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

**Washington,D.C. 20549**

** **

**FORM 10-KSB**

 

**(MARK ONE)**

 

**ý****        ANNUALREPORT UNDER SECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**FOR THEFISCAL YEAR ENDED SEPTEMBER 30, 2004**

 

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

 

**COMMISSIONFILE NUMBER 1-7335**

 

**LEE PHARMACEUTICALS**

(Name of smallbusiness issuer in its charter)

 
| **CALIFORNIA**                                                     | ** ** | **95-2680312**                        |
|--------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)   |       | (I.R.S. Employer  Identification No.) |
|                                                               |       |                                  |
| **1444  SANTA ANITA AVENUE, SOUTH EL MONTE, CALIFORNIA**           | ** ** | **91733**                             |
| (Address of  principal executive offices)                          |       | (Zip code)                            |
|                                                               |       |                                  |
| ISSUER’S  TELEPHONE NUMBER: **(626) 442-3141**                |
|                                                               |       |                                  |
| **SECURITIES  REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT** |

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

 

SECURITIES REGISTEREDUNDER 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 theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes    ý    No    o

 

Check if disclosure ofdelinquent filers in response to Item 405 of Regulation S-B is not contained inthis form, and no disclosure will be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.  ý

 

State issuer’s revenuesfor its most recent fiscal year: $9,477,000 Gross

 

As of the close ofbusiness on November 29, 2004, the aggregate market value of LeePharmaceuticals’ Common Stock held by nonaffiliates was $214,903.

 

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date.  Common Stock,par value $.10; 4,135,162 shares outstanding as of the close of business onNovember 29, 2004.

 

DOCUMENTS INCORPORATED BYREFERENCE:  NONE

 

 

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**PART I**

 

**ITEM 1.****          DESCRIPTIONOF BUSINESS.**

 

The Company is engagedin the development, purchase, manufacture, and marketing of consumer personalcare products and professional dental products, all of which are targeted forthe improved well-being of the human body. The Company’s business is directed to two main areas:  (a) the development and marketing of a rangeof consumer products including over-the-counter items, health and beauty aids,cosmetics and prescription drug products containing controlled substances and(b) the manufacture and sale of materials and supplies for use in theprofessional dental health field.

 

The Company’s executiveoffices are located at 1444 Santa Anita Avenue, South El Monte, California91733, and its telephone number is (626) 442-3141. The Company was incorporatedin April 1971 as a California corporation.

 

**Consumer products segment**

 

The Company manufacturesand sells lip balm, lip gloss, hair removal products, antacid tablets, nasalcare products, artificial fingernail extenders and related fingernail products,a variety of over-the-counter items and prescription drug products.  The Company participates in cooperativeadvertising with many of its retailers.

 

On March 9, 2002, theCompany acquired Cankaid® (oral antiseptic liquid), Medicone®(hemorrhoidal ointment and suppository) and Sayman® (astringent dryand oily cleansing bars and salve – skin protectant) product lines from MerzPharmaceuticals LLC.

 

On April 5, 2002, theCompany acquired One Step at a Time® (nicotine addiction withdrawalsystem) and lite’n® Up (reusable cigarette filter) product linesfrom Category One Products, L.L.C. Secondly, on April 23, 2002, the Company acquired Unguentine®(first aid antiseptic ointment for burns) and Unguentine® Plus(first aid antiseptic and pain relieving cream) product lines from U.S.Dermatologics, Inc.  In addition, onSeptember 10, 2003, the Company acquired OraStat® (oral anestheticgel) from Stiefel Laboratories, Inc.

 

The Consumer ProductsDivision of the Company continues as the major revenue contributor to theCompany.  In fiscal year 2004, the LeeConsumer Products Division generated in excess of 98% of the revenues of theCompany.  The senior management team envisionsthe continued growth and importance of this division and has put in placeresources for further sales development.

 

In fiscal year 2004, theConsumer Products Division continued the emphasis on gaining productdistribution and product line diversification. This diversification was two-fold. First, through the further development of private label (store brands)for major chain accounts (K-Mart, Eckerd, Pathmark, Chain Drug Consortium,Family Dollar, Food Lion) in the USA and internationally.  Secondly, through acquisitions of productswhich are complementary to the existing Company’s products.

 

The primary strategy forfiscal year 2004 was to continue to establish a solid foundation to furtherbuild sales volume in retail establishments. This was done by targeting new trade classes, expanding sales globallyand replacing older, lower sales volume products.

 

In fiscal 2004, theCompany continued with the strategy established in fiscal 2003.  The Company also continued to make asignificant penetration into the dollar store trade class as well as sales soldthrough the internet.  Finally, theCompany continued in the pursuit of selling the lip balm, depilatory and anicotine addiction withdrawal system product lines globally.

 

**Oral CareProducts**

 

The Company continued theexpansion of the lip care category by providing key chain account retailerswith their own label of lip conditioners. This strategy has been successful to further partner with accounts inother categories.  In addition, theCompany has reinforced efforts in selling to both the dollar store as well asthe convenience store trade class which continues to gain consumer marketshare.

 

**Cough andCold Products**

 

The Company has secureddistribution of the saline nasal spray by providing major chain retailers withtheir own private label.  The Companywill continue to pursue this strategy in the future.

 

In fiscal 2004, theCompany secured commitments from various accounts to manufacture an oralanesthetic gel under a private label. Packaging has begun and shipments will begin in early fiscal 2005.

 

Internal and externaldiversification efforts carried out by the Company’s Consumer Products Divisioncontributed long term opportunities for the Company during fiscal year2004.  This effort has:

 

•                  Addedsales volume in brand categories which were nonexistent in prior Companyhistory.

•                  Continuedexpansion efforts into convenience, independent novelty stores, and dollarstores.

•                  Expandedthe Company’s product line into global markets.

 

The Company sold the BeauKreml® (hair tonic) to Lady Renee’ Industries, Inc. in July 2004.

 

The Company discontinuedDr. Hand’s® Teething Lotion in November of 2003; Baby GaszTM (babyproduct), Dentlock® (denture powder) , Haltran®(analgesic tablets – menstrual cramps, aches, pains), and Thermodent®(sensitive toothpaste) in October 2003; Zip® Microwaveable HairRemover and SUPER WATE-ON® Liquid Banana (nutritional product) inJanuary 2004; and SundanceTM 8 oz. Lotion (aloe vera product) in May 2004.

 

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**Domestic consumer productsmarketing**

 

Consumer products aresold nationally, primarily through major retail drug, food and mass storechains.  In addition, Lee Pharmaceuticals’consumer products are now sold on various internet web sites.  The Lee® Lip-Ex® lipbalm and Aquafilter® brands have national distribution inconvenience and dollar stores.  A networkof independent sales representatives sells the Company’s product lines tosecure retail distribution.  LeePharmaceuticals participates in cooperative advertising with many of itsretailers.

 

**Consumer products competition**

 

The Company’s ConsumerProducts Division of operates in a highly competitive environment.  In a majority of its product lines, theCompany competes with companies that are larger and have greater financialresources.

 

The Company continues toexpand its product line via line extensions, in-house development activity andacquisitions.

 

**Regulation of consumer products**

 

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

 

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

 

To the extent the Company’sproducts are marketed in foreign countries, foreign laws are applicable as wellas FDA regulations which control export of cosmetics.  To date, where regulations have beenestablished by foreign ministries of health which differ from those establishedin the United States, the Company has been able to make acceptablesubstitutions.  As a result, marketing ofthe products has not been significantly impeded by foreign regulations.

 

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

 

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

 

**Dental products segment**

 

From its inception in1971 through 2004, the Company at various times introduced dental productsdesigned to satisfy specific material or supply requirements of the practicingdental professional and of the orthodontic specialist.

 

Its dental product lineconsists of a variety of restorative materials (filling materials, core buildup materials) and orthodontic adhesives.

 

**Dental marketing in the UnitedStates**

 

The Company markets itsdental and orthodontic products in the United States through telephonesolicitation, direct mail, and dental dealers. The Company plans and executes its own marketing programs.

 

**Dental marketing outside theUnited States**

 

The Company marketsdental products outside the United States through foreign dental distributorswho either solicit individual dentists and orthodontists and sell the Company’sproducts to them directly for use in the treatment of their patients, or sellthrough local dealers whom they engage to sell the Company’s products on theirbehalf.  The Company plans and executesits own international marketing programs.

 

**Dental competition**

 

The dental preventive andrestorative materials industry is highly competitive, and the Company’s marketshare in the total industry is insignificant. The Company competes with larger corporations which have greaterfinancial resources.

 

**Regulation of Dental Products**

 

**Food and Drug Administration**

 

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

 

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

 

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

 

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

 

For those products placedin Class II, final marketing approval from the FDA is contingent on final acceptanceof the Panel’s findings and on development of standards (in large part beingdone by the American Dental Association). It is expected that, based upon current available information, most ofthe Company’s products will meet the standards currently anticipated; for theproducts that do not meet the standards, the Company will have to submitadequate data directly to the FDA. Failure to gain approval by the FDA could impede the marketing of thesedevices to the point of removal from the market until such time as clearance isobtained.

 

**Other governmental regulations**

 

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

 

There is generallyworldwide movement to increase and/or streamline the regulations controllingmedical devices.  The twenty-twocountries in Europe have consolidated their regulations into a joint codereferred to as ISO 9000.  This coderegulates the manufacture and distribution of medical devices in Europe.  One of the provisions of the code is that theCompany maintain a quality control system very much like the FDA system, butwith some differences.  It appears thatthese differences are being negotiated so that both regulations will beequivalent.

 

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

 

The Company elected tohave two of its major dental brands obtain the CE markings in order to continueto distribute those brands throughout Europe. The Company received the CE Markings on Prosthodent® andInsta-Bond®.

 

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

 

**Department of Transportation**

 

The Materials TransportationBureau administers the Hazardous Materials Regulation, effective July 7,1975.  It has been ascertained that thosedental products and components marketed by the Company which fall within theprovisions of the regulations are brought into compliance by proper labelingand/or filing for exemptions.  TheCompany believes that it is in full compliance with all bureau regulationsapplicable to its products and that compliance with these regulations will notsignificantly impede the marketing of its products.

 

**Applicableto All Segments**

 

**Foreign and Domestic Operationsand Export Sales**

 
| ** **                                       | ** ** | **Year ended September 30** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                       | ** ** | **(000)**                   | ** ** | **(000)** | ** ** | **(000)** | ** ** |
|                                             |       |                        |       |   |   |   |   |
| United States  export sales (except Canada)      |       | $                           | 156        |   | $ | 242 |   | $ | 253 |   |
| United States domestic  sales (including Canada) |       | $                           | 9,321      |   | $ | 9,488 |   | $ | 9,901 |   |

 

**Research program**

 

The Company focuses onbrand acquisitions rather than extensive internal research anddevelopment.  Effective July 1996, theCompany eliminated its internal research and development department, anddecided that future testing and research, that cannot be absorbed by itsquality assurance and production control departments, will be placed outsidethe Company.  The Company follows the policyof expensing all research and development costs when incurred.  The Company did not have any internalresearch and development expenses during fiscal years September 30, 2004 and2003.

 

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**Rawmaterials**

 

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

 

**Patents and trademarks**

 

The Company has adoptedthe policy of making patent disclosures on its products and of filingapplications for patents on the products or on aspects of their manufacture oruse when appropriate.  The Company ownsnine U.S. patents, including Dental Restoration System and Method and owns therights in a number of other U. S. patent applications pending.  The Company believes that, while patentprotection is desirable in certain areas, it is not essential; therefore,certain foreign patents have been abandoned as not necessary to the interest ofthe Company.

 

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

 

**Current regulatory registration**

 

The Company has a licenseto manufacture and sell two dental products from the American DentalAssociation Health Research Foundation, which operates a dental researchfacility in the complex of the National Institute of Standards and Technology.

 

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

 

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

 

Effective November 23,1998, the Company applied for and was granted a Controlled Substance Licensewith the Drug Enforcement Agency (DEA). The license is issued for one year and grants the Company the right todistribute prescription drug products containing controlled substance (s).  As of February 25, 2004, the Company’s DEAlicense was renewed.

 

**Environmental protectionregulation and litigation**

 

The Company owns amanufacturing facility located in South El Monte, California.  The California Regional Water Quality ControlBoard (The “RWQCB”) ordered the Company in 1988 and 1989 to investigate thecontamination on its property (relating to soil and groundwatercontamination).  The Company engaged aconsultant who performed tests and reported to the then Chairman of theCompany.  The Company resisted furtherwork on its property until the property upgradient was tested in greater detailsince two “apparent source” lots had not been tested.  On August 12, 1991, the RWQCB issued a “Cleanupand Abatement Order” directing the Company to conduct further testing and cleanup the site.  In October 1991, theCompany received from an environmental consulting firm an estimate of $465,200for investigation and cleanup costs.  TheCompany believed that this estimate was inconclusive and overstated thecontamination levels.  The Companybelieves that subsequent investigations will support the Company’s conclusions aboutthat estimate.  The Company did notcomplete the testing for the reasons listed above as well as “financialconstraints.”  In June 1992, the RWQCBrequested that the EPA evaluate the contamination and take appropriateaction.  At the EPA’s request, Ecology& Environment, Inc. conducted an investigation of soil and groundwater onthe Company’s property.  Ecology &Environment Inc.’s Final Site Assessment Report, which was submitted to the EPAin June 1994, did not rule out the possibility that some of the contaminationoriginated on-site, and resulted from either past or current operations on theproperty.

 

On April 24, 2002, theRWQCB notified the Company that the detection of emergent chemicals ingroundwater, above State and Federal maximum containment levels or actionlevels, has caused the RWQCB and the EPA to reassess the threat posed togroundwater resources used for domestic supply. The RWQCB directed the Company to test for the presence of emergentchemicals in its groundwater monitoring wells. The groundwater monitoring analytical results were due by July 15,2002.  On May 24, 2002, the Companyinformed RWQCB that it could not comply with the requirement to conductgroundwater sampling due to ongoing financial difficulties.

 

On July 8, 2002, theRWQCB sent a “Second Notice of Violation” to the Company directing the Companyto comply with the requirement to prepare a groundwater remedial action plan(RAP).  The Company previously notifiedthe RWQCB that it could not comply with the requirement to submit a RAP becauseof ongoing financial difficulties.  TheRWQCB requested that the Company submit certain financial information by July29, 2002 to “substantiate any alleged financial losses and determine whetherany suspension of implementing the...(Cleanup and Abatement Order) iswarranted.”  The Company has received anextension to submit the required financial information to August 19, 2002. TheCompany submitted the requested financial information on August 16, 2002.  The Company received a response whereby theirrequest for financial hardship was denied. The Company is in the process of appealing this decision based primarilyupon the continued deterioration in the Company finances since the originalfiling.  The Company may be liable forall or part of the costs of remediating the contamination on its property and couldbe subject to enforcement action by the RWQCB, including injunctive and civilmonetary remedies.  As of the date of thefinancial statements, the Company’s share of the costs have not beendetermined.

 

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

 

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

 

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

 

In August 1995, the Companywas informed that the EPA entered into an Administrative Order of Consent withCardinal Industrial Finishes (“Cardinal”) for a PRP lead remedial investigationand feasibility study (the “Study”) which, the EPA states, will bothcharacterize the extent of groundwater contamination in South El Monte andanalyze alternatives to control the spread of contamination.  The Company and others entered into the SouthEl Monte Operable Unit Site Participation Agreement with Cardinal pursuant towhich, among other things, Cardinal contracted with an environmental firm toconduct the Study.  The Study has beencompleted.  The Company’s share of thecost of the Study was $15,000 and was accrued for in the financial statementsas of September 30, 1995.  The South El MonteOperable Unit (SEMOU) participants developed four remedial alternatives.  The capital cost of the four alternativesrange from $0 (no action) up to $3.49 million. The estimated annual operating cost for the four alternatives range from$0 (no action) to $770,300.  Over a30-year period, the total cost of the four alternatives range from $0 (noaction) up to $13.05 million.  The EPAprefers an alternative which estimates the capital cost up to $3.08 million,the annual operating cost at $.48 million, and the 30-year period total cost upto approximately $9.09 million.  Theselection of the actual alternative implemented is subject to publiccomment.  At the present time, the Companydoes not know what its share of the cost may be, if any.  Therefore, no additional accrual has beenrecognized as a liability on the Company’s books.  The Company requested that the EPA conduct an“ability-to-pay evaluation” to determine whether the Company is entitled to anearly settlement of this matter based upon a limited ability to pay costsassociated with site investigation and remediation.  In August 2000, the EPA informed the Companythat it does not qualify for an early settlement at this time.

 

The EPA has informed theCompany that it has learned that the intermediate zone groundwatercontamination in the western portion of the SEMOU has migrated further west andhas now impacted the City of Monterey Park and Southern California WaterCompany production wells.  The EPA statedthat the City of Monterey Park Water Department, San Gabriel Valley WaterCompany and Southern California Water Company are planning to build treatmentfacilities for their wells.  The EPAstated that these three water purveyors contacted some of the SEMOU PRPs, otherthan the Company, to seek funding to develop groundwater treatment facilitiesfor the contaminated wells.  A group ofthese PRPs calling themselves the “South El Monte Cooperative Group” has beenformed and purportedly has reached a general agreement with the water purveyorsto fund the development of treatment facilities and use the water purveyors’wells in an attempt to contain the groundwater contamination to meet EPA’sgoals.  The Company is not able todetermine what contribution, if any, it may be assessed in connection with thiscleanup activity.

