** **

**SECURITIES AND EXCHANGECOMMISSION**

** **

**Washington, D.C. 20549**

** **

**FORM 10-QSB**

 

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

 

**For the quarterly period ended March 31, 2002**

 

**OR**

 

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

 

**For the transition periodfrom                      to**

 

**Commission file number  1 - 7335**

 

**LEE PHARMACEUTICALS**

(Exact name of small business issuer as specified 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)                               |
|                                                                                |   |                                  |
| **(626)  442-3141**                                                            |
| (Registrant’s telephone  number, including area code)                          |
|                                                                                |   |                                  |
| **N / A**                                                                           |
| (Former name, former address  and former fiscal year, if changed since last report) |

 

As of March 31, 2002 there were outstanding 4,135,162 shares of commonstock of the registrant.

 

Transitional Small Business Disclosure Format (check one):

Yes  o  No  ý

 

----

 

Form10-QSB

 

**LEEPHARMACEUTICALS**

**BALANCESHEET**

**MARCH 31, 2002**

**(Dollarsin thousands)**

**(Unaudited)**

 
| **Assets**                                                                              |   |    |      |      |       |
|-----------------------------------------------------------------------------------------|--------|---------|-----------|-----------|------------|
| Cash                                                                                    |   |    |      | **$**     | **11**     | ** ** |
|                                                                                    |   |    |      |      |       |
| Accounts and notes receivable (net of  allowances: $211)                                |   |    |      | **1,358** | ** ** |
|                                                                                    |   |    |      |      |       |
| Inventories (net of reserves: $512)                                                     |   |    |      |      |       |
| Raw materials                                                                           |   | **$**   | **2,036** |      |       | ** ** |
| Work in process                                                                         |   | **170** |      |      | ** ** |
| Finished goods                                                                          |   | **479** |      |      | ** ** |
| Total inventories                                                                       |   |    |      | **2,685** | ** ** |
|                                                                                    |   |    |      |      |       |
| Other current assets                                                                    |   |    |      | **322**   | ** ** |
|                                                                                    |   |    |      |      |       |
| Total current assets                                                                    |   |    |      | **4,376** | ** ** |
|                                                                                    |   |    |      |      |       |
| Property, plant and equipment (less  accumulated depreciation and amortization: $5,262) |   |    |      | **543**   | ** ** |
|                                                                                    |   |    |      |      |       |
| Intangibles and other assets (net of  accumulated amortization: $1,939)                 |   |    |      | **2,751** | ** ** |
|                                                                                    |   |    |      |      |       |
| **TOTAL**                                                                               |   |    |      | **$**     | **7,670**  | ** ** |
|                                                                                         |        |         |           |           |            |  |  |

 

See notes to financialstatements.

 

2

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**LEEPHARMACEUTICALS**

**BALANCESHEET**

**MARCH 31, 2002**

**(Dollarsin thousands)**

**(Unaudited)**

 
| **LIABILITIES**                                                                                       |   |       |       |
|-------------------------------------------------------------------------------------------------------|--------|------------|------------|
|                                                                                                  |   |       |       |
| Bank overdraft                                                                                        |   | **$**      | **90**     | ** ** |
| Notes payable — bank                                                                             |   | **1,085**  | ** ** |
| Current portion — notes payable, other                                                           |   | **1,054**  | ** ** |
| Current portion — note payable related  party                                                    |   | **730**    | ** ** |
| Accounts payable                                                                                      |   | **961**    | ** ** |
| Other accrued liabilities                                                                             |   | **535**    | ** ** |
| Environmental cleanup liability                                                                       |   | **366**    | ** ** |
| Due to related parties                                                                                |   | **878**    | ** ** |
| Deferred income                                                                                       |   | **108**    | ** ** |
|                                                                                                  |   |       |       |
| Total current liabilities                                                                             |   | **5,807**  | ** ** |
|                                                                                                  |   |       |       |
| Long-term notes payable to related parties                                                            |   | **2,042**  | ** ** |
|                                                                                                  |   |       |       |
| Long-term notes payable, other                                                                        |   | **1,880**  | ** ** |
|                                                                                                  |   |       |       |
| Environmental cleanup liability - Casmalia  Site                                                      |   | **374**    | ** ** |
|                                                                                                  |   |       |       |
| Deferred income                                                                                       |   | **142**    | ** ** |
|                                                                                                  |   |       |       |
| Total liabilities                                                                                     |   | **10,245** | ** ** |
|                                                                                                  |   |       |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                     |   |       |       |
|                                                                                                  |   |       |       |
| **STOCKHOLDERS’ (DEFICIT)**                                                                      |   |       |       |
|                                                                                                  |   |       |       |
| Common stock, $.10 par value; authorized,  7,500,00 shares;  issued and outstanding, 4,135,162 shares |   | **413**    | ** ** |
|                                                                                                  |   |       |       |
| Additional paid-in capital                                                                            |   | **4,222**  | ** ** |
|                                                                                                  |   |       |       |
| Accumulated (deficit)                                                                                 |   | **(7,210** | **)**      |
|                                                                                                  |   |       |       |
| Total stockholders’ deficit                                                                      |   | **(2,575** | **)**      |
|                                                                                                  |   |       |       |
| **TOTAL**                                                                                             |   | **$**      | **7,670**  | ** ** |

 

See notes to financialstatements.

