|               |   |                                       |   |                                            |   |                     |   |
| Common Stock       |   | Dr. Henry L. Lee                           |   | 172,334  shares                                 | (2)    | 4                        | %      |
|               |   | 1444 Santa Anita Avenue                    |   |                                            |   |                     |   |
|               |   | South El Monte, CA 91733                   |   |                                            |   |                     |   |

 

(1)   Includes shares subject tooptions exercisable at or within 60 days after November 30, 2002.

 

(2)   Includes 28,000 shares of theCompany’s common stock which Dr. Lee holds as trustee for the benefit ofcertain family members.  He has theright to vote such shares but otherwise disclaims beneficial ownership.

 

The following table sets forth the ownership of the Company’s CommonStock by its directors and its named executive officers and all executiveofficers and directors as a group.

 
| **Title of class** |   | **Name of  beneficial owner**                     |   | **Amount and  nature  of beneficial ownership** |   | **Percentage  of class** |   |
|--------------------|--------|---------------------------------------------------|--------|-------------------------------------------------|--------|--------------------------|--------|
|               |   |                                              |   |                                            |   |                     |   |
| Common Stock       |   | Ronald G. Lee                                     |   | 1,903,726  shares                          | (1)    | 44                       | %      |
| Common Stock       |   | Dr. Henry L. Lee                                  |   | 172,334  shares                            | (2)    | 4                        | %      |
| Common Stock       |   | William M. Caldwell IV                            |   | —                                          |   | —                   |   |
| Common Stock       |   | All officers and directors as a group (4 persons) |   | 2,090,596  shares                               | (1)(2) | 48                       | %      |

 

(1)   Includes shares subject tooptions exercisable at or within 60 days after November 30, 2002.

 

(2)   Includes 28,000 shares of theCompany’s common stock which Dr. Lee holds as trustee for the benefit ofcertain family  members.  He has the right to vote such shares butotherwise disclaims beneficial ownership.

 

**ITEM 12.****                          ****CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

 

The information regardingborrowings from and sale and leaseback transactions between the Company andit’s Chairman of the Board which is contained in Notes 7 and 9 of Notes toFinancial Statements is incorporated herein by this reference.

 

**ITEM 13.****                          ****EXHIBITS AND REPORTS ON FORM 8-K.**

 

(a)                                  Exhibits. The following exhibits have been or are being filed herewith, and arenumbered in accordance with Item 601 of Regulation S-B:

 

The following exhibits are filed herewith:

 
| 10.91  | -      | Modification of loan and  security agreement dated April 23, 2002, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                |
| 10.92  | -      | Promissory note evidencing  advance made to the Registrant                                                                          |
|   |   |                                                                                                                                |
| 10.93  | -      | Secured promissory note  dated April 23, 2002, between Lee Pharmaceuticals and Preferred Business  Credit, Inc.                     |
|   |   |                                                                                                                                |
| 10.94  | -      | Secured promissory note  dated August 22, 2002, between Lee Pharmaceuticals and Preferred Business  Credit, Inc.                    |

 

33

----

 

The following exhibits have previously beenfiled by the Company:

 
| 3.1    | -      | Articles of Incorporation,  as amended(1)                                                                                                                                                                                         |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                              |
| 3.4    | -      | By-laws, as amended December  20, 1977(2)                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                              |
| 3.5    | -      | Amendment of By-laws  effective March 14, 1978(2)                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                              |
| 3.6    | -      | Amendment to By-laws  effective November 1, 1980(3)                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.1   | -      | Qualified Stock Option Plan  including forms of grant(4)                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                              |
| 10.2   | -      | 1985 Employee Incentive  Stock Option Plan(5)                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                              |
| 10.3   | -      | Description of bonus  agreements between the Registrant and its officers(2)                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.4   | -      | Lease dated December 1,  1990, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California(6)                                                                                                                |
|   |   |                                                                                                                                                                                                                              |
| 10.5   | -      | Lease dated April 16, 1990,  for the premises located at 1425 and 1427 Lidcombe Avenue, South El Monte,  California(6)                                                                                                            |
|   |   |                                                                                                                                                                                                                              |
| 10.6   | -      | Lease dated April 16, 1990,  for the premises located at 1434 Santa Anita Avenue, South El Monte,  California(6)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.7   | -      | Lease dated April 16, 1990,  for the premises located at 1460 Santa Anita Avenue, South El Monte,  California(6)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.8   | -      | Lease dated April 16, 1990,  for the premises located at 1457 Lidcombe, South El Monte, California(6)                                                                                                                             |
|   |   |                                                                                                                                                                                                                              |
| 10.9   | -      | Lease dated April 16, 1990,  for the premises located at 1500 Santa Anita Avenue, South El Monte,  California(6)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.10  | -      | Lease dated April 16, 1990,  for the premises located at 1516 Santa Anita Avenue, South El Monte,  California(6)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.11  | -      | Lease dated March 1, 1991,  for the premises located at 1444 Santa Anita Avenue, South El Monte,  California(6)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.12  | -      | Lease dated March 1, 1991,  for the premises located at 1445 Lidcombe Avenue, South El Monte,  California(7)                                                                                                                      |
|   |   |                                                                                                                                                                                                                              |
| 10.13  | -      | Promissory notes which were  amended in September 1992 evidencing advances by the Registrant’s officers  and directors(8)                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.14  | -      | Promissory notes which were  amended in September 1994 evidencing advances by the Registrant’s officers  and directors(9)                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.15  | -      | Promissory notes evidencing  advances made to the Registrant’s officers and directors(9)                                                                                                                                     |
|   |   |                                                                                                                                                                                                                              |
| 10.16  | -      | Promissory notes evidencing  advances made to the Registrant(9)                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.17  | -      | Promissory notes which were  amended in January 1995 evidencing advances by the Registrant’s officers and  directors(10)                                                                                                     |
|   |   |                                                                                                                                                                                                                              |
| 10.18  | -      | Promissory notes evidencing  advances made by the Registrant’s officers and directors(10)                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.19  | -      | Promissory notes which were  amended in July 1995 evidencing advances made to the Registrant(10)                                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.20  | -      | Royalty agreement dated  August 31, 1994, between Lee Pharmaceuticals and The Fleetwood Company,  regarding a brand acquisition(10)                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.21  | -      | Royalty agreement dated  October 4, 1988, between Lee Pharmaceuticals and Roberts Proprietaries, Inc.  regarding a brand acquisition(10)                                                                                          |
|   |   |                                                                                                                                                                                                                              |
| 10.22  | -      | Note payable to bank dated  April 26, 1996, between Lee Pharmaceuticals and San Gabriel Valley Bank,  secured by the deed on land and building(11)                                                                                |
|   |   |                                                                                                                                                                                                                              |
| 10.23  | -      | Loan and security agreement  dated May 21, 1996, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. regarding a revolving credit facility financing(11)                                                             |
|   |   |                                                                                                                                                                                                                              |
| 10.24  | -      | Secured promissory note  dated September 17, 1996, between Lee Pharmaceuticals and Preferred Business  Credit, Inc.(12)                                                                                                           |
|   |   |                                                                                                                                                                                                                              |
| 10.25  | -      | Promissory notes evidencing  advances made by the Registrant(12)                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.26  | -      | Promissory notes which were  amended in July 1996 evidencing advances made to the Registrant(12)                                                                                                                             |
|   |   |                                                                                                                                                                                                                              |
| 10.27  | -      | Sublease dated November 22,  1995, for the premises located at 1460 Santa Anita Avenue, South El Monte,  California(12)                                                                                                           |