 

By letter dated November13, 2000, the Company was notified that the City of Monterey Park, San GabrielValley Water Company and Southern California Water Company intend to bring suitunder the Safe Drinking Water and Toxic Enforcement Act of 1986, alleging thatthe Company has knowingly released volatile organic compounds in the soil andshallow groundwater beneath the Company’s property between at least on orbefore November 8, 1996 and the present and has failed to promptly clean up allof the contamination.  As of the date ofthis report, the Company has not been served with this lawsuit.

 

The City of South ElMonte, the city in which the Company has its manufacturing facility, is locatedin the San Gabriel Valley.  The SanGabriel Valley has been declared a Superfund site.  The 1995 Water Quality Control Plan issued bythe California Regional Water Quality Control Board states that the primarygroundwater basin pollutants in the San Gabriel Valley are volatile organiccompounds from industry, nitrates from subsurface sewage disposal and pastagricultural activities.  In addition,the Plan noted that hundreds of underground storage tanks leaking gasoline andother toxic chemicals have existed in the San Gabriel Valley.  The California Department of Toxic SubstanceControl has declared large areas of the San Gabriel Valley to beenvironmentally hazardous and subject to cleanup work.

 

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

 

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The Company and otherproperty owners engaged Geomatrix Consultants, Inc., to do a survey of vadosesoil and shallow groundwater in the “hot spots” detected in the previousstudies.  Geomatrix issued a report datedDecember 1, 1997 (the “Report”), on the impact of volatile organic compounds onthe soil and groundwater at the Lidcombe and Santa Anita Avenue site located inSouth El Monte, California (which includes the Company’s facilities).  The Report indicated generally lowconcentrations of tetrachloroethene, trichloaethene and trichloroethane in thegroundwater of the upgradient neighbor. The Report was submitted to the RWQCB for its comments andresponse.  A meeting with the parties andRWQCB was held on February 10, 1998.  TheRWQCB had advised companies that vadose soil contamination is minimal andrequires no further action.  However,there is an area of shallow groundwater which has a higher than desired levelof chlorinated solvents, and the RWQCB requested a proposed work plan besubmitted by Geomatrix.  Geomatrix hassubmitted a “Focused Feasibility Study” which concludes that there are fivepossible methods for cleanup.  The mostexpensive are for a pump and sewer remediation which would cost between$1,406,000 and $1,687,000.  The Companyis actively exploring the less expensive alternative remediation methods, ofwhich the two proposed alternatives range in cost between $985,000 and$1,284,000.  Since there are foureconomic entities involved, the Company’s best estimate at this time, in theirjudgment, would be that their forecasted share would be $287,000 less theliability already recognized on the books of $165,000 thereby requiring anadditional $122,000 liability. Accordingly, the Company recorded an additional accrual of $122,000 inthe third quarter of fiscal 1998.  The$122,000 accrual is in addition to the $79,000 accrual for the Monterey Site aswill be explained in the following paragraph. The $79,000 accrual, in the third quarter of fiscal 1998, related to theMonterey Site is not included in the $287,000 figure above.  In April 2000, the Company received a Noticeof Violation from the RWQCB.  The Noticeof Violation states that the Company and other property owners were required tosubmit a groundwater remedial action plan by November 1, 1999, and that theRWQCB has been advised that the Company and the other property owners wereunable to submit the required remedial action plan because the Company and theother property owners could not agree on the allocation of financialresponsibility to prepare the action plan. The RWQCB stated that it will no longer encourage the cooperativeapproach among the Company and the other property owners in completing thecleanup requirements and will pursue appropriate measures, including whennecessary, enforcement actions.  TheRWQCB states that it may impose civil liability penalties of up to $1,000 perday from November 1, 1999 for failure to file the action plan.  In light of these events, no assurances canbe given that the cleanup costs and possible penalties will not exceed theamount of the Company’s current accruals of $287,000 (which includes the$122,000 charge to income in the third quarter of fiscal 1998).

 

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

 

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

 

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

 

The Company was notifiedby the EPA that the Company may have potential liability for waste material itdisposed of at the Casmalia Disposal Site (“Site”) located on a 252 acre parcelin Santa Barbara County, California.  TheSite was operational from 1973 to 1989, and over 10,000 separate partiesdisposed of waste there.  The EPA statedthat federal, state and local governmental agencies along with the numerousprivate entities that used the Site for waste disposal will be expected to paytheir share as part of this settlement. The U.S. EPA is also pursuing the owner(s)/operator(s) of the Site topay for Site remediation.  The EPA has asettlement offer to the Company with respect to the Site for a cost of$373,950.  The Company accrued a $374,000charge in the first quarter of fiscal 1999 with respect to this possibleliability.  The Company has elected tofile for relief from these obligations under the financial hardships option inthe EPA’s response form.  The Company,the EPA and certain PRPs have entered into an agreement tolling the applicablestatutes of limitation.  The Company hasbeen notified by the EPA that their request for a waiver, due to financialhardship, was “partially granted.” Improvements in the bidding process has lowered the Company’s estimatedshare down to $245,000 (from $374,000) and of that, the EPA was requesting thatthe Company pay $113,000, as a result of their findings on the application forwaiver due to financial hardship.  TheCompany is considering the EPA’s request.

 

The Company has requesteda reduced financial liability or waiver on the three EPA sites:  SEMOU, Operating Industries, Inc. (OII) andCasmalia Disposal Site.  The Company hascontinued to provide the information and documentation requested by the EPA asit relates to its ability to pay.  Inconnection with this request, the Company understands that the EPA isconsidering the information.

 

7

----

 

The total amount ofenvironmental investigation and cleanup costs that the Company may incur withrespect to the foregoing is not known at this time.  However, based upon information available tothe Company at this time, the Company has expensed since 1988 a total of$860,000, of which $89,000 were legal fees, exclusive of legal fees expended inconnection with the Securities and Exchange Commission environmentalinvestigation.  The actual costs coulddiffer materially from the amounts expensed for environmental investigation andcleanup costs to date.

 

As of September 30, 2004,no settlements have been reached.  Thetotal amount expensed in prior years relating to this environmental issue is$860,000.  For the year ended September30, 2004, no additional amounts have been expensed or accrued.  The Company has an accrued liability on thebooks at September 30, 2004 of $740,000 for the environmental cleanup.

 

**Other regulations**

 

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

 

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

 

**Employees**

 

The Company’s work forceof 82 presently includes 30 permanent employees, both salaried and hourly, and52 personnel leased through employment agencies.

 

**Other**

 

The Company is notdependent upon any one supplier for any important raw material item.  Most raw material items are commodities andreadily available in the market.  In mostinstances, the Company utilizes two or more suppliers to furnish raw materialsas needed.  Sources are believed to besufficient to satisfy current and anticipated needs.

 

Demand for some of theCompany’s principal product lines is not seasonal.  The depilatory line of products and lip balmsare generally seasonal, with demand significantly higher during the spring andsummer months for the depilatories and fall and winter for the lip balms.

 

Although the Company doesnot believe that it is dependent upon any one customer or distributor, acustomer accounted for 10% and 12% of the Company’s net revenues during fiscal2004 and 2003, respectively.  No othercustomer accounted for 6% or more of the Company’s net revenues for fiscal 2004and 8% for fiscal 2003.

 

Backorders are notsignificant factors in the Company’s business. Most orders are filled immediately and, in any event, are cancellableunder certain conditions.  There are nomaterial contracts with distributors.

 

Consumer ProductsDivision returns must include proof of purchase, sales receipt and a writtenexplanation 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, overstocked or out of date items may be returned to theCompany.  A procedure is established thatthe customer must receive a “return authorization number” for the product to bereturned.  Once the product is returned,freight prepaid, to the Company’s warehouse, it is counted and a credit will beissued toward a future purchase.  Thecustomer will not receive credit for additional merchandise that may have beenadded to the return which was not authorized.

 

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

 

**ITEM 2.****          DESCRIPTIONOF PROPERTY.**

 

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

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

 

8

----

 

The Company leases thefollowing:

 
| **Address**                  | ** ** | **Approximate  square  footage** | ** ** | **Aggregate  annual  rental** | ** ** | **Lease  expiration  date** | ** ** | **Usage**                                                                             | ** **                                                                                         |
|------------------------------|------------|----------------------------------|------------|-------------------------------|------------|-----------------------------|------------|---------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1434 Santa Anita  Avenue     |       | 11,200                           |       | $                             | 65,070     | *                      | 11/30/2005 |                                                                                  | Inventory control, personnel, data processing,  accounting offices and dental production/shipping. |   |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1460 Santa Anita  Avenue     |       | 14,560                           |       | 84,594                        | *     | 11/30/2005                  |       | Consumer shipping.                                                                    |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1470 Santa Anita  Avenue (1) |       | 8,400                            |       | 48,803                        | *     | 11/30/2005                  |       | Effective July 16, 1996, the building was subleased.                                  |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1500 Santa Anita  Avenue     |       | 17,600                           |       | 102,252                       | *     | 11/30/2005                  |       | Warehouse, consumer packaging operations, injection  molding and corrugated printing. |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1516 Santa Anita  Avenue     |       | 17,600                           |       | 102,252                       | *     | 11/30/2005                  |       | Sales/marketing offices, purchasing and warehouse.                                    |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1444 Santa Anita  Avenue (2) |       | 9,800                            |       | 78,360                        | *     | 11/30/2005                  |       | Executive office, consumer production, quality  control and bottle printing.          |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1427 Lidcombe  Avenue        |       | 6,000                            |       | 34,859                        | *     | 11/30/2005                  |       | Maintenance and chemical processing (rear building).                                  |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1425 Lidcombe  Avenue        |       | 6,000                            |       | 34,859                        | *     | 11/30/2005                  |       | Chemical processing and packaging.                                                    |                                                                                               |
|                         |       |                             |       |                          |       |                        |       |                                                                                  |                                                                                               |
| 1445 Lidcombe  Avenue (2)    |       | 9,200                            |       | 73,560                        | *     | 11/30/2005                  |       | Manufacturing and packaging.                                                          |                                                                                               |
|                              |            |                                  |            |                               |            |                             |            |                                                                                       |                                                                                                    |  |

 

----

*      Revised biannually for consumer priceindex change.

 

(1)          The Company entered intoa sublease agreement, effective April 1, 2001, which expires November 30,2005.  The gross annual rental income is$49,812.  This new sublease replaces thesublease which expired November 30, 2000.

 

(2)          This property is treatedas a sale leaseback agreement between the Company and Ronald G. Lee,President.  The monthly lease paymentswere set at the prevailing rates in the area at the time the leases werewritten.

 

All of the Company’sbusiness segments use the properties owned or leased by the Company except for1470 Santa Anita Avenue (sublease expires November 30, 2005).

 

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

 

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

 

**ITEM 3.****          LEGALPROCEEDINGS.**

 

The action entitled CarmaLaboratories, Inc. v. Lee Pharmaceuticals, related to the tradedress, was settled in April, 2003.  Withrespect to the jars of lip balm related to a private label, the Company willcease and desist from using the color yellow as the background color on the capof its jar.  The parties acknowledge thatthe compromise settlement which has been entered into by them is withoutadmission of wrongdoing, liability or violation of any law on the part ofeither party.

 

In addition, in theordinary course of its business, the Company is involved from time to time inlitigation.  In the opinion of managementof the Company, none of that litigation currently pending will have a materialeffect on its business or financial condition. See Item I – “Applicable to All Segments - Environmental protectionregulation and litigation” for additional information concerning certainenvironmental litigation.

 

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

 

Not applicable.

 

9

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**PART II**

 
| **ITEM 5.** | **MARKET FOR COMMON EQUITY,  RELATED STOCKHOLDERS’ MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY  SECURITIES.** |
|-------------|------------------------------------------------------------------------------------------------------------------------------|

 

The Company’s CommonStock trades on the electronic over-the-counter bulletin board under thetrading symbol LPHM.  For the two most recentfiscal years, its shares have closed at high and low trading prices as follows:

 

| ** **  | ** ** | **QTR** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------|------------|---------|------------|----------|------------|---------|------------|
| **FY 2004** | ** ** | 1Q      |       | $        | .1700      |    | $          | .1000 | ** ** |
|        |       | 2Q      |       | .1700    |       | .1100   |       |
|        |       | 3Q      |       | .1700    |       | .1300   |       |
|        |       | 4Q      |       | .1500    |       | .1100   |       |
| **FY 2003** |       | 1Q      |       | $        | .1300      |    | $          | .0800 |   |
|        |       | 2Q      |       | .1100    |       | .0900   |       |
|        |       | 3Q      |       | .1100    |       | .0900   |       |
|        |       | 4Q      |       | .1600    |       | .0900   |       |

 

There were approximately694 shareholders of record of the Company’s Common Stock as of the close ofbusiness on September 30, 2004.

 

The Company has not paidany cash dividends and has no present intention of paying cash dividends in theforeseeable future.

 

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

 

**Fiscal years ended September 30,2004, and September 30, 2003**

 

In fiscal 2004, netrevenues declined approximately 3% to $8,533,000 from $8,758,000 in fiscal2003.  The decrease ($225,000) in netrevenues was principally attributed to lower sales volume associated with theLee® Lip-Ex® lip balm category ($111,000), variouspersonal care items ($207,000) and One Step at a Time® ($169,000).  In addition, the Company experienced lowervolume from a number of its many over-the-counter items ($367,000).  The Company believes that these declines areto be expected from old established brands that are not being supported byadvertising or promotion.  The Companycontinues to strive to stabilize and grow its sales in these particularproducts.  However, there is no certaintyin any given year that the Company will be successful in accomplishing thesegoals.  Somewhat offsetting these decreasesin net revenues were increases in the private label ($231,000) segment alongwith the added sales of a newly acquired brand ($193,000).  Also, the Company reported increases inseveral over-the-counter items ($248,000). The Company’s sales returns decreased approximately $28,000 or 3% whencomparing fiscal years 2004 and 2003. The Company experienced fewer deletions of their SKUs (stock keepingunits) at the retail store level during fiscal 2004.  Company efforts have continued in thedirection of expansion into the private label business segment.

 

Cost of sales as apercentage of gross revenues for fiscal 2004 and 2003 was 58% and 54%,respectively.  The higher cost of salespercentage shown for fiscal 2004 was because the Company has continued to experiencechanges in the overall product mix along with lower priced commodity-type goodswith an accompanying higher cost of goods attached to them.  Over 32% of the Company’s gross sales weregenerated from the lower gross margin goods. Also, the Company increased its inventory obsolescence reserve($456,000) during fiscal 2004.  TheCompany was able to reduce the overall cost of analytical tests related toquality control by purchasing new equipment and developing test methodsin-house, thereby eliminating the use of an outside laboratory.  The cost savings associated with this changewas approximately $95,000 and was partially offset by higher depreciationexpense ($34,000) due to the addition of the needed testing equipment.

 

Selling and advertisingexpenses decreased $230,000 or 8% when comparing fiscal years 2004 and2003.  The decrease in expenses was dueprimarily to the following factors: (1) lower freight costs ($133,000), (2)lower advertising costs ($115,000), (3) lower bad debt charges ($102,000), (4)lower royalty expense ($75,000) and (5) lower convention, travel andentertainment expenses ($49,000).  Thesedecreases were somewhat offset by increases in: (1) product liability insurance($119,000), (2) labor costs ($85,000) and (3) building rent ($64,000).

 

General andadministrative expenses decreased $71,000 or 5% when comparing fiscal years2004 and 2003.  This decrease wasprincipally due to: (1) lower various supply costs ($98,000) and (2) lower MIS(Management Information Systems) for consulting services ($61,000).  These decreases were offset by: (1) higherdues and subscription costs ($56,000) and (2) higher accounting and auditingfees ($23,000).

 

Financial AccountingStandards No. 142 (FAS-142) became effective for the Company on October 1,2001.  FAS-142 requires goodwill andother intangible assets that have indefinite useful lives to no longer beamortized; however, these assets must be tested at least annually forimpairment.  FAS-142 also requires anevaluation of existing acquired goodwill and other intangible assets for properclassification under the new requirements. As a result of FAS-142, the Company is required to evaluate periodicallyfor impairment of goodwill and other intangible assets.  For the years ended September 30, 2004 and2003, the Company had recorded an impairment charge of $39,000 and $254,000,respectively.

 

10

----

 

Interest expenseincreased $16,000 or 2% when comparing fiscal years 2004 and 2003.  The increase was due primarily to an increasein the prime rate.

 

Other income decreased$154 ,000 or 23% to $512,000 when comparing fiscal years 2004 and 2003.  The decrease was attributed to lower realizedgains from the sale of four of the Company’s product lines ($191,000), adecrease in the Company’s portion of the net profits from its investment of aproduct line with Monticello Drug Company ($153,000) and a decrease of propertytax refunds recorded as other income ($15,000). Offsetting these decreases was an increase of $205,000 from the Company’sdistribution agreement with Monticello Drug Company.