 

3

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**LEE PHARMACEUTICALS**

**STATEMENTS OF OPERATIONS**

**(Dollars in thousands, except per shareamounts)**

**(Unaudited)**

 
|                                       |   | **For the Three Months  Ended March 31,** |       | **For the Six Months  Ended March 31,** |       |
|--------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------|------------|
|                                       |   |                                      |       |
|                                       |   | **2002**                                  |       | **2001**                                |       | **2002** |   | **2001** |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Gross revenues                             |   | **$**                                     | **2,746**  |                                    | $          | 2,920 | ** ** | **$** | **5,180** |   | $ | 5,083 |   |
| Less:    Sales returns      |   | **(265**                                  | **)**      | (449                                    | )          | **(446** | **)** | (548 | ) |
| Cash discounts  and others                 |   | **(20**                                   | **)**      | (18                                     | )          | **(41** | **)** | (40 | ) |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Net revenues                               |   | **2,461**                                 |       | 2,453                                   | ** ** | **4,693** |   | 4,495 |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Costs and  expenses:                       |   |                                      |       |                                    |       |   |   |   |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Cost of sales                              |   | **1,201**                                 |       | 1,237                                   | ** ** | **2,363** |   | 2,239 |   |
| Selling and  advertising expense           |   | **792**                                   |       | 691                                     | ** ** | **1,400** |   | 1,286 |   |
| General and  administrative expense        |   | **319**                                   |       | 288                                     | ** ** | **615** |   | 546 |   |
| Interest  expense                          |   | **184**                                   |       | 219                                     | ** ** | **366** |   | 421 |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Total costs and  expenses                  |   | **2,496**                                 |       | 2,435                                   | ** ** | **4,744** |   | 4,492 |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Income (loss)  from operations             |   | **(35**                                   | )          | 18                                      | ** ** | **(51** | ) | 3 |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Other income                               |   | **27**                                    |       | 2                                       | ** ** | **53** |   | 26 |   |
|                                       |   |                                      |       |                                    |       |   |   |   |   |
| Net income  (loss)                         |   | **$**                                     | **(8**     | **)**                                   | $          | 20 | ** ** | **$** | **2** |   | $ | 29 |   |
|                                       |   |                                      | ** ** |                                    |       |   |   |   |   |
| Per share:                                 |   |                                      | ** ** |                                    |       |   |   |   |   |
|                                       |   |                                      | ** ** |                                    |       |   |   |   |   |
| Basic and  diluted income (loss) per share |   | **$**                                     | **.00**    | ** **                              | $          | .01 | ** ** | **$** | **.00** |   | $ | .01 |   |

 

See notes to financial statements.

 

