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**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

FORM10-QSB

 
| **x** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------|

**For thequarterly period ended                                                         Ju n e  30,  2001                                                                **

 

**OR**

 
| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

** **

**For thetransition period from                                                                                to                                                                     **

 

 

 

**Commissionfile number                                                                          1- 7 3 3 5                                                                      **

 

| **L E  E  P H A R M A C E U T I C A L S**                                                                                                        |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| (Exact name of small business issuer as specified in  its charter)                                                                                    |
|                                                                                                                                                  |
| **C a l i f o r n i a**                                                                                                                               | **9 5 - 2 6 8 0 3 1 2** |
| (State or other jurisdiction of incorporation                                                                                                         | (I.R.S. Employer Identification No.) |
| or organization)                                                                                                                                      |   |
|                                                                                                                                                  |   |
| **1 4 4 4  S a n t a  A n i t  a  A v e n u e,  S o u t h   E l  M o n t e,  C a l i f o r n i a  9 1 7 3 3** |
| (Address of principal executive offices)                                                                                                              |
| (Zip Code)                                                                                                                                            |
|                                                                                                                                                  |
| **(6 2 6)  4 4 2 - 3 1 4 1**                                                                                                                     |
| (Registrant's telephone number, including area code)                                                                                                  |
|                                                                                                                                                  |   |
| **N / A**                                                                                                                                             |
| (Former name, former address and former fiscal year,  if changed since last report)                                                                   |

                    As of June 30, 2001 there were outstanding4,135,162 shares of common stock of the registrant.

                Transitional Small Business Disclosure Format (checkone):Yes o    Noý

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**LEE PHARMACEUTICALSBALANCE SHEETJUNE 30, 2001(Dollars in thousands)(Unaudited)**

 

| **ASSETS**                                               |                              |    |
|----------------------------------------------------------|-----------------------------------|---------|
|                                                     |                              |    |
| Current assets:                                          |                              |    |
| Cash                                                     |                              | **$**   | **3** |
| Accounts and notes receivable (net  of allowances: $397) |                              | **621** |
| Inventories (net of reserves: $465)                      |                              |    |
|                                                     | Raw materials                     | **$**   | **1,974** |   |
|                                                     | Work in process                   | **295** |   |
|                                                     | Finished goods                    | **414** |   |
|                                                     |                              | ****    |   |
|                                                     | Total inventories                 |    | **2,683** |
| Other current assets                                     |                              | **637** |
|                                                     |                              | ****    |
|                                                     | Total current assets              |    | **3,944** |
| Property, plant and equipment (less                      |                              |    |
|                                                     | accumulated depreciation and      |    |   |
|                                                     | amortization: $5,131)             |    | **456** |
| Intangibles and other assets (net  of                    |                              |    |
|                                                     | accumulated amortization: $7,692) |    | **2,846** |
|                                                     |                              |    | **** |
|                                                     | **TOTAL**                         |    | **$** | **7,246** |
|                                                     |                              |    | **** |
|                                                          |                                   |         |  |  |  |  |

See notes to financial statements.

 

|                                                        | **LIABILITIES**                           |       |      |
|-------------------------------------------------------------|-------------------------------------------|------------|-----------|
| Current liabilities:                                        |                                      |       |
| Bank overdraft                                              | **$**                                     | **75**     |      |
| Notes payable – bank                                   | **794**                                   |       |
| Current portion - notes payable,  other                     | **1,211**                                 |       |
| Current portion - note payable  related party               | **640**                                   |       |
| Accounts payable                                            | **1,359**                                 |       |
| Other accrued liabilities                                   | **427**                                   |       |
| Environmental cleanup liability                             | **366**                                   |       |
| Due to related parties                                      | **806**                                   |       |
| Deferred income                                             | **108**                                   |       |
|                                                        | ****                                      |       |
|                                                        | Total current liabilities                 | **5,786**  |      |
| Long-term liabilities:                                      |                                           |       |
| Long-term notes payable to related  parties                 | **2,192**                                 |       |
| Long-term notes payable, other                              | **1,250**                                 |       |
| Deferred income                                             | **224**                                   |       |
| Environmental cleanup liability -  Casmalia Site            | **374**                                   |       |
|                                                        | ****                                      |       |
|                                                        |                                      |       |
|                                                        | Total long-term liabilities               | **4,040**  |      |
|                                                        | ****                                      |       |
|                                                        | Total liabilities                         | **9,826**  |      |
|                                                        | ****                                      |       |
|                                                        |                                      |       |
|                                                        | **COMMITMENTS  AND CONTINGENCIES**        |       |      |
|                                                        |                                      |       |
|                                                        |                                      |       |
|                                                        | **STOCKHOLDERS'  (DEFICIT)**              |       |      |
|                                                        |                                      |       |      |
| Common stock, $.10 par value;  authorized, 7,500,00 shares; |                                      |       |
|                                                        | issued and outstanding, 4,135,162  shares | **413**    |      |
| Additional paid-in capital                                  | **4,222**                                 |       |
| Accumulated (deficit)                                       | **(7,215**                                | **)**      |
|                                                        | ****                                      |       |
|                                                        | Total stockholders' deficit               | **(2,580** | **)**     |
|                                                        | ****                                      |       |
|                                                        | **TOTAL**                                 | **$**      | **7,246** |   |
|                                                        | ****                                      |       |
|                                                             |                                           |            |           |  |  |  |

See notes to financial statements.