 

The Company reported anet loss of $1,229,000, or 30 cents per share, during fiscal year 2004 as aresult of the aforementioned.

 

**Liquidityand capital resources**

 

Working capital was anegative $3,519,000 at September 30, 2004, as compared with a negative$3,524,000 at September 30, 2003.  Theratio of current assets to current liabilities was .5 to 1 at September 30,2004 and September 30, 2003.  Thedecrease in the negative working capital of $5,000 was due primarily to anincrease in accounts receivable ($432,000), an increase in other prepaids($199,000) and a decrease in the short term portion of notes payable($556,000).  Offsetting these wereincreases in accounts payable ($601,000), amounts due to related parties($315,000) and inventory reserves ($250,000). The Company has failed to make principal and interest payments oncertain loans.  The total arrearage isprincipal of $1,712,000 plus interest of $1,071,000, an aggregate of$2,783,000, of which $2,005,000 is due to related parties and $778,000 tonon-related parties.

 

Effective September 1,2004, the Company reached an agreement with a non-related party to consolidateeleven (11) of its notes payable plus accrued and unpaid related interest(totaling $2,176,000) into one (1) note payable, due on December 1, 2005, withinterest payable at the one month LIBOR (London Interbank Offered Rate)rate.  The interest rates on the abovecancelled eleven (11) notes payable were at 20% or 24%.  The LIBOR rate at September 30, 2004 was1.8401%. The Company anticipates a cash savings of approximately $381,000 peryear.  Also, effective September 20, 2004,the Company implemented a wage freeze for all employees, plus a staff and correspondingsalary reduction in certain areas.  TheCompany anticipates a cash savings of approximately $450,000 per year.  The total savings of these two actions isapproximately $831,000.

 

Subsequent to September30, 2004, the Company sold one of its product lines for $750,000 cash.

 

In addition, in November2004, the Company’s outside finance lender agreed to adjust the Company’smonthly principal payments on its various equipment loans by one-half,commencing January 1, 2005.  The expectedannual principal payment savings (net of interest) related to this transactionis approximately $40,000.

 

The Company is expectingto increase sales volume by expanding existing product lines.  There can be no guarantee that this willmaterialize.

 

In comparing fiscal years2004 and 2003, accounts receivable turnover increased (10.7 versus 10.5) andthe number of day’s sales were in average accounts receivable improved (28 daysversus 29 days).  This data wasrelatively constant during fiscal years 2004 and 2003 due to continuedcollection efforts.  Accounts payable asa percentage of total costs and expenses was 12% in fiscal 2004 versus 10% infiscal 2003.

 

Effective April 23, 2002,the Company renewed its accounts receivable financing, maturing May 2005,whereby 70% of the eligible domestic accounts receivable, not to exceed thegreater of $1,400,000 or $1,400,000 less amounts advanced on inventory, can beadvanced.  At September 30, 2004, theamount advanced to the Company was $986,000. The agreement is renewable for successive one year periodsthereafter.  Also, the agreement requiresminimum monthly interest of $3,000 with an interest rate of 8% above Union Bankof California’s prime rate. Additionally, there is a separate $400,000 term loan on the Company’sequipment.  As monthly payments are madeto reduce the equipment term loan balance, the Company, from time to time, asneeded, can request additional financing for new and used equipment at 80% ofthe purchase price.  As of September 30,2004, the equipment term loan balance was $223,000.  This equipment financing is secured by asecurity interest in all of the Company’s assets and requires monthly paymentsof $21,400 plus interest at Union Bank of California’s prime rate plus 8%.  The continuing personal guarantee by theCompany’s President, of obligations of the Company, remains in force.

 

During fiscal 2003, theCompany financed the acquisition of a product line.  The debt incurred for the financing of thisproduct line was $90,000 at an interest rate of 20%.

 

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 anaccumulated deficit of $10,456,000.  TheCompany’s past recurring losses and fiscal 2001 and 2000’s nominal profits fromoperations and inability to generate sufficient cash flow from normaloperations to meet its obligations as they come due raise substantial doubtabout the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due.

 

The Company does notbelieve that inflation had a significant impact on its operations during fiscalyears 2004 and 2003.

 

11

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**ITEM 7.          FINANCIAL STATEMENTS.**

 
| **Index  to Financial Statements**                                                                         | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|
|                                                                                                       |       |
| Report  of Independent Registered Accounting Firm                                                          |       |
|                                                                                                       |       |
| Financial  Statements:                                                                                     |       |
|                                                                                                       |       |
| Balance sheet as of  September 30, 2004                                                                    |       |
|                                                                                                       |       |
| Statements  of operations for the years ended  September 30, 2004 and September 30, 2003                   |       |
|                                                                                                       |       |
| Statements of  stockholders’ (deficit) for the years ended  September 30, 2004 and September 30, 2003 |       |
|                                                                                                       |       |
| Statements  of cash flows for the years ended  September 30, 2004 and September 30, 2003                   |       |
|                                                                                                       |       |
| Notes to financial  statements                                                                             |       |

 

12

----

 

**GeorgeBrenner, CPA**

**APROFESSIONAL CORPORATION**

**10680 W.PICO BOULEVARD, SUITE 260**

**LOSANGELES, CALIFORNIA 90064**

**310/202-6445****–****FAX 310/202-6494**

 

REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

of Lee Pharmaceuticals

 

I have audited the accompanying balance sheet of Lee Pharmaceuticals (aCalifornia corporation) as of September 30, 2004, and the related statements ofoperations, stockholders’ (deficit) and cash flows for the years endedSeptember 30, 2004 and 2003.  Thesefinancial statements are the responsibility of the Company’s management.  My responsibility is to express an opinion onthese financial statements based on my audit.

 

I conducted my audit in accordance with auditing standards of thePublic Company Accounting Oversight Board (United States).  Those standards require that I plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  I believe that my audit provides a reasonablebasis for my opinion.

 

In my opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of Lee Pharmaceuticalsas of September 30, 2004 and the results of its operations and its cash flowsfor the years ended September 30, 2004 and 2003, in conformity with accountingprinciples generally accepted in the United States of America.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 1 of the financial statements, the Company has notshown a trend for generating sufficient net income and cash flow from normaloperations.  Those conditions raisesubstantial doubt about its ability to continue as a going concern.  Management’s plans regarding those mattersare also described in Note 1.  Thefinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 

As discussed in Note 13 to the financial statements, the Company isnamed in several environmental remediation actions.  Although the Company has accrued a liabilityin the amount of $740,000, the total costs of these actions cannot be presentlydetermined.  The total amount of expensefrom inception relating to this issue is $860,000.  However, the actual costs could differmaterially from the amounts expensed to date.

 
| ** **              | **GEORGE BRENNER**  |
|-------------------------|---------------------|
|                    |                |
|                    | George Brenner, CPA |
|                    |                |
| Los Angeles, California |                |
| December 14, 2004       |                |

 

13

----

 

**LEEPHARMACEUTICALS**

 

**BALANCE SHEET**

(rounded tothousands)

 

**SEPTEMBER30, 2004**

 
| **ASSETS**                                                                                                     |   |        |      |
|----------------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| ** **                                                                                                     |   |        |      |
| **CURRENT  ASSETS:**                                                                                           |   |        |      |
| Cash                                                                                                           |   | $           | 28,000    |   |
| Accounts  receivable, less allowance for doubtful accounts of $31,000 and sales returns  allowance of $163,000 |   | 1,012,000   |      |
| Inventories                                                                                                    |   | 2,179,000   |      |
| Deposits                                                                                                       |   | 298,000     |      |
| Other current  assets                                                                                          |   | 230,000     |      |
| **TOTAL  CURRENT ASSETS**                                                                                      |   | 3,747,000   |      |
|                                                                                                           |   |        |      |
| **PROPERTY,  PLANT AND EQUIPMENT, AT COST:**                                                                   |   |        |      |
| Land                                                                                                           |   | 49,000      |      |
| Building                                                                                                       |   | 217,000     |      |
| Machinery and  equipment                                                                                       |   | 5,796,000   |      |
| Leasehold  improvements                                                                                        |   | 421,000     |      |
|                                                                                                           |   | 6,483,000   |      |
| Less accumulated  depreciation and amortization                                                                |   | (5,661,000  | )         |
| **NET  PROPERTY, PLANT AND EQUIPMENT**                                                                         |   | 822,000     |      |
| **OTHER  ASSETS:**                                                                                             |   |        |      |
| Intangible  assets, net of accumulated amortization of $1,372,000 and impairment of  $2,102,000                |   | 1,682,000   |      |
| Non-current  deposits                                                                                          |   | 46,000      |      |
| **TOTAL  OTHER ASSETS**                                                                                        |   | 1,728,000   |      |
|                                                                                                           |   |        |      |
| **TOTAL**                                                                                                      |   | $           | 6,297,000 |   |
|                                                                                                           |   |        |      |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT)**                                                               |   |        |      |
|                                                                                                           |   |        |      |
| **CURRENT  LIABILITIES:**                                                                                      |   |        |      |
| Bank overdraft                                                                                                 |   | $           | 13,000    |   |
| Notes payable -  finance company                                                                               |   | 1,079,000   |      |
| Current portion  - notes payable, other                                                                        |   | 871,000     |      |
| Current portion  - note payable related party                                                                  |   | 1,307,000   |      |
| Accounts payable                                                                                               |   | 1,059,000   |      |
| Accrued  liabilities                                                                                           |   | 975,000     |      |
| Environmental  cleanup liability                                                                               |   | 366,000     |      |
| Due to related  parties                                                                                        |   | 1,419,000   |      |
| Deferred income                                                                                                |   | 177,000     |      |
| **TOTAL  CURRENT LIABILITIES**                                                                                 |   | 7,266,000   |      |
|                                                                                                           |   |        |      |
| **LONG-TERM  NOTES PAYABLE TO RELATED PARTIES**                                                                |   | 1,489,000   |      |
| **LONG-TERM  NOTES PAYABLE – FINANCE COMPANY**                                                            |   | 147,000     |      |
| **LONG-TERM  NOTES PAYABLE, OTHER**                                                                            |   | 2,710,000   |      |
| **ENVIRONMENTAL  CLEANUP LIABILITY – CASMALIA SITE**                                                      |   | 374,000     |      |
| **DEFERRED  INCOME**                                                                                           |   | 132,000     |      |
| **TOTAL  LIABILITIES**                                                                                         |   | 12,118,000  |      |
|                                                                                                           |   |        |      |
| **COMMITMENTS  AND CONTINGENCIES**                                                                             |   | —      |      |
|                                                                                                           |   |        |      |
| **STOCKHOLDERS’  (DEFICIT):**                                                                             |   |        |      |
| Common stock,  $.10 par value; authorized 7,500,000 shares;  issued and outstanding, 4,135,162 shares          |   | 413,000     |      |
| Additional  paid-in capital                                                                                    |   | 4,222,000   |      |
| Accumulated  (deficit)                                                                                         |   | (10,456,000 | )         |
| **TOTAL  STOCKHOLDERS’ (DEFICIT)**                                                                        |   | (5,821,000  | )         |
|                                                                                                           |   |        |      |
| **TOTAL**                                                                                                      |   | $           | 6,297,000 |   |

 

The accompanyingnotes are an integral part of the financial statements.

 

14

----

 

**LEEPHARMACEUTICALS**

 

**STATEMENTS OF OPERATIONS**

(rounded tothousands)

 

**FOR THEYEARS ENDED SEPTEMBER 30,**

 
| ** **                                                           | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                                 |       |      |       |      |       |
| **GROSS  REVENUES**                                                  |       | $         | 9,477,000  |      | $          | 9,730,000 |   |
| Less:  Sales returns, discounts and allowances                  |       | (944,000  | )          | (972,000  | )          |
|                                                                 |       |      |       |      |       |
| **NET  REVENUES**                                                    |       | 8,533,000 |       | 8,758,000 |       |
|                                                                 |       |      |       |      |       |
| **COSTS  AND EXPENSES:**                                             |       |      |       |      |       |
| Cost of sales                                                        |       | 5,499,000 |       | 5,252,000 |       |
| Selling and advertising                                              |       | 2,631,000 |       | 2,861,000 |       |
| General and  administrative                                          |       | 1,238,000 |       | 1,309,000 |       |
| Intangible  impairment loss                                          |       | 39,000    |       | 254,000   |       |
|                                                                 |       |      |       |      |       |
| **Total  costs and expenses**                                        |       | 9,407,000 |       | 9,676,000 |       |
|                                                                 |       |      |       |      |       |
| **OPERATING  (LOSS)**                                                |       | (874,000  | )          | (918,000  | )          |
| **INTEREST  EXPENSE**                                                |       | (867,000  | )          | (851,000  | )          |
| **(LOSS)  GAIN ON SALE OF FIXED ASSETS**                             |       | —    |       | (1,000    | )          |
| **OTHER  INCOME**                                                    |       | 512,000   |       | 666,000   |       |
| ** **                                                           |       |      |       |      |       |
| **NET  (LOSS)**                                                      |       | $         | (1,229,000 | )         | $          | (1,104,000 | ) |
|                                                                 |       |      |       |      |       |
| **LOSS  PER SHARE DATA:**                                            |       |      |       |      |       |
|                                                                 |       |      |       |      |       |
| Basic and fully  diluted (loss) per share                            |       | $         | (.30       | )         | $          | (.27 | ) |
|                                                                 |       |      |       |      |       |
| Weighted average  common shares outstanding, basic and fully diluted |       | 4,135,162 |       | 4,135,162 |       |

 

The accompanyingnotes are an integral part of the financial statements.

 

15

----

 

**LEEPHARMACEUTICALS**

 

**STATEMENTSOF STOCKHOLDERS’ (DEFICIT)**

(rounded tothousands)

 

**FOR THEYEARS ENDED SEPTEMBER 30,**

 
| ** **                     | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  (Deficit)** | ** ** | **Total**  | ** ** |
|--------------------------------|------------|------------------|------------|----------------------------------|------------|----------------------------|------------|------------|------------|
| **Number of  Shares**          | ** ** | **Amount**       |
|                           |       |             |       |                             |       |                       |       |       |       |   |   |
| Balance at September  30, 2002 |       | 4,135,162        |       | $                                | 413,000    |                       | $          | 4,222,000  |       | $ | (8,123,000 | ) | $ | (3,488,000 | ) |
|                           |       |             |       |                             |       |                       |       |       |       |   |   |
| Net (loss)                     |       |             |       |                             |       |                       |       | (1,104,000 | )          | (1,104,000 | ) |
|                           |       |             |       |                             |       |                       |       |       |       |   |   |
| Balance at  September 30, 2003 |       | 4,135,162        |       | 413,000                          |       | 4,222,000                  |       | (9,227,000 | )          | (4,592,000 | ) |
|                           |       |             |       |                             |       |                       |       |       |       |   |   |
| Net (loss)                     |       |             |       |                             |       |                       |       | (1,229,000 | )          | (1,229,000 | ) |
|                           |       |             |       |                             |       |                       |       |       |       |   |   |
| Balance at  September 30, 2004 |       | 4,135,162        |       | $                                | 413,000    |                       | $          | 4,222,000  |       | $ | (10,456,000 | ) | $ | (5,821,000 | ) |

 

The accompanyingnotes are an integral part of the financial statements.