4

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**LEEPHARMACEUTICALS**

**STATEMENTSOF CASH FLOWS**

**(Dollarsin thousands)**

**(Unaudited)**

 
|                                                                                     |   | **For the  Six Months  Ended March 31,** |       |
|------------------------------------------------------------------------------------------|--------|------------------------------------------|------------|
|                                                                                     |   |                                     |
|                                                                                     |   | **2002**                                 |       | **2001** |   |
|                                                                                     |   |                                     |       |   |   |
| Cash flows from operating activities:                                                    |   |                                     |       |   |   |
| Net income                                                                               |   | **$**                                    | **2**      |   | $ | 29 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:       |   |                                     |       |   |   |
| Depreciation                                                                             |   | **89**                                   |       | 86 |   |
| Amortization of intangibles                                                              |   | **213**                                  |       | 252 |   |
| (Decrease) in deferred income                                                            |   | **(55**                                  | **)**      | (11 | ) |
| (Gain) on disposal of property, plant, and equipment                                     |   | **—**                               |       | (5 | ) |
| Change in operating assets and liabilities:                                              |   |                                     |       |   |   |
| (Increase) in accounts receivable                                                        |   | **(492**                                 | **)**      | (171 | ) |
| (Decrease) increase in allowance for doubtful accounts and sales  returns and allowances |   | **(117**                                 | **)**      | 121 |   |
| (Increase) in inventories                                                                |   | **(276**                                 | **)**      | (298 | ) |
| Decrease (increase) in deposits                                                          |   | **61**                                   | ** ** | (357 | ) |
| (Increase) in other current assets                                                       |   | **(61**                                  | **)**      | (46 | ) |
| Increase in accounts payable and accrued liabilities                                     |   | **152**                                  | ** ** | 734 |   |
| Increase in due to related parties - accrued interest                                    |   | **24**                                   | ** ** | 65 |   |
| (Decrease) in accrued royalties                                                          |   | **—**                               | ** ** | (39 | ) |
| Total adjustments                                                                        |   | **(462**                                 | **)**      | 331 |   |
| Net cash (used in) provided by operating activities                                      |   | **(460**                                 | **)**      | 360 |   |
|                                                                                     |   |                                     | ** ** |   |   |
| Cash flows from investing activities:                                                    |   |                                     | ** ** |   |   |
| Additions to property, plant, and equipment                                              |   | **(70**                                  | **)**      | (39 | ) |
| Proceeds from sale of equipment                                                          |   | **—**                               | ** ** | 7 |   |
| Proceeds from sale of product brand                                                      |   | **265**                                  | ** ** | — |   |
| Acquisition of product brands                                                            |   | **(225**                                 | **)**      | (199 | ) |
| Increase in non-current deposit                                                          |   | —                                   | ** ** | 11 |   |
| Net cash (used in) investing activities                                                  |   | **(30**                                  | **)**      | (242 | ) |
|                                                                                     |   |                                     | ** ** |   |   |
| Cash flows from financing activities:                                                    |   |                                     | ** ** |   |   |
| Proceeds from notes payable to related party                                             |   | **50**                                   | ** ** | 39 |   |
| (Payments on) notes payable to related party                                             |   | **(81**                                  | **)**      | (104 | ) |
| Decrease in due from related party                                                       |   | **—**                               | ** ** | 25 |   |
| Increase in notes payable                                                                |   | **162**                                  | ** ** | 102 |   |
| Proceeds from notes payable, other                                                       |   | **900**                                  | ** ** | 550 |   |
| Payments on notes payable, other                                                         |   | **(540**                                 | **)**      | (637 | ) |
| Increase (decrease) in bank overdraft                                                    |   | **5**                                    |       | (76 | ) |
| Net cash provided by (used in) financing activities                                      |   | **496**                                  |       | (101 | ) |
|                                                                                     |   |                                     |       |   |   |
| Net increase in cash                                                                     |   | **6**                                    |       | 17 |   |
| Cash, beginning of year                                                                  |   | **5**                                    |       | 12 |   |
|                                                                                     |   |                                     |       |   |   |
| Cash, end of year                                                                        |   | **$**                                    | **11**     |   | $ | 29 |   |
|                                                                                     |   |                                     |       |   |   |
| **Supplemental disclosures of cash flow  information:**                                  |   |                                     |       |   |   |
|                                                                                     |   |                                     |       |   |   |
| Cash paid during the year for:                                                           |   |                                     |       |   |   |
| Interest                                                                                 |   | **$**                                    | **326**    |   | $ | 340 |   |
| Taxes                                                                                    |   | **$**                                    | **1**      |   | $ | — |   |

 

See notes to financial statements.

 

5

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**Notes to Financial Information**

 

1.                    Basis ofpresentation:

 

The condensed interim financial statementsincluded herein have been prepared by Lee Pharmaceuticals without audit,pursuant to the rules and regulations of the Securities and ExchangeCommission.  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations, although the Company believesthat the disclosures are adequate to make the information presented notmisleading.

 

These statements reflect all adjustments,consisting of normal recurring adjustments which, in the opinion of management,are necessary for fair presentation of the information contained herein.  It is suggested that these condensedfinancial statements be read in conjunction with the financial statements andnotes thereto included in the Company’s Annual Report on Form 10-KSB for theyear ended September 30, 2001.  TheCompany follows the same accounting policies in preparation of interim reports.

 

Results of operations for theinterim periods may not be indicative of annual results.

 

The Company is involved in various mattersinvolving environmental cleanup issues. See “Item 2. Management’s Discussion and Analysis or Plan ofOperations” and Note 11 of Notes to Financial Statements included in theCompany’s Form 10-KSB for the fiscal year ended September 30, 2001.  The ultimate outcome of these matters cannotpresently be determined.  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 proportionateshare of the liabilities are recorded when environmental remediation and/orcleanups are probable, and the costs can be reasonably estimated.

 

2.                    Continued existence:

 

The accompanying financial statements havebeen prepared assuming that the Company will continue as a going concern.  Although the Company experienced nominal netincome in fiscal years 2000 and 2001, past recurring losses and inability togenerate sufficient cash flow from normal operations to meet its obligations asthey became due, raises substantial doubt about its ability to continue as agoing concern.  The financial statementsdo not include any adjustments to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that may result from the possible inability of the Company tocontinue as a going concern.

 

3.                    Earningsper share:

 

The Company has a simple capital structure,and there were no changes under the SFAS 128 methodology to the previouslyreported earnings (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 5,265,162for the three and six months ended March 2002 and 5,194,496 for the three andsix months ended March 2001. Differences in the weighted average number of shares outstanding forpurposes of computing diluted earnings per share were due to the inclusion ofthe dilutive effect of stock options previously granted.  These differences in the weighted averagenumber of shares outstanding for the calculation of basic and diluted earningsper share resulted in no differences in the earnings per share.

 

4.                    Acquisitions:

 

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

 

6

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On February 12, 2001, the Company purchasedcertain assets of the Black Draught®laxative product line from The Monticello Companies, Inc. for $185,000.  This amount includes $37,000 of inventoryand was remitted in full at closing. The balance of $148,000 is for a five year covenant not to compete.