**LEEPHARMACEUTICALSSTATEMENTS OF OPERATIONS(Dollars in thousands, except per share amounts)(Unaudited)**

 

|                     | **For the  Three Months  **   | ** **    | **For the  Nine Months  ** |       |
|--------------------------|------------------------------------|---------------|---------------------------------|------------|
|                     | **Ended June  30,  **         | ** **    | **Ended June  30,  **      |       |
|                     |                               |          |                            |       |
|                     | **2001**                           | ** **    | **2000**                        | ** ** | **2001** | ** ** | **2000** |   |
|                     | ****                               |          | ****                            |       | **** |   | **** |   |
| Gross revenues           | **$**                              | 2,074         |                            | $          | 2,063 | ** ** | **$** | 7,157 |   | $ | 7,326 |   |
| Less:                    | Sales  returns                     | ** (71** | **)**                           | (208       | ) | **(619** | **)** | (667 | ) |
|                     | Cash discounts and others          | **(18**       | **)**                           | (21        | ) | **(58** | **)** | (64 | ) |   |
|                     | ****                               |          |                                 |       | **** |   |  |   |   |
|                     |                               |          |                            |       |   |   |   |   |   |
| Net revenues             | **1,985**                          |          | 1,834                           | ** ** | **6,480** |   | 6,595 |   |   |
|                     | ****                               |          |                                 |       | **** |   |  |   |   |
| Costs and expenses:      |                               |          |                            |       |   |   |   |   |   |
|                     | Cost of sales                      | **1,072**     |                            | 833        | ** ** | **3,311** |   | 3,099 |   |   |
|                     | Selling and advertising expense    | **510**       |                            | 532        | ** ** | **1,796** |   | 1,999 |   |   |
|                     | General and administrative expense | **313**       |                            | 267        | ** ** | **859** |   | 859 |   |   |
|                     | Interest expense                   | **182**       |                            | 208        | ** ** | **603** |   | 647 |   |   |
|                     |                               |          |                            |       |   |   |   |   |   |
|                     |                                    |          |                                 |       |  |   |  |   |   |
| Total costs and expenses | **2,077**                          |          | 1,840                           | ** ** | **6,569** |   | 6,604 |   |   |
|                     |                               |          |                            |       |   |   |   |   |   |
|                     |                                    |          |                                 |       |  |   |  |   |   |
| (Loss) from operations   | **(92**                            | )             | (6                              | **)**      | **(89** | ) | (9 | ) |   |
| Other income             | **107**                            |          | 17                              | ** ** | **133** |   | 48 |   |   |
|                     |                                    |          |                                 |       |  |   |  |   |   |
|                     |                               |          |                            |       |   |   |   |   |   |
| Net income               | **$**                              | 15            |                            | $          | 11 | ** ** | **$** | 44 |   | $ | 39 |   |   |
|                     |                                    |          |                                 |       |  |   |  |   |   |
|                     |                               |          |                            |       |   |   |   |   |   |
| Per share:               |                               |          |                            |       |   |   |   |   |   |
|                     | Net income                         | **$**         | .00                             |       | $ | .00 | ** ** | **$** | .01 |   | $ | .01 |   |   |
|                     | ****                               |          |                                 |       | **** |   |  |   |   |
|                          |                                    |               |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

See notes to financialstatements.