 

16

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**LEEPHARMACEUTICALS**

 

**STATEMENTS OF CASH FLOWS**

(rounded tothousands)

 

**FOR THEYEARS ENDED SEPTEMBER 30,**

 
| ** **                                                                       | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|----------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                                             |       |      |       |      |       |
| CASH FLOWS  PROVIDED BY OPERATING ACTIVITIES:                                    |       |      |       |      |       |
| Net (loss)                                                                       |       | $         | (1,229,000 | )         | $          | (1,104,000 | ) |
| Adjustments to  reconcile net loss to net cash required by operating activities: |       |      |       |      |       |
| Depreciation                                                                     |       | 206,000   |       | 173,000   |       |
| Amortization of  intangibles                                                     |       | 207,000   |       | 198,000   |       |
| Intangible  impairment loss                                                      |       | 39,000    |       | 254,000   |       |
| Loss (gain) on  disposal of property, plant, and equipment                       |       | —    |       | 1,000     |       |
| (Decrease) in  deferred income                                                   |       | (244,000  | )          | (172,000  | )          |
| (Gain) on sale  of product brand                                                 |       | (4,000    | )          | (266,000  | )          |
| Change in  operating assets and liabilities:                                     |       |      |       |      |       |
| (Increase)  decrease in accounts receivable, net                                 |       | (432,000  | )          | 506,000   |       |
| Decrease  (increase) in inventories                                              |       | 327,000   |       | (88,000   | )          |
| (Increase)  decrease in deposits                                                 |       | (76,000   | )          | 99,000    |       |
| (Increase)  decrease in other current assets                                     |       | (123,000  | )          | 76,000    |       |
| (Decrease)  increase in bank overdraft                                           |       | (87,000   | )          | 27,000    |       |
| Increase  (decrease) in accounts payable and accrued liabilities                 |       | 601,000   |       | (241,000  | )          |
| (Decrease)  increase in due to related parties                                   |       | (82,000   | )          | 599,000   |       |
|                                                                             |       |      |       |      |       |
| Net cash (used  in) provided by operating activities                             |       | (897,000  | )          | 62,000    |       |
|                                                                             |       |      |       |      |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                           |       |      |       |      |       |
| Additions to  property, plant and equipment                                      |       | (373,000  | )          | (311,000  | )          |
| Proceeds from  sale of equipment                                                 |       | —    |       | —    |       |
| Proceeds from  sale of product brand                                             |       | 4,000     |       | 665,000   |       |
| Acquisition of  product brands and covenants not to compete                      |       | —    |       | (90,000   | )          |
|                                                                             |       |      |       |      |       |
| Net cash (used  in) provided by investing activities                             |       | (369,000  | )          | 264,000   |       |
|                                                                             |       |      |       |      |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                           |       |      |       |      |       |
| Proceeds from  notes payable to related party                                    |       | 277,000   |       | —    |       |
| (Payments on) notes  payable to related party                                    |       | (4,000    | )          | (156,000  | )          |
| Increase  (decrease) in notes payable                                            |       | 250,000   |       | (258,000  | )          |
| Proceeds from  notes payable, other                                              |       | 893,000   |       | 1,000,000 |       |
| (Payments on)  notes payable, other                                              |       | (138,000  | )          | (922,000  | )          |
|                                                                             |       |      |       |      |       |
| Net cash  provided by (used in) financing activities                             |       | 1,278,000 |       | (336,000  | )          |
|                                                                             |       |      |       |      |       |
| NET INCREASE  (DECREASE) IN CASH                                                 |       | 12,000    |       | (10,000   | )          |
| Cash, beginning  of year                                                         |       | 16,000    |       | 26,000    |       |
|                                                                             |       |      |       |      |       |
| Cash, end of  year                                                               |       | $         | 28,000     |      | $          | 16,000 |   |
|                                                                             |       |      |       |      |       |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                               |       |      |       |      |       |
|                                                                             |       |      |       |      |       |
| Cash paid during  the year for:                                                  |       |      |       |      |       |
| Interest                                                                         |       | $         | 459,000    |      | $          | 789,000 |   |
| Taxes                                                                            |       | $         | 1,000      |      | $          | 1,000 |   |

 

The accompanyingnotes are an integral part of the financial statements.

 

17

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**LEEPHARMACEUTICALS**

**NOTES TO FINANCIAL STATEMENTS**

 

**NOTE 1 -****       SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Descriptionof business**

 

The Company is engaged inthe development, purchase, manufacture, and marketing of consumer personal careproducts and professional dental products, all of which are targeted for theimproved well-being of the human body. The Company’s business is directed to two main areas:  (a) the development and marketing of a rangeof consumer products including over-the-counter items, health and beauty aids,cosmetics and prescription drug products containing controlled substances and(b) the manufacture and sale of materials and supplies for use in theprofessional dental health field.

 

**Continuedexistence**

 

The financial statementshave been prepared assuming the Company will continue as a going concern.  The Company has an accumulated deficit of$10,456,000.  The Company’s recurringlosses from operations and inability to generate sufficient cash flow fromnormal operations to meet its obligations as they come due raise substantialdoubt about the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due. Management’s plans in regard to these matters are to increaseprofitability by increasing sales, control expenses and seek additionalfinancing from outside lenders.  Thefinancial statements do not include any adjustments to reflect the possiblefuture effects of the recoverability and classification of assets or theamounts and classification of liabilities that may result from the possibleinability of the Company to continue as a going concern.

 

**Accountsreceivable**

 

The Company providesallowances for doubtful accounts and for returned merchandise.  The Company’s estimates are based onhistorical collection and return experience and a review of the current statusof trade accounts receivable.  It isreasonably possible that the Company’s estimate of the allowances for doubtfulaccounts and returned merchandise will change in the future.  In connection with the Company’s distributionagreement, see Note 20.

 

**Inventories**

 

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

 

**Depreciationand amortization**

 

Property and Equipment

 

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

 

| Building                 |   | 31 years  |   |
|--------------------------|--------|-----------|--------|
| Machinery and  equipment |   | 5-7 years |   |
| Leasehold  improvements  |   | 10 years  |   |

 

Depreciation expense was$206,000 and $173,000 for the years ended September 30, 2004 and 2003,respectively.

 

Intangibles

 

Intangible assets arebeing amortized under the straight-line method using the following lives:

 

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

 

Amortization expense was$207,000 and $198,000 for the years ended September 30, 2004 and 2003,respectively.

 

18

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**Environmentalexpenditures**

 

Environmentalexpenditures that relate to an existing condition caused by past operations,and which do not contribute to current or future revenue generation, areexpensed.  The Company’s proportionate shareof the liabilities are recorded when environmental remediation and/or cleanupsare probable, and the costs can be reasonably estimated.  Management believes that the total amountprovided at September 30, 2004 for remedial cost studies is adequate based oncurrent information available.  (See Note13 - “Assessment for environmental cleanup.”)

 

**Customerconcentration and vendors**

 

The Company had one majorcustomer with sales volume approximating 10% of the Company’s net revenues forfiscal year ending September 30, 2004, and 12% for fiscal year ending September30, 2003.  The amount due from thecustomer was $209,000 and $58,000 at September 30, 2004, and 2003,respectively, and is included in accounts receivable in these financialstatements.  The Company has five vendorsthat accounted for 36% of the total inventory purchased for the fiscal yearended September 30, 2004.

 

**Revenueand expense recognition**

 

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

 

**Concentrationof credit risk**

 

Financial instrumentswhich potentially subject the Company to concentrations of credit risk consistof cash and trade receivables.  TheCompany places its cash with high credit quality financial institutions.  At times such investments may be in excess ofthe FDIC limit.  In regards to tradereceivables, the risk is limited due to the large number of customerscomprising the customer base, and the dispersion in different industries andgeographies.  Generally, the Company doesnot require collateral for its trade receivables.

 

**Deferredincome tax accounts**

 

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

 

**Use ofestimates**

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosures of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

**Fairvalue of financial instruments**

 

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

 

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

 

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

 

**Advertisingcosts**

 

Advertising costs areexpensed as incurred.  Advertising costsfor fiscal years ended September 30, 2004 and 2003 were $180,000 and $297,000,respectively.

 

19

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**Stockoption plan**

 

The Company applies theintrinsic value-based method of accounting prescribed by Accounting PrinciplesBoard (“ABP”) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations, in accounting forits outstanding stock options.  As such,deferred compensation expense would generally be recorded on the date of grantonly if the current market price of the underlying stock exceeded the exerciseprice.  Such deferred compensation isexpensed pro-rata over the vesting period of the stock option.  Repriced stock options are accounted forusing variable plan accounting which requires periodic re-measurement of theintrinsic value of the related stock option until its exercise, forfeiture orcancellation. (See Note 14 - “Stock Options.”)

 

**Segmentreporting**

 

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

 

Information available onreportable segments is as follows:

 
| ** **                                    | ** ** | **For Year Ended September 30** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| Revenue from  consumer personal care products |       | $                               | 9,333,000  |   | $ | 9,530,000 |   |
| Revenue from  professional dental products    |       | $                               | 144,000    |   | $ | 200,000 |   |

 

The Company does notidentify or allocate assets by operating segment and does not allocate cost ofsales, operating profits, depreciation or other expenses by operating segments.

 

**Newaccounting pronouncements**

 

In September 2001, theFinancial Accounting Standards Board (FASB) issued Statement No. 143, *Asset Retirement Obligations*.  This statement addresses financial accountingand reporting for obligations associated with the retirement of tangiblelong-lived assets and the associated asset retirement costs.  The statement will be effective for the Company’sfiscal years ending 2003 and 2004. Management does not expect the adoption of this standard to have amaterial impact on the Company’s financial statements.

 

In April 2002, the FASBissued Statement No. 145, *Rescission of FASBStatements No. 4, 44, and 64, Amendments of FASB Statement No. 13, andTechnical Correction*s.  TheCompany does not believe that the adoption of this pronouncement will have amaterial effect on its financial statements.

 

In June 2002, the FASBissued Statement No. 146, *Accounting for CostsAssociated With Exit or Disposal Activities*.  This statement requires the recognition of aliability for a cost associated with an exit or disposal activity when theliability is incurred versus the date the Company commits to an exit plan.  In addition, this statement states theliability should be initially measured at fair value.  The statement is effective for exit ordisposal activities that are initiated after December 31, 2002.  The Company does not believe that theadoption of this pronouncement will have a material effect on its financialstatements.

 

In January 2003, the FASBissued SFAS No. 148, *Accounting for Stock-BasedCompensation – Transition and Disclosure*.  This statement provides alternative methodsof transition for a voluntary change to the fair value-based method ofaccounting for stock-based employee compensation.  In addition, this statement also amends thedisclosure requirements of SFAS No. 123 to require more prominent and frequentdisclosures in the financial statements about the effects of stock-basedcompensation The Company does not believe that the adoption of this standardwill have a material effect on its financial statements.

 

In January 2003, the FASBissued Interpretation No. 45, *Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others*.  FASBInterpretation No. 45 clarifies that a guarantor is required to recognize, atthe inception of a guarantee, a liability for the fair value of the obligationundertaken in issuing certain guarantees. The Company does not expect that this interpretation will have amaterial effect on its financial statements.

 

In January 2003, the FASBissued Interpretation No. 46, *Consolidation of VariableInterest Entities*.  Thisinterpretation establishes standards for identifying a variable interest entityand for determining under what circumstances a variable interest entity shouldbe consolidated with its primary beneficiary. Until now, a company generally has included another entity in itsconsolidated financial statements only if it controlled the entity throughvoting interests.  Interpretation No. 46changes that by requiring a variable interest entity to be consolidated by acompany if that company is subject to a majority of the risk of loss from thevariable interest entity’s activities or is entitled to receive a majority ofthe entity’s residual returns or both. The Company does not believe that the adoption of this pronouncementwill have a material effect on its financial statements.

 

20

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

 

Basic net (loss) pershare is computed using the weighted-average number of shares of Common Stockoutstanding.  Diluted net (loss) pershare is computed using the weighted-average number of shares of Common Stockoutstanding and, when dilutive, potentially dilutive shares from restrictedstock and options to purchase Common Stock using the treasury stock method.

 

The following is areconciliation of the shares used in the computation of basic and diluted net(loss) per share:

 
| ** **                                                                            | ** ** | **For Year Ended September 30** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                            | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| Basic net (loss)  per share - weighted average number of common shares outstanding    |       | 4,135,162                       |       | 4,135,162 |   |
| Effect of  potentially dilutive securities outstanding - restricted stock and options |       | —                          |       | — |   |
| Shares used in  diluted net (loss) per share computation                              |       | 4,135,162                       |       | 4,135,162 |   |

 

Options to purchaseshares of Common Stock at an average share price which is greater than the averagemarket price of the shares are not included in the computation of dilutedearnings per share, or EPS, because the effect of their inclusion would havebeen anti-dilutive.  For the years endedSeptember 30, 2004 and 2003, there were no options outstanding respectively.

 

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

 

Inventoriesconsist of the following at September 30, 2004:

 

| Raw materials               |   | $         | 2,121,000 |   |
|-----------------------------|--------|-----------|-----------|--------|
| Work-in-process             |   | 303,000   |      |
| Finished goods              |   | 605,000   |      |
|                        |   | 3,029,000 |      |
| Allowance for  obsolescence |   | (850,000  | )         |
| Total                       |   | $         | 2,179,000 |   |

 

**NOTE 4 -****       INTANGIBLEASSETS**

 

The Company acquiredcertain product lines prior to fiscal 2004 (see Note 18).  Amounts related to these acquisitions areallocated to intangible assets.  Includedin intangible assets, which have not been fully amortized at September 30,2004, are the following:

 
| ** **                | ** ** | **Cost**  | ** ** | **Accumulated  Amortization  and Impairment  at 10/1/03** | ** ** | **Acquisitions  (Sales)  Current Year** | ** ** | **Current  Year  Amortization** | ** ** | **Current  Year  Impairment** | ** ** | **Net  Unamortized  at 9/30/04** | ** ** |
|---------------------------|------------|-----------|------------|-----------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|----------------------------------|------------|
|                      |       |      |       |                                                      |       |                                    |       |                            |       |                          |       |                             |       |
| Product lines             |       | $         | 3,065,000  |                                                      | $          | (2,063,000                              | )          | $                               | —     |                          | $          | —                           |       | $ | (39,000 | ) | $ | 963,000 |   |
| Covenants not to  compete |       | 2,091,000 |       | (1,165,000                                                | )          | —                                  |       | (207,000                        | )          | —                        |       | 719,000                          |       |
|                      |       |      |       |                                                      |       |                                    |       |                            |       |                          |       |                             |       |
| Total                     |       | $         | 5,156,000  |                                                      | $          | (3,228,000                              | )          | $                               | —     |                          | $          | (207,000                         | )          | $ | (39,000 | ) | $ | 1,682,000 |   |

 

**Productlines**

 

Since the acquisition,profit margins for certain of the products have been below management’sexpectations principally as a result of lower than expected sales levels.  During 2004, the Company performed a detailedevaluation of the product lines which took into consideration estimated futurecash flows of the individual brands based on the brands’ projected sales andthe direct costs associated with manufacturing and selling the brands.  Where the individual brands’ undiscountedcash flow projections were less than the carrying value, an impairment loss wascalculated and recognized.  Indetermining the amount of impairment loss, the value of each product line wascalculated using the discounted future estimated annual cash flows.  A discount rate of 33.3%, which represents anestimated risk-adjusted cost of capital, was used in the calculation.  This evaluation resulted in a noncash chargeto operations for the years ended September 30, 2004 of $39,000 and September30, 2003 of $254,000.

 

**Covenantnot to compete**

 

Covenant not to competeagreements (net unamortized) $719,000 at September 30, 2004, represents theportion of the purchase price associated with the acquisition of nine differentproduct lines allocated to noncompetition agreements.  Under these agreements, the former companiesagreed not to compete with the Company for periods ranging from five to tenyears.  The related cost is beingamortized on the straight-line method over the terms of the agreements.

 

21

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

 

The agreement with thelender covering the following notes payable contains a solvency provision whichhas been waived by the lender:

 
| Note payable (accounts receivable financing),  secured by accounts receivable, equipment, inventories, and certain other  assets, maximum revolving advance is $1,400,000 (based on domestic accounts  receivable as defined in the agreement less amounts loaned on inventory, not  to exceed $95,000, can be advanced), requires minimum monthly interest of  $3,000, interest rate is 8% above Union Bank of California’s prime rate. The  agreement matures May 2005 and is renewable annually. The continuing personal  guarantee by the Company’s President, of the obligations of the Company,  remains in force. |   | $          | 908,000   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|-----------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |      |
| Note payable, secured by inventory, maximum amount  of term loan is the lessor of $95,000 or 25% of the amount of eligible  inventory, requires monthly payments of $5,000 plus interest at Union Bank of  California’s prime rate plus 8%, maturing May 2005.                                                                                                                                                                                                                                                                                                                                                                |   | 95,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |      |
| Note payable, maximum amount of term loan is  $70,000, secured by the Company’s machinery and equipment, requires monthly  payments of $2,900 plus interest at Union Bank of California’s prime rate  plus 8%, maturing May 2005.                                                                                                                                                                                                                                                                                                                                                                                        |   | 7,000      |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |      |
| Note payable, maximum amount of term loan is  $50,000, secured by the Company’s machinery and equipment, requires monthly  payments of $2,000 plus interest at Union Bank of California’s prime rate  plus 8%, maturing May 2005.                                                                                                                                                                                                                                                                                                                                                                                        |   | 12,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |      |
| Note payable, maximum amount of term loan is  $60,000, secured by the Company’s machinery and equipment, requires monthly  payments of $2,500 plus interest at Union Bank of California’s prime rate  plus 8%, maturing May 2005.                                                                                                                                                                                                                                                                                                                                                                                        |   | 36,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |      |
| Note payable, maximum amount of term loan is  $216,000, secured by the Company’s machinery and equipment, requires monthly  payments of $9,000 plus interest at Union Bank of California’s prime rate  plus 8%, maturing May 2005.                                                                                                                                                                                                                                                                                                                                                                                       |   | 168,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   | $          | 1,226,000 |   |
| Less current  portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   | (1,079,000 | )         |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   | $          | 147,000   |   |

 

Interest expense on theabove notes was $164,000 for the year ended September 30, 2004.

 

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

 

For the year endedSeptember 30, 2004, accrued liabilities consisted of the following:

 

| Payroll taxes             |   | $       | 13,097  |   |
|---------------------------|--------|---------|---------|--------|
| Royalties                 |   | 91,114  |    |
| Commissions               |   | 33,747  |    |
| Customers’  deposits |   | 44,208  |    |
| Rental deposits           |   | 8,641   |    |
| Salaries and  vacation    |   | 125,451 |    |
| Professional  fees        |   | 32,965  |    |
| Other                     |   | 625,777 |    |
| Total                     |   | $       | 975,000 |   |

 

**NOTE 7 -****       DUETO RELATED PARTIES**

 

Due to related partiestotaling $1,419,000 at September 30, 2004, is comprised of accrued interest of$1,043,000 (see Note 10) and advances of $376,000 from thePresident/Stockholder and Director/Stockholder that are unsecured.