 

On August 22, 2001, the Company purchasedcertain assets of the DeWitt’s® Pillsproduct line from The Monticello Companies, Inc. for $265,000.  The DeWitt’s is an analgesic pill forbackache and joint relief.  The Companyremitted the full $265,000 at closing. On October 16, 2001, the Company exercised it’s option to resell certainassets of DeWitt’s® Pills product line back toThe Monticello Companies, Inc.  TheCompany received $265,000 related to the resell of DeWitt’s® Pills.

 

On March 9, 2002, the Company purchasedcertain assets of product lines from Merz Pharmaceuticals LLC for $225,000 plusapproximately $63,000 for inventory. The product lines included Cankaid®, an oral antiseptic, Medicone®, a hemorrhoidal suppository, and Sayman®, an astringent cleansing bar.  The purchase price of $225,000 includes$200,000 for goodwill and $25,000 for a covenant not to compete.  The full $225,000 was remitted atclosing.  In addition, the Company isobligated to pay a royalty as follows: for the first twelve-month period following closing (i) twenty-fivepercent (25%) of the net sales of Medicone® andSayman®; (ii) twenty-five percent (25%) of the net salesof the first 4,800 dozen sold of Cankaid®, and(iii) forty percent (40%) of the Cankaid® soldin excess of the first 4,800 dozen.  Forthe next two 12-month periods after closing (8 consecutive quarters), theroyalty payments will be (i) twenty percent (20%) of the net sales of Medicone® and Sayman®; (ii)twenty percent (20%) of the net sales of the first 4,800 dozen sold per12-month period of Cankaid®, and (iii)forty percent (40%) of the Cankaid® units soldin excess of the first 4,800 dozen per 12-month period.  Notwithstanding the above, no royalty shallbe due on Lee’s sales of Cankaid® inventorywith 10/02 or 11/02 expirations to closeout/dollar store/off-price retailers atwholesale prices of less than seventy cents ($.70).  The minimum royalty due is $75,000 per year for the next threeyears.  The March 2002 portion of theminimum royalty ($5,000) was not expensed in the quarter.

 

5.                    Incometaxes:

 

As of March 31, 2002, the Company had netoperating loss (NOL) carryforwards of approximately $10,300,000 for Federal and$1,600,000 for California tax purposes which 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 2005.  The Company has provided an allowance forthe entire amount of the deferred asset applicable to the NOL.

 

6.                    Otherincome:

 

For the six months ended March 31, 2002, theCompany realized a gain of approximately $52,000 related to the sale of theKlutch® product line.  The realized gain pertains to therecognition of the earned portion of the deferred income of the consultingagreements arising from the sale of the Klutch®brand.  The other income for the sixmonths ended March 31, 2001, consisted of $11,000 for the final amortization ofthe prior sale of two buildings, $11,000 for the sale of a trademark, as wellas a gain from the sale of equipment.

 

7.                    Subsequentevents:

 

On April 5, 2002, the Company purchasedcertain assets of the One Step at a Time®, a nicotine addiction withdrawal system, andlite’n® Up, a reusable cigarette filter, product linesfrom Category One Products, L.L.C., for $350,000 plus inventory.  A clause in the agreement stipulates that ifcertain customers deletes one of the product lines, the purchase price will beadjusted downward.  The full $350,000was remitted at the closing.

 

7

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On April 23, 2002, the Company purchasedcertain assets of product lines Unguentine®, an ointment for burns, and Unguentine® Plus, a first aid antiseptic and pain relievingcream, from U.S. Dermatologics, Inc. The purchase price is $85,000 for a covenant not to compete and as yetan undetermined amount of inventory. $25,000 of the purchase price was paid at closing and a Promissory notewas signed for the remaining $60,000. The note calls for a monthly payment of $3,000 plus interest beginningJune 15, 2002.

 

**Item2.**

 

**Management’sDiscussion and Analysis or Plan of Operations**

**Material Changes inResults of Operations**

**Three Months EndedMarch 31, 2002, and March 31, 2001**

 

Gross revenues for the three months endedMarch 31, 2002, were $2,746,000, a decrease of approximately $174,000, or 6%,from the comparable three months ended March 31, 2001.  The Company reported decreased volume inseveral products.  The significantdecrease in revenues was associated with Nosebetter® ($173,000), depilatories ($91,000) and otherover-the-counter (OTC) brands ($196,000). In addition, with the sale of the Klutch product line during fiscal year2001, sales of this product are irregular because the Company manufactures itas a co-packer for the owner.  The abovedecreases were partially offset by higher sales volume of existing brandsnamely; the Lee® Lip-Ex® line of products ($166,000), the added sales ofthe newly acquired brands ($61,000) and the private label line of business($60,000).

 

Net revenues increased approximately $8,000,for the three months ended March 31, 2002, as compared to the three monthsended March 31, 2001.  The Company’ssales returns decreased approximately $184,000, or 41%, when comparing thethree months ended March 31, 2002 and 2001. During the three months ended March 31, 2001 the Company experienced thediscontinuance of a few of its SKU’s (stock keeping units) at the retail storelevel, thereby realizing a higher rate of sales returns.

