<PAGE>

                    U. S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                   FORM 10-KSB

(MARK ONE)

          [ X ] ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE
                SECURITIES EXCHANGE ACT OF 1934
                FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998

          [   ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934


                          COMMISSION FILE NUMBER 1-7335

                               LEE PHARMACEUTICALS
                               -------------------
                 (Name of small business issuer in its charter)

                 CALIFORNIA                              95-2680312
                 ----------                              ----------
      (State or other jurisdiction of      (I.R.S. Employer Identification No.)
       incorporation or organization)

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

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


SECURITIES REGISTERED UNDER SECTION 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 Exchange Act during the past 12 months (or for 
such shorter period that the registrant was required to file such reports), 
and (2) has been subject to such filing requirements for the past 90 days. 
Yes X   No
   ---     ---

Check if there is no disclosure of delinquent filers in response to Item 405 
of Regulation S-B is not contained in this form, and no disclosure will be 
contained, to the best of registrant's knowledge, in definitive proxy or 
information statements incorporated by reference in Part III of this Form 
10-KSB or any amendment to this Form 10-KSB. [ ]

State issuer's revenues for its most recent fiscal year:  $9,059,000 Gross

As of the close of business on November 30, 1998, the aggregate market value 
of Lee Pharmaceuticals common stock held by nonaffiliates was $515,889.

State the number of shares outstanding of each of the issuer's classes of 
common equity, as of the latest practicable date. Common stock, par value 
$.10; 4,135,162 shares outstanding as of the close of business on November 
30, 1998.

DOCUMENTS INCORPORATED BY REFERENCE:  NONE


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                                       2

                                     PART I

ITEM 1.   DESCRIPTION OF BUSINESS.

     Lee Pharmaceuticals is engaged in the research, development, purchase, 
manufacture, and marketing of consumer personal care products and 
professional dental products, all of which are targeted for the improved 
well-being of the human body. The Company's business is directed to two main 
areas: (a) the development and marketing of a range of consumer products 
including nail extenders and strengtheners, depilatories, and 
over-the-counter drug items and (b) the manufacture and sale of materials and 
supplies for use in the professional dental health field. For all years 
presented, revenues, operating results and identifiable assets of the 
consumer products group were in excess of 91% of total company operations.

     Lee Pharmaceuticals' executive offices are located at 1444 Santa Anita 
Avenue, South El Monte, California 91733, and its telephone number is (626) 
442-3141. The Company was incorporated in April 1971 as a California 
corporation.

CONSUMER PRODUCTS SEGMENT

     The Company's consumer products line consists primarily of a variety of 
artificial fingernail extenders and related fingernail products. In addition, 
the Company manufactures and sells hair removal products, antacid tablets, 
nasal care products, infant items and a variety of over-the-counter drug 
products. The Company's product lines have been developed internally, 
particularly in the case of fingernail products, and by outside product line 
acquisitions.

     In fiscal years 1993 and 1994, the research and development capability 
of Lee Pharmaceuticals generated several new product entries, including Lee 
Press-On Body Tattoos, Lee Brush-On Nail Bleach, Lee Nail Whitener, and the 
Lee Fancy Fingers Nail Jewelry Kit. In addition, the consumer products line 
of the Company was further diversified by the acquisition of seven products 
from other manufacturers, including six over-the-counter drug products and 
Sundance, a line of aloe vera skin care products.

     In fiscal year 1995, the research and development capability of Lee 
Pharmaceuticals generated several new product entries, including a new 
product line -- Lee Press-On Nails - Professional Salon Style in fourteen 
high fashion nail colors plus a nail extender product line known as Lee 
Elegant Edge Nail Tip kits. In addition, there was further diversification of 
the Company's consumer products line by the acquisition of products from 
other manufacturers, including aloe vera skin care products, a line of men's 
after shave lotions, infant care items, and additional over-the-counter drug 
products.

     In fiscal 1996, the research and development capability of Lee 
Pharmaceuticals generated new product entries primarily in the nail care 
category-specifically eight new colors of Lee Press On Nails in trendy, 
fashionable colors. In addition, two holiday displays-Lee Halloween Fun Press 
On Nails and Lee Holiday Elegance-Christmas, were developed. Lee 
Pharmaceuticals expanded it's personal care category of products through two 
acquisitions. On February 15, 1996, Lee acquired the Breath-Gard-TM- breath 
tablets from Sundance Healthcare Products, Inc. in Valencia, California. On 
September 20, 1996, Lee Pharmaceuticals acquired the full line of 
Aquafilter-Registered Trademark-Cigarette Holders from the Aquafilter 
Corporation, Ft. Lauderdale, FL. The acquisition of this well recognized 
filtration system and its assimilation into the Lee Pharmaceuticals marketing 
and distribution program was intended to be an important contribution to the 
Company's growth in 1997 and beyond.

     In fiscal 1997, the Company purchased two oral care brands from Lactona 
Corporation for $175,000 including inventory valued at approximately $30,000. 
Also, in fiscal 1997, the Company purchased twenty-eight (28) brands 
including ointments, nutritional supplements, vitamins, analgesics, and 
various over-the-counter (OTC) brands from Roberts Laboratories, Inc. for 
$1,168,089. During fiscal 1997 Lee Lip-Ex Lip Balms were internally 
developed. The Lip-Ex line includes three lip balms and six glossy flavored 
lip balms.

     In fiscal 1998, the Company expanded its Lee-Registered 
Trademark-Lip-Ex-TM-  line to include lip balms with an SPF 8 protection and 
also packaged the Lip-Ex into convenient tin top jars. The Company purchased 
several new OTC items including Pain-A-Lay-Registered Trademark-, an oral 
anesthetic/analgesic, and EVAC-U-GEN-Registered Trademark-, a chewable 
laxative.

DOMESTIC CONSUMER PRODUCTS MARKETING

     Consumer products are sold nationally, principally through major retail 
drug, food and discount department store chains. Retail distribution is 
primarily accomplished through a network of independent general merchandise 
sales representatives. All lines are advertised in a variety of media, 
including television, magazines and newspapers.

CONSUMER PRODUCTS COMPETITION

     The Consumer Products Division of Lee Pharmaceuticals operates in a 
highly competitive environment. In the area of fingernail extension, Lee 
Pharmaceuticals competes with five to six companies, some of which are larger 
companies with greater financial resources.

     Competition in the depilatory product category is intense, with 
competitors even more numerous than in the artificial fingernail field. The 
acquisition of Zip Wax and Bikini Bare brands of hair removal products has 
given Lee Pharmaceuticals two brands in this category.

     Lee Pharmaceuticals continues to expand its product line via a 
combination of acquisitions and in-house research and development activity. 
The consumer products line was historically dominated by nail extension, nail 
treatment, and nail decor

<PAGE>

                                       3

products, but it now includes depilatory products, wax hair removal products, 
a nail biting deterrent product, nasal care items, over-the-counter drug 
products, skin care products, men's fragrance products, tobacco accessory 
products, and lip balms. The Company's consumer products line today is no 
longer restricted solely to the cosmetics business.

REGULATION OF CONSUMER PRODUCTS

     The Company's consumer products are regulated by the Food and Drug 
Administration. The regulations deal principally with consumer safety and 
with the effectiveness of the products for the purposes for which they are 
proposed to be used. For many years, the cosmetic regulations were applied 
only in cases of adulteration or misbranding. Under the Fair Packaging and 
Labeling Act (1966), the FDA has moved to require new labeling data as to 
ingredients in cosmetics.

     The Company believes that all its cosmetic products are manufactured and 
sold in compliance with the laws of each state and that no pre-marketing 
clearance of its products is required from any state. The Company maintains a 
comprehensive data file on each of its consumer products and believes that it 
would be able to apply for any required clearances expeditiously if data were 
ever required for its cosmetic products.

     To the extent the Company's products are marketed in foreign countries, 
foreign laws are applicable as well as FDA regulations which control export 
of cosmetics. To date, where regulations have been established by foreign 
ministries 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 has not been significantly impeded by 
foreign regulations.

     Material Safety Data Sheets (MSDS) are available on all its consumer 
finished products. The MSDS's are supplied to the Company's customers upon 
request.

     All products for export shipped by air or sea which contain listed 
hazardous materials meet United Nations 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" commonly called 
"The Orange Book".

DENTAL PRODUCTS SEGMENT

     From its inception in 1971 through 1998, the Company at various times 
introduced dental products designed to satisfy specific material or supply 
requirements of the practicing dental professional and of the orthodontic and 
endodontic specialist.

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

     In 1991, the Company licensed the right to certain patents and 
technology developed by the American Dental Association Health Foundation 
through research it sponsored at the Paffenbarger Center for Excellence in 
Dental Research at the National Institute of Technology and Standards for 
fabricating dental inserts and inlays of special formulas of beta quartz. The 
Company has been marketing nine shapes and sizes, and has introduced 
twenty-six more sizes and shapes which are intended to offer the dentist 
several new classes of restorations between amalgam and composite 
restorations on the one hand, and laboratory inlays on the other hand. Beta 
quartz designs are intended to permit the dentist to prepare inlays in one 
visit, directly at the chairside, without the need for time consuming 
impressions, or the need for expensive laboratory work.

DENTAL MARKETING IN THE UNITED STATES

     The Company markets its dental, orthodontic and endodontic products in 
the United States through telephone solicitation, direct mail, advertisement 
in trade journals, attendance at conventions, and dental dealers. The Company 
plans and executes its own marketing programs, prepares its own technical 
literature, produces its own clinical and marketing films, and displays its 
dental products at conventions throughout the country.

DENTAL MARKETING OUTSIDE THE UNITED STATES

     The Company markets dental products outside the United States through 
foreign dental distributors who either solicit individual dentists and 
orthodontists and sell the Company's products to them directly for use in the 
treatment of their patients, or sell through local dealers whom they engage 
to sell the Company's products on their behalf. The Company plans and 
executes its own international marketing programs and regularly displays its 
dental products at international conventions by way of its distributors.

DENTAL COMPETITION

     The dental preventive and restorative materials industry is highly 
competitive, and the Company's market share in the total industry is 
insignificant. The Company competes with larger corporations which have 
greater financial resources and believes other companies may enter this 
field. The Company's principal competitors are 3M Dental Division, Kerr, 
Dentsply, and Unitek. The principal methods of competition are in the area of 
product marketing performance, technical assistance provided to the customer, 
and price.

<PAGE>

                                       4

REGULATION OF DENTAL PRODUCTS

FOOD AND DRUG ADMINISTRATION

     Dental materials are classified as devices under the Medical Device 
Amendments of 1976 to the Federal Food, Drug and Cosmetic Act.

     All the dental device products marketed by the Company were registered 
as devices with the FDA at the mandatory time (December 31, 1977). All new 
devices marketed after May 28, 1976, must be processed under the FDA 
premarketing notification regulation (510 k) for determination of equivalency 
to preenactment devices, or the product must be submitted as a new device 
which requires providing considerable extra test data.

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

     As required by the FDA, the Company observes certain procedures and 
policies in the manufacture, quality control, and after-sale monitoring of 
performance for its products. Although the various criteria to be used by the 
FDA in regulating devices have not been finalized, the Company believes that 
all of its products and procedures comply with all current and anticipated 
device regulations. Over half the Company's products fall into the FDA's 
Class II classification which requires that those products must meet certain 
performance standards. The Company believes that all affected products meet 
all current performance standards.

     For those products placed in Class II, final marketing approval from the 
FDA is contingent on final acceptance of the Panel's findings and on 
development of standards (in large part 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 to 
submit adequate data directly to the FDA. Failure to gain approval by the FDA 
could impede the marketing of these devices to the point of removal from the 
market until such time as clearance is obtained.

OTHER GOVERNMENTAL REGULATIONS

     To the extent the Company's products are marketed in foreign countries, 
the Company believes it has complied with the laws of such countries, and 
with the FDA regulations which control export of devices. In those countries 
which ban use of certain ingredients, the Company has reformulated certain of 
its products to meet the specifications of that particular country.

     There is generally world wide movement to increase and/or streamline the 
regulations controlling medical devices. The twenty two countries in Europe 
have consolidated their regulations into a joint code referred to as ISO 
9000. This code regulates the manufacture and distribution of medical devices 
in Europe. One of the provisions of the code is that the company maintain a 
quality control system very much like the FDA system, but with some 
differences. It appears that these differences are being negotiated so that 
both regulations will be equivalent.