|   |   |                                                                                                                                                                                                                              |
| 10.28  | -      | Sublease dated June 11,  1996, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California(12)                                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.29  | -      | Lease dated December 1,  1995, for the premises located at 1444 Santa Anita Avenue, South El Monte,  California(12)                                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.30  | -      | Lease dated December 1,  1995, for the premises located at 1445 Lidcombe Avenue, South El Monte,  California(12)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.31  | -      | 1997 Employee Incentive  Stock Option Plan(13)                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.32  | -      | 1997 Stock Option Plan(13)                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                              |
| 10.33  | -      | Promissory note which was  amended in October 1997 evidencing advances made to the Registrant(14)                                                                                                                                 |
|   |   |                                                                                                                                                                                                                              |
| 10.34  | -      | Promissory notes which were  amended (modified) in December 1997 evidencing advances made to the  Registrant(14)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.35  | -      | Modification of loan and  security agreement dated September 10, 1997, between Lee Pharmaceuticals and  Preferred Business Credit, Inc.(14)                                                                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.36  | -      | Promissory note which was  amended in February 1997 evidencing advances made to the Registrant(14)                                                                                                                                |
|   |   |                                                                                                                                                                                                                              |
| 10.37  | -      | Secured promissory note  dated October 21, 1996, between Lee Pharmaceuticals and Roberts Laboratories,  Inc.(14)                                                                                                                  |
|   |   |                                                                                                                                                                                                                              |
| 10.38  | -      | Promissory note evidencing  advance made to the Registrant(15)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.39  | -      | Promissory note evidencing  advance made to the Registrant(15)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.40  | -      | Modification of loan and  security agreement dated May 21, 1996, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. regarding a revolving credit facility  financing(16)                                            |
|   |   |                                                                                                                                                                                                                              |
| 10.41  | -      | Modification of secured  promissory note dated August 29, 1997, between Lee Pharmaceuticals and Preferred  Business Credit, Inc.(16)                                                                                              |
|   |   |                                                                                                                                                                                                                              |
| 10.42  | -      | Secured promissory note  dated May 15, 1998, between Lee Pharmaceuticals and Preferred Business  Credit, Inc.(16)                                                                                                                 |
|   |   |                                                                                                                                                                                                                              |
| 10.43  | -      | Continuing guaranty dated  May 15, 1998, between Lee Pharmaceuticals and Preferred Business Credit,  Inc.(16)                                                                                                                     |
|   |   |                                                                                                                                                                                                                              |
| 10.44  | -      | Asset Purchase and Sale  Agreement dated June 29, 1999, between Lee Pharmaceuticals (buyer) and  Premier Consumer Products, Inc. (seller) and Advanced Polymer Systems, Inc.,  regarding a brand acquisition(17)                  |
|   |   |                                                                                                                                                                                                                              |
| 10.45  | -      | Promissory note evidencing  advance made to the Registrant(17)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.46  | -      | Promissory note evidencing  advance made to the Registrant(18)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.47  | -      | Promissory note evidencing  advance made to the Registrant(19)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.48  | -      | Modification of loan and  security agreement dated October 29, 1999, between Lee Pharmaceuticals and  Finova Capital Corporation (formerly Preferred Business Credit, Inc.)  regarding a revolving credit facility financing(19)  |
|   |   |                                                                                                                                                                                                                              |
| 10.49  | -      | Modification of secured (by  inventory) promissory note dated October 29, 1999, between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.)(19)                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.50  | -      | Modification of secured (by  equipment) promissory note dated October 29, 1999 ,between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.)(19)                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.51  | -      | Promissory note evidencing  advance made to the Registrant(20)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.52  | -      | Modification of loan and  security agreement dated May 19, 2000, between Lee Pharmaceuticals and Finova  Capital Corporation (formerly Preferred Business Credit, Inc.) regarding a  revolving credit facility financing(21)      |
|   |   |                                                                                                                                                                                                                              |
| 10.53  | -      | Modification of secured (by  inventory) promissory note dated May 19, 2000, between Lee Pharmaceuticals  and Finova Capital Corporation (formerly Preferred Business Credit, Inc.)(21)                                            |
|   |   |                                                                                                                                                                                                                              |
| 10.54  | -      | Modification of secured (by  equipment) promissory note dated May 19, 2000, between Lee Pharmaceuticals  and Finova Capital Corporation (formerly Preferred Business Credit, Inc.)(21)                                            |
|   |   |                                                                                                                                                                                                                              |