 

Cost of sales as a percentage of gross revenueswas 44% for the three months ended March 31, 2002, compared to 42% for thethree months ended March 31, 2001.  Theincreased cost of sales percentage was due to the continued change in theproduct mix and lower priced commodity-type goods with an accompanying highercost of goods attached to them, thereby generating lower gross margins on salesof these related products.  In addition,the Company incurred higher raw material costs and increased direct labor as aresult of a rise in the minimum hourly wage ($6.75 effective January 1, 2002versus $6.25).

 

Selling and advertising expenses increased$101,000, or 15%, when comparing the three months ended March 31, 2002 with thethree months ended March 31, 2001.  Theincrease in expenses were due to the following factors: (1) higher commissions($14,000) due to added manufacturers representatives covering territories thatwere previously open, (2) higher sales force commissions/bonuses resulting fromincreased sales to convenience store accounts ($28,000), (3) higher salesmensalaries & related fringe benefits due to the hiring of a higher salariedsalesman who replaced lower salaried sales personnel ($24,000), (4) increasedfreight costs ($29,000), and (5) increased convention/show expense ($28,000) asa result of more shows attended.  Theabove increases were partially offset by lower cooperative advertising($44,000).  An additional accrual forcooperative advertising expense was recorded during the three months endedMarch 31, 2001 and there was no comparable entry during the current quarter.

 

General and administrative expenses increased$31,000, or 11%, when comparing the three months ended March 31, 2002, with thethree months ended March 31, 2001.  Thisincrease included data processing consulting services ($12,000) related tocustomer software compliance and expanded requirements associated with EDI(Electronic Data Interchange), higher supply and travel and entertainmentexpenses.  The above increases were partiallyoffset by reduced building rental expenses. The rental income from a new tenant, subleasing one of the Company’sfacilities, offset the rental expense on the master lease.

 

Interest expense decreased $35,000, or 16%,when comparing the three months ended March 31, 2002, with the three monthsended March 31, 2001.  The decrease wasdue to lower average prime

 

8

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interest rate (4.75 % vs. 8.50%) in referenceto certain loans which are tied to prime.

 

**Material Changes inResults of Operations**

**Six Months EndedMarch 31, 2002, and March 31, 2001**

 

Gross revenues for the six months ended March31, 2002, were $5,180,000, an increase of approximately $97,000 or 2% from thecomparable six months ended March 31, 2001. The increase in gross revenues was due to the higher sales volume of theLee® Lip-ExÔ line of products, the added volume of newlyacquired brands along with the introduction of private label salesrevenue.  The above increases werepartially offset by the lower sales volume of depilatories ($119,000), Take-Off® ($62,000) and other over-the-counter items.

 

Net revenues for the six months ended March31, 2002 were $4,693,000, an increase of $198,000 or 4% from the comparable sixmonths ended March 31, 2001.  The changein net revenues was principally due to the same explanations discussedabove.  The Company’s sales returnsdecreased approximately $102,000 or 19% when comparing fiscal years 2002 and2001.  The Company experienced thediscontinuance of a few of its SKU’s (stock keeping units) at the retail storelevel, thereby realizing a higher rate of sales returns for the 6 months endedMarch 31, 2001 versus March 31, 2002.

 

Cost of sales as a percentage of grossrevenues for the six months ended March 31, 2002, as compared to the six monthsended March 31, 2001, was 46% versus 44% respectively.  This slight increase in the cost of salespercentage was due to the continued change in the product mix along with lowerpriced commodity-type goods with an accompanying higher cost attached to them,thereby generating lower gross margins on sales of these related products.  In addition, the Company incurred higher rawmaterial costs and increased direct labor as a result of a rise in the minimumhourly wage ($6.75 effective January 1, 2002 versus $6.25).

 

Selling and advertising expenses increased$114,000, or 9% when comparing the six months ended March 31, 2002 with the sixmonths ended March 31, 2001.  Theincrease in expenses was due to the following factors:  1) higher commissions ($38,000) due to addedmanufacturers representatives covering territories that were previously open,(2) higher salesmen salaries and related fringe benefits due to the hiring of ahigher salaried salesman who replaced lower salaried sales personnel ($23,000),(3) higher sales force commissions/bonuses resulting from increased sales toconvenience store accounts ($23,000), and (4) increased convention/show expense($35,000) as a result of more shows attended. The above increases were partially offset by lower amortization expenses($38,000) because of the finalization of several write-off periods associatedwith prior product brand acquisitions and lower cooperative advertisingexpense.

 

General and administrative expenses increased$69,000, or 13%, when comparing the six months ended March 31, 2002, with thesix months ended March 31, 2001.  Theexplanations for the expense fluctuations were consistent with theaforementioned comments related to the three months ended March 31, 2002 versusMarch 31, 2001.

 

Interest expense decreased $55,000, or 13%,when comparing the six months ended March 31, 2002, with the six months endedMarch 31, 2001.  The decrease was due tolower average prime interest rate (4.91% vs. 9.00%) in reference to certainloans which are tied to prime.