**LEEPHARMACEUTICALSSTATEMENTS OF CASH FLOWS(Dollars in thousands)(Unaudited)**

|                                                    | **For the Nine Months**                           |       |
|---------------------------------------------------------|--------------------------------------------------------|------------|
|                                                    | **Ended June 30,**                                |       |
|                                                    | **2001**                                               | ** ** | **2000** |   |
|                                                    | ****                                                   |       | **** |   |
| Cash flows from operating  activities:                  |                                                   |       |   |   |
|                                                    | Net income                                             | **$**      | 44 |   | $ | 39 |   |
|                                                    |                                                   | ****       |   |  |   |
|                                                    | Adjustments to reconcile net  income to                |       |   |   |   |
|                                                    | net cash provided by  operating activities:            |       |   |   |   |
|                                                    | Depreciation                                           | **128**    |   | 114 |   |
|                                                    | Amortization of intangibles                            | **362**    |   | 664 |   |
|                                                    | (Decrease) in deferred  income                         | **(11**    | ) | (48 | ) |
|                                                    | (Gain) on disposal of  property, plant, and equipment  | **(2**     | ) | (1 | ) |
| Change in operating assets  and liabilities:            |                                                   |       |   |   |
|                                                    | Decrease in accounts  receivable                       | **425**    |   | 103 |   |
|                                                    | Increase in allowance for  doubtful accounts           |       |   |   |   |
|                                                    | and sales returns and  allowances                      | **52**     |   | 65 |   |
|                                                    | (Increase) in inventories                              | **(396**   | ) | (105 | ) |
|                                                    | (Increase) in deposits                                 | **(55**    | ) | (78 | ) |
|                                                    | (Increase) decrease in other  current assets           | **(89**    | ) | 107 |   |
|                                                    | Increase in accounts payable  and accrued liabilities  | **467**    |   | 34 |   |
|                                                    | Increase in due to related  parties - accrued interest | **73**     |   | 76 |   |
|                                                    | (Decrease) in accrued  royalties                       | **(39**    | ) | (3 | ) |
|                                                    | Increase in deferred income  and advance payments      | **350**    |   | – |   |
|                                                    | ****                                                   |       |  |   |
|                                                    | Net cash provided by  operating activities             | **1,309**  |   | 967 |   |
|                                                    | ****                                                   |       |  |   |
| Cash flows from investing  activities:                  |                                                   |       |   |   |
|                                                    | Additions to property,  plant, and equipment           | **(53**    | ) | (219 | ) |
|                                                    | Proceeds from sale of  equipment                       | **7**      |   | 1 |   |
|                                                    | Acquisition of product  brands                         | **(199**   | ) | (194 | ) |
|                                                    | Increase in non-current  deposit                       | **(11**    | ) | – |   |
|                                                    | ****                                                   |       |  |   |
|                                                    | Net cash (used in) investing  activities               | **(256**   | ) | (412 | ) |
|                                                    | ****                                                   |       |  |   |
| Cash flows from financing  activities:                  |                                                   |       |   |   |
|                                                    | Proceeds from notes payable  to related party          | **44**     |   | – |   |
|                                                    | (Payments on) notes payable  to related party          | **(135**   | ) | (4 | ) |
|                                                    | Decrease in due from related  party                    | **25**     |   | 39 |   |
|                                                    | (Decrease) in notes payable                            | **(142**   | ) | (18 | ) |
|                                                    | Proceeds from notes payable,  other                    | **750**    |   | 800 |   |
|                                                    | Payments on notes payable,  other                      | **(1,329** | ) | (1,383 | ) |
|                                                    | (Decrease) increase in bank  overdraft                 | **(275**   | ) | 12 |   |
|                                                    | ****                                                   |       |  |   |
|                                                    | Net cash (used in) financing  activities               | **(1,062** | **)** | (554 | ) |
|                                                    | ****                                                   |       |  |   |
|                                                    |                                                   |       |   |   |
| Net (decrease) increase in  cash                        | **(9**                                                 | )          | 1 |   |
| Cash, beginning of year                                 | **12**                                                 |       | 4 |   |
|                                                    | ****                                                   |       |  |   |
| Cash, end of year                                       | **$**                                                  | 3          |   | $ | 5 |   |
|                                                    | ****                                                   |       |  |   |
| **Supplemental  disclosures of cash flow information:** |                                                   |       |   |   |
| Cash paid during the year  for:                         |                                                   |       |   |   |
|                                                    | Interest                                               | **$**      | 525 |   | $ | 538 |   |
|                                                    | ****                                                   |       |  |   |
|                                                    | Taxes                                                  | **$**      | 1 |   | $ | 1 |   |
|                                                    | ****                                                   |       |  |   |
|                                                    |                                                   |       |   |   |
| **Non cash  financing and investing activity:**         |                                                   |       |   |   |
| Acquisition of product  brands:                         |                                                   |       |   |   |
|                                                    | Fair value of assets  acquired                         | **$**      | 199 |   | $ | 394 |   |
|                                                    | Fair value of liabilities  incurred                    | **–** |   | (200 | ) |
|                                                    | ****                                                   |       |  |   |
|                                                    | Net cash payments                                      | **$**      | 199 |   | $ | 194 |   |
|                                                    | ****                                                   |       |  |   |
|                                                         |                                                        |            |  |  |  |  |  |  |  |

See notes to financialstatements.

**Notes to Financial Information**

1.          Basis of presentation:

The condensed interim financial statements includedherein have been prepared by Lee Pharmaceuticals without audit, pursuant to therules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations, although the Company believes that the disclosures areadequate to make the information presented not misleading.

These statements reflect all adjustments, consistingof normal recurring adjustments which, in the opinion of management, arenecessary for a fair presentation of the information contained herein.  It is suggested that these condensedfinancial statements be read in conjunction with the financial statements and notesthereto included in the Company's Annual Report on Form 10-KSB for the yearended September 30, 2000.  The Companyfollows the same accounting policies in preparation of interim reports.  The results of operations for the three andnine months ended June 30, 2001 are not necessarily indicative of the resultsthat may be expected for the year ending September 30, 2001 or any otherperiod.

The Company is involved in various matters involvingenvironmental cleanup issues.  See"Item 2. Management's Discussion and Analysis or Plan of Operations" andNote 11 of Notes to Financial Statements included in the Company's Form 10-KSBfor the fiscal year ended September 30, 2000. The ultimate outcome of these matters cannot presently be determined.  Environmental expenditures that relate to anexisting condition caused by past operations, and which do not contribute tocurrent or future revenue generation, are expensed.  The Company's proportionate share of the liabilities are recordedwhen environmental remediation and/or cleanups are probable, and the costs canbe reasonably estimated.