 

**NOTE 8 -****       RELATEDPARTY TRANSACTIONS**

 

The amounts of rents paidto the President/Stockholder were $152,000 for September 30, 2004 and $148,000for September 30, 2003.

 

During the fiscal yearending September 30, 2004, the total interest expensed to related parties (seeNote 10) was $112,000 of which $34,000 was paid.  Included in due to related parties, as ofSeptember 30, 2004, was accrued interest of $1,043,000.

 

During the fiscal yearending September 30, 2003, the total interest expensed to related parties (seeNote 10) was $109,000 of which $46,000 was paid.  Included in due to related parties, as ofSeptember 30, 2003, was accrued interest of $965,000.

 

22

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**NOTE 9 -****       NOTESPAYABLE - OTHER**

 
| Note payable to a company, secured by product brand,  payable in monthly installments of $12,000, plus interest, commencing July  25, 2001, and continuing monthly thereafter, until and including September  25, 2001. Thereafter, monthly installment payments will be $22,000. The  interest rate is the highest prime rate published by Citibank, N.A., during  the preceding month. This note is past due its maturity. |   | $         | 417,000   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|-----------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable to bank, secured by a deed on land and  building, requires monthly payments of $3,500, including interest at the  bank’s reference rate (4.75% at September 30, 2004) plus 4%, maturing January  2006. The note is guaranteed by the President and former Chairman of the  Company.                                                                                                                        |   | 53,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable, secured by product brand, bearing  interest at 20%. The note, as renewed, matures December 1, 2004. As of the  date of this report, the Company is seeking to negotiate an extension of the  maturity date to December 1, 2005. Interest only payments are made monthly.                                                                                                                                       |   | 50,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable, unsecured, with interest only payments  at 10%, commencing August 20, 2003. The due date of the note is October 12,  2005, and is guaranteed by the President of the Company. After two years from  July 17, 2003, either party can give 90 days written notice to pay off in  full.                                                                                                                           |   | 300,000   |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable, unsecured, in the amount of $150,000,  plus accrued interest at 24% from December 3, 2003 through March 1, 2004.  Principal and interest due and payable March 1, 2004. This note is past due  its maturity.                                                                                                                                                                                                   |   | 120,000   |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable, unsecured, in the amount of $200,000,  plus accrued interest at 15% from May 17, 2004. Principal and accrued  interest is due and payable August 14, 2004. This note is past due its  maturity.                                                                                                                                                                                                                |   | 200,000   |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable, secured by product brand, in the  amount of $300,000, plus interest at 20%, payable in monthly installments of  $5,000, commencing April 1, 2004. This note replaces a $200,00 note dated  July 1, 2002 which had been paid down to $100,000.                                                                                                                                                                  |   | 265,000   |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   |      |      |
| Note payable, secured by product brand, in the  amount of $2,176,000, plus interest at the one month LIBOR rate (1.8401% at  September 30, 2004), payable monthly. Principal amount is due December 1,  2005.                                                                                                                                                                                                                |   | 2,176,000 |      |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   | 3,581,000 |      |
| Less current  portion ($737,000 in arrears)                                                                                                                                                                                                                                                                                                                                                                                  |   | (871,000  | )         |
|                                                                                                                                                                                                                                                                                                                                                                                                                         |   | $         | 2,710,000 |   |

 

Interest expense on theabove notes was $529,000 for the year ended September 30, 2004.

 

**NOTE 10 -****     NOTESPAYABLE - RELATED PARTIES (LEE FAMILY MEMBERS)**

 
| Notes payable to relatives of the  President/Stockholder, unsecured, bearing interest at bank’s prime rate  (4.75% at September 30, 2004), maturing January 2005. Payable interest only.  At September 30, 2004, accrued interest was $8,000.                                                                                                                           |   | $          | 36,000    |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|-----------|--------|
|                                                                                                                                                                                                                                                                                                                                                                         |   |       |      |
| Note payable to Director/Stockholder, unsecured,  bearing interest at bank’s prime rate (4.75% at September 30, 2004),  principal and accrued interest is payable in January 2005. At September 30,  2004, accrued interest was $1,000.                                                                                                                                 |   | 372,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                         |   |       |      |
| Notes payable to related party (Lee Foundation),  secured by product brand, bearing interest at bank’s prime rate (4.75% at  September 30, 2004), principal and accrued interest is payable in January  2005. At September 30, 2004, accrued interest was $82,000.                                                                                                      |   | 400,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                         |   |       |      |
| Note payable to the estate of a relative of a  Director/Stockholder, unsecured, bearing interest at bank’s prime rate (4.75%  at September 30, 2004), and principal payable based on a twelve (12) year  fully amortized schedule commencing March 15, 1997. No principal payments  have been made on this note. At September 30, 2004, accrued interest was  $948,000. |   | 1,440,000  |      |
|                                                                                                                                                                                                                                                                                                                                                                         |   |       |      |
| Note payable to Director/Stockholder, secured by  product brand, bearing interest at bank’s prime rate (4.75% at September 30,  2004), principal and accrued interest is payable in January 2005.                                                                                                                                                                       |   | 21,000     |      |
|                                                                                                                                                                                                                                                                                                                                                                         |   |       |      |
| Note payable to Director/Stockholder, unsecured,  bearing interest at bank’s prime rate (4.75% at September 30, 2004),  principal and accrued interest is payable in January 2005. At September 30,  2004, accrued interest was $1,000.                                                                                                                                 |   | 250,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                         |   |       |      |
| Demand note payable to Director/Stockholder,  unsecured, bearing interest at 12% commencing June 15, 2004. Payment due upon  demand by the note holder. At September 30, 2004, accrued interest was  $3,000.                                                                                                                                                                 |   | 277,000    |      |
|                                                                                                                                                                                                                                                                                                                                                                         |   | 2,796,000  |      |
| Less current  portion ($975,000 in arrears)                                                                                                                                                                                                                                                                                                                                  |   | (1,307,000 | )         |
|                                                                                                                                                                                                                                                                                                                                                                         |   | $          | 1,489,000 |   |

 

23

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Interest expense on theabove notes was $112,000 for the year ended September 30, 2004.

 

**NOTE 11 -****     DEBTMATURITIES SCHEDULE**

 

AtSeptember 30, 2004, the Company was committed to the following minimumprincipal payments:

 
| **Year ending  September 30,** | ** ** | **Notes payable  finance company** | ** ** | **Related  parties** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                           |       |                               |       |                 |       |      |       |      |       |
| 2005                           |       | $                                  | 1,079,000  |                 | $          | 2,386,000 |       | $         | 3,047,000  |   | $ | 6,512,000 |   |
| 2006                           |       | 147,000                            |       | 120,000              |       | 389,000   |       | 656,000   |       |
| 2007                           |       | —                             |       | 120,000              |       | 60,000    |       | 180,000   |       |
| 2008                           |       | —                             |       | 120,000              |       | 60,000    |       | 180,000   |       |
| 2009                           |       | —                             |       | 50,000               |       | 25,000    |       | 75,000    |       |
|                           |       |                               |       |                 |       |      |       |      |       |
| Total                          |       | $                                  | 1,226,000  |                 | $          | 2,796,000 |       | $         | 3,581,000  |   | $ | 7,603,000 |   |

 

**NOTE 12 -****     DEFERREDINCOME**

 

The deferred income consistsof nine assistance agreements paid for in advance by the purchaser of theproduct lines Klutch®, Astring-o-Sol®, and iodex®(see Note 19). The original agreements vary in length from thirty-six toforty-eight months.  At September 30,2004, the income to be earned per the agreements is as follows:

 

| **Year ending  September 30,** | ** ** | **Amount** | ** ** |
|--------------------------------|------------|------------|------------|
|                           |       |       |       |
| 2005                           |       | $          | 177,000    |   |
| 2006                           |       | 118,000    |       |
| 2007                           |       | 14,000     |       |
| 2008                           |       | —     |       |
|                           |       |       |       |
| Total                          |       | $          | 309,000    |   |

 

**NOTE 13 -****     COMMITMENTSAND CONTINGENCIES**

 

**Leasecommitments**

 

At September 30, 2004,the Company is committed to its Chairman and to others under noncancellableoperating leases for land and buildings requiring minimum annual rentals asfollows:

 
| **Year ending  September 30,** | ** ** | **Others** | ** ** | **Chairman** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------|------------|--------------|------------|-----------|------------|
|                           |       |       |       |         |       |      |       |
| 2005                           |       | $          | 474,000    |         | $          | 152,000   |       | $ | 626,000 | ** ** |
| 2006                           |       | 79,000     |       | 25,000       |       | 104,000   | ** ** |
| 2007                           |       | —     |       | —       |       | —    | ** ** |
| 2008                           |       | —     |       | —       |       | —    | ** ** |
| 2009                           |       | —     |       | —       |       | —    | ** ** |
|                           |       |       |       |         |       |      |       |
| Total                          |       | $          | 553,000    |         | $          | 177,000   |       | $ | 730,000 | ** ** |

 

The leases expireNovember 30, 2005.  The renewal calls forConsumer Price Index (based on Los Angeles - Riverside - Orange County: Allitems - All Urban Consumers) adjustments on December 1, 2002 and December 1,2004 pertaining to the leases above (Others) and adjustments on April 1, 2005for the Chairman’s leases.  The lesseehas an option to renew at the end of all lease terms.

 

24

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Generally, the leasesprovide that maintenance, insurance and a portion of property taxes are to bepaid by the Company.  The Company alsohas a right of first refusal to acquire most of the buildings which itleases.  The Company’s rental expense forthe years ended September 30, 2004, and 2003, net of sublease income, was$574,000 and $515,000, respectively.

 

During fiscal year 2004,there was one sublease.  The lease issubleased to another company.  Subleaseincome was $50,400 and $104,000 for fiscal years ended September 30, 2004 and2003, respectively.  This sublease for$4,116 per month was signed April 1, 2001. The monthly rental increased to $4,200 May 1, 2003.  It will expire November 30, 2005.

 

| **Year ending  September 30,** | ** ** | **Sublease  revenues** | ** ** |
|--------------------------------|------------|------------------------|------------|
|                           |       |                   |       |
| 2005                           |       | $                      | 50,400     |   |
| 2006                           |       | 8,400                  |       |
| 2007                           |       | —                 |       |
| 2008                           |       | —                 |       |
| 2009                           |       | —                 |       |
|                           |       |                   |       |
| Total                          |       | $                      | 58,800     |   |

 

**Assessmentfor environmental cleanup**

 

The Company owns amanufacturing facility located in South El Monte, California.  The California Regional Water Quality ControlBoard (The “RWQCB”) ordered the Company in 1988 and 1989 to investigate thecontamination on its property (relating to soil and groundwatercontamination).  The Company engaged aconsultant who performed tests and reported to the then Chairman of theCompany.  The Company resisted furtherwork on its property until the property upgradient was tested in greater detailsince two “apparent source” lots had not been tested.  On August 12, 1991, the RWQCB issued a “Cleanupand Abatement Order” directing the Company to conduct further testing and cleanup the site.  In October 1991, theCompany received from an environmental consulting firm an estimate of $465,200for investigation and cleanup costs.  TheCompany believed that this estimate was inconclusive and overstated thecontamination levels.  The Companybelieves that subsequent investigations will support the Company’s conclusions aboutthat estimate.  The Company did notcomplete the testing for the reasons listed above as well as “financialconstraints.”  In June 1992, the RWQCBrequested that the EPA evaluate the contamination and take appropriateaction.  At the EPA’s request, Ecology& Environment, Inc. conducted an investigation of soil and groundwater onthe Company’s property.  Ecology &Environment Inc.’s Final Site Assessment Report, which was submitted to the EPAin June 1994, did not rule out the possibility that some of the contaminationoriginated on-site, and resulted from either past or current operations on theproperty.

 

On April 24, 2002, theRWQCB notified the Company that the detection of emergent chemicals ingroundwater, above State and Federal maximum containment levels or actionlevels, has caused the RWQCB and the EPA to reassess the threat posed togroundwater resources used for domestic supply. The RWQCB directed the Company to test for the presence of emergentchemicals in its groundwater monitoring wells. The groundwater monitoring analytical results were due by July 15,2002.  On May 24, 2002, the Companyinformed RWQCB that it could not comply with the requirement to conductgroundwater sampling due to ongoing financial difficulties.

 

On July 8, 2002, theRWQCB sent a “Second Notice of Violation” to the Company directing the Companyto comply with the requirement to prepare a groundwater remedial action plan(RAP).  The Company previously notifiedthe RWQCB that it could not comply with the requirement to submit a RAP becauseof ongoing financial difficulties.  TheRWQCB requested that the Company submit certain financial information by July29, 2002 to “substantiate any alleged financial losses and determine whetherany suspension of implementing the...(Cleanup and Abatement Order) iswarranted.”  The Company has received anextension to submit the required financial information to August 19, 2002.  The Company submitted the requested financialinformation on August 16, 2002.  The Companyreceived a response whereby their request for financial hardship was denied.  The Company is in the process of appealingthis decision based primarily upon the continued deterioration in the Companyfinances since the original filing.  TheCompany may be liable for all or part of the costs of remediating thecontamination on its property and could be subject to enforcement action by theRWQCB, including injunctive and civil monetary remedies.  As of the date of the financial statements,the Company’s share of the costs have not been determined.

 

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

 

25

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

 

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

 

In August 1995, theCompany was informed that the EPA entered into an Administrative Order ofConsent with Cardinal Industrial Finishes (“Cardinal”) for a PRP lead remedialinvestigation and feasibility study (the “Study”) which, the EPA states, willboth characterize the extent of groundwater contamination in South El Monte andanalyze alternatives to control the spread of contamination.  The Company and others entered into the SouthEl Monte Operable Unit Site Participation Agreement with Cardinal pursuant towhich, among other things, Cardinal contracted with an environmental firm toconduct the Study.  The Study has beencompleted.  The Company’s share of thecost of the Study was $15,000 and was accrued for in the financial statementsas of September 30, 1995.  The South El MonteOperable Unit (SEMOU) participants developed four remedial alternatives.  The capital cost of the four alternativesrange from $0 (no action) up to $3.49 million. The estimated annual operating cost for the four alternatives range from$0 (no action) to $770,300.  Over a30-year period, the total cost of the four alternatives range from $0 (noaction) up to $13.05 million.  The EPAprefers an alternative which estimates the capital cost up to $3.08 million,the annual operating cost at $.48 million, and the 30-year period total cost upto approximately $9.09 million.  Theselection of the actual alternative implemented is subject to public comment.  At the present time, the Company does not knowwhat its share of the cost may be, if any. Therefore, no additional accrual has been recognized as a liability onthe Company’s books.  The Companyrequested that the EPA conduct an “ability-to-pay evaluation” to determinewhether the Company is entitled to an early settlement of this matter basedupon a limited ability to pay costs associated with site investigation andremediation.  In August 2000, the EPAinformed the Company that it does not qualify for an early settlement at thistime.

 

The EPA has informed theCompany that it has learned that the intermediate zone groundwatercontamination in the western portion of the SEMOU has migrated further west andhas now impacted the City of Monterey Park and Southern California WaterCompany production wells.  The EPA statedthat the City of Monterey Park Water Department, San Gabriel Valley WaterCompany and Southern California Water Company are planning to build treatmentfacilities for their wells.  The EPAstated that these three water purveyors contacted some of the SEMOU PRPs, otherthan the Company, to seek funding to develop groundwater treatment facilitiesfor the contaminated wells.  A group ofthese PRPs calling themselves the “South El Monte Cooperative Group” has beenformed and purportedly has reached a general agreement with the water purveyorsto fund the development of treatment facilities and use the water purveyors’wells in an attempt to contain the groundwater contamination to meet EPA’sgoals.  The Company is not able todetermine what contribution, if any, it may be assessed in connection with thiscleanup activity.

 

By letter dated November13, 2000, the Company was notified that the City of Monterey Park, San GabrielValley Water Company and Southern California Water Company intend to bring suitunder the Safe Drinking Water and Toxic Enforcement Act of 1986, alleging thatthe Company has knowingly released volatile organic compounds in the soil andshallow groundwater beneath the Company’s property between at least on orbefore November 8, 1996 and the present and has failed to promptly clean up allof the contamination.  As of the date ofthis report, the Company has not been served with this lawsuit.

 

The City of South ElMonte, the city in which the Company has its manufacturing facility, is locatedin the San Gabriel Valley.  The SanGabriel Valley has been declared a Superfund site.  The 1995 Water Quality Control Plan issued bythe California Regional Water Quality Control Board states that the primarygroundwater basin pollutants in the San Gabriel Valley are volatile organiccompounds from industry, nitrates from subsurface sewage disposal and pastagricultural activities.  In addition,the Plan noted that hundreds of underground storage tanks leaking gasoline andother toxic chemicals have existed in the San Gabriel Valley.  The California Department of Toxic SubstanceControl has declared large areas of the San Gabriel Valley to beenvironmentally hazardous and subject to cleanup work.