 

**Liquidity and CapitalResources**

 

At March 31, 2002, working capital was anegative $1,431,000 compared with a negative $1,750,000 as of September 30,2001.  The ratio of current assets tocurrent liabilities was .8 to 1 at March 31, 2002, and .7 to 1 at September 30,2001.  The decrease in the Company’snegative working capital was primarily due to increases in accounts receivableand inventory.

 

The Company has an accumulated deficit of$7,210,000.  Although the Companyexperienced nominal net income in fiscal years 2000 and 2001, past recurringlosses and inability to generate sufficient cash flow from normal operations tomeet its obligations as they become due, raises substantial doubt about theCompany’s ability to continue as a going concern.  The Company’s ability to continue in

 

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existence is dependent upon futuredevelopments, including retaining current financing and achieving a level ofprofitable operations sufficient to enable it to meet its obligations as theybecome due.

 

**Environmental Matters**

 

The Company owns a manufacturing facilitylocated in South El Monte, California. The California Regional Water Quality Control Board (The “RWQCB”)ordered the Company in 1988 and 1989 to investigate the contamination on itsproperty (relating to soil and groundwater contamination).  The Company engaged a consultant whoperformed tests and reported to the then Chairman of the Company.  The Company resisted further work on itsproperty until the property upgradient was tested in greater detail since two“apparent source” lots had not been tested. On August 12, 1991, the RWQCB issued a “Cleanup and Abatement Order”directing the Company to conduct further testing and cleanup the site.  In October 1991, the Company received froman environmental consulting firm an estimate of $465,200 for investigation andcleanup costs.  The Company believedthat this estimate was inconclusive and overstated the contamination levels.  The Company believes that subsequent investigationswill support the Company’s conclusions about that estimate.  The Company did not complete the testing forthe reasons listed above as well as “financial constraints”.  In June 1992, the RWQCB requested that theEPA evaluate the contamination and take appropriate action.  At the EPA’s request, Ecology &Environment, Inc. conducted an investigation of soil and groundwater on theCompany’s property.  Ecology &Environment Inc.’s Final Site Assessment

 

Report, which was submitted to the EPA in June1994, 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 nearby property owners, inconsort with their comprehensive general liability (CGL) carriers, engaged aconsultant to perform a site investigation with respect to soil and shallowgroundwater contamination over the entire city block.  The CGL carriers provided $290,000 in funding which paid for the$220,000 study, $20,000 in legal fees for project oversight, and a $50,000balance in the operating fund.  Earlierthe Company had accrued $87,500 as its proportionate share of the earlier quoteof $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 this project (as the entire costwas borne by the CGL carriers), but remains on the books as an accrual againstthe cost of remediation of the same site that was included in the study.

 

The tenants of nearby properties upgradienthave sued the Company alleging that hazardous materials from the Company’sproperty caused contamination on the properties leased by the tenants.  The case name is Del Ray IndustrialEnterprises, Inc. v. Robert Malone, et al., Los Angeles CountySuperior 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 Monte manufacturingfacility is also located over a large area of possibly contaminated regionalgroundwater which is part of the San Gabriel Valley Superfund Site.  The Company has been notified that it is apotentially 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 Company was informed thatthe EPA entered into an Administrative Order of Consent with CardinalIndustrial Finishes (“Cardinal”) for a PRP lead remedial investigation andfeasibility study (the “Study”) which, the EPA states, will both characterizethe extent of groundwater contamination in South El Monte and analyzealternatives to control the spread of contamination.  The Company and others entered into the South El Monte OperableUnit Site Participation Agreement with Cardinal pursuant to which, among otherthings, Cardinal contracted with an environmental firm to conduct theStudy.  The Study has beencompleted.  The Company’s share of thecost of the Study

 

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was $15,000 and was accrued for in thefinancial statements as of September 30, 1995. The South El Monte Operable Unit (SEMOU) participants developed fourremedial alternatives.  The capital costof the four alternatives range from $0 (no action) up to $3.49 million.  The estimated annual operating cost for thefour alternatives range from $0 (no action) to $770,300.  Over a 30-year period, the total cost of thefour alternatives range from $0 (no action) up to $13.05 million.  The EPA prefers an alternative whichestimates the capital cost up to $3.08 million, the annual operating cost at$.48 million, and the 30-year period total cost up to approximately $9.09 million.  The selection of the actual alternativeimplemented is subject to public comment. At the present time, the Company does not know what its share of thecost may be, if any.  Therefore, noadditional accrual has been recognized as a liability on the Company’sbooks.  The Company requested that theEPA 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 the Company that it haslearned that the intermediate zone groundwater contamination in the westernportion of the SEMOU has migrated further west and has now impacted the City ofMonterey Park and Southern California Water Company production wells.  The EPA stated that the City of MontereyPark Water Department, San Gabriel Valley Water Company and Southern CaliforniaWater Company are planning to build treatment facilities for their wells.  The EPA stated that these three waterpurveyors contacted some of the SEMOU PRPs, other than the Company, to seekfunding to develop groundwater treatment facilities for the contaminatedwells.  A group of these PRPs callingthemselves the “South El Monte Cooperative Group” has been formed andpurportedly has reached a general agreement with the water purveyors to fundthe development of treatment facilities and use the water purveyors’ wells inan attempt 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 to itsparticipation 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, theCompany was notified that the City of Monterey Park, San Gabriel Valley WaterCompany and Southern California Water Company intend to bring suit under theSafe Drinking Water and Toxic Enforcement Act of 1986 alleging that the Companyhas knowingly released volatile organic compounds in the soil and shallowground water beneath the Company’s property between at least on or beforeNovember 8, 1996 and the present and has failed to promptly clean up all of thecontamination.  As of the date of thisreport, the Company has not been served with this lawsuit.