In May 2001, the Company sold one of its productbrands for $375,000 cash.  Included inthe sales price is $25,000 for goodwill and $350,000 for three serviceagreements with the buyer.  In addition,the Company has agreed to manufacture the product for the buyer for twoyears.  The service agreements call forthe Company to provide the buyer with technical and marketing strategyassistance for the three years and customer service assistance for fouryears.  The amount received for thegoodwill has been recorded as income and included in other income on thestatement of operations.  The amountsreceived for the service agreements have been recorded as deferred income onthe balance sheet and income will be recognized over the life of theagreements, which is approximately $9,000 per month.  For the current period ending June 30, 2001, $18,000 has beenrecognized in other income, $108,000 is included in current liabilities and$224,000 is included in long-term liabilities.

2.          Continued existence:

The Company has suffered substantial recurring lossesfrom operations and has a working capital deficiency.  The Company must increase revenue and profitability and obtainadditional equity and/or debt financing in order to continue to operate.  The Company has taken certain actions in aneffort to become profitable and improve cash flow from operations in thefuture.  These actions include seekingnew revenue opportunities and additional financing sources.  Management continues to implement plans toincrease revenues, reduce existing cost structures and improve operatingefficiencies.  There can be no assurancethat management will be successful in the implementation of its plans.

3.          Earnings per share:

The Company has a simple capital structure, and therewere no changes under the SFAS 128 methodology to the previously reportedearnings (loss) per share amounts for any of the fiscal years.  Basic earnings per share under SFAS 128 werecomputed using the weighted average number of shares outstanding of 5,194,496in June 2001 and 4,135,162 in June 2000. Differences in the weighted average number of shares outstanding forpurposes of computing diluted earnings per share were due to the inclusion of thedilutive effect of stock options previously granted.  These differences in the weighted average number of sharesoutstanding for the calculation of basic and diluted earnings per shareresulted in no differences in the earnings per share.

 

4.          Acquisitions:

On November 15, 1999, the Company purchased certainassets of the product lines from U.S. Dermatologics, Inc. which includes Cope®, a tension headache relief tablet, andAstring-o-Sol®, a concentrated mouthwash, for $400,000.  The Company has remitted $200,000 at closingand is required to make twenty-four equal monthly installments of $8,000 plusinterest at a rate equal to the highest prime rate (published in the WallStreet Journal) during the preceding month commencing January 25, 2000 andending on December 25, 2001, and a final payment of all remaining principal dueon January 25, 2002.  Included in theabove purchase price was certain inventories valued at approximately$60,000.  The balance of $340,000 is foran eight year covenent not to compete.

On January 31, 2000, the Company purchased certainassets of the product Serutan®, toasted granules, a bulk-forminglaxative, for $60,000 cash.  Included inthe purchase price was certain inventories valued at approximately $6,000.  The balance of $54,000 is for an eight yearcovenent not to compete.

On October 30, 2000, the Company purchased certainassets of the Sloans® liniment temporary pain relief product from C.B.Fleet Co., Inc. for $50,000 plus approximately $600 of inventory.  The Company remitted the full $50,000 atclosing.  The balance of $50,000 is fora five year covenent not to compete.

On February 12, 2001, the Company purchased certainassets of the Black Draught® laxative product line from TheMonticello Companies, Inc., for $185,000. This amount includes approximately $37,000 of inventory and was remittedin full at closing.  The balance of$148,000 is for a five year covenent not to compete.

5.          Related party transactions:

During the quarter ended June 30, 2001, non-cashtransactions were recorded whereby $25,000 in prior cash advances to relatedparties were prepaid and offset against long-term notes of the same amount, dueto the same related parties.

6.          Miscellaneous income:

For the quarter ending June 30, 2001, the Companysettled an outstanding debt of $352,000 for $270,000.  The difference of $82,000 has been recorded as a relief of debtand is included in other income on the statement of operations.

7.          Income taxes:

As of September 30, 2000, the Company had netoperating loss (NOL) carryforwards of approximately $10,000,000 for Federal and$2,200,000 for California which for tax purposes can be used to offset futureFederal and California income taxes. The differences in the state carryforwards relate primarily to thetreatment of loss carryforwards and depreciation of property, plant andequipment.  The Federal carryforwardsexpire from 2005 through 2020; California expires from 2001 through 2004.  The Company has provided an allowance for theentire amount of the deferred asset applicable to the NOL.

8.          Line of credit:

Effective February 20, 2001, the Company renewed itsaccounts receivable financing, maturing May 2003, whereby 75% of the eligibledomestic accounts receivable, not to exceed the greater of $1,400,000 or$1,400,000 less amounts advanced on inventory can be advanced.  The agreement is renewable for successiveone year periods.  Also, the agreementrequires minimum monthly interest of $3,000 with an interest rate of 8% aboveUnion Bank of California's prime rate. The financing agreement includes a $300,000 term loan on inventory whichis incorporated in the working capital line of credit above.  The inventory term loan requires monthlypayments of $5,000 with an interest rate of 8% above Union Bank of California'sprime rate.  Additionally, there is aseparate $400,000 term loan on the Company's equipment.  This financing is secured by a securityinterest in all of the Company's assets and requires monthly payments of$10,000 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.