     Prior to this time, the Company generally had to apply to each 
individual country to obtain permission to sell in that country. With the 
consolidated regulations, a company needs only to apply to one. At the moment 
all test data needed for an application must be generated in Europe or 
validated in Europe. The resolution of differences between the FDA and the 
ISO 9000 regulations will probably result in U.S. data being accepted in 
Europe, and vice versa. Whether this consolidation will apply to prescription 
drugs is uncertain.

     The Company elected to have three of its major dental brands obtain the 
CE markings in order to continue to distribute those brands throughout 
Europe. The Company received the CE Markings on Prosthodent-Registered 
Trademark-, Insta-Bond-TM- and Beta Quartz-TM- Glass Ceramic Inserts and 
Inlays.

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

DEPARTMENT OF TRANSPORTATION

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

                           APPLICABLE TO ALL SEGMENTS

FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
<TABLE>
<CAPTION>
                                                    YEAR ENDED SEPTEMBER 30
                                                   1998       1997       1996
                                                   ----       ----       ----
                                                  (000)       (000)      (000)
<S>                                               <C>         <C>        <C>
United States export sales 
  (except Canada)...............................  $  430      $  827    $  834
</TABLE>

<PAGE>

                                       5

RESEARCH PROGRAM

     The recent Company trend has been in the direction of brand acquisitions 
rather than extensive internal research and development. Effective July 1996 
the Company eliminated its internal research and development department, and 
decided that future testing and research, that cannot be absorbed by its 
quality assurance and production control departments, will be placed outside 
the Company. As needed, clinical research on products is also done under 
contract with dental schools and clinics. The Company follows the policy of 
expensing all research and development costs when incurred. The Company did 
not have any internal research and development expenses during fiscal years 
September 30, 1998 and 1997.

RAW MATERIALS

     The raw materials used by the Company in the manufacture of most of its 
dental and consumer products are obtained from commercial sources where they 
are presently available in sufficient quantities and are refined by the 
Company as needed for use in its products. The Company generally carries 
sufficient amounts of raw materials inventory to meet the delivery 
requirements of customers.

PATENTS AND TRADEMARKS

     The Company has adopted the policy of making patent disclosures on its 
products and of filing applications for patents on the products or on aspects 
of their manufacture or use when appropriate. The Company owns nine U.S. 
patents, including Dental Restoration System and Method which was recently 
granted during the year, and owns the rights in a number of other U. S. 
patent applications pending. The Company believes that, while patent 
protection is desirable in certain areas, it is not essential; therefore, 
certain foreign patents have been abandoned as not necessary to the interest 
of the Company.

     United States trademarks for the major dental products as well as some 
consumer products, have been granted. Additional trademarks for other 
products have been applied for, both in the U. S. and in foreign countries. 
Trademarks for certain minor products, or in countries with minor market 
potential, have been abandoned as not necessary to the interest of the 
Company.

CURRENT REGULATORY REGISTRATION

     The Company has a license to manufacture and sell two dental products 
from the American Dental Association Health Research Foundation, which 
operates a dental research facility in the complex of the National Institute 
of Standards and Technology.

     The Company is registered with the Federal and State of California FDA 
agencies as a manufacturer and distributor of Drugs, Medical Devices and 
Cosmetics. The Company is also registered as a waste generator with the 
Environmental Protection Agency (EPA).

     The Company has been granted CE Certification for three dental products: 
Prosthodent VL Core Build Up Material, Lee Insta-Bond Orthodontic Bracket 
Adhesive, and Lee Beta Quartz Glass Ceramic Modular Inserts and Inlays.

     The Company applied for a Controlled Substance License with the Drug 
Enforcement Agency (DEA) due to the new product lines the Company has 
recently acquired. Effective November 23, 1998, the Company was granted its 
DEA license.

ENVIRONMENTAL PROTECTION REGULATION AND LITIGATION

     The Company believes that its manufacturing facilities are operated in 
compliance with all federal, state and local provisions regulating the 
discharge of materials into the environment or otherwise relating to the 
protection of the environment.

     The Company owns a manufacturing facility located in South El Monte, 
California. The California Regional Water Quality Control Board (The "RWQCB") 
ordered the Company in 1988 and 1989 to investigate the contamination on its 
property (relating to soil and groundwater contamination). The Company 
engaged a consultant who performed tests and reported to the then Chairman of 
the Company. The Company resisted further work on its property 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 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 subsequent investigations 
will support the Company's conclusions about that estimate. The Company 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 take appropriate action. At the EPA's request, Ecology & 
Environment, Inc. conducted an investigation of soil and groundwater on the 
Company's property. Ecology & Environment Inc.'s Final Site Assessment 
Report, which was submitted to the EPA in June 1994, did not rule out the 
possibility that some of the contamination originated on-site, and resulted 
from either past or current operations on the property. The Company may be 
liable for all or part of the costs of remediating the contamination on its 
property. The EPA has not taken any further action in this matter, but may do 
so in the future.

     The Company and nearby property owners, in consort with their 
comprehensive general liability (CGL) carriers, have engaged a consultant to 
perform a site investigation with respect to soil and shallow groundwater 
contamination over the entire city block. The CGL carriers provided $290,000 
in funding 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 of the earlier quote 
of $175,000. Since that time, the overall scope of the project was increased 
to $205,000 plus $15,000 for waste water disposal,

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                                       6

bringing the total to the above listed $220,000. The $87,500 accrual was not 
spent on this project (as the entire cost was borne by the CGL carriers), but 
remains on the books as an accrual against the cost of remediation of the 
same site that was included in the study.

     The tenants of nearby properties upgradient have sued the Company 
alleging that hazardous materials from the Company's property caused 
contamination on the properties leased by the tenants. The case name is DEL 
RAY INDUSTRIAL ENTERPRISES, INC. v. ROBERT MALONE, ET AL., Los Angeles County 
Superior Court, Northwest District, commenced August 21, 1991. In this 
action, the plaintiff alleges environmental contamination by defendants of 
its property, and seeks a court order preventing further contamination and 
monetary damages. The Company does not believe there is any basis for the 
allegations and is vigorously defending the lawsuit.

     The Company's South El Monte manufacturing facility is also located over 
a large area of possibly contaminated regional groundwater which is part of 
the San Gabriel Valley Superfund site. The Company has been notified that it 
is a potentially responsible party ("PRP") for the contamination. In 1995, 
the Company was informed that the EPA estimated the cleanup costs for the 
South El Monte's portion of the San Gabriel Valley Superfund site to be $30 
million. The Company's potential share of such amount has not been 
determined. Superfund PRPs are jointly and severally liable for superfund 
site costs, and are responsible for negotiating among themselves the 
allocation of the costs based on, among other things, the outcome of 
environmental investigation.

     In August 1995 the Company was informed that the EPA entered into an 
Administrative Order of Consent with Cardinal Industrial Finishes 
("Cardinal") for a PRP lead remedial investigation and feasibility study (the 
"Study") which, the EPA states, will both characterize the extent of 
groundwater contamination in South El Monte and analyze alternatives to 
control the spread of contamination. The Company and others have entered into 
the South El Monte Operable Unit Site Participation Agreement with Cardinal 
pursuant to which, among other things, Cardinal will contract with an 
environmental firm to conduct the Study. The Study has been completed but the 
final program has not been reported. The Company's share of the cost of the 
Study is currently $15,000 and was accrued for in the financial statements as 
of September 30, 1995.

     The City of South El Monte, the city in which the Company has its 
manufacturing facility, is located in the San Gabriel Valley. The San Gabriel 
Valley has been declared a Superfund site. The 1995 Water Quality Control 
Plan issued by the California Regional Water Quality Control Board states 
that the primary groundwater basin pollutants in the San Gabriel Valley are 
volatile organic compounds from industry, nitrates from subsurface sewage 
disposal and past agricultural activities. In addition, the Plan noted that 
hundreds of underground storage tanks leaking gasoline and other toxic 
chemicals have existed in the San Gabriel Valley. The California Department 
of Toxic Substance Control have declared large areas of the San Gabriel 
Valley to be environmentally hazardous and subject to cleanup work.

     The Company believes the City of South El Monte does not appear to be 
located over any of the major plumes. However, the EPA recently announced it 
is studying the possibility that, although the vadose soil and groundwater, 
while presenting cleanup problems, there may be a contamination by DNAPs 
(dense non-aqueous phase liquids), i.e., "sinkers", usually chlorinated 
organic cleaning solvents. The EPA has proposed to drill six "deep wells" 
throughout the City of South El Monte at an estimated cost of $1,400,000. The 
EPA is conferring with SEMPOA (South El Monte Property Owners Association) as 
to cost sharing on this project. SEMPOA has obtained much lower preliminary 
cost estimates. The outcome cost and exact scope of this are unclear at this 
time.

     The Company and other property owners engaged Geomatrix Consultants, 
Inc., to do a survey of vadose soil and shallow groundwater in the "hot 
spots" detected in the previous studies. Geomatrix issued a report dated 
December 1, 1997 (the "Report"), on the impact of volatile organic compounds 
on the soil and groundwater at the Lidcombe and Santa Anita Avenue site 
located in South El Monte, California (which includes the Company's 
facilities). The Report indicated generally low concentrations of 
tetrachloroethene, trichloaethene and trichloroethane in the groundwater of 
the upgradient neighbor. The Report was submitted to the RWQCB for its 
comments and response. A meeting with the parties and RWQCB was held on 
February 10, 1998. The RWQCB had advised companies that vadose soil 
contamination is minimal and requires no further action. However, there is an 
area of shallow groundwater which has a higher than desired level of 
chlorinated solvents, and the RWQCB requested a proposed work plan be 
submitted by Geomatrix. Geomatrix has submitted a "Focused Feasibility Study" 
which concludes that there are five possible methods for cleanup. The most 
expensive are for a pump and sewer remediation which would cost between 
$1,406,000 and $1,687,000. The Company is actively exploring the less 
expensive alternative remediation methods, of which the two proposed 
alternatives range in cost between $985,000 and $1,284,000. Accordingly, the 
Company has taken the average of the two amounts ($985,000 and $1,284,000) as 
the total amount of estimated cost. Since there are four economic entities 
involved, the Company's best estimate at this time, in their judgment, would 
be that their forecasted share would be 25% or $284,000 less the liability 
already recognized on the books of $162,000 thereby requiring an additional 
$122,000 liability. Accordingly, the Company recorded an additional accrual 
of $122,000 in the third quarter of fiscal 1998. The $122,000 accrual is in 
addition to the $79,000 accrual for the Monterey Site as will be explained in 
the following paragraph. The $79,000 accrual, in the third quarter of fiscal 
1998, related to the Monterey Site is not included in the $284,000 figure 
above. No assurances can be given that any of the alternative remediation 
methods will be feasible or that the actual cost to the Company of the 
remediation will not exceed the amount of the Company's current accruals of 
$284,000 (which includes the $122,000 charge to income in the third quarter 
of fiscal 1998).

     Without any prior correspondence or inkling of the Company's potential 
liability, the EPA has recently informed the Company that the Company may 
have potential liability for the ongoing remediation of Operating Industries, 
Inc. (as they have gone out of business) Landfill Superfund Site in Monterey 
Park, California (the "Monterey Site"). The Monterey Site is a 190 acre 
landfill that operated from 1948 to 1984, in which the Company disposed of 
non toxic pH balanced waste water on six occasions between 1974 and 1978. 
Over 4,000 companies have been identified as having contributed waste to the 
Monterey Site. The EPA has offered to settle the Company's potential 
liability with respect to the Monterey Site for a cost to the Company of 
$79,233. The Company 

<PAGE>

                                       7

accrued a $79,000 charge in the third quarter of fiscal 1998 with respect to 
this possible liability. The Company has elected to file for relief from 
these obligations under the financial hardship option in the EPA's response 
form.

     The total amount of environmental investigation and cleanup costs that 
the Company may incur with respect to the foregoing is not known at this 
time. However, based upon information available to the Company at this time, 
the Company has expensed since 1988 a total of $486,000, of which $89,000 
were legal fees, exclusive of legal fees expended in connection with the SEC 
environmental investigation. The actual costs could differ materially from 
the amounts expensed for environmental investigation and cleanup costs to 
date.