 

The City of South El Monte, the city in whichthe Company has its manufacturing facility, is located in the San GabrielValley.  The San Gabriel Valley has beendeclared a Superfund site.  The 1995Water Quality Control Plan issued by the California Regional Water QualityControl Board states that the primary groundwater basin pollutants in the SanGabriel Valley are volatile organic compounds from industry, nitrates fromsubsurface sewage disposal and past agricultural activities.  In addition, the Plan noted that hundreds ofunderground storage tanks leaking gasoline and other toxic chemicals haveexisted in the San Gabriel Valley.  TheCalifornia Department of Toxic Substance Control has declared large areas ofthe San Gabriel Valley to be environmentally hazardous and subject to cleanupwork.

 

The Company believes the City of South ElMonte does not appear to be located over any of the major plumes.  However, the EPA has announced it isstudying the 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 thistime.

 

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The Company and other property owners engagedGeomatrix Consultants, Inc., to do a survey of vadose soil and shallowgroundwater in the “hot spots” detected in the previous studies.  Geomatrix issued a report dated December 1,1997 (the “Report”), on the impact of volatile organic compounds on the soiland groundwater at the Lidcombe and Santa Anita Avenue site located in South ElMonte, 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. The RWQCB had advised companies that vadose soil contamination isminimal and requires no further action. However, there is an area of shallow groundwater which has a higher thandesired level of chlorinated solvents, and the RWQCB requested a proposed workplan be submitted by Geomatrix. Geomatrix has submitted a “Focused Feasibility Study” which concludesthat there are five possible methods for cleanup.  The most expensive are for a pump and sewer remediation whichwould cost between $1,406,000 and $1,687,000. The Company is actively exploring the less expensive alternativeremediation methods, of which the two proposed alternatives range in costbetween $985,000 and $1,284,000.  Sincethere are four economic entities involved, the Company’s best estimate at thistime, in their judgment, would be that their forecasted share would be $287,000less the liability already recognized on the books of $165,000 therebyrequiring an additional $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 offiscal 1998, related to the Monterey Site is not included in the $287,000figure above.  In April 2000, theCompany received a Notice of Violation from the RWQCB.  The Notice of Violation states that theCompany and other property owners were required to submit a groundwaterremedial action plan by November 1, 1999, and that the RWQCB has been advisedthat the Company and the other property owners were unable to submit therequired remedial action plan because the Company and the other property ownerscould not agree on the allocation of financial responsibility to prepare theaction plan.  The RWQCB stated that itwill no longer encourage the cooperative approach 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, the property owners formed theLidcombe & Santa Anita Avenue Work Group (LSAAW) in response to the RWQCBrequest for the preparation of an action plan. The LSAAW submitted a Focused Feasibility Study to the RWQCB for theirreview and approval of the selected remedial action method for the site.  After receiving RWQCB approval, LSAAWobtained three cost proposals to implement the RWQCB approved pump and treatremedial method.  According to thesecost proposals, the lowest estimated costs for an assumed five (5) years ofpump and treat remediation is $600,000. This cost is lower than the previous cost proposed work plan, discussedabove, from Geomatrix Consultants, Inc. The capital costs including contingencies are approximately $300,000.

 

The LSAAW is hopeful the Water QualityAuthority (WQA) is willing and able to reauthorize its grant for one-half (1/2)of the capital costs of its remediation system construction not to exceed$150,000.  It is estimated at this timethat the reserves for the Company’s share of this cost proposal are adequatesince its prior accrual was based on the higher cost estimate from Geomatrix.

 

Without any prior correspondence or inklingof the Company’s potential liability, the EPA informed the Company that theCompany may have potential liability for the ongoing remediation of OperatingIndustries, Inc. (as they have gone out of business) Landfill Superfund Site inMonterey Park, California (the “Monterey Site”).  The Monterey Site is a 190 acre landfill that operated from 1948 to1984, in which the Company disposed of non toxic pH balanced waste water on sixoccasions between 1974 and 1978.  Over4,000 companies have been identified as having contributed waste to theMonterey Site.  The EPA has offered tosettle the Company’s potential liability with respect to the Monterey Site fora cost to the Company of $79,233.  TheCompany accrued a $79,000 charge in the third quarter of fiscal 1998 withrespect to this possible liability.  TheCompany has 

 