9.          Use of estimates:

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

10.        Litigation:

The Company is subject to certain legal proceedings,claims and litigation arising in the ordinary course of business (other thanrelating to the environmental issue discussed in Management's Discussion andAnalysis).  While the amounts claimedmay be substantial, the ultimate liability cannot presently be determinedbecause of considerable uncertainties that exist.  Therefore, it is possible the outcome of such legal proceedings,claims and litigation could have a material effect on quarterly or annualoperating results or cash flows when resolved in a future period.  However, based on facts currently available,other than the environmental issue discussed in Management's Discussion andAnalysis, management believes such matters will not have a material adverseeffect on the Company's financial position, results of operations or cashflows.

**Item2.**

**Management's Discussion and Analysisor Plan of Operations**

**Material Changes in Results ofOperationsThree Months Ended June 30, 2001, and June 30, 2000**

Gross revenues for the three months ended June 30,2001, were $2,074,000, an increase of approximately $11,000 from the comparablethree months ended June 30, 2000.  Theincrease in gross revenues was principally due to the higher volume ($85,000)in sales of the Lee® Lip-ExTM line of products.  In addition, the Company reported sales volume increases indepilatories ($34,000), several personal care category of brands ($71,000), andthe added sales of the newly acquired brands ($67,000).  The above increases were offset by areduction in sales of Take-Off® ($40,000) and other over-the-counteritems ($148,000).

Net revenues increased approximately $151,000 or 8%for the three months ended June 30, 2001 as compared to the three months endedJune 30, 2000.  The change in netrevenues was due to the same explanations discussed above along with a declinein sales returns of approximately $137,000 or 66% when comparing fiscal years2001 and 2000.  Most of these returnshad been provided for by way of prior period reserve.  These sales returns relate to the discontinuance of one of theCompany's SKU's (stock keeping unit) at the retail store level, and continuedproduct returns of a brand containing phenylpropanolamine (PPA) which the Food& Drug Administration (FDA) ruled as a nonmonograph during early calendaryear 2000.

Cost of sales increased $239,000 for the three monthsended June 30, 2001 versus June 30, 2000. Cost of sales as a percentage of gross revenues was 52% for the threemonths ended June 30, 2001 compared to 40% for the comparative three monthsperiod ended June 30, 2000.  The highercost of sales percentage was due to a change in the product mix and lowerpriced commodity-type goods with an accompanying higher cost of goodsassociated to them, thereby generating lower gross margins on sales of theserelated products.  Also, the Companyincurred increased raw material costs, higher direct labor costs as a result ofa rise in the minimum hourly wage ($6.25 effective January 1, 2001 vs. $5.75)and increased building rental expense due to the Consumer Price Index (CPI)adjustment.

Selling and advertising expenses decreased $22,000 or4% when comparing the three months ended June 30, 2001, with the three monthsended June 30, 2000.  The decrease inexpenses was primarily due to lower amortization expense because of thefinalization of several write-off periods associated with prior product brandacquisitions and reduced sales aid expenses. The above expenses were partially offset by increases in travel andentertainment, additional convention/show costs the result of an increase inthe number of shows attended and the replacement of an outside sales person ata higher salary plus fringe benefits.

General and administrative expenses increased $46,000or 17% when comparing the three months ended June 30, 2001 versus June 30,2000.  The  increase  in  expenses was due to increased travel and entertainment, higher building rentalexpenses as a result of a Consumer Price Index (CPI) adjustment,  a loan fee  associated  with  the  Company's asset basedfinancing lender which was non-existent in fiscal year 2000 and increasedprinting material costs.  The aboveincreases were principally offset by lower consulting expenses.

Interest expense decreased $26,000 or 13% when comparingthe three months ended June 30, 2001, with the three months ended June 30,2000.  The decrease was due to reducedborrowings from the Company's related parties along with a lower average primeinterest rate (7.35% vs. 9.25%) in reference to certain loans which are tied toprime.

Other income was $107,000, as compared to $17,000 inthe prior three months ended June 30, 2000, an increase of $90,000 or529%.  This significant increase wasprimarily attributable to the Company's settlement of an outstanding debt of$352,000 for $270,000.  The differenceof $82,000 was recorded as a relief of debt and is included in other income.

**Material Changes in Results ofOperationsNine Months Ended June 30, 2001, and June 30, 2000**

Gross revenues for the nine months ended June 30,2001, were $7,157,000, a decrease of approximately $169,000 or 2% from thecomparable nine months ended June 30, 2000.   This decrease was caused by a reduction in sales of Take-Off® ($247,000), depilatories ($189,000) andother over-the-counter items ($526,000). This was offset by an increase in gross revenues due to the significantincrease ($544,000) in sales of the Lee®Lip-ExTM line of products.  In addition, the Company reported salesvolume increases in Nosebetter®, along with several over-the-countercategory of brands and the added sales of newly acquired brands.  These accounted for approximately $268,000in increases.