OTHER REGULATIONS

     During the last several years, several state, local and federal agencies 
have finalized or proposed regulations relating to hazardous materials. These 
include Los Angeles County Hazardous Materials Business Plan, California and 
federal OSHA "right to know" laws, EPA "community right to know" laws and 
Extremely Hazardous Substance Regulations, Los Angeles County's program for 
monitoring and closing underground tanks, the California Safe Drinking and 
Toxic Enforcement Act of 1986 (Prop 65), California Connelly-Sterling Toxic 
Hot Spots Information Act and AQMD's New Source of Carcinogenic Air 
Contaminants (Rule 1401). The Company believes it is in compliance with these 
regulations that are in effect and is anticipating it will be in compliance 
with those of these acts yet to be finalized.

     The Internal Standards Organization in September 1996 released 
specifications (ISO 14000) for companies to use as guidelines in reducing 
worldwide contamination and improving on recycling operations. The Company 
believes that demonstrating that the Company meets these specifications is 
good citizenship and also in time will be necessary for international trade. 
The Company is proceeding to apply for an ISO 14000 rating.

EMPLOYEES

     The Company's work force of 97 presently includes 26 permanent 
employees, both salaried and hourly, and 71 personnel leased through 
employment agencies.

OTHER

     The Company is not dependent upon any one supplier for any important raw 
material item. Most raw material items are commodities and readily available 
in the market. In most instances, the Company utilizes two or more suppliers 
to furnish raw materials as needed. Sources are believed to be sufficient to 
satisfy current and anticipated needs.

     Demand for the Company's principal product line 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 not believe that it is dependent upon any one 
customer or distributor, a customer accounted for 9% and 14% of the Company's 
net revenues during fiscal 1998 and 1997, respectively. No other customer 
accounted for 8% or more of the Company's net revenues for those fiscal years.

     Backlog is not a significant factor in the Company's business. Most 
orders are filled immediately and in any event, are cancelable under certain 
conditions. There are no material contracts with distributors.

     Consumer Products Division returns must include proof of purchase, sales 
receipt and a written explanation of the reason for the return. The Company 
generally provides credits for replacement of product, however, on occasion 
it may provide a cash refund.

     In addition, discontinued or overstocked items may be returned once the 
customer receives a computer printed "return authorization" and "shipping 
labels" for full case stock of factory fresh product to be sent freight 
prepaid to the Company's warehouse. The customer will not receive credit for 
additional merchandise that may have been added to the return.

     The Company's sales return policy for the Dental Division, is as 
follows: "products returned to Lee Pharmaceuticals for credit must be sent 
postage paid and within 90 days of purchase". Defective merchandise can be 
replaced free of charge at any time prior to the date of expiration. 
Excessively used or improperly stored merchandise is not eligible for 
replacement.


<PAGE>

                                       8

ITEM 2.   DESCRIPTION OF PROPERTY.

     The Company occupies, through ownership or lease, seven buildings on
contiguous lots in South El Monte, California. The Company owns the following:
<TABLE>
<CAPTION>
                                    APPROXIMATE
                                      SQUARE
ADDRESS                               FOOTAGE        USAGE
-------                               -------        -----
<S>                                   <C>            <C>
1428 Santa Anita Avenue               10,000         Chemical processing and filling
</TABLE>


     The Company leases the following:
<TABLE>
<CAPTION>
                           APPROXIMATE      AGGREGATE        LEASE
                             SQUARE          ANNUAL       EXPIRATION
ADDRESS                      FOOTAGE         RENTAL          DATE              USAGE
-------                      -------         ------          ----              -----
<S>                          <C>             <C>             <C>               <C>
1434 Santa Anita Avenue      11,000         $52,812**      11/30/2000      Inventory control, personnel, data processing,
                                                                           accounting offices and dental production/shipping
1460 Santa Anita Avenue (1)  15,000          64,728**      11/30/2000      Effective January 15, 1996, the building was
                                                                           subleased.
1470 Santa Anita Avenue (2)   8,000          43,056**      11/30/2000      Effective July 16, 1996, the building was
                                                                           subleased.
1500 Santa Anita Avenue      18,000          85,884**      11/30/2000      Warehouse, consumer packaging operations,
                                                                           injection molding and corrugated printing
1516 Santa Anita Avenue      18,000          87,960**      11/30/2000      Sales/marketing offices, purchasing, consumer
                                                                           shipping, and warehouse
1444 Santa Anita Avenue (3)  10,000          67,302*       11/30/2005      Executive office, consumer production,
                                                                           quality control and bottle printing
1427 Lidcombe Avenue          6,000          28,134**      11/30/2000      Maintenance and chemical processing
                                                                           (rear building)
1425 Lidcombe Avenue          6,000          28,134**      11/30/2000      Chemical processing and packaging
1445 Lidcombe Avenue (3)(4)   8,000          63,177*       11/30/2005      Effective November 8, 1995, the building was
                                                                           subleased on a one-year agreement.  Subsequent
                                                                           to November 1996, the sublessee is on a month to
                                                                           month agreement with a 45-day advance notice to
                                                                           relocate. The gross monthly rental income is
                                                                           $3,676.
</TABLE>
*    Revised biannually for consumer price index change.
**   Can be revised biannually for consumer price index change, but has not been
     adjusted, by the owner, on December 1, 1992, December 1, 1994 or December
     1, 1996.

(1)  The Company entered into a sublease agreement, effective January 15, 1996,
     which expires November 30, 2000. The gross annual rental income is $67,268.
     In April 1997 the sublessee commenced occupancy of the entire 15,000 square
     footage (previously occupied 13,000 square feet). The annual rental income
     for fiscal year 1998 includes a cost of living adjustment regarding the
     sublease effective June 1998.

(2)  The Company entered into a sublease agreement, effective July 16, 1996,
     which expires November 30, 2000. The gross annual rental income is $39,312.
     In July 1998 the sublease was adjusted from $3,276 per month to $3,360 per
     month.

(3)  This property is treated as a sale leaseback agreement between the Company
     and one of its directors (former Chairman). The monthly lease payments were
     set at the prevailing rates in the area at the time the leases were
     written. The buildings were bought by Ronald G. Lee, President, from Dr.
     Henry L. Lee, former Chairman, in December 1995.

(4)  The gross monthly rental income is $3,678. The Company will continue to
     sublease the building until the owner can locate a buyer or the Company
     gives notice to the tenant and takes back the facility to expand its
     operations.

     All of the Company's business segments use the properties owned or leased
     by the Company except for 1470 Santa Anita Avenue (subleased effective July
     16, 1996), 1460 Santa Anita Avenue (subleased effective January 15, 1996),
     and 1445 Lidcombe Avenue (subleased effective November 8, 1995).

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

<PAGE>

                                       9

     The Company believes that its existing facilities are adequate to enable 
     it to continue to produce its products at their present volume together 
     with any moderate increases thereto.

ITEM 3.   LEGAL PROCEEDINGS.

     In the ordinary course of its business, the Company is involved from 
time to time in litigation. In the opinion of management of the Company none 
of the litigation currently pending will have a material effect on its 
business or financial condition. See Item I - "Applicable to All Segments - 
Environmental protection regulation and litigation" for additional 
information concerning certain litigation.

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

     Not applicable.


                                     PART II

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

     During January 1996 the Company's Common Stock was delisted from the 
American Stock Exchange (AMEX) and was no longer traded on the AMEX. The 
Company did not meet the guidelines for continued listing of the Company's 
Common Stock on the American Stock Exchange. Effective January 25, 1996, the 
Company's Common Stock commenced trading on the electronic over-the-counter 
bulletin board under the trading symbol LPHM. For the two most recent fiscal 
years, its shares have closed at high and low trading prices as follows:
<TABLE>
<CAPTION>
                                       QTR           HIGH               LOW
<S>                                    <C>           <C>                <C>
                 FY 1998                1Q          $.3125            $.2500
                                        2Q           .3400             .2000
                                        3Q           .3600             .2000
                                        4Q           .2000             .1550
                 FY 1997                1Q          $.2200            $.1400
                                        2Q           .2000             .1500
                                        3Q           .3200             .2500
                                        4Q           .3250             .2500
</TABLE>

     There were approximately 776 shareholders of record of the Company's 
Common Stock as of the close of business on September 30, 1998.

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

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

FISCAL YEARS ENDED SEPTEMBER 30, 1998, AND SEPTEMBER 30, 1997

     Net revenues decreased during fiscal 1998 by $563,000 or 6% when 
compared to fiscal 1997. The decrease in net revenues was due to the reduced 
sales revenues of the nail category products and depilatories. The above 
decrease in sales revenues was partially offset by volume generated from 
recently acquired brands such as: Klutch-Registered Trademark- and 
Painalay-Registered Trademark-, plus the in-house product Lee-Registered 
Trademark- Lip-Ex-TM-. The newly acquired brand acquisitions accounted for 
approximately $445,000 or 5% of the Company's total net revenues. Also, the 
Company's sales returns decreased approximately $53,000 or 6% when comparing 
fiscal years 1998 and 1997. The lower sales returns during the current fiscal 
year was primarily the result of a 57% decrease in the nail extender 
category. This was due to the continued decline in the nail products sales 
volume. The Company's retail customers have continued to change their 
planograms, where they are stocking fewer SKU's (stock keeping units) of the 
Company's products.

     The financial crisis overseas has helped slow the Company's foreign 
sales in fiscal 1998. The economic crisis in Japan contributed to the 
Company's plummeting sales (66% in Japan) during fiscal 1998 compared to 
fiscal 1997. As a result, foreign market sales were down 48% overall.

     As noted under "Description of Business - Consumer Products Segment" the 
Company has pursued a policy of diversifying its product line via product 
line acquisitions. Certain of the Company's products have been expanded into 
dollar stores and convenience stores in an attempt to increase the number of 
outlets carrying the Company's products.

     Cost of sales as a percentage of gross revenues was 42% for fiscal year 
1998, compared to 40% for fiscal year 1997. The cost of sales percentage was 
higher due to increased raw material purchases (normal quantity reordered, 
per purchase order, was tripled for

<PAGE>

                                       10


certain high turnover items), increased manufacturing labor dollars as a 
result of two (September 1997 and March 1998) hourly rate increases (15%) in 
minimum wages and sale of some slow moving finished goods at lower than 
normal margins. The above explanations were somewhat offset by benefits 
achieved from the production learning curve, associated with the previously 
acquired brands, increased production runs, and a favorable product mix.

     Selling and advertising expenses increased $99,000 or 3% when comparing 
fiscal years 1998 and 1997. The increases in expenses were primarily due to 
the following factors; (1) an increase in salaries and wages plus related 
fringe benefits, the result of new hires which includes two outside salesmen 
($183,000), and higher related travel and entertainment expenses ($55,000), 
(2) higher manufacture representative commissions ($56,000), and (3) an 
increase in the amortization expense (approximately $40,000) related to 
acquisitions by the Company during September 1997 and February 1998. The 
aforementioned increased expenses were offset, in part, by a decrease in the 
cooperative advertising ($171,000) and non-recurring "special allowance" 
($62,000) which was awarded to a key customer in fiscal 1997.

     Research and development expenses were non-existent for fiscal year 1998 
versus 1997. The Company trend over the last two plus years has been in the 
direction of brand acquisitions rather than extensive internal research and 
development. Effective July 1996 the Company eliminated it's internal 
research and development department, and decided that future testing and 
research, that cannot be absorbed by its quality assurance and production 
control departments, will be placed outside the Company.

     General and administrative expenses increased $273,000 or 24% when 
comparing fiscal years 1998 and 1997. This significant increase was 
principally due to; (1) employee new hires (salary and wages) plus related 
fringe benefits (approximately $75,000), (2) an accrual of $79,000 
(non-recurring) related to the Monterey Park waste site cleanup, and (3) an 
accrual of $122,000 related to the Company's best estimate of its share of 
the remediation costs as described in Note 10 to the financial statements 
under the caption "Assessment for environmental cleanup."

     Interest expense increased $52,000 or 9% when comparing fiscal years 
1998 and 1997. The higher interest expense was attributed to the increased 
borrowings from the Company's asset based financing lender and increased 
borrowings on notes payable plus a higher rate of interest (from 15% to 20%) 
paid on various notes payable.

     Gain on sale of buildings relates to the sale leaseback arrangement 
since 1991 whereby the Company is realizing a constant deferred gain over the 
lease term.

LIQUIDITY AND CAPITAL RESOURCES

     Working capital was a negative $719,000 at September 30, 1998, as 
compared with $114,000 at September 30, 1997. The decrease in working capital 
of $833,000 was primarily due to an increase in current liabilities of 
$56,000 (basically an increase in the current portion of notes payable as a 
result of newly acquired product brands and an increase in the environmental 
cleanup liability) and a decrease in current assets of $777,000 primarily due 
to a decrease in accounts receivable and deposits. The ratio of current 
assets to current liabilities was .8 to 1 at September 30, 1998, and 1.0 to 1 
at September 30, 1997.