| 10.55  | -      | Modification of secured (by  Accutek equipment) promissory note dated May 19, 2000, between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.)(21)                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.56  | -      | Modification of secured (by  Accutek equipment) promissory note dated May 19, 2000 between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.)(21)                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.57  | -      | Promissory note evidencing  advance made to the Registrant(22)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.58  | -      | Promissory note evidencing  advance made to the Registrant(22)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.59  | -      | Lease dated May 25, 2000,  for the premises located at 1470 Santa Anita Avenue, South El Monte,  California(22)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.60  | -      | Lease dated May 25, 2000,  for the premises located at 1425 and 1427 Lidcombe Avenue, South El Monte,  California(22)                                                                                                             |
|   |   |                                                                                                                                                                                                                              |
| 10.61  | -      | Lease dated May 25, 2000,  for the premises located at 1434 Santa Anita Avenue, South El Monte,  California(22)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.62  | -      | Lease dated May 25, 2000,  for the premises located at 1460 Santa Anita Avenue, South El Monte,  California(22)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.63  | -      | Lease dated May 25, 2000,  for the premises located at 1500 Santa Anita Avenue, South El Monte,  California(22)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.64  | -      | Lease dated May 25, 2000,  for the premises located at 1516 Santa Anita Avenue, South El Monte,  California(22)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.65  | -      | Sublease dated September  14, 2000, for the premises located at 1460 Santa Anita Avenue, South El  Monte, California(23)                                                                                                          |
|   |   |                                                                                                                                                                                                                              |
| 10.66  | -      | Sublease guaranty dated  September 14, 2000, for the premises located at 1460 Santa Anita Avenue,  South El Monte, California(23)                                                                                                 |
|   |   |                                                                                                                                                                                                                              |
| 10.67  | -      | Promissory note evidencing  advance made to the Registrant(23)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.68  | -      | Promissory note evidencing  advance made to the Registrant(24)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.69  | -      | Loan and security agreement  dated February 20, 2001, between Lee Pharmaceuticals and Preferred Business  Credit, Inc., regarding a revolving credit facility financing(24)                                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.70  | -      | Secured promissory note  dated February 20, 2001, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc.(24)                                                                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.71  | -      | Secured promissory note  dated February 20, 2001, regarding inventory, between Lee Pharmaceuticals and  Preferred Business Credit, Inc.(24)                                                                                       |
|   |   |                                                                                                                                                                                                                              |
| 10.72  | -      | Sublease dated March 9,  2001, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California(24)                                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.73  | -      | Sublease guaranty dated  March 9, 2001, for the premises located at 1470 Santa Anita Avenue, South El  Monte, California between Jing Jing Long (guarantor) and Lee Pharmaceuticals,  Inc. (sublandlord)(24)                      |
|   |   |                                                                                                                                                                                                                              |
| 10.74  | -      | Promissory note evidencing  advance made to the Registrant(25)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.75  | -      | Sublease dated April 17,  2001, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California(25)                                                                                                              |
|   |   |                                                                                                                                                                                                                              |
| 10.76  | -      | Restructuring and Offset  Agreement dated July 23, 2001, between Lee Pharmaceuticals, AP Pharma, Inc.  (formerly Advanced Polymer Systems, Inc.) and Premier Consumer Products,  Inc., regarding a prior brand acquisition(26)    |
|   |   |                                                                                                                                                                                                                              |
| 10.77  | -      | Amended and Restated  Security Agreement dated July 23, 2001, between Lee Pharmaceuticals (grantor)  and AP Pharma, Inc. (formerly Advanced Polymer Systems, Inc.)  (Secured Party) regarding a prior brand  acquisition(26) |
|   |   |                                                                                                                                                                                                                              |
| 10.78  | -      | Promissory note dated July  23, 2001, between Lee Pharmaceuticals and AP Pharma, Inc. (formerly Advanced  Polymer Systems, Inc.)(26)                                                                                              |
|   |   |                                                                                                                                                                                                                              |
| 10.79  | -      | Promissory note evidencing  advance made to the Registrant(26)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.80  | -      | Promissory note which was  amended (modified) in November, 2001, evidencing advance made to the  Registrant(26)                                                                                                                   |
|   |   |                                                                                                                                                                                                                              |
| 10.81  | -      | Secured promissory note  dated March 16, 2001, between Lee Pharmaceuticals and Preferred Business  Credit, Inc.(26)                                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.82  | -      | Modification of secured  promissory note dated March 16, 2001, between Lee Pharmaceuticals and  Preferred Business Credit, Inc.(26)                                                                                               |
|   |   |                                                                                                                                                                                                                              |
| 10.83  | -      | Promissory note evidencing  advance made to the Registrant(27)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.84  | -      | Promissory note evidencing  advance made to the Registrant(28)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.85  | -      | Promissory note evidencing  advance made to the Registrant(28)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.86  | -      | Promissory note evidencing  advance made to the Registrant(29)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.87  | -      | Promissory note evidencing  advance made to the Registrant(29)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.88  | -      | Promissory note evidencing  advance made to the Registrant(29)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.89  | -      | Promissory note evidencing  advance made to the Registrant(29)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                              |
| 10.90  | -      | Promissory note dated April  23, 2002, between Lee Pharmaceuticals and U.S. Dermatologics, Inc. (29)                                                                                                                         |