Net revenues for the nine months ended June 30, 2001were $6,480,000, a decrease of $115,000 or 2% from  the  comparable  nine months ended  June 30, 2000.  The change in net revenues was principallydue to the same explanations discussed above. The Company's sales returns decreased approximately $48,000 or 7% whencomparing fiscal years 2001 and 2000. The Company continues to experience returns, as a result of thediscontinuance of one of the Company's SKU's (stock keeping unit) at the retailstore level and the continued product returns of a brand containingphenylpropanolamine (PPA) which the Food & Drug Administration (FDA) ruledas a nonmonograph during early calendar year 2000.

Cost of sales increased $212,000 for the nine monthsended June 30, 2001 versus June 30, 2000. Cost of sales as a percentage ofgross revenues for the nine months ended June 30, 2001, as compared to the ninemonths ended June 30, 2000, was 46% versus 42% respectively.  The higher cost of sales percentage was dueto a change in the product mix and lower priced commodity-type goods with anaccompanying higher cost of goods attached to them, thereby generating lowergross margins on sales of these related products.  In addition, the Company incurred higher raw material costs,increased direct labor costs as a result of a rise in the minimum hourly wage($6.25 effective January 1, 2001 vs. $5.75) and increased building rentalexpense due to the Consumer Price Index (CPI) adjustment.

Selling and advertising expenses decreased $203,000 or10% when comparing the nine months ended June 30, 2001, with the nine monthsended June 30, 2000.  The decrease inexpenses was primarily due to lower amortization expense ($280,000) because ofthe finalization of several write-off periods associated with prior productbrand acquisitions, less royalty expenses ($24,000) and lower sales aidexpenses ($16,000).  The above decreaseswere offset by increased convention/show expense ($16,800) as a result of moreshows attended, increased travel and entertainment expenses ($49,800), highersalesmen salaries and related fringe benefits due to the addition of an outsidesales person ($65,000).

General and administrative expenses were consistantwhen comparing the nine months ended June 30, 2001, with the nine months endedJune 30, 2000.

Interest expense decreased $44,000 or 7% whencomparing the nine months ended June 30, 2001, with the nine months ended June30, 2000.  This decrease was due to alower average prime interest rate (8.50% vs. 8.76%) related to certainborrowings which are tied to prime and reduced borrowings from the Company'sasset based financing lender.

Other income increased $85,000 or 177%, to $133,000from $48,000 when comparing the nine months ended June 30, 2001 and June 30,2000, respectively.  This significantincrease was primarily attributed to the settlement of a Company outstandingdebt of $352,000 for $270,000.  Thedifference of $82,000 was recorded as a relief of debt and is included in otherincome.

**Liquidityand Capital Resources**

At June 30, 2001, working capital was a negative$1,842,000 compared with a negative $2,332,000 as of September 30, 2000.  The ratio of current assets to currentliabilities was .7 to 1 at June 30, 2001, and .6 to 1 at September 30,2000.  The decrease  in  the  Company's negative  working capital wasprimarily due to an increase in inventory along with the lowering of currentdebt associated with acquisitions.

The Company has an accumulated deficit of$7,215,000.  Although the Companyexperienced nominal net income in fiscal years 1997 and 2000 and to date in2001, past recurring losses and inability to generate sufficient cash flow fromnormal operations to meet its obligations as they become 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.

**EnvironmentalMatters**

The Company owns amanufacturing facility located in South El Monte, California.  The California Regional Water QualityControl Board (The "RWQCB") ordered the Company in 1988 and 1989 toinvestigate the contamination 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"Cleanup and Abatement Order" directing the Company to conductfurther testing and cleanup the site. In October 1991, the Company received from an environmental consultingfirm an estimate of $465,200 for investigation and cleanup costs.  The Company believed that this estimate wasinconclusive and overstated the contamination levels.  The Company believes that subsequent  investigations  will support  the  Company’s conclusions  about  that estimate.   The Company did notcomplete the testing for the reasons listed above as well as "financialconstraints".  In June 1992,the  RWQCB  requested  that  the EPA evaluate the  contamination  and take  appropriate action.  At the EPA's request, Ecology &Environment, Inc. conducted an investigation of soil and groundwater on theCompany's property.  Ecology &Environment Inc.'s Final Site Assessment Report, which was submitted to the EPAin June 1994, did not rule out the possibility that some of the contaminationoriginated on-site, and resulted from either past or current operations on theproperty.  The Company may be liable forall or part of the costs of remediating the contamination on its property.  The EPA has not taken any further action inthis matter, but may do so in the future.

The Company and nearbyproperty owners, in consort with their comprehensive general liability (CGL)carriers , engaged a consultant to perform a site investigation with respect tosoil and shallow groundwater contamination over the entire city block.  The CGL carriers provided $290,000 infunding which paid for the $220,000 study, $20,000 in legal fees for projectoversight, and a $50,000 balance in the operating fund.  Earlier the Company had accrued $87,500 asits proportionate share of the earlier quote of $175,000. Since that time, theoverall scope of the project was increased to $205,000 plus $15,000 for wastewater 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 was includedin 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 DelRay Industrial 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 El Montemanufacturing facility is also located over a large area of possiblycontaminated regional groundwater which is part of the San Gabriel ValleySuperfund Site.  The Company has beennotified that it is a potentially responsible party  ("PRP")  for  the contamination.   In 1995, theCompany was informed that the EPA estimated the cleanup costs for the South ElMonte’s portion of the San Gabriel Valley Superfund Site to be $30million.  The Company’s potential shareof such amount has not been determined. Superfund PRPs are jointly and severally liable for superfund sitecosts, and are responsible for negotiating among themselves the allocation ofthe costs based on, among other things, the outcome of environmentalinvestigation.