     In comparing fiscal years 1998 and 1997, accounts receivable turnover 
increased (7.5 versus 7.3) primarily due to the Company's reduction in 
extended credit terms. Accounts payable as a percentage of total costs and 
expenses was constant (12% in fiscal 1998 and 1997) due to the Company's 
continued improved timely payments to vendors plus payment of several 
non-recurring commitments, the result of better cash flow from accounts 
receivable collections.

     Customer consolidations, as expected, materialized in fiscal 1998 and 
may continue in fiscal 1999. Management continues to face lower retail store 
inventory levels and expanded computerization in the field such as; EDI 
(electronic data interchange), ASN (advance shipping notice), and UCC-128 
(Uniform Code Council) bar code labels.

     Due to the inventory acquired from product line acquisitions, the 
inventory increased $142,000. Partially offsetting the overall increase in 
inventory, the Company continued to reduce it's inventory of slow moving 
items at a price below the listed sales price and scrapping obsolete 
inventory items.

     Effective May 21, 1998, the Company renewed its accounts receivable 
financing, maturing May 2000, whereby 75% of the eligible domestic accounts 
receivable, not to exceed the greater of $1,100,000 or $1,100,000 less 
amounts advanced on inventory, can be advanced. The new financing agreement 
includes a $400,000 term loan on inventory which is incorporated in the 
working capital line of credit above. Additionally, there is a separate 
$440,000 term loan on the Company's equipment. This financing is secured by a 
security interest in all of the Company's assets.

     See "Business - Applicable to All Segments - Environmental protection 
regulation and litigation" for a description of certain environmental matters 
relating to the Company.

     The Company has an accumulated deficit of $6,734,000. The Company's past 
recurring losses and fiscal 1997's nominal profit from operations and 
inability to generate sufficient cash flow from normal operations to meet its 
obligations as they come due raise substantial doubt about the Company's 
ability to continue as a going concern. The Company's ability to continue in 
existence is dependent upon future developments, including retaining current 
financing and achieving a level of profitable operations sufficient to enable 
it to meet its obligations as they become due.

     The Company does not believe that inflation had a significant impact on its
operations during fiscal years 1998 and 1997.


<PAGE>

                                       11

YEAR 2000 READINESS

     Most companies have computer systems that use two digits to identify a 
year in the date field (e.g. "98" for 1998). These systems must be modified 
to handle turn-of-the century calculations. If not corrected, systems 
failures or miscalculations could occur, potentially causing disruptions of 
operations, including, among other things, the inability to process 
transactions, send invoices, or engage in other normal business activities. 
This creates potential risk for all companies, even if their own computer 
systems are Year 2000 compliant.

     In 1998, the Company initiated a comprehensive review of its computer 
systems to identify processes that could be adversely affected by Year 2000 
issues. In addition, the Company identified computer application systems that 
required modification or replacement.

     The Company will be required to modify or replace certain portions of 
its software so that its systems will function properly with respect to dates 
in the Year 2000 and thereafter. The Company has replaced its existing 
hardware computer system and has solicited the assistance of a software 
reengineering company specializing in services to resolve the Year 2000 
problem to remediate non-compliant code in existing applications and systems. 
The Company is also utilizing internal resources to reprogram or replace and 
test the software for Year 2000 modifications.

     The Company has an ongoing program of communicating with suppliers and 
vendors to determine the extent to which those companies are addressing Year 
2000 compliance issues. There can be no assurance that the Company will be 
able to develop a contingency plan that will adequately address issues that 
may arise in the Year 2000.

     In 1999, a contingency plan will be developed in the event key or 
critical suppliers or vendors are unable to meet the Year 2000 compliance. If 
needed, such steps as identifying alternative suppliers and vendors will be 
addressed. The timeframe for completing or documenting contingency plans has 
not been finalized.

     The Company estimates that the cost of remediation will be less than 
$100,000. The remediation costs include internal labor costs, as well as fees 
and expenses paid to outside contractors specifically associated with 
programming and purchased hardware and upgraded software.

     The Company's Year 2000 plans, including costs, preparation for testing, 
and completion schedules (by October 1999), are based on management's best 
estimates. These estimates were derived using assumptions of future events 
including third party input, availability of qualified personnel, and other 
factors.

     Based on currently available information, management does not believe 
that the Year 2000 matters discussed above will have a material adverse 
impact on the Company's financial condition or results of operations; 
however, because of the uncertainties in this area, no assurances can be 
given in this regard.

ITEM 7.   FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
                                                                          PAGE
INDEX TO FINANCIAL STATEMENTS                                             NUMBER
<S>                                                                       <C>
Independent Auditor's Report                                                12

Financial Statements:

     Balance sheet as of September 30, 1998                                 13

     Statements of operations for each of the years in 
      the two-year period ended September 30, 1998                          14

     Statements of changes in stockholders' deficiency for each of
     the years in the two-year period ended September 30, 1998              15

     Statements of cash flows for each of the years in the two-year 
     period ended September 30, 1998                                        16

     Notes to financial statements                                         17-25
</TABLE>

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

<PAGE>

                                       12


                                 GEORGE BRENNER

                           CERTIFIED PUBLIC ACCOUNTANT
                       9300 WILSHIRE BOULEVARD, SUITE 480
                         BEVERLY HILLS, CALIFORNIA 90212



                          Independent Auditor's Report


Board of Directors
Lee Pharmaceuticals
South El Monte, California

I have audited the accompanying balance sheet of Lee Pharmaceuticals as of 
September 30, 1998 and the related statements of operations, changes in 
stockholders' deficiency, and cash flows for each of the years in the 
two-year period ended September 30, 1998. These financial statements are the 
responsibility of the Company's management. My responsibility is to express 
an opinion on these financial statements based on my audit.

I conducted my audit in accordance with generally accepted auditing 
standards. Those standards require that I plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement. An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the overall 
financial statement presentation. I believe that my audit provides a 
reasonable basis for my opinion.

In my opinion, the financial statements referred to above present fairly, in 
all material respects, the financial position of Lee Pharmaceuticals as of 
September 30, 1998, and the results of its operations and its cash flows for 
each of the years in the two-year period ended September 30, 1998, in 
conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the 
Company will continue as a going concern. As more fully described in Note 1 
to the financial statements ("Continued Existence"), the Company's current 
and recurring past losses from operations, fiscal 1997's nominal profit, and 
inability to generate sufficient cash flow from normal operations raise 
substantial doubt about its ability to continue as a going concern. 
Management's plans in regard to these matters are also described in Notes 1 
and 15. The financial statements do not include any adjustments to reflect 
the possible future effects on the recoverability and classification of 
assets or the amounts and classification of liabilities that may result from 
the possible inability of the Company to continue as a going concern.

As discussed in Note 10, "Commitments and Contingencies - Assessment for 
environmental cleanup," the Company is attempting to quantify its cleanup 
cost liability, however, the ultimate outcome of this liability cannot 
presently be determined.

                                           GEORGE BRENNER

                                           George Brenner, CPA
December 9, 1998
Beverly Hills, California

<PAGE>

                                      13

                             LEE PHARMACEUTICALS

                                BALANCE SHEET

                             SEPTEMBER 30, 1998

                                   ASSETS
<TABLE>
<S>                                                                                                       <C>
CURRENT ASSETS:
   Cash............................................................................................       $    42,000
   Accounts receivable, less allowance for doubtful accounts of $38,000
     and sales returns allowance of $141,000.......................................................           894,000
   Due from related party..........................................................................           251,000
   Inventories.....................................................................................         2,122,000
   Prepaid royalties...............................................................................           132,000
   Deposits........................................................................................           229,000
   Other current assets............................................................................           142,000
                                                                                                          -----------
     TOTAL CURRENT ASSETS..........................................................................         3,812,000
                                                                                                          -----------
PROPERTY, PLANT AND EQUIPMENT, AT COST:
   Land............................................................................................            49,000
   Building........................................................................................           217,000
   Machinery and equipment.........................................................................         6,017,000
   Leasehold improvements..........................................................................           375,000
                                                                                                          -----------
                                                                                                            6,658,000
   Less accumulated depreciation and amortization..................................................        (6,174,000)
                                                                                                          -----------
     NET PROPERTY, PLANT AND EQUIPMENT.............................................................           484,000
                                                                                                          -----------
INTANGIBLE AND OTHER ASSETS, net of accumulated amortization of $5,791,000.........................         2,167,000
                                                                                                          -----------
TOTAL..............................................................................................       $ 6,463,000
                                                                                                          -----------
                                                                                                          -----------
                                   LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
   Bank overdraft..................................................................................       $    86,000
   Notes payable...................................................................................           815,000
   Current portion - notes payable, other (long-term)..............................................           582,000
   Current portion - royalty agreements............................................................           132,000
   Current portion - note payable related party....................................................           375,000
   Accounts payable................................................................................         1,058,000
   Accrued royalties...............................................................................           289,000
   Accrued liabilities.............................................................................           366,000
   Environmental cleanup liability.................................................................           289,000
   Due to related parties..........................................................................           474,000
   Deferred income.................................................................................            65,000
                                                                                                          -----------
     TOTAL CURRENT LIABILITIES.....................................................................         4,531,000

LONG-TERM NOTES PAYABLE TO RELATED PARTIES.........................................................         2,939,000
LONG-TERM NOTES PAYABLE, other.....................................................................         1,016,000
DEFERRED INCOME....................................................................................            76,000
                                                                                                          -----------
     TOTAL LIABILITIES.............................................................................         8,562,000
                                                                                                          -----------
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' DEFICIENCY:
   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.............................................................................        (6,734,000)
                                                                                                          -----------
     TOTAL STOCKHOLDERS' DEFICIENCY................................................................        (2,099,000)
                                                                                                          -----------
TOTAL..............................................................................................       $ 6,463,000
                                                                                                          -----------
                                                                                                          -----------
</TABLE>
    The accompanying notes are an integral part of the financial statements.

<PAGE>

                                      14

                            LEE PHARMACEUTICALS

                         STATEMENTS OF OPERATIONS

                     FOR THE YEARS ENDED SEPTEMBER 30,

<TABLE>
<CAPTION>
                                                                        1998             1997
                                                                        ----             ----
<S>                                                                  <C>              <C>
GROSS REVENUES................................................       $9,059,000       $9,675,000
   Less: Sales returns, discounts and allowances..............         (807,000)        (860,000)
                                                                     ----------       ----------

NET REVENUES..................................................        8,252,000        8,815,000
                                                                     ----------       ----------

COSTS AND EXPENSES:
   Cost of sales..............................................        3,839,000        3,820,000
   Selling and advertising....................................        3,472,000        3,373,000
   General and administrative.................................        1,399,000        1,126,000
                                                                     ----------       ----------

TOTAL COSTS AND EXPENSES......................................        8,710,000        8,319,000
                                                                     ----------       ----------

OPERATING (LOSS) INCOME.......................................         (458,000)         496,000
INTEREST EXPENSE..............................................         (602,000)        (550,000)
GAIN ON SALE OF BUILDINGS AND OTHER...........................           65,000           65,000
OTHER INCOME..................................................            7,000           18,000
                                                                     ----------       ----------

NET (LOSS) INCOME.............................................       $ (988,000)      $   29,000
                                                                     ----------       ----------
                                                                     ----------       ----------
PER  SHARE:
   Net (loss) income..........................................       $     (.24)      $      .01
                                                                     ----------       ----------
                                                                     ----------       ----------
</TABLE>

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

                                       15


                               LEE PHARMACEUTICALS

                STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY

                        FOR THE YEARS ENDED SEPTEMBER 30,
<TABLE>
<CAPTION>
                                           Common Stock                            Retained
                                           ------------           Additional       Earnings
                                    Number of                       Paid-in      (Accumulated
                                     Shares         Amount          Capital         Deficit)            Total
                                     ------         ------          -------         -------             -----
<S>                                <C>            <C>             <C>              <C>               <C>
Balance at September 30, 1996      4,135,162      $  413,000      $ 4,222,000      $(5,775,000)      $(1,140,000)

Net income                                                                              29,000            29,000
                                   ---------      ----------      -----------      -----------       -----------
Balance at September 30, 1997      4,135,162      $  413,000      $ 4,222,000      $(5,746,000)      $(1,111,000)