 

The Company believes theCity of South El Monte does not appear to be located over any of the majorplumes.  However, the EPA has announcedit is studying the possibility that, although the vadose soil and groundwater,while presenting cleanup problems, there may be a contamination by DNAPs (densenon-aqueous phase liquids), i.e., “sinkers,” usually chlorinated 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 ElMonte Property Owners Association) as to cost sharing on this project.  SEMPOA has obtained much lower preliminarycost estimates.  The outcome cost andexact scope of this are unclear at this time.

 

26

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The Company and otherproperty owners engaged Geomatrix Consultants, Inc., to do a survey of vadosesoil and shallow groundwater in the “hot spots” detected in the previousstudies.  Geomatrix issued a report datedDecember 1, 1997 (the “Report”), on the impact of volatile organic compounds onthe soil and groundwater at the Lidcombe and Santa Anita Avenue site located inSouth El Monte, California (which includes the Company’s facilities).  The Report indicated generally lowconcentrations of tetrachloroethene, trichloaethene and trichloroethane in thegroundwater of the upgradient neighbor. The Report was submitted to the RWQCB for its comments andresponse.  A meeting with the parties andRWQCB was held on February 10, 1998.  TheRWQCB had advised companies that vadose soil contamination is minimal andrequires no further action.  However,there is an area of shallow groundwater which has a higher than desired levelof chlorinated solvents, and the RWQCB requested a proposed work plan besubmitted by Geomatrix.  Geomatrix hassubmitted a “Focused Feasibility Study” which concludes that there are fivepossible methods for cleanup.  The mostexpensive are for a pump and sewer remediation which would cost between$1,406,000 and $1,687,000.  The Companyis actively exploring the less expensive alternative remediation methods, ofwhich the two proposed alternatives range in cost between $985,000 and$1,284,000.  Since there are foureconomic entities involved, the Company’s best estimate at this time, in theirjudgment, would be that their forecasted share would be $287,000 less theliability already recognized on the books of $165,000 thereby requiring anadditional $122,000 liability. Accordingly, the Company recorded an additional accrual of $122,000 inthe third quarter of fiscal 1998.  The$122,000 accrual is in addition to the $79,000 accrual for the Monterey Site aswill be explained in the following paragraph. The $79,000 accrual, in the third quarter of fiscal 1998, related to theMonterey Site is not included in the $287,000 figure above.  In April 2000, the Company received a Noticeof Violation from the RWQCB.  The Noticeof Violation states that the Company and other property owners were required tosubmit a groundwater remedial action plan by November 1, 1999, and that theRWQCB has been advised that the Company and the other property owners wereunable to submit the required remedial action plan because the Company and theother property owners could not agree on the allocation of financial responsibilityto prepare the action plan.  The RWQCBstated that it will no longer encourage the cooperative approach among theCompany and the other property owners in completing the cleanup requirementsand will pursue appropriate measures, including when necessary, enforcementactions.  The RWQCB states that it mayimpose civil liability penalties of up to $1,000 per day from November 1, 1999for failure to file the action plan.  Inlight of these events, no assurances can be given that the cleanup costs andpossible penalties will not exceed the amount of the Company’s current accrualsof $287,000 (which includes the $122,000 charge to income in the third quarterof fiscal 1998).

 

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

 

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

 

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

 

The Company was notifiedby the EPA that the Company may have potential liability for waste material itdisposed of at the Casmalia Disposal Site (“Site”) located on a 252 acre parcelin Santa Barbara County, California.  TheSite was operational from 1973 to 1989, and over 10,000 separate partiesdisposed of waste there.  The EPA statedthat federal, state and local governmental agencies along with the numerousprivate entities that used the Site for waste disposal will be expected to paytheir share as part of this settlement. The U.S. EPA is also pursuing the owner(s)/operator(s) of the Site topay for Site remediation.  The EPA has asettlement offer to the Company with respect to the Site for a cost of$373,950.  The Company accrued a $374,000charge in the first quarter of fiscal 1999 with respect to this possibleliability.  The Company has elected tofile for relief from these obligations under the financial hardships option inthe EPA’s response form.  The Company,the EPA and certain PRPs have entered into an agreement tolling the applicablestatutes of limitation.  The Company hasbeen notified by the EPA that their request for a waiver, due to financialhardship, was “partially granted.” Improvements in the bidding process has lowered the Company’s estimatedshare down to $245,000 (from $374,000) and of that, the EPA was requesting thatthe Company pay $113,000, as a result of their findings on the application forwaiver due to financial hardship.  TheCompany is considering the EPA’s request.

 

27

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The Company has requesteda reduced financial liability or waiver on the three EPA sites:  SEMOU, Operating Industries, Inc. (OII) andCasmalia Disposal Site.  The Company hascontinued to provide the information and documentation requested by the EPA asit relates to its ability to pay.  Inconnection with this request, the Company understands that the EPA isconsidering the information.

 

The total amount ofenvironmental investigation and cleanup costs that the Company may incur withrespect to the foregoing is not known at this time.  However, based upon information available tothe Company at this time, the Company has expensed since 1988 a total of$860,000, of which $89,000 were legal fees, exclusive of legal fees expended inconnection with the Securities and Exchange Commission environmentalinvestigation.  The actual costs coulddiffer materially from the amounts expensed for environmental investigation andcleanup costs to date.

 

As of September 30, 2004,no settlements have been reached.  Thetotal amount expensed in prior years relating to this environmental issue is$860,000.  For the year ended September30, 2004, no additional amounts have been expensed or accrued.  The Company has an accrued liability on thebooks at September 30, 2004 of $740,000 for the environmental cleanup.

 

**NOTE 14 -****     STOCKOPTIONS**

 

The 1997 EmployeeIncentive Stock Option Plan was adopted by the Board of Directors on January20, 1997, and was approved by the Company’s shareholders on March 11,1997.  The Employee Incentive Stock OptionPlan provides for the granting of options to selected officers and keyemployees of the Company for the purchase of a total of 980,000 shares ofCommon Stock of the Company at a price per share equal to the fair market valueon the date of the grant.  The optionsexpire five years from the date of the grant. For the year ended September 30, 2003, options of 212,000 expired.  As of September 30, 2004, there were nooptions outstanding.

 

An additional 1997 StockOption Plan was adopted by the Board of Directors on January 20, 1997, and wasapproved by the Company’s shareholders on March 11, 1997.  This Stock Option Plan provides for thegranting of options to the Company’s outside directors for the purchase of150,000 shares of Common Stock of the Company at a price per share equal to thefair market value on the date of the grant. For the year ended September 30, 2003, 150,000 options expired.  As of September 30, 2004, there were nooptions outstanding.

 

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

 

Under both plans, theprice per share of the shares subject to each option shall not be less than100% of the fair market value of such stock on the date the stock option isgranted.  Stock options shall not beexercisable until one and one-half years from the date of the grant.  Commencing eighteen (18), thirty (30), andforty-two (42) months, respectively, after the date of the grant, an option maybe exercised to the extent of one third of the total number of shares to whichit relates.  Upon a change in control ofthe Company (as defined), all stock options granted to any optionee will becomefully exercisable.  Any stock option grantedto an employee who at the time the option is granted, owns stock representingmore than ten percent (10%) of the total combined voting power of all classesof stock of the Company, will be granted at a price equal to one hundred andten percent (110%) of the fair market value determined as of the date the stockoption is granted.  Both plans willexpire on December 31, 2006.

 

The following is a statusof the stock options outstanding at September 30, 2004 and 2003 and the changesduring the years then ended:

 
| ** **                                      | ** ** | **2004**    | ** ** | **2003**                              | ** ** |
|-------------------------------------------------|------------|-------------|------------|---------------------------------------|------------|
| ** **                                      | ** ** | **Options** | ** ** | **Weighted  average  exercise price** | ** ** | **Options** | ** ** | **Weighted  average  exercise price** | ** ** |
|                                            |       |        |       |                                  |       |   |   |   |   |
| Outstanding,  beginning of year                 |       | —      |       | $                                     | —     |   | 212,000 |   | $ | 0.22 |   |
|                                            |       |        |       |                                  |       |   |   |   |   |
| Granted                                         |       | —      |       | —                                |       | — |   | — |   |
| Exercised                                       |       | —      |       | —                                |       | — |   | — |   |
| Expired/Forfeited                               |       | —      |       | $                                     | —     |   | (212,000 | ) | $ | 0.22 |   |
|                                            |       |        |       |                                  |       |   |   |   |   |
| Outstanding, end  of year                       |       | —      |       | $                                     | —     |   | — |   | $ | — |   |
|                                            |       |        |       |                                  |       |   |   |   |   |
| Exercisable at  end of year                     |       | —      |       | $                                     | —     |   | — |   | $ | — |   |
|                                            |       |        |       |                                  |       |   |   |   |   |
| Weighted average  fair value of options granted |       |        |       | $                                     | —     |   |   |   | $ | — |   |

 

There were no stockoptions outstanding at September 30, 2004.

 

28

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**NOTE 15 -****     DEFERREDINCOME TAXES**

 

The net deferred taxamounts included in the accompanying balance sheet contain the followingamounts of deferred tax assets and liabilities:

 
| Deferred tax  asset - current         |   | $          | 249,000   |   |
|---------------------------------------|--------|------------|-----------|--------|
| Deferred tax  liability - current     |   | —     |      |
|                                  |   | 249,000    |      |
| Less valuation  allowance             |   | (249,000   | )         |
| Net deferred tax  asset - current     |   | $          | —    |   |
|                                  |   |       |      |
| Deferred tax  asset - non-current     |   | $          | 2,533,000 |   |
| Deferred tax  liability - non-current |   | —     |      |
|                                  |   | 2,533,000  |      |
| Less valuation  allowance             |   | (2,533,000 | )         |
| Net deferred tax  asset - non-current |   | $          | —    |   |

 

The deferred tax asset -current, results from an allowance for bad debts and inventory reserves, forfinancial statement purposes not allowed for income tax purposes.

 

The deferred tax asset -non-current, results from an estimated net operating loss carryforward forfederal and state income tax purposes, and from book depreciation andamortization in excess of tax amounts.

 

The Company has recordeda valuation allowance to reflect the estimated amount of deferred asset, whichmay not be realized.  Since the Companyhad net operating loss (NOL) carryforwards of approximately $14,775,000 forFederal and $2,329,000 for State, the tax rate used to calculate the deferredtax asset for Federal is 15% and 8.84% for State.

 

Significant components ofthe Company’s deferred tax assets and liabilities are as follows:

 
| Deferred tax  assets - current:                           |   |       |   |
|-----------------------------------------------------------|--------|------------|--------|
| Allowance for  bad debts and returned merchandise         |   | $          | 46,000 |   |
| Allowance for  inventory obsolescence                     |   | 203,000    |   |
| Total deferred  tax assets - current                      |   | 249,000    |   |
|                                                      |   |       |   |
| Deferred tax  assets - non-current:                       |   |       |   |
| Depreciation,  amortization and impairment                |   | 111,000    |   |
| Net operating  loss carryforward                          |   | 2,422,000  |   |
| Total deferred  tax assets - non-current                  |   | 2,533,000  |   |
|                                                      |   |       |   |
| Total net  deferred tax assets before valuation allowance |   | 2,782,000  |   |
| Valuation  allowance                                      |   | (2,782,000 | )      |
| Net deferred tax  assets                                  |   | $          | — |   |

 

**NOTE 16 -****     INCOMETAXES**

 

As of September 30, 2004,the Company had net operating loss (NOL) carryforwards of approximately$14,775,000 for Federal and $2,329,000 for California which for tax purposescan be used to offset future Federal and California income taxes.  The differences in the state carryforwardsrelate primarily to the treatment of loss carryforwards and depreciation ofproperty, plant and equipment.  TheFederal carryforwards expire from 2005 through 2024; California carryforwardsexpire from 2004 through 2009.  Californiahas temporarily suspended net operating losses. The Company has provided anallowance for the entire amount of the deferred asset applicable to the NOL.

 

**NOTE 17 -****     EMPLOYEEBENEFIT PLANS**

 

The Company has a 401(k)Profit Sharing Plan (the “Plan”) available to all employees who meet the Plan’seligibility requirements.  Under thePlan, participating employees may defer a percentage (not to exceed 50%) oftheir eligible pretax earnings up to the Internal Revenue Service’s annualcontribution limit (up to $13,000).  However,employees deemed to be highly compensated employees (HCE) for the Plan year maydefer a percentage (not to exceed 20%) of their eligible pretax earnings up tothe Internal Revenue Service’s annual contribution limit (up to $13,000).  Participants who have attained the age offifty by the end of the calendar year, and have contributed the maximum amountpermitted, are also eligible to make an additional contribution (catch-upcontribution) up to $3,000 for calendar year 2004.  Company contributions are not required. Todate, the Company has not made any contributions to the Plan.

 

29

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**NOTE 18 -****     ACQUISITIONS**

 

In December 2002, theCompany signed an agreement with Monticello Drug Company relating to theacquisition of a product line in conjunction with a large pharmaceuticalcompany.  The original agreement calledfor Lee Pharmaceuticals to have a 40% ownership interest in the product lineand to receive 40% of the net product profits as a monthly royalty.  This investment was recorded on the books for$800,800.  The Company paid $430,000 andrecorded a current liability of $370,800. This agreement was revised in April 2003, so that Lee Pharmaceuticals’ownership interest and monthly royalty were reduced to 20%.  Monticello Drug Company repaid $215,000 ofthe original amount paid by the Company, and the Company reduced the currentliability ‘Due on Investment Acquisition’ to $185,400.  In June 2003, the agreement was furtherrevised so that Monticello Drug Company repurchased the remaining 20% of theCompany’s ownership interest.

 

On September 10, 2003,the Company purchased certain assets of the product line OraStat®Oral Anesthetic Gel from Stiefel Laboratories, Inc.  The purchase price was $90,000 for a covenantnot to compete and an undetermined amount for inventory.  The purchase price of $90,000 was paid incash at closing.

 

During fiscal 2004, theCompany did not have any acquisitions.

 

**NOTE 19 -****     OTHERINCOME**

 

For the year ended September30, 2004, the Company realized gains of approximately $43,000 related to thesale of the Astring-o-Sol® product line, approximately $73,000related to the sale of the Klutch® product line and approximately$127,000 related to the sale of the iodex® product line.  These realized gains pertain to therecognition of the earned portion of the deferred income of the consultingagreements arising from the sale of the Astring-o-Sol® , Klutch®,and iodex® brands.  Theseamounts are included in other income on the statement of operations.  Also included in other income is $265,000from the new marketing and distribution agreement with Monticello Drug Companyand $4,000 from the sale of the Beau Kreml® product line.

 

**NOTE 20 -****     DISTRIBUTIONAGREEMENT**

 

In July 2003, the Companyentered into a distribution agreement with Monticello Drug Company whereby theCompany will warehouse, ship, bill and collect for certain Monticello DrugCompany owned products.  The Company willreceive a fee based on Monticello Drug Company’s gross sales for thisservice.  The distribution agreement isscheduled for a five year period commencing August 1, 2003.  The distribution agreement can be cancelledby Monticello Drug Company with a thirty day notice or by the Company with aone year notice.  The accountsreceivables and the related accounts payables are offset, and the resultingamount (approximately 15% of the accounts receivables) is included as othercurrent assets on the balance sheet and included as other income in thestatement of operations.

 

**NOTE 21 -****     SUBSEQUENTEVENTS**

 

On October 12, 2004, theCompany sold its Nose Better® line of products to The WoolfoamCorporation for $750,000, plus approximately $14,000 of inventory.  The entire selling price of $750,000 wasreceived in cash at the time of closing and recorded as a gain on the sale ofassets.

 

30

----

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

 

As previously reported ina Current Report on Form 8-K, on September 18, 2003, the Board of Directors ofthe Company authorized, effective September 18, 2003, (1) the resignation ofengagement of Caldwell, Becker, Dervin, Petrick & Co., L.L.P., asindependent auditors for the Company for the fiscal year ended September 30,2003 and (2) the engagement of George Brenner, CPA, as independent auditor forthe Company for fiscal 2003.  GeorgeBrenner, CPA, was engaged as the Company’s principal independent auditor onSeptember 18, 2003.

 

In connection with itsactivities for the period June 16, 2000, (the date Caldwell, Becker, Dervin,Petrick & Co., L.L.P., was engaged), through September 18, 2003, there wereno disagreements on any matter of accounting principles or practices, financialstatement disclosure, or auditing scope or procedure, which disagreements ifnot resolved to the satisfaction of Caldwell, Becker, Dervin, Petrick &Co., L.L.P., would have caused them to make reference in connection with theirreport to the subject matter.  The opinionsof Caldwell, Becker, Dervin, Petrick & Co., L.L.P., with respect to theCompany’s financial statements did state that the financial statements wereprepared assuming the Company would continue as a going concern. Caldwell,Becker, Dervin, Petrick & Co., L.L.P., resigned from the engagement.

 

Prior to such firm’sengagement, George Brenner, CPA, was not consulted by the Company (or anyoneacting on its behalf) regarding (1) either the application of accountingprinciples to a specified transaction, either completed or proposed, or thetype of audit opinion that might be rendered on the Company’s financialstatements or (2) any matter that was either the subject of a “disagreement” ofa “reportable event” as such terms are defined in Regulation S-K promulgated bythe Securities and Exchange Commission.