In August 1995, the Companywas informed that the EPA entered into an Administrative Order of Consent withCardinal Industrial Finishes ("Cardinal") for a PRP lead remedialinvestigation and feasibility study (the "Study") which, the EPAstates, will both characterize the extent of groundwater contamination in SouthEl Monte and analyze alternatives to control the spread of contamination.  The Company and others entered into theSouth El Monte Operable Unit Site Participation Agreement with Cardinalpursuant to which, among other things, Cardinal contracted with anenvironmental firm to conduct the Study. The Study  has been  completed. The  Company's  share of the cost of the Study was $15,000and was accrued for in the financial statements as of September 30, 1995.  The South El Monte Operable Unit (SEMOU)participants developed four remedial alternatives.  The capital cost of the four  alternatives  range from  $0 (no action)  up to $3.49 million.  The  estimated annual operating cost for the fouralternatives range from $0 (no action) to $770,300.  Over a 30-year period, the total cost of the four alternativesrange from $0 (no action) up to $13.05 million.  The EPA prefers an alternative which estimates the capital costup to $3.08 million, the annual operating cost at $.48 million, and the 30-yearperiod total cost up to approximately $9.09 million.  The selection of the actual alternative implemented is subject topublic comment.  At the present time,the Company does not know what its share of the cost may be, if any.  Therefore, no additional accrual has beenrecognized as a liability on the Company's books.  The Company requested that the EPA conduct an"ability-to-pay evaluation" to determine whether the Company isentitled to an early settlement of this matter based upon a limited ability topay costs associated 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 EPAstated that the City of Monterey Park Water Department, San Gabriel ValleyWater Company and Southern California Water Company are planning to buildtreatment facilities for their wells. The EPA stated that these three  water purveyors contactedsome of the SEMOU PRPs, other than the Company, to seek funding to developgroundwater treatment facilities for the contaminated wells.  A group of these PRPs calling themselves the"South El Monte Cooperative Group" has been  formed  and purportedlyhas reached a general agreement with the water purveyors to fund thedevelopment of treatment facilities and use the water purveyors' wells in anattempt to contain the groundwater contamination to meet EPA's goals.  At this time, the EPA has not reviewed orapproved any specific plan to address contamination at the purveyor wells, norhas the EPA compromised its right to recover response costs from any person whois legally responsible for contamination within the SEMOU.  As of the date of this report, the Companyhas not been contacted by the South El Monte Cooperative Group in respect toits participation in any proposed cleanup activity.  As a result, the Company is not able to determine whatcontribution, if any, it may be assessed in connection with this cleanupactivity.

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

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

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

The Company and other propertyowners engaged Geomatrix Consultants, Inc., to do a survey of vadose soil andshallow groundwater in the "hot spots" detected in the previousstudies.  Geomatrix issued a reportdated December 1, 1997 (the “Report”), on the impact of volatile organiccompounds on the soil and groundwater at the Lidcombe and Santa Anita  Avenue site located in South El Monte, California (which includes the Company’sfacilities).  The Report indicatedgenerally low concentrations of tetrachloroethene, trichloaethene andtrichloroethane in the groundwater of the upgradient  neighbor.  The Report  was submitted  to  the RWQCB for its comments and response. A meeting with the parties and RWQCB was held on February 10, 1998.  The RWQCB had advised companies that vadosesoil contamination is minimal and requires no further action.  However, there is an area of shallowgroundwater which has a higher than desired level of chlorinated solvents,  and the RWQCB requested a proposed work planbe submitted by Geomatrix.  Geomatrixhas submitted a "Focused Feasibility Study" which concludes thatthere are five possible methods for cleanup. The most expensive are for a pump and sewer remediation which would costbetween $1,406,000 and $1,687,000.  TheCompany is actively exploring the less expensive alternative remediationmethods, of which the two proposed alternatives range in cost between $985,000and $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  the RWQCB has been advised that the Companyand the other property owners were unable to submit the required remedialaction 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  cooperative approach  among  the Company  and  the other  property  owners in  completing the cleanuprequirements and will pursue appropriate measures, including when necessary,enforcement actions.  The RWQCB statesthat it may impose civil liability penalties of up to $1,000 per day fromNovember 1, 1999 for failure to file the action plan.  In light of these events, no assurances can be given that thecleanup costs and possible penalties will not exceed the amount of theCompany's current accruals of $287,000 (which includes the $122,000 charge toincome in the third quarter of fiscal 1998).

In July 2000, the propertyowners formed the Lidcombe & Santa Anita Avenue Work Group (LSAAW) inresponse to the RWQCB request for the preparation of an action plan.  The LSAAW submitted a Focused FeasibilityStudy to the RWQCB for their review and approval of the selected remedialaction method for the site.  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 are approximately $300,000.