Net (loss)                                                                            (988,000)         (988,000)
                                   ---------      ----------      -----------      -----------       -----------
Balance at September 30, 1998      4,135,162      $  413,000      $ 4,222,000      $(6,734,000)      $(2,099,000)
                                   ---------      ----------      -----------      -----------       -----------
                                   ---------      ----------      -----------      -----------       -----------
</TABLE>


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


<PAGE>

                                       16

                               LEE PHARMACEUTICALS

                            STATEMENTS OF CASH FLOWS

                        FOR THE YEARS ENDED SEPTEMBER 30,
<TABLE>
<CAPTION>
                                                                                            1998              1997
                                                                                            ----              ----
<S>                                                                                 <C>                   <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net (loss) income.........................................................       $      (988,000)      $        29,000
                                                                                    ---------------       ---------------
   Adjustments to reconcile net income (loss) to net
    cash provided by operating activities:
   Depreciation..............................................................               119,000               113,000
   Amortization of intangibles...............................................               922,000             1,416,000
   (Decrease) in deferred income ............................................               (65,000)              (65,000)
   (Gain) on disposal of property, plant and equipment.......................                (7,000)              (17,000)
Change in operating assets and liabilities:
   Decrease (increase) in accounts receivable................................               409,000              (191,000)
   (Increase) in due from related party......................................              (143,000)              (35,000)
   (Increase) decrease in inventories........................................              (142,000)              318,000
   Decrease (increase) in other current assets...............................               669,000               (22,000)
   Increase (decrease) in notes payable......................................                99,000              (150,000)
   Increase (decrease) in accounts payable...................................                38,000              (624,000)
   Increase in due to related parties........................................                69,000                57,000
   Increase in accrued and environmental cleanup liabilities.................                79,000               266,000
   (Decrease) in accrued royalties...........................................              (535,000)              (69,000)
                                                                                    ---------------       ---------------
   Total adjustments.........................................................             1,512,000               997,000
                                                                                    ---------------       ---------------
     Net cash provided by operating activities...............................               524,000             1,026,000
                                                                                    ---------------       ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Additions to property, plant and equipment................................               (94,000)              (77,000)
   Proceeds from sale of equipment...........................................                13,000                17,000
   Acquisition of product brands.............................................               (80,000)             (260,000)
   Increase in long-term deposits............................................               (14,000)                    -
                                                                                    ---------------       ---------------
     Net cash (used in) investing activities.................................              (175,000)             (320,000)
                                                                                    ---------------       ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   (Payments on) notes payable to related party..............................                (5,000)                    -
   Net (decrease) in notes payable-other.....................................               (84,000)             (170,000)
   Net (decrease) in long-term royalty agreements............................              (121,000)             (660,000)
   (Decrease) increase in bank overdraft.....................................              (123,000)              137,000
                                                                                    ----------------      ---------------
     Net cash (used) by financing activities.................................              (333,000)             (693,000)
                                                                                    ---------------       ---------------
NET INCREASE IN CASH.........................................................                16,000                13,000
Cash, beginning of year......................................................                26,000                13,000
                                                                                    ---------------       ---------------

Cash, end of year............................................................       $        42,000       $        26,000
                                                                                    ---------------       ---------------
                                                                                    ---------------       ---------------
               SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Cash paid during the year for:
   Interest..................................................................       $       508,000       $       524,000
                                                                                    ---------------       ---------------
                                                                                    ---------------       ---------------
Acquisition of product brands:
   Fair value of assets acquired.............................................       $       270,000       $     1,403,000
   Fair value of liabilities incurred........................................              (190,000)           (1,143,000)
                                                                                    ---------------       ---------------
     Net cash payments.......................................................       $        80,000       $       260,000
                                                                                    ---------------       ---------------
                                                                                    ---------------       ---------------
</TABLE>
       The accompanying notes are an integral part of the financial statements.
<PAGE>

                                      17

                            LEE PHARMACEUTICALS
                       NOTES TO FINANCIAL STATEMENTS

NOTE 1 -  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

          DESCRIPTION OF BUSINESS

          The Company manufactures and markets consumer products to national and
          regional retailers of varying financial strength. The Company also
          manufactures and sells dental products to dental service providers
          principally in the United States. For all years presented, sales,
          operating results and identifiable assets of the consumer products
          group were in excess of 91% of total company operations.

          CONTINUED EXISTENCE

          The financial statements have been prepared assuming the Company will
          continue as a going concern. The Company has an accumulated deficit of
          $6,734,000. The Company's recurring losses from operations and
          inability to generate sufficient cash flow from normal operations to
          meet its obligations as they come due raise substantial doubt about
          the Company's ability to continue as a going concern. The Company's
          ability to continue in existence is dependent upon future
          developments, including retaining current financing and achieving a
          level of profitable operations sufficient to enable it to meet its
          obligations as they become due. Management's plans in regard to these
          matters are described in Note 15 - "Subsequent Events." The financial
          statements do not include any adjustments to reflect the possible
          future effects of the recoverability and classification of assets or
          the amounts and classification of liabilities that may result from the
          possible inability of the Company to continue as a going concern.

          INVENTORIES

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

          DEPRECIATION AND AMORTIZATION

          Property, plant and equipment are depreciated using the straight-line
          method over estimated useful lives of three to ten years for machinery
          and equipment and building improvements and thirty-one years for the
          building. Leasehold improvements are amortized over the shorter of the
          estimated useful lives of the assets or the related lease term.

          Royalties are amortized ($800,000 for fiscal year 1998) over the
          maximum period of the royalty agreement. All other intangibles are
          amortized ($649,000 for fiscal year 1998) over estimated useful lives
          which range from six (6) to forty (40) years.

          ENVIRONMENTAL EXPENDITURES

          Environmental expenditures that relate to an existing condition caused
          by past operations, and which do not contribute to current or future
          revenue generation, are expensed. The Company's proportionate share of
          the liabilities are recorded when environmental remediation and/or
          cleanups are probable, and the costs can be reasonably estimated. A
          provision of $122,000 has been accrued for in fiscal 1998. In
          addition, $79,000 has been provided in fiscal 1998 for the Monterey
          Site. Management believes that the total amount provided at September
          30, 1998 for remedial cost studies is adequate based on current
          information available. See Note 10 - "Assessment for environmental
          cleanup."

          MAJOR CUSTOMER

          The Company had one major customer with sales volume approximating 9%
          and 14% of the Company's net revenues for the years ending September
          30, 1998, and 1997, respectively. The amount due from the customer was
          $180,000 and $542,000 at September 30, 1998, and 1997, respectively,
          and is included in accounts receivable in these financial statements.

          CONCENTRATION OF CREDIT RISK

          Financial instruments which potentially subject the Company to
          concentrations of credit risk consist of cash and trade receivables.
          The Company places its cash with high credit quality financial
          institutions. At times such investments may be in excess of the FDIC
          limit. In regards to trade receivables, the risk is limited due to the
          large number of customers comprising the customer base, and the
          dispersion in different industries and geographies. Generally, the
          Company does not require collateral for its trade receivables.

          INCOME TAXES

          Income taxes are provided based on earnings reported for financial
          statement purposes. In accordance with FASB Statement No. 109, the
          asset and liability method requires the recognition of deferred tax
          liabilities and assets for the expected future tax consequences of
          temporary differences between tax basis and financial reporting basis
          of assets and liabilities.

          USE OF ESTIMATES

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

<PAGE>

                                     18

          FAIR VALUE OF FINANCIAL INSTRUMENTS

          Based on borrowing rates currently available to the Company for bank
          loans with similar terms and maturities, the fair value of the
          Company's long-term debt approximates the carrying value. Furthermore,
          the carrying value of all other financial instruments potentially
          subject to valuation risk (principally consisting of accounts
          receivable and accounts payable) also approximates fair value.

          ACCOUNTING FOR STOCK BASED COMPENSATION

          Stock option grants are set at the closing price of the Company's
          common stock on the day prior to the date of grant. Therefore, under
          the principles of APB Opinion No. 25, the Company does not recognize
          compensation expense associated with the grant of stock options. SFAS
          No. 123, "Accounting for Stock-Based Compensation," requires the use
          of option valuation models to provide supplemental information
          regarding options granted after 1994. Pro forma information regarding
          net income and earnings per share shown below was determined as if the
          Company had accounted for its employee stock options under the fair
          value method of that statement.

          The fair value of the options was estimated at the date of grant using
          a Black-Scholes option pricing model with the following weighted
          average assumptions: risk-free interest rates of 6.0%; dividend yields
          of 0% for 1998 and 1997; volatility factors of the expected market
          price of the Company's common stock of 50% for 1998 and 1997; and
          expected life of the options of two years. These assumptions resulted
          in weighted average fair values of $0.08 and $0.09 per share for stock
          options outstanding in 1998 and 1997 respectively.

          The Black-Scholes option valuation model was developed for use in
          estimating the fair value of traded options. The Company's employee
          stock options have characteristics significantly different from those
          of traded options such as vesting restrictions and extremely limited
          transferability.

          For purposes of pro forma disclosures, the estimated fair value of the
          options is amortized over the option vesting periods. The pro forma
          effect on net income for 1998 and 1997 is not representative of the
          pro forma effect on net income in future years because it does not
          take into consideration pro forma compensation expense related to
          grants made prior to 1995. Pro forma information in future years will
          reflect the amortization of a larger number of stock options granted
          in several succeeding years. The Company's pro forma information is as
          follows (in thousands except share data) for years ended September 30:

<TABLE>
<CAPTION>
                                                    1998        1997
                                                    ----        -----
               <S>                                <C>           <C>
               Pro forma net income (loss)        $(1,015)      $2
               Pro forma (loss) per share         $ (0.25)      $0.00
</TABLE>

          Information regarding stock options outstanding as of September 30,
          1998 is included in Note 11 "Stock Options."

NOTE 2 -  NET INCOME (LOSS) PER SHARE

          Net loss per share for fiscal 1998 and net profit per share for fiscal
          1997 are based on 4,135,162 common shares outstanding. Common stock
          equivalents (common stock options) were not considered in the net loss
          per share calculation since the effect is anti-dilutive. For fiscal
          1997 common stock equivalents were not considered in the calculation
          of earnings per share calculation since the effect is immaterial.

NOTE 3 -  INVENTORIES

          Inventories consist of the following at September 30, 1998:

<TABLE>
               <S>                                             <C>
               Raw materials.............................      $2,070,000
               Work-in-process...........................         272,000
               Finished goods............................         275,000
                                                               ----------
                                                                2,617,000
               Allowance for obsolescence................        (495,000)
                                                               ----------
               Total.....................................      $2,122,000
                                                               ----------
                                                               ----------
</TABLE>

NOTE 4 -  INTANGIBLE AND OTHER ASSETS

          The Company acquired certain product lines in 1998 (See Note 14) and
          prior years. Amounts related to these acquisitions were allocated to
          intangible assets. Included in intangible assets at September 30,
          1998, are the following: 

<TABLE>
<CAPTION>
                                                                               Amortization
                                                                  Cost         period (years)
                                                              -----------      --------------
               <S>                                            <C>              <C>
               Goodwill..................................     $ 1,583,000         4 - 40
               Covenants not to compete..................       2,840,000         1 - 5
               Trademark.................................         322,000             5
               Royalty agreements........................       2,802,000         4 - 6
               Other.....................................         411,000         2 - 3
                                                              -----------
               Total.....................................       7,958,000
               Less:  accumulated amortization...........      (5,791,000)
                                                              -----------
               Intangibles - net.........................     $ 2,167,000
                                                              -----------
                                                              -----------
</TABLE>

<PAGE>

                                      19

NOTE 5 -  NOTES PAYABLE - CURRENT

<TABLE>
          <S>                                                                         <C>
          A.  Note payable to bank (accounts receivable financing), secured by
              accounts receivable, equipment, inventories, and certain other
              assets, maximum revolving advance is $1,100,000 (based on
              domestic accounts receivable as defined in the agreement), requires
              minimum monthly interest of $3,000, interest rate is 5% above
              prime rate.  The agreement, as renewed, is for a term of two years
              from May 1998 and is renewable for successive one year periods
              thereafter.                                                             $514,000

          B.  Note payable to bank, secured by inventory, maximum amount of
              term loan is $400,000, requires monthly payments of $11,110,
              interest rate is 6% above prime rate, maturing May 2000.                 250,000

          C.  Note payable to bank, maximum amount of term loan is $440,000,
              secured by the Company's machinery and equipment, requires
              monthly payments of $11,800 including interest at the bank's
              prime rate plus 6%, maturing May 2000.                                    51,000
                                                                                      --------
                                                                                      $815,000
                                                                                      --------
                                                                                      --------
</TABLE>

NOTE 6 -  RELATED PARTY TRANSACTIONS

          In 1991 the Company sold and leased back two of its operating
          facilities in a transaction with its former Chairman. An initial gain
          was recognized and a deferred gain was recorded which is to be
          amortized over the term of the two leases which expire November 2000.
          The amount of deferred gain realized during 1998 and 1997 was $65,000.