 

**ITEM 8A.       CONTROLS AND PROCEDURES.**

 

As of September 30, 2004,the chief executive officer and chief financial officer of the Company (the “certifyingofficer”) evaluated the effectiveness of the Company’s disclosure controls andprocedures.  These disclosure controlsand procedures are designed to ensure that the information required to bedisclosed by the Company in its periodic reports filed with the Securities andExchange Commission (the “Commission”) is recorded, processed, summarized andreported, within the time periods specified by the Commission’s rules andforms, and that the information is communicated to the certifying officer on atimely basis.

 

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

 

Management has determinedthat the Company has invoiced certain customers before the product was shippedand double shipped to certain other customers. Management has implemented changes to correct these deficiencies as partof the Company’s upgrade of its electronic data interchange with itscustomers.  In addition, management haschanged its procedures to require that all customer deductions be approved bythe Sales Manager or President.  Theseitems had no impact on the financial statements contained herein.

 

31

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**PART III**

 

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

 

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

 
| **Name**                | ** ** | **Age** | ** ** | **Positions held  with Company**                       | ** ** | **A director  or officer  since** | ** ** | **Principal occupation  during the past five years (1)**                                                                                                                                                                                                                                                                                                                                                                     | ** ** |
|-------------------------|------------|---------|------------|--------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                    |       |    |       |                                                   |       |                              |       |                                                                                                                                                                                                                                                                                                                                                                                                                         |       |
| Dr. Henry L. Lee        |       | 78      |       | 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           |       | 52      |       | President, Chairman and Director                       |       | 1977                              |       | President and since April 1995, Chairman of the  Board of the Company                                                                                                                                                                                                                                                                                                                                                        |       |
|                    |       |    |       |                                                   |       |                              |       |                                                                                                                                                                                                                                                                                                                                                                                                                         |       |
| Michael L.  Agresti     |       | 62      |       | Vice President – Finance, Treasurer and Secretary |       | 1977                              |       | Vice President - Finance, Treasurer and Secretary of  the Company                                                                                                                                                                                                                                                                                                                                                            |       |
|                    |       |    |       |                                                   |       |                              |       |                                                                                                                                                                                                                                                                                                                                                                                                                         |       |
| William M.  Caldwell IV |       | 57      |       | Director                                               |       | 1987                              |       | Chief Executive Officer of Advanced Cell  Technologies, Inc., a biotechnology company focused on developing therapies  in the area of regenerative medicine; Chairman and President of ITX, Inc., a  company that offers telecommunications, data and network security equipment  and services to a variety of intermediaries and end users; and President of  CAIS Internet, an internet infra-structure solutions company. |       |

 

----

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

 

**Family Relationships**

 

Ronald G. Lee is the sonof Dr. Henry L. Lee.

 

No one on the boardcurrently qualifies as an audit committee financial expert, and due to thefinancial condition of Lee Pharmaceuticals, the Company does not believe itcould bring on a director that would meet that criteria.

 

The Company has notadopted a Code of Ethics for its principal executive officer, principalfinancial officer, principal accounting officer, controller or persons performingsimilar functions.  However, the Companyanticipates formulating a Code of Ethics which will be adopted within the nexttwelve months.

 

**ITEM 10.       EXECUTIVE COMPENSATION.**

 

The following table setsforth information with respect to remuneration paid by the Company to theexecutive officers of the Company with total annual salary and bonus of atleast $100,000 for services in all capacities while acting as officers and directorsof the Company during the fiscal years ended September 30, 2004, 2003 and 2002:

 

**SUMMARYCOMPENSATION TABLE**

 
|                                   |     |   |            |                    |   |                                |   | **Long Term  Compensation  Awards** |                             |   |   |
|----------------------------------------|----------|--------|-----------------|-------------------------|--------|-------------------------------------|--------|-------------------------------------|----------------------------------|--------|--------|
|                                   |     |   |            | **Annual Compensation** |   |                                |   |                                |
| **Name and  Principal Position**       |     |   |            |                    |   | **Other  Annual  Compensation ($)** |   |                                | **All  Other  Compensation ($)** |   |
|                                   | **Year** |   | **Salary  ($)** |                    |   | **Options  (#)**                    |   |                                |
|                                   |     |   |            |                    |   |                                |   |                                |                             |   |   |
| Ronald G. Lee                          |     | 2004   |            | 217,049                 |   | 2,750                               | (1)    | —                              | (2)                              | — |   |
| President,  Chairman                   |     | 2003   |            | 213,095                 |   | 2,739                               | (1)    | —                              | (2)                              | $      | 5,000  | (3) |
| (since April 26, 1995)  & Director |     | 2002   |            | 217,907                 |   | 3,732                               | (1)    | —                              | (2)                              | — |   |
|                                        |          |        |                 |                         |        |                                     |        |                                     |                                  |        |        |  |

 

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(1)         Includes reimbursement ofmedical and dental expenses not covered by the Company’s insurance plan.

(2)         No stock options weregranted during fiscal years 2004, 2003 or 2002.

(3)         Additional compensationfor non-business expenses.

 

Eachof the directors of the Company who is not employed by the Company receives adirector’s fee of $750 for each quarter and $500 for each meeting of the Boardof Directors attended, except Dr. Henry L. Lee. As holder of the honorary title of Founder Chairman, Dr. Lee waived hisfees.

 

32

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**AGGREGATED OPTION EXERCISES INLAST FISCAL YEAR**

**AND FISCAL YEAR END OPTION VALUES**

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

 

No stock options wereoutstanding at September 30, 2004.

 

**ITEM 11.****       SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS, AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.**

 

The following table setsforth the persons who, as of November 30, 2004, were known to the Company to bebeneficial owner of more than five percent of the Company’s Common Stock:

 

| **Title of class** | ** ** | **Name and address  of beneficial owner**                        | ** ** | **Amount and nature  of beneficial ownership** | ** ** | **Percentage  of class** | ** ** |
|--------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------|------------|
|               |       |                                                             |       |                                           |       |                     |       |
| Common Stock       |       | Ronald G. Lee  1444 Santa Anita Avenue  South El Monte, CA 91733 |       | 1,740,726 shares                               |       | 42                       | %          |

 

The following table setsforth the ownership of the Company’s Common Stock by its directors and itsnamed executive officers and all executive officers and directors as a group:

 

| **Title of class** | ** ** | **Name of  beneficial owner**                      | ** ** | **Amount and nature  of beneficial ownership** | ** ** | **Percentage  of class** | ** ** |
|--------------------|------------|----------------------------------------------------|------------|------------------------------------------------|------------|--------------------------|------------|
|               |       |                                               |       |                                           |       |                     |       |
| Common Stock       |       | Ronald G. Lee                                      |       | 1,740,726 shares                               |       | 42                       | %          |
|               |       |                                               |       |                                           |       |                     |       |
| Common Stock       |       | Dr. Henry L. Lee                                   |       | 144,334 shares                                 |       | 3                        | %          |
|               |       |                                               |       |                                           |       |                     |       |
| Common Stock       |       | William M. Caldwell IV                             |       | —                                         |       | —                   |       |
|               |       |                                               |       |                                           |       |                     |       |
| Common Stock       |       | All officers and directors  as a group (4 persons) |       | 1,899,596 shares                               |       | 46                       | %          |

 

The following table setsforth the Company’s Equity Compensation Plan information with respect to thefiscal year ended September 30, 2004:

 
| **Plan category**                                                 | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights****(a)** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights****(b)** | ** ** | **Number of securities  remaining available  for future issuance  under equity compensation  plans (excluding securities  reflected in column (a))****(c)** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                              |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
| **Equity  compensation  plans approved by  security holders**     | ** ** | ** **                                                                                                 | ** ** | ** **                                                                                | ** ** | ** **                                                                                                                                                  | ** ** |
|                                                              |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
| The 1997  Employee  Incentive Stock Option Plan                   |       | 0                                                                                                          |       | 0                                                                                         |       | 980,000                                                                                                                                                     |       |
|                                                              |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
| The 1997 Stock  Option Plan                                       |       | 0                                                                                                          |       | 0                                                                                         |       | 150,000                                                                                                                                                     |       |
|                                                              |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
| **Equity  compensation  plans not approved  by security holders** |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
|                                                              |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
| None                                                              |       | 0                                                                                                          |       | 0                                                                                         |       | 0                                                                                                                                                           |       |
|                                                              |       |                                                                                                       |       |                                                                                      |       |                                                                                                                                                        |       |
| Total                                                             |       | 0                                                                                                          |       | 0                                                                                         |       | 1,130,000                                                                                                                                                   |       |

 

33

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**ITEM 12.****                      CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.**

 

The information regardingborrowings from and sale and leaseback transactions between the Company and it’sChairman of the Board which is contained in Notes 8 and 10 of Notes toFinancial Statements is incorporated herein by this reference.

 

**ITEM 13.****                      EXHIBITS**

 

The following exhibitshave been or are being filed herewith, and are numbered in accordance with Item601 of Regulation S-B:

 

The following exhibits arefiled herewith:

 
| 10.    | 113    | -      | Cancellation of  previous eleven (11) promissory notes and replacing them with a promissory  note consolidating the cancelled notes with the Registrant |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                    |
| 31.    | 1      | -      | Certification by  Chief Executive Officer and Chief Financial Officer                                                                                   |
|   |   |   |                                                                                                                                                    |
| 32.    | 1      | -      | Section 1350  Certification                                                                                                                             |

 

The following exhibitshave been previously 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)           |

 

34

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| 10.    | 13     | -      | Promissory notes which  were amended in September 1992 evidencing advances by the Registrant’s  officers and directors (8)                                        |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                   |
| 10.    | 14     | -      | Promissory notes which  were amended in September 1994 evidencing advances by the Registrant’s  officers and directors (9)                                        |
|   |   |   |                                                                                                                                                                   |
| 10.    | 15     | -      | Promissory notes  evidencing advances made to the Registrant’s officers and directors (9)                                                                         |
|   |   |   |                                                                                                                                                                   |
| 10.    | 16     | -      | Promissory notes  evidencing advances made to the Registrant (9)                                                                                                       |
|   |   |   |                                                                                                                                                                   |
| 10.    | 17     | -      | Promissory notes which  were amended in January 1995 evidencing advances by the Registrant’s officers  and directors (10)                                         |
|   |   |   |                                                                                                                                                                   |
| 10.    | 18     | -      | Promissory notes  evidencing advances made by the Registrant’s officers and directors (10)                                                                        |
|   |   |   |                                                                                                                                                                   |
| 10.    | 19     | -      | Promissory notes which  were amended in July 1995 evidencing advances made to the Registrant (10)                                                                      |
|   |   |   |                                                                                                                                                                   |
| 10.    | 20     | -      | Royalty agreement dated  August 31, 1994, between Lee Pharmaceuticals and The Fleetwood Company,  regarding a brand acquisition (10)                                   |
|   |   |   |                                                                                                                                                                   |
| 10.    | 21     | -      | Royalty agreement dated  October 4, 1988, between Lee Pharmaceuticals and Roberts Proprietaries, Inc.  regarding a brand acquisition (10)                              |
|   |   |   |                                                                                                                                                                   |
| 10.    | 22     | -      | Note payable to bank  dated April 26, 1996, between Lee Pharmaceuticals and San Gabriel Valley  Bank, secured by the deed on land and building (11)                    |
|   |   |   |                                                                                                                                                                   |
| 10.    | 23     | -      | Loan and security  agreement dated May 21, 1996, between Lee Pharmaceuticals and Preferred  Business Credit, Inc. regarding a revolving credit facility financing (11) |
|   |   |   |                                                                                                                                                                   |
| 10.    | 24     | -      | Secured promissory note  dated September 17, 1996, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. (12)                                               |
|   |   |   |                                                                                                                                                                   |
| 10.    | 25     | -      | Promissory notes  evidencing advances made by the Registrant (12)                                                                                                      |
|   |   |   |                                                                                                                                                                   |
| 10.    | 26     | -      | Promissory notes which  were amended in July 1996 evidencing advances made to the Registrant (12)                                                                      |
|   |   |   |                                                                                                                                                                   |
| 10.    | 27     | -      | Sublease dated November  22, 1995, for the premises located at 1460 Santa Anita Avenue, South El  Monte, California (12)                                               |
|   |   |   |                                                                                                                                                                   |
| 10.    | 28     | -      | Sublease dated June 11,  1996, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California (12)                                                   |
|   |   |   |                                                                                                                                                                   |
| 10.    | 29     | -      | Lease dated December 1,  1995, for the premises located at 1444 Santa Anita Avenue, South El Monte,  California (12)                                                   |
|   |   |   |                                                                                                                                                                   |
| 10.    | 30     | -      | Lease dated December 1,  1995, for the premises located at 1445 Lidcombe Avenue, South El Monte,  California (12)                                                      |
|   |   |   |                                                                                                                                                                   |
| 10.    | 31     | -      | 1997 Employee Incentive  Stock Option Plan (13)                                                                                                                        |
|   |   |   |                                                                                                                                                                   |
| 10.    | 32     | -      | 1997 Stock Option Plan  (13)                                                                                                                                           |
|   |   |   |                                                                                                                                                                   |
| 10.    | 33     | -      | Promissory note which  was amended in October 1997 evidencing advances made to the Registrant (14)                                                                     |
|   |   |   |                                                                                                                                                                   |
| 10.    | 34     | -      | Promissory notes which  were amended (modified) in December 1997 evidencing advances made to the  Registrant (14)                                                      |
|   |   |   |                                                                                                                                                                   |
| 10.    | 35     | -      | Modification of loan  and security agreement dated September 10, 1997, between Lee Pharmaceuticals  and Preferred Business Credit, Inc. (14)                           |
|   |   |   |                                                                                                                                                                   |
| 10.    | 36     | -      | Promissory note which  was amended in February 1997 evidencing advances made to the Registrant (14)                                                                    |
|   |   |   |                                                                                                                                                                   |
| 10.    | 37     | -      | Secured promissory note  dated October 21, 1996, between Lee Pharmaceuticals and Roberts Laboratories,  Inc. (14)                                                      |

 

35

----

 
| 10.    | 38     | -      | Promissory note  evidencing advance made to the Registrant (15)                                                                                                                                                                   |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 39     | -      | Promissory note  evidencing advance made to the Registrant (15)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 40     | -      | Modification of loan  and security agreement dated May 21, 1996, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. regarding a revolving credit facility  financing (16)                                           |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 41     | -      | Modification of secured  promissory note dated August 29, 1997, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (16)                                                                                             |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 42     | -      | Secured promissory note  dated May 15, 1998, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. (16)                                                                                                                |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 43     | -      | Continuing guaranty  dated May 15, 1998, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. (16)                                                                                                                    |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 44     | -      | Asset Purchase and Sale  Agreement dated June 29, 1999, between Lee Pharmaceuticals (buyer) and  Premier Consumer Products, Inc. (seller) and Advanced Polymer Systems, Inc.,  regarding a brand acquisition (17)                 |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 45     | -      | Promissory note  evidencing advance made to the Registrant (17)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 46     | -      | Promissory note  evidencing advance made to the Registrant (18)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 47     | -      | Promissory note  evidencing advance made to the Registrant (19)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 48     | -      | Modification of loan  and security agreement dated October 29, 1999, between Lee Pharmaceuticals  and Finova Capital Corporation (formerly Preferred Business Credit, Inc.)  regarding a revolving credit facility financing (19) |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 49     | -      | Modification of secured  (by inventory) promissory note dated October 29, 1999, between Lee Pharmaceuticals  and Finova Capital Corporation (formerly Preferred Business Credit, Inc.)  (19)                                      |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 50     | -      | Modification of secured  (by equipment) promissory note dated October 29, 1999 ,between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.) (19)                                      |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 51     | -      | Promissory note  evidencing advance made to the Registrant (20)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 52     | -      | Modification of loan  and security agreement dated May 19, 2000, between Lee Pharmaceuticals and  Finova Capital Corporation (formerly Preferred Business Credit, Inc.)  regarding a revolving credit facility financing (21)     |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 53     | -      | Modification of secured  (by inventory) promissory note dated May 19, 2000, between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.) (21)                                          |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 54     | -      | Modification of secured  (by equipment) promissory note dated May 19, 2000, between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.) (21)                                          |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 55     | -      | Modification of secured  (by Accutek equipment) promissory note dated May 19, 2000, between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.) (21)                                  |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 56     | -      | Modification of secured  (by Accutek equipment) promissory note dated May 19, 2000 between Lee  Pharmaceuticals and Finova Capital Corporation (formerly Preferred Business  Credit, Inc.) (21)                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 57     | -      | Promissory note  evidencing advance made to the Registrant (22)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 58     | -      | Promissory note  evidencing advance made to the Registrant (22)                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 59     | -      | Lease dated May 25,  2000, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California (22)                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 60     | -      | Lease dated May 25,  2000, for the premises located at 1425 and 1427 Lidcombe Avenue, South El Monte,  California (22)                                                                                                            |
|   |   |   |                                                                                                                                                                                                                              |
| 10.    | 61     | -      | Lease dated May 25,  2000, for the premises located at 1434 Santa Anita Avenue, South El Monte,  California (22)                                                                                                                  |