 

34

----

 

----

| (1)    |   | Filed as an Exhibit of the  same number with the Company’s Form S-1 Registration Statement filed with the  Securities and Exchange Commission on February 5, 1973, (Registrant No.  2-47005), and incorporated herein by reference.                                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                     |
| (2)    |   | Filed as Exhibits 3.4, 3.5  and 13.18 with the Company’s Form 10-K Annual Report for the fiscal year ended  September 30, 1978, filed with the Securities and Exchange Commission in  December 1978 and incorporated herein by reference.                                           |
|   |   |                                                                                                                                                                                                                                                                                     |
| (3)    |   | Filed as an Exhibit of the  same number with the Company’s Form 10-K Annual Report for the fiscal year  ended September 30, 1979, filed with the Securities and Exchange Commission  in December 1979 and incorporated herein by reference.                                         |
|   |   |                                                                                                                                                                                                                                                                                     |
| (4)    |   | Filed as Exhibit 5.1 with  the Company’s Form 10-K Annual Report for the fiscal year ended September 30,  1973, filed with the Securities and Exchange Commission in December 1973 and  incorporated herein by reference.                                                           |
|   |   |                                                                                                                                                                                                                                                                                     |
| (5)    |   | Filed as Exhibits 13.27 and  13.28 with the Company’s Form 10-K Annual Report for the fiscal year  ended  September 30, 1986, filed with  the Securities and Exchange Commission in December 1986 and incorporated  herein by reference.                                       |
|   |   |                                                                                                                                                                                                                                                                                     |
| (6)    |   | Filed as Exhibit 13.31 with  the Company’s Form 10-K Annual Report for the fiscal year ended September 30,  1990, filed with the Securities and Exchange Commission in December 1990 and  incorporated herein by reference.                                                         |
|   |   |                                                                                                                                                                                                                                                                                     |
| (7)    |   | Filed as Exhibit 13.32 with  the Company’s Form 10-K Annual Report for the fiscal year ended September 30,  1991, filed with the Securities and Exchange Commission in December 1991 and  incorporated herein by reference.                                                         |
|   |   |                                                                                                                                                                                                                                                                                     |
| (8)    |   | Filed as Exhibit 13.33 with  the Company’s Form 10-K Annual Report for the fiscal year ended September 30,  1992, filed with the Securities and Exchange Commission in December 1992 and  incorporated herein by reference.                                                         |
|   |   |                                                                                                                                                                                                                                                                                     |
| (9)    |   | Filed as Exhibits 10.14,  10.15 and 10.16 with the Company’s Form 10-KSB Annual Report for the fiscal  year ended September 30, 1994, filed with the Securities and Exchange  Commission in December 1994 and incorporated herein by reference.                                     |
|   |   |                                                                                                                                                                                                                                                                                     |
| (10)   |   | Filed as Exhibits 10.17,  10.18, 10.19, 10.20 and 10.21 with the Company’s Form 10-KSB Annual Report  for the fiscal year ended September 30, 1995, filed with the Securities and  Exchange Commission in December 1995 and incorporated herein by reference.                       |
|   |   |                                                                                                                                                                                                                                                                                     |
| (11)   |   | Filed as Exhibits 10.22 and  10.23 with the Company’s Form 10-QSB Quarterly Report for the nine months  ended June 30, 1996, filed with the Securities and Exchange Commission in  August 1996 and incorporated herein by reference.                                                |
|   |   |                                                                                                                                                                                                                                                                                     |
| (12)   |   | Filed as Exhibits 10.24,  10.25, 10.26, 10.27, 10.28, 10.29 and 10.30 with the Company’s Form 10-KSB  Annual Report for the fiscal year ended September 30, 1996, filed with the  Securities and Exchange Commission in December 1996 and incorporated herein  by reference.        |
|   |   |                                                                                                                                                                                                                                                                                     |
| (13)   |   | Included as an attachment  to the Company’s definitive Proxy Statement to shareholders for the meeting  dated March 11, 1997 and incorporated herein by reference.                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                     |
| (14)   |   | Filed as Exhibits 10.33,  10.34, 10.35, 10.36 and 10.37 with the Company’s Form 10-KSB Annual Report  for the fiscal year ended September 30, 1997, filed with the Securities and  Exchange Commission in December 1997 and incorporated herein by reference.                       |
|   |   |                                                                                                                                                                                                                                                                                     |
| (15)   |   | Filed as Exhibits 10.37 and  10.38 with the Company’s Form 10-QSB Quarterly Report for the three months  ended December 31, 1997, filed with the Securities and Exchange Commission in  February 1998 and incorporated herein by reference.                                         |