          The amounts of rents paid to related parties were $133,000 and
          $133,000 for September 30, 1998, and 1997, respectively.

          During the fiscal year ending September 30, 1998, the total interest
          expensed to related parties (Note 7) was $276,000 out of which
          $182,000 was paid and $472,000 was accrued as of September 30, 1998.

          During the fiscal year ending September 30, 1997, the total interest
          expensed to related parties (Note 7) was $275,000 out of which
          $188,000 was paid and $405,000 was accrued as of September 30, 1997.

NOTE 7 -  NOTES PAYABLE - RELATED PARTIES

<TABLE>
          <S>                                                                             <C>
          A.  Notes payable to related parties, unsecured, bearing interest at bank's
              prime rate (8.5% at September 30, 1998), maturing January 2005.             $     85,000

          B.  Note payable to officer, unsecured, bearing interest at bank's prime
              rate (8.5% at September 30, 1998), principal is maturing and accrued
              interest is payable in January 2005.                                             193,000

          C.  Note payable to officer, unsecured, bearing interest at bank's prime
              rate (8.5% at September 30, 1998), principal is maturing and accrued
              interest is payable in January 2005.                                             150,000

          D.  Note payable to officer, unsecured, bearing interest at bank's prime
              rate (8.5% at September 30, 1998), principal is maturing and accrued
              interest is payable in January 2005.                                             371,000

          E.  Notes payable to related party, secured by product brand, bearing 
              interest at bank's prime rate (8.5% at September 30, 1998), principal 
              is maturing and accrued interest is payable in January 2005.                     400,000

          F.  Note payable to related party, secured by assets of the Company 
              (secondary position) bearing interest at bank's prime rate (8.5% at 
              September 30, 1998), and principal payable based on a twelve (12) year 
              fully amortized schedule commencing March 15, 1997.                            1,440,000

          G.  Notes payable to officer, secured by product brand, bearing interest at 
              bank's prime rate (8.5% at September 30, 1998), principal is maturing 
              and accrued interest is payable in January 2005.                                 250,000

          H.  Note payable to officer, secured by product brand, bearing interest at 
              bank's prime rate (8.5% at September 30, 1998), principal is maturing 
              and accrued interest is payable in January 2005.                                 100,000

          I.  Note payable to officer, unsecured, bearing interest at bank's prime rate
              (8.5% at September 30, 1998), principal is maturing and accrued interest is
              payable in July 1998.                                                             65,000

          J.  Note payable to officer, unsecured, bearing interest at bank's prime rate
              (8.5% at September 30, 1998), principal is maturing and accrued interest is
              payable in January 2005.                                                         250,000
</TABLE>

<PAGE>

                                      20

<TABLE>
          <S>                                                                                   <C>

          K.  Note payable to officer, unsecured, bearing interest at bank's prime 
              rate (8.5% at September 30, 1998), maturing January 2005.                             10,000
                                                                                                ----------
                                                                                                 3,314,000
              Less current portion ($255,000 in arrears)                                          (375,000)
                                                                                                ----------
                                                                                                $2,939,000
                                                                                                ----------
                                                                                                ----------
</TABLE>

NOTE 8 -  NOTES PAYABLE, OTHER - NONCURRENT

<TABLE>
          <S>                                                                                   <C>

          A.  Note payable to seller on acquisition of product brand payable in equal 
              monthly installments of $3,000 principal and interest until September 
              16, 1999. The balance of unpaid principal and accrued interest is payable 
              on October 16, 1999. The interest rate is the highest prime rate during 
              any payment period. The interest rate at September 30, 1998, was 8.5%.            $   43,000

          B.  Note payable to seller on acquisition of product brands (28) payable in 
              equal monthly installments of $19,751, plus interest, until October 1, 
              2000, with any unpaid balance payable November 1, 2000. The interest 
              rate is the highest prime rate during the previous month. The interest 
              rate at September 30, 1998, was 8.5%.                                                474,000

          C.  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 March 2001.  The note is guaranteed by the President
              and former Chairman.                                                                 241,000

          D.  Note payable to seller on acquisition of product brand payable in equal 
              monthly installments of $5,300 plus interest until August 25, 2001, with 
              any unpaid balance payable September 25, 2001.                                       190,000

          E.  Note payable secured by product brands, bearing interest at 20%, interest 
              payable monthly, maturity January 1, 2000. The previous notes were 
              canceled, consolidated and converted into one new note. The terms of the 
              new note require monthly principal payments of $20,000 to be made 
              commencing January 1, 1999.                                                          600,000

          F.  Note payable secured by product brand bearing interest at 20%.  The note, 
              as renewed, matures July 1999.                                                        50,000
                                                                                                ----------
                                                                                                 1,598,000
              Less current portion                                                                (582,000)
                                                                                                ----------
                                                                                                $1,016,000
                                                                                                ----------
                                                                                                ----------
</TABLE>

NOTE 9 -  LONG-TERM DEBT MATURITIES

          At September 30, 1998, the Company was committed to the following
          minimum principal payments.

<TABLE>
<CAPTION>
                YEAR ENDING            RELATED
               SEPTEMBER 30,           PARTIES             OTHERS
               -------------         ----------          ----------
               <S>                   <C>                 <C>
                   1999              $  375,000          $  582,000
                   2000                 120,000             580,000
                   2001                 120,000             267,000
                   2002                 120,000              24,000
                   2003                 120,000              24,000
                Thereafter            2,459,000             121,000
                                     ----------          ----------
                   Total             $3,314,000          $1,598,000
                                     ----------          ----------
                                     ----------          ----------
</TABLE>

NOTE 10 - COMMITMENTS AND CONTINGENCIES

          LEASE COMMITMENTS

          At September 30, 1998, the Company was committed to its Chairman and
          to others under noncancelable operating leases for land and buildings
          requiring minimum annual rentals as follows:

<TABLE>
<CAPTION>
                YEAR ENDING
               SEPTEMBER 30,         OTHERS          CHAIRMAN
               -------------        --------         ---------
               <S>                  <C>              <C>

                  1999              $391,000          $134,000
                  2000               391,000           134,000
                  2001                65,000           134,000
                  2002                     -           134,000
                  2003                     -           134,000
               Thereafter                  -           290,000
                                    --------          --------
                 Total              $847,000          $960,000
                                    --------          --------
                                    --------          --------
</TABLE>

<PAGE>

                                      21


          Generally, the leases provide that maintenance, insurance and a
          portion of property taxes are to be paid by the Company. The Company
          also has a right of first refusal to acquire most of the buildings
          which it leases. The Company's rental expense for the years ended
          September 30, 1998, and 1997, was $521,000 and $521,000, respectively.

          Some of the above leases are subleased to other companies. Two of the
          three subleases are long term with annual rental revenues as follows:

<TABLE>
<CAPTION>
                             YEAR ENDING          SUBLEASE
                            SEPTEMBER 30,         REVENUES
                            ------------          ---------
                            <S>                   <C>
                                1999              $ 97,600
                                2000                97,600
                                2001                16,300
                                2002                     -
                                                  --------

                                Total             $211,500
                                                  --------
                                                  --------
</TABLE>

          ASSESSMENT FOR ENVIRONMENTAL CLEANUP

          The Company owns a manufacturing facility located in South El Monte,
          California. The California Regional Water Quality Control Board (The
          "RWQCB") ordered the Company in 1988 and 1989 to investigate the
          contamination on its property (relating to soil and groundwater
          contamination). The Company engaged a consultant who performed tests
          and reported to the then Chairman of the Company. The Company resisted
          further work on its property 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 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
          subsequent investigations will support the Company's conclusions about
          that estimate. The Company 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 take
          appropriate action. At the EPA's request, Ecology & Environment, Inc.
          conducted an investigation of soil and groundwater on the Company's
          property. Ecology & Environment Inc.'s Final Site Assessment Report,
          which was submitted to the EPA in June 1994, did not rule out the
          possibility that some of the contamination originated on-site, and
          resulted from either past or current operations on the property. The
          Company may be liable for all or part of the costs of re mediating the
          contamination on its property. The EPA has not taken any further
          action in this matter, but may do so in the future.

          The Company and nearby property owners, in consort with their
          comprehensive general liability (CGL) carriers, have engaged a
          consultant to perform a site investigation with respect to soil and
          shallow groundwater contamination over the entire city block. The CGL
          carriers provided $290,000 in funding 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 of the earlier quote of $175,000. Since
          that time, the overall scope of the project 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 entire cost was borne by the CGL carriers), but remains on the
          books as an accrual against the cost of remediation of the same site
          that was included in the study.

          The tenants of nearby properties upgradient have sued the Company
          alleging that hazardous materials from the Company's property caused
          contamination on the properties leased by the tenants. The case name
          is DEL RAY INDUSTRIAL ENTERPRISES, INC. v. ROBERT MALONE, ET AL., Los
          Angeles County Superior Court, Northwest District, commenced August
          21, 1991. In this action, the plaintiff alleges environmental
          contamination by defendants of its property, and seeks a court order
          preventing further contamination and monetary damages. The Company
          does not believe there is any basis for the allegations and is
          vigorously defending the lawsuit.

          The Company's South El Monte manufacturing facility is also located
          over a large area of possibly contaminated regional groundwater which
          is part of the San Gabriel Valley Superfund site. The Company has been
          notified that it is a potentially responsible party ("PRP") for the
          contamination. In 1995, the Company was informed that the EPA
          estimated the cleanup costs for the South El Monte's portion of the
          San Gabriel Valley Superfund site to be $30 million. The Company's
          potential share of such amount has not been determined. Superfund PRPs
          are jointly and severally liable for superfund site costs, and are
          responsible for negotiating among themselves the allocation of the
          costs based on, among other things, the outcome of environmental
          investigation.

          In August 1995 the Company was informed that the EPA entered into an
          Administrative Order of Consent with Cardinal Industrial Finishes
          ("Cardinal") for a PRP lead remedial investigation and feasibility
          study (the "Study") which, the EPA states, will both characterize the
          extent of groundwater contamination in South El Monte and analyze
          alternatives to control the spread of contamination. The Company and
          others have entered into the South El Monte Operable Unit Site
          Participation Agreement with Cardinal pursuant to which, among other
          things, Cardinal will contract with an environmental firm to conduct
          the Study. The Study has been completed but the final program has not
          been reported. The Company's share of the cost of the Study is
          currently $15,000 and was accrued for in the financial statements as
          of September 30, 1995.

<PAGE>

                                     22


          The City of South El Monte, the city in which the Company has its
          manufacturing facility, is located in the San Gabriel Valley. The San
          Gabriel Valley has been declared a Superfund site. The 1995 Water
          Quality Control Plan issued by the California Regional Water Quality
          Control Board states that the primary groundwater basin pollutants in
          the San Gabriel Valley are volatile organic compounds from industry,
          nitrates from subsurface sewage disposal and past agricultural
          activities. In addition, the Plan noted that hundreds of underground
          storage tanks leaking gasoline and other toxic chemicals have existed
          in the San Gabriel Valley. The California Department of Toxic
          Substance Control have declared large areas of the San Gabriel Valley
          to be environmentally hazardous and subject to cleanup work.

          The Company believes the City of South El Monte does not appear to be
          located over any of the major plumes. However, the EPA recently
          announced it is studying the possibility that, although the vadose
          soil and groundwater, while presenting cleanup problems, there may be
          a contamination by DNAPs (dense non-aqueous phase liquids), i.e.,
          "sinkers", usually chlorinated organic cleaning solvents. The EPA has
          proposed to drill six "deep wells" throughout the City of South El
          Monte at an estimated cost of $1,400,000. The EPA is conferring with
          SEMPOA (South El Monte Property Owners Association) as to cost sharing
          on this project. SEMPOA has obtained much lower preliminary cost
          estimates. The outcome cost and exact scope of this are unclear at
          this time.