 

36

----

 
| 10.    | 62     | -      | Lease dated May 25,  2000, for the premises located at 1460 Santa Anita Avenue, South El Monte,  California (22)                                                                                                                |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 63     | -      | Lease dated May 25,  2000, for the premises located at 1500 Santa Anita Avenue, South El Monte,  California (22)                                                                                                                |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 64     | -      | Lease dated May 25,  2000, for the premises located at 1516 Santa Anita Avenue, South El Monte,  California (22)                                                                                                                |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 65     | -      | Sublease dated  September 14, 2000, for the premises located at 1460 Santa Anita Avenue,  South El Monte, California (23)                                                                                                       |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 66     | -      | Sublease guaranty dated  September 14, 2000, for the premises located at 1460 Santa Anita Avenue,  South El Monte, California (23)                                                                                              |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 67     | -      | Promissory note  evidencing advance made to the Registrant (23)                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 68     | -      | Promissory note  evidencing advance made to the Registrant (24)                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 69     | -      | Loan and security  agreement dated February 20, 2001, between Lee Pharmaceuticals and Preferred  Business Credit, Inc., regarding a revolving credit facility financing (24)                                                    |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 70     | -      | Secured promissory note  dated February 20, 2001, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (24)                                                                                    |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 71     | -      | Secured promissory note  dated February 20, 2001, regarding inventory, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (24)                                                                                    |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 72     | -      | Sublease dated March 9,  2001, for the premises located at 1470 Santa Anita Avenue, South El Monte,  California (24)                                                                                                            |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 73     | -      | Sublease guaranty dated  March 9, 2001, for the premises located at 1470 Santa Anita Avenue, South El  Monte, California between Jing Jing Long (guarantor) and Lee Pharmaceuticals,  Inc. (sublandlord) (24)                   |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 74     | -      | Promissory note  evidencing advance made to the Registrant (25)                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 75     | -      | Sublease dated April  17, 2001, for the premises located at 1470 Santa Anita Avenue, South El  Monte, California (25)                                                                                                           |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 76     | -      | Restructuring and  Offset Agreement dated July 23, 2001, between Lee Pharmaceuticals, AP Pharma,  Inc. (formerly Advanced Polymer Systems, Inc.) and Premier Consumer Products,  Inc., regarding a prior brand acquisition (26) |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 77     | -      | Amended and Restated  Security Agreement dated July 23, 2001, between Lee Pharmaceuticals (grantor)  and AP Pharma, Inc. (formerly Advanced Polymer Systems, Inc.) (Secured Party)  regarding a prior brand acquisition (26)    |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 78     | -      | Promissory note dated  July 23, 2001, between Lee Pharmaceuticals and AP Pharma, Inc. (formerly  Advanced Polymer Systems, Inc.) (26)                                                                                           |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 79     | -      | Promissory note  evidencing advance made to the Registrant (26)                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 80     | -      | Promissory note which  was amended (modified) in November, 2001, evidencing advance made to the  Registrant (26)                                                                                                                |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 81     | -      | Secured promissory note  dated March 16, 2001, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. (26)                                                                                                            |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 82     | -      | Modification of secured  promissory note dated March 16, 2001, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (26)                                                                                            |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 83     | -      | Promissory note  evidencing advance made to the Registrant (27)                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 84     | -      | Promissory note  evidencing advance made to the Registrant (28)                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                            |
| 10.    | 85     | -      | Promissory note  evidencing advance made to the Registrant (28)                                                                                                                                                                 |

 

37

----

 
| 10.    | 86     | -      | Promissory note  evidencing advance made to the Registrant (29)                                                                                                                         |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                    |
| 10.    | 87     | -      | Promissory note  evidencing advance made to the Registrant (29)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 88     | -      | Promissory note  evidencing advance made to the Registrant (29)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 89     | -      | Promissory note  evidencing advance made to the Registrant (29)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 90     | -      | Promissory note dated  April 23, 2002, between Lee Pharmaceuticals and U.S. Dermatologics, Inc. (29)                                                                                    |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 91     | -      | Modification of loan  and security agreement dated April 23, 2002, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (30)                                                |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 92     | -      | Promissory note  evidencing advance made to the Registrant (30)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 93     | -      | Secured promissory note  dated April 23, 2002, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. (30)                                                                    |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 94     | -      | Secured promissory note  dated August 22, 2002, between Lee Pharmaceuticals and Preferred Business  Credit, Inc. (30)                                                                   |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 95     | -      | Promissory note  evidencing advance made to the Registrant (31)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 96     | -      | Promissory note  evidencing advance made to the Registrant (31)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 97     | -      | Promissory note which  was amended (modified) in November 2002, evidencing advance made to the  Registrant (31)                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 98     | -      | Promissory note  evidencing advance made to the Registrant (32)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 99     | -      | Modification of secured  promissory note dated February 4, 2003, regarding inventory, between Lee  Pharmaceuticals and Preferred Business Credit, Inc. (32)                             |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 100    | -      | Secured promissory note  dated November 14, 2002, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (32)                                            |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 101    | -      | Secured promissory note  dated February 4, 2003, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (32)                                             |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 102    | -      | Promissory note  evidencing advance made to the Registrant (33)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 103    | -      | Promissory note  evidencing advance made to the Registrant (34)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 104    | -      | Promissory note  evidencing advance made to the Registrant (34)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 105    | -      | Promissory note  evidencing advance made to the Registrant (35)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 106    | -      | Promissory note which  was amended (modified) in November 2003, evidencing advance made to the  Registrant (35)                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 107    | -      | Promissory note  evidencing advance made to the Registrant (36)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 108    | -      | Secured promissory note  dated November 19, 2003, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (36)                                            |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 109    | -      | Secured promissory note  dated February 3, 2004, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. (36)                                             |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 110    | -      | Promissory note  evidencing advance made to the Registrant (37)                                                                                                                         |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 111    | -      | Modification of loan  and security agreement dated May 20, 2004, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. regarding a revolving credit facility  financing (37) |
|   |   |   |                                                                                                                                                                                    |
| 10.    | 112    | -      | Demand promissory note  evidencing advance made to the Registrant (37)                                                                                                                  |

 

38

----

 

----

(1)                            Filedas an Exhibit of the same number with the Company’s Form S-1 RegistrationStatement filed with the Securities and Exchange Commission on February 5,1973, (Registrant No. 2-47005), and incorporated herein by reference.

 

(2)                            Filedas Exhibits 3.4, 3.5 and 13.18 with the Company’s Form 10-K Annual Report forthe fiscal year ended September 30, 1978, filed with the Securities andExchange Commission in December 1978 and incorporated herein by reference.

 

(3)                            Filedas an Exhibit of the same number with the Company’s Form 10-K Annual Report forthe fiscal year ended September 30, 1979, filed with the Securities andExchange Commission in December 1979 and incorporated herein by reference.

 

(4)                            Filedas Exhibit 5.1 with the Company’s Form 10-K Annual Report for the fiscal yearended September 30, 1973, filed with the Securities and Exchange Commission inDecember 1973 and incorporated herein by reference.

 

(5)                            Filedas Exhibits 13.27 and 13.28 with the Company’s Form 10-K Annual Report for thefiscal year ended September 30, 1986, filed with the Securities and ExchangeCommission in December 1986 and incorporated herein by reference.

 

(6)                            Filedas Exhibit 13.31 with the Company’s Form 10-K Annual Report for the fiscal yearended September 30, 1990, filed with the Securities and Exchange Commission inDecember 1990 and incorporated herein by reference.

 

(7)                            Filedas Exhibit 13.32 with the Company’s Form 10-K Annual Report for the fiscal yearended September 30, 1991, filed with the Securities and Exchange Commission inDecember 1991 and incorporated herein by reference.

 

(8)                            Filedas Exhibit 13.33 with the Company’s Form 10-K Annual Report for the fiscal yearended September 30, 1992, filed with the Securities and Exchange Commission inDecember 1992 and incorporated herein by reference.

 

(9)                            Filedas Exhibits 10.14, 10.15 and 10.16 with the Company’s Form 10-KSB Annual Reportfor the fiscal year ended September 30, 1994, filed with the Securities andExchange Commission in December 1994 and incorporated herein by reference.

 

(10)                            Filedas Exhibits 10.17, 10.18, 10.19, 10.20 and 10.21 with the Company’s Form 10-KSBAnnual Report for the fiscal year ended September 30, 1995, filed with theSecurities and Exchange Commission in December 1995 and incorporated herein byreference.

 

(11)                            Filedas Exhibits 10.22 and 10.23 with the Company’s Form 10-QSB Quarterly Report forthe nine months ended June 30, 1996, filed with the Securities and ExchangeCommission in August 1996 and incorporated herein by reference.

 

(12)                            Filedas Exhibits 10.24, 10.25, 10.26, 10.27, 10.28, 10.29 and 10.30 with the Company’sForm 10-KSB Annual Report for the fiscal year ended September 30, 1996, filedwith the Securities and Exchange Commission in December 1996 and incorporatedherein by reference.

 

(13)                            Includedas an attachment to the Company’s definitive Proxy Statement to shareholdersfor the meeting dated March 11, 1997 and incorporated herein by reference.

 

(14)                            Filedas Exhibits 10.33, 10.34, 10.35, 10.36 and 10.37 with the Company’s Form 10-KSBAnnual Report for the fiscal year ended September 30, 1997, filed with theSecurities and Exchange Commission in December 1997 and incorporated herein byreference.

 

(15)                            Filedas Exhibits 10.37 and 10.38 with the Company’s Form 10-QSB Quarterly Report forthe three months ended December 31, 1997, filed with the Securities andExchange Commission in February 1998 and incorporated herein by reference.

 

(16)                            Filedas Exhibits 10.1, 10.2, 10.3 and 10.4 with the Company’s Form 10-QSB QuarterlyReport for the nine months ended June 30, 1998, filed with the Securities andExchange Commission in August 1998 and incorporated herein by reference.

 

(17)                            Filedas Exhibits 10.1 and 10.2 with the Company’s Form 10-QSB Quarterly Report forthe nine months ended June 30, 1999, filed with the Securities and ExchangeCommission in August 1999 and incorporated herein by reference.

 

(18)                            Filedas Exhibit 10.46 with the Company’s Form 10-KSB Annual Report for the fiscalyear ended September 30, 1999, filed with the Securities and ExchangeCommission in December 1999 and incorporated herein by reference.

 

(19)                            Filedas Exhibits 10.1, 10.2, 10.3 and 10.4 with the Company’s Form 10-QSB QuarterlyReport for the three months ended December 31, 1999, filed with the Securitiesand Exchange Commission in February 2000 and incorporated herein by reference.

 

(20)                            Filedas Exhibit 10.1 with the Company’s Form 10-QSB Quarterly Report for the sixmonths ended March 31, 2000, filed with the Securities and Exchange Commissionin May 2000 and incorporated herein by reference.

 

(21)                            Filedas Exhibits 10.1, 10.2, 10.3, 10.4 and 10.5 with the Company’s Form 10-QSBQuarterly Report for the nine months ended June 30, 2000, filed with theSecurities and Exchange Commission in August 2000 and incorporated herein byreference.

 

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(22)                            Filedas Exhibits 10.57, 10.58, 10.59, 10.60, 10.61, 10.62, 10.63 and 10.64 with theCompany’s Form 10-KSB Annual Report for the fiscal year ended September 30,2000, filed with the Securities and Exchange Commission in December 2000 andincorporated herein by reference.

 

(23)                            Filedas Exhibits 10.1, 10.2 and 10.3 with the Company’s Form 10-QSB Quarterly Reportfor the three months ended December 31, 2000, filed with the Securities andExchange Commission in February 2001 and incorporated herein by reference.

 

(24)                            Filedas Exhibit 10.1, 10.2, 10.3, 10.4 and 10.6 with the Company’s Form 10-QSBQuarterly Report for the six months ended March 31, 2001, filed with theSecurities and Exchange Commission in May 2001 and incorporated herein byreference.

 

(25)                            Filedas Exhibits 10.1 and 10.2 with the Company’s Form 10-QSB Quarterly Report forthe nine months ended June 30, 2001, filed with the Securities and ExchangeCommission in August 2001 and incorporated herein by reference.

 

(26)                            Filedas Exhibits 10.76, 10.77, 10.78, 10.79, 10.80, 10.81 and 10.82 with the Company’sForm 10-KSB Annual Report for the fiscal year ended September 30, 2001, filedwith the Securities and Exchange Commission in December 2001 and incorporatedherein by reference.

 

(27)                            Filedas Exhibit 10.1 with the Company’s Form 10-QSB Quarterly Report for the threemonths ended December 31, 2001, filed with the Securities and ExchangeCommission in February 2002 and incorporated herein by reference.

 

(28)                            Filedas Exhibits 10.1 and 10.2 with the Company’s Form 10-QSB Quarterly Report forthe six months ended March 31, 2002, filed with the Securities and Exchange Commissionin May 2002 and incorporated herein by reference.

 

(29)                            Filedas Exhibits 10.1, 10.2, 10.3, 10.4 and 10.5 with the Company’s Form 10-QSBQuarterly Report for the nine months ended June 30, 2002, filed with theSecurities and Exchange Commission in August 2002 and incorporated herein byreference.

 

(30)                            Filedas Exhibits 10.91, 10.92, 10.93 and 10.94 with the Company’s Form 10-KSB AnnualReport for the fiscal year ended September 30, 2002, filed with the Securitiesand Exchange Commission in December 2002 and incorporated herein by reference.

 

(31)                            Filedas Exhibit 10.1, 10.2 and 10.3 with the Company’s Form 10-QSB Quarterly Reportfor the three months ended December 31, 2002, filed with the Securities andExchange Commission in February 2003 and incorporated herein by reference.

 

(32)                            Filedas Exhibits 10.1, 10.2, 10.3 and 10.4 with the Company’s Form 10-QSB QuarterlyReport for the six months ended March 31, 2003, filed with the Securities andExchange Commission in May 2003 and incorporated herein by reference.

 

(33)                            Filedas Exhibits 10.1, 31.1 and 32.1 with the Company’s Form 10-QSB Quarterly Reportfor the nine months ended June 30, 2003, filed with the Securities and ExchangeCommission in August 2003 and incorporated herein by reference.

 

(34)                            Filedas Exhibits 10.3 and 10.4 with the Company’s Form 10-KSB Annual Report for thefiscal year ended September 30, 2003, filed with the Securities and ExchangeCommission in December 2003 and incorporated herein by reference.

 

(35)                            Filedas Exhibits 10.1, 10.2, 31.1 and 32.1 with the Company’s Form 10-QSB QuarterlyReport for the three months ended December 31, 2003, filed with the Securitiesand Exchange Commission in February 2004 and incorporated herein by reference.

 

(36)                            Filedas Exhibits 10.1, 10.2, 10.3, 31.1 and 32.1 with the Company’s Form 10-QSBQuarterly Report for the six months ended March 31, 2004, filed with theSecurities and Exchange Commission in May 2004 and incorporated herein byreference.

 

(37)                            Filedas Exhibits 10.1, 10.2, 10.3, 31.1  and32.1 with the Company’s Form 10-QSB Quarterly Report for the nine months endedJune 30, 2004, filed with the Securities and Exchange Commission in August 2004and incorporated herein by reference.

 

**ITEM 14.****                       PRINCIPALACCOUNTANT FEES AND SERVICES.**

 

*AuditFees.*  The audit feesbilled to the Company by its principal accountant for fiscal years endedSeptember 30, 2004 and 2003 were approximately $24,000 and $42,000,respectively.  These fees pertain to theaudit of the Company’s annual financial statements and quarterly Form 10-QSBs.

 

*Audit-RelatedFees, Tax Fees and All Other Fees.*  No “audit-related fees,” “tax fees” or “allother fees,” as those terms are defined by the Securities and ExchangeCommission, were paid to our principal accountant for the fiscal years endedSeptember 30, 2004 and 2003.

 

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**SIGNATURES**

 

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

 
| **LEE  PHARMACEUTICALS** |
|--------------------------|
|                     |   |
|                     |   |
| Date:                    |    DECEMBER  22, 2004 |   | RONALD G. LEE |
|                     | Ronald G. Lee |
|                     | Chairman of the Board  and President |
|                          |  |  |  |

 

 

In accordance with the Securities Exchange Act of1934, this report has been signed by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 

 
| Date:  |    DECEMBER  22, 2004                                  |   | RONALD G. LEE          |
|--------|-----------------------------------------------------------------------|--------|------------------------|
|   | Ronald G. Lee                                                         |
|   | Chairman of the Board  & President                                |
|   | (Principal Executive,  Financial and Accounting Officer) and Director |
|   |                                                                  |
| Date:  |    DECEMBER  22, 2004                                  |   | HENRY L. LEE, JR.      |
|   | Henry L. Lee, Jr.                                                     |
|   | Director                                                              |
|   |                                                                  |
| Date:  |    DECEMBER  22, 2004                                  |   | WILLIAM M. CALDWELL IV |
|   | William M. Caldwell IV                                                |
|   | Director                                                              |

 

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