|   |   |                                                                                                                                                                                                                                                                                     |
| (16)   |   | Filed as Exhibits 10.1,  10.2, 10.3 and 10.4 with the Company’s Form 10-QSB Quarterly Report for the nine  months ended June 30, 1998, filed with the Securities and Exchange Commission  in August 1998 and incorporated herein by reference.                                      |
|   |   |                                                                                                                                                                                                                                                                                     |
| (17)   |   | Filed as Exhibits 10.1 and  10.2 with the Company’s Form 10-QSB Quarterly Report for the nine months  ended June 30, 1999, filed with the Securities and Exchange Commission in  August 1999 and incorporated herein by reference.                                                  |
|   |   |                                                                                                                                                                                                                                                                                     |
| (18)   |   | Filed as Exhibit 10.46 with  the Company’s Form 10-KSB Annual Report for the fiscal year ended September  30, 1999, filed with the Securities and Exchange Commission in December 1999  and incorporated herein by reference.                                                       |
|   |   |                                                                                                                                                                                                                                                                                     |
| (19)   |   | Filed as Exhibits 10.1,  10.2, 10.3 and 10.4 with the Company’s Form 10-QSB Quarterly Report for the  three months ended December 31, 1999, filed with the Securities and Exchange  Commission in February 2000 and incorporated herein by reference.                               |
|   |   |                                                                                                                                                                                                                                                                                     |
| (20)   |   | Filed as Exhibit 10.1 with  the Company’s Form 10-QSB Quarterly Report for the six months ended March 31,  2000, filed with the Securities and Exchange Commission in May 2000 and  incorporated herein by reference.                                                               |
|   |   |                                                                                                                                                                                                                                                                                     |
| (21)   |   | Filed as Exhibits 10.1,  10.2, 10.3, 10.4 and 10.5 with the Company’s Form 10-QSB Quarterly Report for  the nine months ended June 30, 2000, filed with the Securities and Exchange  Commission in August 2000 and incorporated herein by reference.                                |
|   |   |                                                                                                                                                                                                                                                                                     |
| (22)   |   | Filed as Exhibits 10.57,  10.58, 10.59, 10.60, 10.61, 10.62, 10.63 and 10.64 with the Company’s Form  10-KSB Annual Report for the fiscal year ended September 30, 2000, filed with  the Securities and Exchange Commission in December 2000 and incorporated  herein by reference. |
|   |   |                                                                                                                                                                                                                                                                                     |
| (23)   |   | Filed as Exhibits 10.1,  10.2 and 10.3 with the Company’s Form 10-QSB Quarterly Report for the three  months ended December 31, 2000, filed with the Securities and Exchange  Commission in February 2001 and incorporated herein by reference.                                     |
|   |   |                                                                                                                                                                                                                                                                                     |
| (24)   |   | Filed as Exhibit 10.1,  10.2, 10.3, 10.4 and 10.6 with the Company’s Form 10-QSB Quarterly Report for  the six months ended March 31, 2001, filed with the Securities and Exchange  Commission in May 2001 and incorporated herein by reference.                                    |
|   |   |                                                                                                                                                                                                                                                                                     |
| (25)   |   | Filed as Exhibits 10.1 and  10.2 with the Company’s Form 10-QSB Quarterly Report for the nine months  ended June 30, 2001, filed with the Securities and Exchange Commission in  August 2001 and incorporated herein by reference.                                                  |
|   |   |                                                                                                                                                                                                                                                                                     |
| (26)   |   | Filed as Exhibits 10.76,  10.77, 10.78, 10.79, 10.80, 10.81 and 10.82 with the Company’s Form 10-KSB  Annual Report for the fiscal year ended September 30, 2001, filed with the  Securities and Exchange Commission in December 2001 and incorporated herein  by reference.        |
|   |   |                                                                                                                                                                                                                                                                                     |
| (27)   |   | Filed as Exhibit 10.1 with  the Company’s Form 10-QSB Quarterly Report for the three months ended  December 31, 2001, filed with the Securities and Exchange Commission in  February 2002 and incorporated herein by reference.                                                     |
|   |   |                                                                                                                                                                                                                                                                                     |
| (28)   |   | Filed as Exhibits 10.1 and  10.2 with the Company’s Form 10-QSB Quarterly Report for the six months ended  March 31, 2002, filed with the Securities and Exchange Commission in May 2002  and incorporated herein by reference.                                                     |
|   |   |                                                                                                                                                                                                                                                                                     |
| (29)   |   | Filed as Exhibits 10.1,  10.2, 10.3, 10.4 and 10.5 with the Company’s Form 10-QSB Quarterly Report for  the nine months ended June 30, 2002, filed with the Securities and Exchange  Commission in August 2002 and incorporated herein by reference.                                |