          The Company and other property owners engaged Geomatrix Consultants,
          Inc., to do a survey of vadose soil and shallow groundwater in the
          "hot spots" detected in the previous studies. Geomatrix issued a
          report dated December 1, 1997 (the "Report"), on the impact of
          volatile organic compounds on the soil and groundwater at the Lidcombe
          and Santa Anita Avenue site located in South El Monte, California
          (which includes the Company's facilities). The Report indicated
          generally low concentrations of tetrachloroethene, trichloaethene and
          trichloroethane in the groundwater of the upgradient neighbor. The
          Report was submitted to the RWQCB for its comments and response. A
          meeting with the parties and RWQCB was held on February 10, 1998. The
          RWQCB had advised companies that vadose soil contamination is minimal
          and requires no further action. However, there is an area of shallow
          groundwater which has a higher than desired level of chlorinated
          solvents, and the RWQCB requested a proposed work plan be submitted by
          Geomatrix. Geomatrix has submitted a "Focused Feasibility Study" which
          concludes that there are five possible methods for cleanup. The most
          expensive are for a pump and sewer remediation which would cost
          between $1,406,000 and $1,687,000. The Company is actively exploring
          the less expensive alternative remediation methods, of which the two
          proposed alternatives range in cost between $985,000 and $1,284,000.
          Accordingly, the Company has taken the average of the two amounts
          ($985,000 and $1,284,000) as the total amount of estimated cost. Since
          there are four economic entities involved, the Company's best estimate
          at this time, in their judgment, would be that their forecasted share
          would be 25% or $284,000 less the liability already recognized on the
          books of $162,000 thereby requiring an additional $122,000 liability.
          Accordingly, the Company recorded an additional accrual of $122,000 in
          the third quarter of fiscal 1998. The $122,000 accrual is in addition
          to the $79,000 accrual for the Monterey Site as will be explained in
          the following paragraph. The $79,000 accrual, in the third quarter of
          fiscal 1998, related to the Monterey Site is not included in the
          $284,000 figure above. No assurances can be given that any of the
          alternative remediation methods will be feasible or that the actual
          cost to the Company of the remediation will not exceed the amount of
          the Company's current accruals of $284,000 (which includes the
          $122,000 charge to income in the third quarter of fiscal 1998).

          Without any prior correspondence or inkling of the Company's potential
          liability, the EPA has recently informed the Company that the Company
          may have potential liability for the ongoing remediation of Operating
          Industries, Inc. (as they have gone out of business) Landfill
          Superfund Site in Monterey Park, California (the "Monterey Site"). The
          Monterey Site is a 190 acre landfill that operated from 1948 to 1984,
          in which the Company disposed of non toxic pH balanced waste water on
          six occasions between 1974 and 1978. Over 4,000 companies have been
          identified as having contributed waste to the Monterey Site. The EPA
          has offered to settle the Company's potential liability with respect
          to the Monterey Site for a cost to the Company of $79,233. The Company
          accrued a $79,000 charge in the third quarter of fiscal 1998 with
          respect to this possible liability. The Company has elected to file
          for relief from these obligations under the financial hardship option
          in the EPA's response form.

          The total amount of environmental investigation and cleanup costs that
          the Company may incur with respect to the foregoing is not known at
          this time. However, based upon information available to the Company at
          this time, the Company has expensed since 1988 a total of $486,000, of
          which $89,000 were legal fees, exclusive of legal fees expended in
          connection with the SEC environmental investigation. The actual costs
          could differ materially from the amounts expensed for environmental
          investigation and cleanup costs to date.

NOTE 11 - STOCK OPTIONS

          Under the Company's 1985 Employee Incentive Stock Option Plan, as
          amended, common stock options may be granted to officers and other key
          employees for the purchase of up to a total of 580,000 shares of
          common stock of the Company at a price per share equal to its fair
          market value on the date of grant. Options expire five years from the
          date of grant, are contingent upon continued employment and become
          exercisable in equal installments during each of the three years
          beginning eighteen months after the date of grant.

<PAGE>

                                      23


          The following table sets forth the number of shares under option and
          the related option prices at September 30, 1997, and 1998:

<TABLE>
<CAPTION>
                                                                                      OPTION PRICE RANGE
                                                                         NUMBER            PER SHARE
                                                                        -------      -------------------
          <S>                                                           <C>          <C>
          Outstanding at September 30, 1996 and 1997..............      205,500        $0.50 -- $1.3125
              Canceled............................................            0
                                                                        -------
          Outstanding at September 30, 1998.......................      205,500        $0.50 -- $1.3125
                                                                        -------
                                                                        -------
</TABLE>

          At September 30, 1998, 167,700 shares are eligible to be exercised. No
          additional options can be granted under this plan.

          The 1987 Stock Option Plan was adopted by the Board of Directors on
          January 4, 1988, and was approved by the Company's shareholders on
          March 8, 1988. This Stock Option Plan provides for the granting of
          options to the Company's outside directors for the purchase of a total
          of 50,000 shares of common stock of the Company at a price per share
          equal to the fair market value on the date of grant. Options expire
          five years from the date of grant and become exercisable in equal
          installments during each of the three years beginning eighteen months
          after the date of grant.

          At September 30, 1998, options to purchase 16,600 shares were
          outstanding and 14,900 shares are eligible to be exercised at an
          average price of $1.13 per share. No additional options can be granted
          under this plan.

          The 1997 Employee Incentive Stock 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
          Plan provides for the granting of options to selected officers and key
          employees of the Company for the purchase of a total of 980,000 shares
          of common stock of the Company at a price per share equal to the fair
          market value on the date of grant. Options expire five years from the
          date of grant.

          Only incentive stock options may be granted under the Employee
          Incentive Stock Option Plan. The price per share of the shares subject
          to each option shall not be less than 100% of the fair market value of
          such stock on the date the stock option is granted. Stock options
          shall not be exercisable until one and one-half years from the date of
          grant. Commencing eighteen (18), thirty (30), and forty-two (42)
          months, respectively, after the date of grant, an option may be
          exercised to the extent of one third of the total number of shares to
          which it relates. Upon a change in control of the Company (as
          defined), all stock options granted to any optionee will become fully
          exercisable. Any stock option granted to an employee who at the time
          the option is granted, owns stock representing more than ten percent
          (10%) of the total combined voting power of all classes of stock of
          the Company, will be granted at a price equal to one hundred and ten
          percent (110%) of the fair market value determined as of the date the
          stock option is granted. The Employee Incentive Stock Option Plan will
          expire on December 31, 2006.

          The following table sets forth the number of shares under option and
          the related option price at September 30, 1998:

<TABLE>
<CAPTION>
                                                                                      OPTION PRICE RANGE
                                                                         NUMBER            PER SHARE
                                                                        -------      -------------------
          <S>                                                           <C>          <C>
          Outstanding at September 30, 1997.......................      768,000        $.16-- $.176
              Granted.............................................      212,000        $.22
                                                                        -------

          Outstanding at September 30, 1998.......................      980,000        $.16-- $.22
                                                                        -------
                                                                        -------
</TABLE>

          As of September 30, 1998, options to purchase 980,000 shares were
          outstanding and 256,000 shares are eligible to be exercised at an
          average price of $.17 per share under the 1997 Employee Incentive
          Stock Option Plan. No additional options can be granted under this
          plan.

          The 1997 Stock 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. This Stock Option Plan provides for the granting of
          options to the Company's outside directors for the purchase of a total
          of 150,000 shares of common stock of the Company at a price per share
          equal to the fair market value on the date of grant. Options expire
          five years from the date of grant.

          Only nonqualified stock options may be granted under the 1997 Stock
          Option Plan. The price per share of the shares subject to each option
          shall not be less than 100% of the fair market value of such stock on
          the date the stock option is granted. Stock options shall not be
          exercisable until one and one-half years from the date of grant.
          Commencing eighteen (18), thirty (30) and forty-two (42) months,
          respectively, after the date of grant, an option may be exercised to
          the extent of one third of the total number of shares to which it
          relates. Upon a change in control of the Company (as defined), all
          stock options granted to any optionee will become fully exercisable.
          The 1997 Stock Option Plan will expire on December 31, 2006.

<PAGE>

                                     24


          The following table sets forth the number of shares under option and
          the related option price at September 30, 1998:

<TABLE>
<CAPTION>
                                                                                      OPTION PRICE RANGE
                                                                         NUMBER            PER SHARE
                                                                        -------      -------------------
          <S>                                                           <C>          <C>
          Outstanding at September 30, 1997.......................      150,000          $.16
              Granted.............................................            0
                                                                        -------
          Outstanding at September 30, 1998.......................      150,000          $.16
                                                                        -------
                                                                        -------
</TABLE>

          At September 30, 1998, 50,000 shares are eligible to be exercised
          under the 1997 Stock Option Plan. There are no shares available for
          future grant under the plan as of September 30, 1998.

NOTE 12 - INCOME TAXES

          As of September 30, 1998, the Company had net operating loss (NOL)
          carryforwards of approximately $9,604,000 for Federal and $3,930,000
          for California which for tax purposes can be used to offset future
          Federal and California income taxes. The differences in the state
          carryforwards relate primarily to the treatment of loss carryforwards
          and depreciation of property, plant and equipment. The carryforwards
          expire from 2007 through 2013. The Company has provided an allowance
          for the entire amount of the deferred asset applicable to the NOL.

NOTE 13 - EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

          The Company established an Employee Stock Ownership Plan and Trust
          ("Plan") effective December 1, 1985. The Plan is a tax-qualified
          employee stock ownership plan which is designed to invest primarily in
          the common stock of the Company for the benefit of the employees and
          their beneficiaries.

          The benefits provided by the Plan are paid for entirely by the
          Company. The Company contributions are used to purchase the common
          stock of the Company which is credited to the individual accounts
          maintained for each participant. For each twelve-consecutive-month
          period of employment, employees receive a one-year period of service
          credit. After three years of service employees have a 20% vested
          interest in their accounts under the Plan, increasing at a rate of 20%
          per year with full vesting occurring at seven years of service.

          The Plan consists of a stock bonus plan, ("Plan A") and a money
          purchase pension plan, ("Plan B"). Under Plan A, the Company's Board
          of Directors annually determines the amount to be contributed to the
          Plan. The contribution by the Company for any single plan year
          (October 1 through September 30) cannot exceed fifteen percent (15%)
          of the total compensation paid to Plan participants for the year. Plan
          B requires an automatic contribution equal to ten percent (10%) of
          participant compensation each Plan Year. The Company did not make any
          contributions (expense) related to Plan A for the year ending
          September 30, 1996, or September 30, 1995.

          Effective June 30, 1993, Plan B was terminated; therefore, there was
          no contribution under Plan B for the year ended September 30, 1996, or
          for the period October 1, 1994, through September 30, 1995. All
          participants under Plan B became 100% vested on July 1, 1993, due to
          the termination of Plan B.

          Effective September 30, 1995, Plan A was terminated. All participants
          under Plan A became 100% vested on September 30, 1995, due to the
          termination of Plan A.

          In November 1996 the Company received its final determination letter
          from the Internal Revenue Service. During fiscal 1997 all participants
          account balances have been distributed by the Company except for a few
          former participants account balances of less than $100 in the
          aggregate.

NOTE 14 - ACQUISITIONS

          On October 16, 1996, the Company purchased certain assets of the
          Vince-Registered Trademark- mouthwash rinse and Perma-Grip-Registered
          Trademark-denture adhesive line from Lactona Corporation for $175,000.
          The Company remitted $75,000 at closing and is required to make
          monthly payments of $3,000, including interest at prime, commencing
          November 16, 1996, and ending September 16, 1999. Lastly, one final
          payment of any remaining principal and accrued interest is payable on
          October 16, 1999.

          On October 21, 1996, the Company purchased certain assets from Roberts
          Laboratories for $1,048,089. The Company remitted $100,000 at closing
          and is required to make monthly payments of $19,751 plus interest at
          prime beginning November 1, 1996, and ending October 1, 2000. In
          addition, the Company purchased certain inventories from Roberts
          Laboratories for $193,000.

          On September 8, 1997, the Company purchased certain assets of the
          Klutch-Registered Trademark- denture adhesive powder line from I.
          Putnam, Inc. for $320,000. The Company remitted $225,000 at closing
          and is required to make one payment of $7,000 plus interest, and
          eleven equal monthly payments of $8,000, plus interest at the prime
          rate. In addition, the Company purchased certain inventories from I.
          Putnam, Inc., for $51,063 at closing.