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elected to file for relief from theseobligations under the financial hardship option in the EPA’s responseform.  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 notified by the EPA that theCompany may have potential liability for waste material it disposed of at theCasmalia Disposal Site (“Site”) located on a 252-acre parcel in Santa BarbaraCounty, California.  The Site wasoperational from 1973 to 1989, and over 10,000 separate parties disposed ofwaste there.  The EPA stated thatfederal, state and local governmental agencies along with the numerous privateentities that used the Site for waste disposal will be expected to pay theirshare as part of this settlement.  TheU.S. EPA is also pursuing the owner(s)/operator(s) of the Site to pay for Siteremediation.  The EPA has a settlementoffer to the Company with respect to the Site for a cost of $373,950.  The Company accrued a $374,000 charge in thefirst quarter of fiscal 1999 with respect to this possible liability.  The Company has elected to file for relieffrom these obligations under the financial hardships option in the EPA’sresponse form.  The Company, the EPA andcertain PRPs have entered into an agreement tolling the applicable statutes oflimitation.  The Company has beennotified by the EPA that their request for a waiver, due to financial hardship,was “partially granted.”  Improvementsin the bidding process has lowered the Company’s estimated share down to$245,000 (from $374,000) and of that, the EPA was requesting that the Companypay $113,000, as a result of their findings on the application for waiver dueto financial hardship.  The Company isconsidering the EPA’s request.

 

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

 

As of March 31, 2002, no additional amountshave been incurred and no settlements have been reached.

 

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**PART II - OTHERINFORMATION**

 

Item 1.    LegalProceedings

 

The information set forth under Part I, Item2, “Management’s Discussion and Analysis or Plan of Operations - EnvironmentalMatters” is incorporated herein by reference. See also “Legal Proceedings” in the Company’s Form 10-KSB for thefiscal year ended September 30, 2001.

 

Item 4.    Submissionof Matters to a Vote of Security Holders

 

The Annual Meeting of Stockholders of theregistrant occurred on March 12, 2002. At that meeting, the following directors were elected:

 
|                   |   | **VOTES** |   |
|------------------------|--------|-----------|--------|
| **Director**           |   | **FOR**   |   | **WITHHELD** |   |
|                   |   |      |   |   |   |
| Dr. Henry L. Lee       |   | 3,596,306 |   | 58,002 |   |
| Ronald G. Lee          |   | 3,596,115 |   | 58,193 |   |
| William M. Caldwell IV |   | 3,590,308 |   | 64,000 |   |

 
|                                                                                                                |   | **VOTES** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|-----------|--------|
|                                                                                                                |   | **FOR**   |   | **AGAINST** |   | **ABSTAIN** |   | **NON-VOTE** |   |
|                                                                                                                |   |      |   |   |   |   |   |   |   |
| The amendment to the Bylaws to reduce the  authorized number of directors to not less than three nor more than five |   | 2,338,708 |   | 50,512 |   | 40,498 |   | 1,224,590 |   |

 
|                                                                                            |   | **VOTES** |   |
|-------------------------------------------------------------------------------------------------|--------|-----------|--------|
|                                                                                            |   | **FOR**   |   | **AGAINST** |   | **ABSTAIN** |   |
|                                                                                            |   |      |   |   |   |   |   |
| The appointment of Caldwell, Becker,  Dervin, Petrick & Co., L.L.P. as independent auditors |   | 3,598,404 |   | 26,612 |   | 29,292 |   |

 

Item 6.    Thefollowing exhibits are filed herewith:

 
| 10.1                                                               |   | — |   | Promissory note evidencing advance made to  the Registrant |
|--------------------------------------------------------------------|--------|--------|--------|------------------------------------------------------------|
|                                                               |   |   |   |                                                       |
| 10.2                                                               |   | — |   | Promissory note evidencing advance made to  the Registrant |
|                                                               |   |   |   |                                                       |
| 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 thesame number with the Company’s Form S-1 Registration Statement filed with theSecurities and Exchange Commission on February 5, 1973, (Registrant No.2-47005), and incorporated herein by reference.

 

(2)     Filed as Exhibits 3.4 and3.5 with the Company’s Form 10-K Annual Report for the fiscal year endedSeptember 30, 1978, filed with the Securities and Exchange Commission andincorporated herein by reference.

 

(3)     Filed as an Exhibit of thesame number with the Company’s Form 10-K Annual Report for the fiscal yearended September 30, 1979, filed with the Securities and Exchange Commission andincorporated herein by reference.

 

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SIGNATURES

 

In accordance with the requirements of theSecurities Exchange Acts of 1934, the registrant has caused this report to besigned on its behalf by theundersigned thereunto duly authorized.

 

 
|   |   |                 |   |   | LEE PHARMACEUTICALS                                                          |   |
|--------|--------|----------------------|--------|--------|------------------------------------------------------------------------------|--------|
|   |   |                 |   |   | (Registrant)                                                                 |   |
|   |   |                 |   |   |                                                                         |
|   |   |                 |   |   |                                                                         |
|   |   |                 |   |   |                                                                         |
|   | Date:  |    May 14, 2002 |   |   | /s/RONALD G. LEE                                                             |   |
|   |   |                 |   |   | Ronald G. Lee                                                                |   |
|   |   |                 |   |   | Chairman of the Board, President and  Chief Financial and Accounting Officer |
|        |        |                      |        |        |                                                                              |        |  |

 

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