 

35

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(b)           Reportson Form 8-K:

 

None

 

**ITEM 14.****                          ****CONTROLS AND PROCEDURES.**

 

In the ninety day periodbefore the filing of the report, the chief executive officer and chieffinancial officer of the Company (the “certifying officer”) evaluated theeffectiveness of the Company’s disclosure controls and procedures.  These disclosure controls and procedures aredesigned to ensure that the information required to be disclosed by the Companyin its periodic reports filed with the Securities and Exchange Commission (the“Commission”) is recorded, processed, summarized and reported, within the timeperiods specified by the Commission’s rules and forms, and that the informationis communicated to the certifying officer on a timely basis.

 

The certifying officerconcluded, based on his evaluation, that the Company’s disclosure controls andprocedures are effective for the Company.

 

No significant changes in theCompany’s internal controls or in other factors were detected that couldsignificantly affect the Company’s internal controls subsequent to the datewhen the internal controls were evaluated.

 

36

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**SIGNATURES**

 

In accordance with Section 13or 15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

**LEE PHARMACEUTICALS**

 
| Date:   DECEMBER  23, 2002 | RONALD G. LEE                              |
|-------------------------------------------|--------------------------------------------|
|                                      |  Ronald G. Lee                        |
|                                      |  Chairman of the Board  and President |

 

In accordance with theSecurities Exchange Act of 1934, this report has been signed by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 
| Date:   DECEMBER  23, 2002 | RONALD G. LEE                                                               |
|-------------------------------------------|-----------------------------------------------------------------------------|
|                                      |  Ronald G. Lee                                                         |
|                                      |  Chairman of the Board  & President                                |
|                                      |  (Principal Executive,  Financial and Accounting Officer) and Director |

 
| Date:   DECEMBER  23, 2002 | HENRY L. LEE, JR.       |
|-------------------------------------------|-------------------------|
|                                      |  Henry L. Lee, Jr. |
|                                      |  Director          |

 
| Date:   DECEMBER  23, 2002 | WILLIAM M. CALDWELL IV        |
|-------------------------------------------|-------------------------------|
|                                      |  William M. Caldwell  IV |
|                                      |  Director                |

 

**CERTIFICATIONS***

 

I, Ronald L. Lee, certify that:

 

1. I have reviewed this annual report on Form10-KSB of Lee Pharmaceuticals;

 

2. Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4. The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a) designed such disclosure controls and proceduresto ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c) presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a) all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6. The registrant’s other certifying officersand I have indicated in this annual report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:   DECEMBER  23, 2002 | RONALD G. LEE                                                          |
|-------------------------------------------|------------------------------------------------------------------------|
|                                      |  Ronald G. Lee                                                    |
|                                      |  President (Chief  Executive Officer and Chief Financial Officer) |

 

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*Provide a separate certification for each principal executive officer andprincipal financial officer of the registrant. See Rules 13a-14 and 15d-14.  Therequired certification must be in the exact form set forth above.

 

37

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