<PAGE>

                                       25


          On February 17, 1998, the Company purchased certain assets of the
          Painalay-Registered Trademark- throat spray line from Medtech
          Laboratories, Inc. for $70,000. The Company is required to make five
          payments of $14,000 each plus interest at 10% starting 61 days after
          the close. In addition, the Company purchased for cash inventory
          valued at $27,764.

          On September 28, 1998, the Company purchased certain assets of the
          Evac-U-Gen-Registered Trademark- brand of laxatives from Walker, Corp.
          & Co., Inc. for $234,000. The Company remitted $100,000 at closing and
          is required to make monthly payments of $5,300, plus interest,
          beginning November 25, 1998 and ending September 25, 2001. This note
          is personally guaranteed by the Company's Chairman. The interest rate
          is equal to the highest prime rate during any one period. In addition,
          the Company purchased certain inventories from Walker, Corp. & Co.,
          Inc. for $54,500 at closing.

NOTE 15 - SUBSEQUENT EVENTS (UNAUDITED)

          The Company has completed its financial obligation regarding an annual
          minimum royalty commitment of $500,000. In addition, the Company has
          borrowed funds to acquire other product lines which management
          believes will be profitable contributors to the Company's overall
          financial situation. The amount of borrowed funds is in the form of a
          promissory note. The $500,000 promissory note requires monthly
          payments of $14,000 each plus interest at 15%, commencing January 1,
          1999 and continuing until November 1, 2001, plus one payment of all
          remaining principal, plus interest, on December 1, 2001. This note is
          personally guaranteed by the Company's Chairman. Management believes
          that from actions such as the aforementioned, it will be able to meet
          its obligations as they become due. However, there can be no assurance
          that this will occur.

NOTE 16 - FOURTH QUARTER RESULTS (UNAUDITED)

          The Company's unaudited operating loss for the fourth quarter, ended
          September 30, 1998, was $129,000. The Company's average loss over the
          prior three quarters, during fiscal 1998, was approximately $287,000.
          The fourth quarter loss of $129,000 was comparatively lower due to the
          cost cutting measures the Company adopted in June 1998 by laying off
          several permanent and/or temporary employees.

          On October 1, 1998, the Company purchased certain assets from Roberts
          Pharmaceutical Corporation for $685,000. The Company remitted $600,000
          at closing and is required to make monthly payments of $3,538 plus
          interest at a rate equal to the highest prime rate (published in the
          Wall Street Journal) during the preceding month commencing January 1,
          1999 and ending on November 1, 2000, and a final payment of all
          remaining principal due on December 1, 2000. In addition, the Company
          purchased certain inventories valued at approximately $184,000 at
          closing.

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

     Not applicable
<PAGE>
                                      26

PART   III

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

     Directors are elected to serve until the next annual stockholders' 
meeting or until their respective successors have been elected and qualified 
or as otherwise provided in the bylaws. Set forth below for the current 
directors and executive officers are their ages, principal occupations during 
the past five years, and the period during which they have served as a 
director or officer of the Company.
<TABLE>
<CAPTION>
                                                       A DIRECTOR
                                 POSITIONS HELD        OR OFFICER      PRINCIPAL OCCUPATION
NAME                    AGE      WITH COMPANY          SINCE           DURING THE PAST FIVE YEARS (1)
----                    ---      ------------          -----           ------------------------------
<S>                     <C>      <C>                   <C>             <C>
Dr. Henry L. Lee         72     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            46     President, Chairman    1977       President and since April 1995, Chairman of
                                and Director                      the Board of the Company

Michael L. Agresti       56     Vice President -       1977       Vice President - Finance, Treasurer and 
                                Finance, Treasurer                Secretary of the Company
                                and Secretary

William M. Caldwell IV   51     Director               1987       President of Union Jack Group, a merchant
                                                                  banking firm
</TABLE>

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

FAMILY RELATIONSHIPS

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


<PAGE>

                                       27

ITEM 10.  EXECUTIVE COMPENSATION.

     The following table sets forth information with respect to remuneration
paid by the Company to the executive officers of the Company with total annual
salary and bonus of at least $100,000 for services in all capacities while
acting as officers and directors of the Company during the fiscal years ended
September 30, 1998, 1997, and 1996.
<TABLE>
<CAPTION>
                                                SUMMARY COMPENSATION TABLE

                                                                             LONG TERM
                                                                           COMPENSATION
                                            ANNUAL COMPENSATION               AWARDS
                                      -------------------------------       -----------
Name and                                                Other Annual                              All Other
Principal Position         Year       Salary ($)      Compensation ($)      Options (#)        Compensation ($)
------------------         ----       ---------       ---------------       -----------        ----------------
<S>                        <C>         <C>               <C>                <C>                      <C>
Ronald G. Lee              1998        222,574           3,471 (1)          212,000 (2)              --
   President, Chairman     1997        220,616           5,617 (1)          568,000 (2)              --
   (since April 26, 1995)  1996        179,624           2,382 (1)             --                    --
   & Director
</TABLE>

(1)  Includes reimbursement of medical and dental expenses not covered by
     the Company's insurance plan of $3,471, $5,617, and $2,382,
     respectively, in 1998, 1997, and 1996.

(2)  The Company granted 212,000 stock options on January 28, 1998 which
     had an option price of $.22 at the date of grant and 568,000 stock
     options on March 12, 1997, which had an option price of $.176 at the
     date of grant.

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



                 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                        AND FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
                          Number of Unexercised Options
                             at Fiscal Year End (#)
                          -----------------------------
Name                        Exercisable/Unexercisable
                          -----------------------------
<S>                               <C>
Ronald G. Lee                     297,666/617,334
</TABLE>

<PAGE>
                                      28

                     EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

     The Company established an Employee Stock Ownership Plan and Trust 
("Plan") effective December 1, 1985. The Plan is a tax-qualified employee 
stock ownership plan which is designed to invest primarily in the common 
stock of the Employer for the benefit of the employees and their 
beneficiaries.

     The benefits provided by the Plan are paid for entirely by the Employer. 
The Employer contributions are used to purchase the common stock of the 
Employer, which is credited to the individual accounts maintained for each 
participant. In addition to providing an opportunity for employees to 
participate in the Employer's growth through stock ownership and to provide 
funds for employees' retirement, the Plan is designed to be available as a 
technique of corporate finance to the Employer.

     All employees who had completed at least a six-month period of service 
with the Employer as of the effective date of this Plan (December 1, 1985) 
became participants in the Plan as of such date. Every other employee will 
become a participant in the Plan as of the first day of the month coinciding 
with or next following the date upon which he completes a six-month period of 
service provided that he is employed by the Employer on such date.

     The Employer makes contributions only on behalf of the participants who 
are employed by it on the last day of each Plan year, September 30. 
Contributions made on behalf of the employees will not be taxable to them 
until the time benefits are actually paid to them.

     Effective October 1, 1989, the Plan consists of two (2) parts: Plan A, a 
stock bonus plan, and Plan B, a money purchase pension plan. The Company's 
Board of Directors determines the amount to be contributed annually to Plan A 
up to a maximum of fifteen percent (15%) participant compensation for the 
Plan year (October 1 through September 30). The contribution under Plan B is 
a non-discretionary amount equal to ten percent (10%) of participant 
compensation for the Plan year. The contribution by the Company to the Trust 
for any single Plan year cannot exceed twenty-five percent (25%) of the total 
compensation paid to Plan participants for the year.

     Company contributions are allocated to each Participant's Company 
Contribution Account in the proportion that his compensation for the Plan 
year bears to the total compensation paid to all participants for the Plan 
year. Forfeitures which arise under Plan A are allocated to the accounts of 
the other participants at the end of the Plan year during which the 
forfeitures arise due to termination of employment in the same manner as 
Company contributions are allocated. Forfeitures which arise under Plan B are 
used to offset the Company's required contribution under Plan B.

     The term "vested" as applied in the context of employee benefit plans 
refers to that portion of a participant's accounts which has become 
nonforfeitable because the participant has accrued a certain number of 
period-of-service credits. If a participant reaches normal retirement age 
(age 65), becomes permanently disabled, dies or retires at age 65, his 
interest in his accounts becomes immediately 100% vested, i.e. nonforfeitable.

     Effective July 1, 1993, the plan was amended for a second time. On June 
30, 1993, Plan B was terminated; therefore, all participants became 100% 
vested, in Plan B only, effective July 1, 1993. No contribution was made to 
Plan A or B for the period October 1, 1993, through September 30, 1994.

     Effective September 30, 1995, Plan A was terminated. All participants 
under Plan A became 100% vested on September 30, 1995, due to the termination 
of Plan A. No contribution was made to Plan A or B for fiscal year 1995 or 
1996. In connection with the termination of Plan A, the Company wrote off the 
Employee Stock Ownership Plan and Trust receivable as of September 30, 1995.

     In November 1996 the Company received its final determination letter 
from the Internal Revenue Service. During fiscal 1998 all participants 
account balances have been distributed by the Company except for a few former 
participants account balances of less than $100 in the aggregate.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     The following table sets forth the persons who, as of November 30, 1998, 
were known to the Company to be beneficial owner of more than five percent of 
the Company's Common Stock:
<TABLE>
<CAPTION>
                             NAME AND ADDRESS                  AMOUNT AND NATURE            PERCENTAGE
TITLE OF CLASS               OF BENEFICIAL OWNER            OF BENEFICIAL OWNERSHIP          OF CLASS
--------------               -------------------            -----------------------         ----------
<S>                          <C>                                <C>                             <C>
Common Stock                 Ronald G. Lee                      1,152,783 shares                26%
                             1444 Santa Anita Avenue
                             South El Monte, CA 91733

Common Stock                 Dr. Henry L. Lee                     197,334 shares (1)             5%
                             1444 Santa Anita Avenue
                             South El Monte, CA 91733
</TABLE>
(1)  Includes 28,000 shares of the Company's common stock which Dr. Lee holds as
     trustee for the benefit of certain family members. He has the right to vote
     such shares but otherwise disclaims beneficial ownership.

<PAGE>
                                      29

     The following table sets forth the ownership of the Company's Common 
Stock by its directors and its named executive officers and all executive 
officers and directors as a group.
<TABLE>
<CAPTION>
                                  NAME OF                      AMOUNT AND NATURE           PERCENTAGE
TITLE OF CLASS               BENEFICIAL OWNER               OF BENEFICIAL OWNERSHIP         OF CLASS
--------------               ----------------               -----------------------         --------
<S>                          <C>                                <C>                           <C>
Common Stock                 Ronald G. Lee                      1,152,783 (1)                 26%
Common Stock                 Dr. Henry L. Lee                     197,334 (2)                  5%
Common Stock                 All officers and directors
                              as a group (4 persons)            1,530,586 (1) (2)             33%
</TABLE>

(1)  Includes shares subject to options exercisable at or within 60 days after
     December 31, 1998.

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

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information regarding borrowings from and sale and leaseback
transactions between the Company and it's Chairman of the Board which is
contained in Item 6 and Note 6 of Notes to Financial Statements is incorporated
herein by this reference.

<PAGE>
                                      30

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

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

     The following exhibit is filed herewith:

          27     -  Financial data schedule

     The following exhibits have previously been filed 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)
<PAGE>
                                      31

         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)


     (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.
<PAGE>
                                      32

     (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 10.33 and 10.34 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 10.35, 10.36, 10.37, and 10.38 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.

(b)  Reports on Form 8-K:
     None
<PAGE>
                                      33

                                   SIGNATURES

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

                               LEE PHARMACEUTICALS


Date:    DECEMBER 23, 1998                 RONALD G. LEE
     --------------------------            -----------------------------------
                                           Ronald G. Lee
                                           Chairman of the Board and President



     In accordance with the Securities Exchange Act of 1934, this report has 
been signed by the following persons on behalf of the registrant and in the 
capacities and on the dates indicated.

Date:     DECEMBER 23, 1998                RONALD G. LEE
     --------------------------            -----------------------------------
                                           Ronald G. Lee
                                           Chairman of the Board & President
                                           (Principal  Executive,  Financial  
                                           and  Accounting  Officer) and
                                           Director

Date:     DECEMBER 23, 1998                HENRY L. LEE, JR.
     --------------------------            -----------------------------------
                                           Henry L. Lee, Jr.
                                           Director

Date:     DECEMBER 23, 1998                WILLIAM M. CALDWELL IV
     --------------------------            -----------------------------------
                                           William M. Caldwell IV
                                           Director