The LSAAW is hopeful the WaterQuality 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 "Monterey Site").  The Monterey Site is a 190  acre landfill  that  operated from 1948  to 1984, in which theCompany disposed of non toxic pH balanced waste water on six occasions between1974 and 1978.  Over 4,000 companieshave been identified as having contributed waste to the Monterey Site.  The EPA has offered to settle the Company'spotential liability with respect to the Monterey Site for a cost to the Companyof $79,233.  The Company accrued a  $79,000 charge in the third quarter of fiscal 1998 with respect to this possibleliability.  The Company has elected tofile for relief from these obligations under the financial hardship option in theEPA's response form.  On June 30, 2000,the EPA informed the Company that the EPA believed the Company is able to paythe full settlement cost, but offered to reduce the amount of the settlement to$75,271.  The Company is in the processof responding to this letter.

The Company was notified bythe EPA that the Company may have potential liability for waste material itdisposed of at the Casmalia Disposal Site ("Site") located on a252-acre parcel in Santa Barbara County, California.  The Site was operational from 1973 to 1989, and over 10,000separate parties disposed of waste there. The EPA  stated  that federal, state  and  local governmental agencies along with thenumerous private entities that used the Site for waste disposal will beexpected to pay their share as part of this settlement.  The U.S. EPA is also pursuing theowner(s)/operator(s) of the Site to pay for Site remediation.  The EPA has a settlement offer to theCompany with respect to the Site for a cost of $373,950.  The Company accrued a $374,000 charge in thefirst quarter of fiscal 1999 with respect to this possible liability.  The Company has elected to file for relieffrom these obligations under the financial hardships option in the EPA's responseform.  The Company, the EPA and certainPRPs have entered into an agreement tolling the applicable statutes oflimitation.  The Company was recentlynotified by the EPA that their request for a waiver, due to financial hardship,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 total amount ofenvironmental investigation and cleanup costs that the Company may incur withrespect to the foregoing is not known at this time.  However, based upon information available to the Company at thistime, the Company has expensed since 1988 a total of $860,000, of which $89,000were legal fees, exclusive of legal fees expended in connection with the SECenvironmental investigation.  The actualcosts could differ materially from the amounts expensed for environmental investigationand cleanup costs to date.

 

**PARTII - OTHER INFORMATION**

 

Item 1.            Legal Proceedings

The information set forthunder Part I, Item 2, "Management's Discussion and Analysis or Plan ofOperations - Environmental Matters" is incorporated herein by reference.  See also "LegalProceedings" in the Company's Form 10-KSB for the fiscal year endedSeptember 30, 2000.

 

| Item 6. | The following  exhibits are filed herewith:                        |
|---------|--------------------------------------------------------------------|
|    |                                                               |
|    | 10.1                                                               | - | Promissory note  evidencing advance made to the Registrant |
|    |                                                               |   |   |
|    | 10.2                                                               | - | Sublease dated  April 17, 2001, for the premises located at 1470 Santa Anita Avenue, So. El  Monte, California |
|    |                                                               |   |   |
|    | The following  exhibits have previously been filed by the Company: |
|    |                                                               |
|    | 3.1                                                                | - | Articles of  Incorporation, as amended (1) |
|    |                                                               |   |   |
|    | 3.4                                                                | - | By-laws, as amended  December 20, 1997 (2) |
|    |                                                               |   |   |
|    | 3.5                                                                | - | Amendment of  By-laws effective March 14, 1978 (2) |
|    |                                                               |   |   |
|    | 3.6                                                                | - | Amendment to  By-laws effective November 1, 1980 (3) |
|    |                                                               |   |   |
|    | (1)                                                                | Filed as an  Exhibit of the same number with the Company's Form S-1 Registration Statement  filed with the Securities and Exchange Commission on February 5, 1973,  (Registrant No. 2-47005), and incorporated herein by reference. |
|    |                                                               |   |
|    | (2)                                                                | Filed as  Exhibits 3.4 and 3.5 with the Company's Form 10-K Annual Report for the  fiscal year ended September 30, 1978, filed with the Securities and Exchange  Commission and incorporated herein by reference. |
|    |                                                               |   |
|    | (3)                                                                | Filed as an  Exhibit of the same number with the Company's Form 10-K Annual Report for the  fiscal year ended September 30, 1979, filed with the Securities and Exchange  Commission and incorporated herein by reference. |

 

 

 

SIGNATURE

In accordance with the requirementsof the Securities Exchange Acts of 1934, the registrant has caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 

|   |           |   | LEE PHARMACEUTICALS                     |
|--------|----------------|--------|-----------------------------------------|
|   |           |   |                                         |
|   |           |   | (Registrant)                            |
|   |           |   |                                    |   |   |
|   |           |   |                                    |   |   |
|   |           |   |                                    |   |   |
| Date:  | August 2, 2001 |   | RONALD  G. LEE                          |
|   |                |   |                                         |
|   |           |   |                                    | Ronald G. Lee |
|   |           |   |                                    | Chairman of the  Board, President and |
|   |           |   | Chief Financial  and Accounting Officer |