**UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, 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                       December  31, 2003** |
|                                                                                                                                                                                             |                                                                                          |
| **OR**                                                                                                                                                                                           |
|                                                                                                                                                                                             |                                                                                          |
| **o**                                                                                                                                                                                            | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                             |                                                                                          |
| **For  the transition period from                            to**        |

 

 

**Commissionfile number 1-7335**

 

**LEE PHARMACEUTICALS**(Exact name of small business issuer as specified in itscharter)

 

| **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)                                           |
|                                                                                |
| **(626)  442-3141**                                                                 |
| (Issuer’s  telephone number)                                                   |
|                                                                                |
| **N/A**                                                                             |
| (Former name,  former address and former fiscal year, if changed since last report) |

 

As of December 31, 2003 there were outstanding4,135,162 shares of common stock of the registrant.

 

Transitional Small Business Disclosure Format (checkone):

Yes o No ý

 

 

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**LEE PHARMACEUTICALS**

**BALANCE SHEET**

**DECEMBER 31, 2003**

**(Dollars in thousands)**

**(Unaudited)**

 
| **Assets**                                                                                    |   |    |      |      |       |
|-----------------------------------------------------------------------------------------------|--------|---------|-----------|-----------|------------|
| Cash                                                                                          |   |    |      | **$**     | **56**     | ** ** |
|                                                                                          |   |    |      |      |       |
| Accounts  and notes receivable (net of allowances: $303)                                      |   |    |      | **1,178** | ** ** |
|                                                                                          |   |    |      |      |       |
| Inventories  (net of reserves: $454)                                                          |   |    |      |      |       |
| Raw  materials                                                                                |   | **$**   | **1,885** |      |       | ** ** |
| Work  in process                                                                              |   | **187** |      |      | ** ** |
| Finished  goods                                                                               |   | **293** |      |      | ** ** |
| Total  inventories                                                                            |   |    |      | **2,365** | ** ** |
|                                                                                          |   |    |      |      |       |
| Other  current assets                                                                         |   |    |      | **556**   | ** ** |
| Total  current assets                                                                         |   |    |      | **4,155** | ** ** |
|                                                                                          |   |    |      |      |       |
| Property,  plant and equipment (less accumulated depreciation and amortization: $5,504)       |   |    |      | **621**   | ** ** |
|                                                                                          |   |    |      |      |       |
| Intangibles  and other assets (net of accumulated amortization: $2,367 and impairment:  $913) |   |    |      | **1,922** | ** ** |
|                                                                                          |   |    |      |      |       |
| **TOTAL**                                                                                     |   |    |      | **$**     | **6,698**  | ** ** |
|                                                                                               |        |         |           |           |            |  |  |

 

See Accompanying SelectedInformation to Unaudited Condensed Financial Statements.

 

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**LEE PHARMACEUTICALS**

**BALANCE SHEET**

**DECEMBER 31, 2003**

**(Dollars in thousands)**

**(Unaudited)**

 
| **LIABILITIES**                                                                                       |   |   |   |       |       |
|-------------------------------------------------------------------------------------------------------|--------|--------|--------|------------|------------|
|                                                                                                  |   |   |   |       |       |
| Bank  overdraft                                                                                       |   |   |   | **$**      | **144**    |   |
| Notes  payable – finance company                                                                 |   |   |   | **1,499**  |       |
| Current  portion - notes payable, other                                                               |   |   |   | **1,502**  |       |
| Current  portion - note payable related party                                                         |   |   |   | **940**    |       |
| Accounts  payable                                                                                     |   |   |   | **826**    |       |
| Other  accrued liabilities                                                                            |   |   |   | **884**    |       |
| Environmental  cleanup liability                                                                      |   |   |   | **366**    |       |
| Due  to related parties                                                                               |   |   |   | **1,282**  |       |
| Deferred  income                                                                                      |   |   |   | **223**    |       |
|                                                                                                  |   |   |   |       |       |
| Total  current liabilities                                                                            |   |   |   | **7,666**  |       |
|                                                                                                  |   |   |   |       |       |
| Long-term  notes payable to related parties                                                           |   |   |   | **1,540**  |       |
| Long-term  notes payable, other                                                                       |   |   |   | **1,438**  |       |
| Environmental  cleanup liability - Casmalia Site                                                      |   |   |   | **374**    |       |
| Deferred  income                                                                                      |   |   |   | **260**    |       |
|                                                                                                  |   |   |   |       |       |
| Total  long-term liabilities                                                                          |   |   |   | **3,612**  |       |
|                                                                                                  |   |   |   |       |       |
| Total  liabilities                                                                                    |   |   |   | **11,278** |       |
|                                                                                                  |   |   |   |       |       |
| **COMMITMENTS  AND CONTINGENCIES**                                                                    |   |   |   |       |       |
|                                                                                                  |   |   |   |       |       |
| **STOCKHOLDERS’  (DEFICIT)**                                                                     |   |   |   |       |       |
|                                                                                                  |   |   |   |       |       |
| Common  stock, $.10 par value; authorized, 7,500,00 shares; issued and outstanding,  4,135,162 shares |   |   |   | **413**    | ** ** |
|                                                                                                  |   |   |   |       |       |
| Additional  paid-in capital                                                                           |   |   |   | **4,222**  | ** ** |
|                                                                                                  |   |   |   |       |       |
| Accumulated  (deficit)                                                                                |   |   |   | **(9,215** | **)**      |
|                                                                                                  |   |   |   |       |       |
| Total  stockholders’ (deficit)                                                                   |   |   |   | **(4,580** | **)**      |
|                                                                                                  |   |   |   |       |       |
| **TOTAL**                                                                                             |   |   |   | **$**      | **6,698**  | ** ** |

 

See Accompanying SelectedInformation to Unaudited Condensed Financial Statements.

 

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**LEEPHARMACEUTICALS**

**STATEMENTS OFOPERATIONS**

**(Dollars inthousands, except per share amounts)**

**(Unaudited)**

** **
|                                |                       | **For  the Three Months  Ended December 31,** |       |
|-------------------------------------|----------------------------|-----------------------------------------------|------------|
|                                |                       | **2003**                                      |       | **2002** |   |
|                                |                       |                                          |       |   |   |
| Gross  revenues                     |                       | **$**                                         | **2,826**  |   | $ | 2,691 |   |
| Less:                               | Sales  returns             |                                          | **(322**   | **)** | (280 | ) |
|                                | Cash  discounts and others |                                          | **(31**    | **)** | (26 | ) |
|                                |                       |                                          | ** ** |   |   |
| Net  revenues                       |                       | **2,473**                                     | ** ** | 2,385 |   |
|                                |                       |                                          | ** ** |   |   |
| Costs  and expenses:                |                       |                                          | ** ** |   |   |
|                                |                       |                                          | ** ** |   |   |
| Cost  of sales                      |                       | **1,353**                                     | ** ** | 1,237 |   |
| Selling  and advertising expense    |                       | **741**                                       | ** ** | 721 |   |
| General  and administrative expense |                       | **332**                                       | ** ** | 305 |   |
| Interest  expense                   |                       | **191**                                       | ** ** | 203 |   |
|                                |                       |                                          | ** ** |   |   |
| Total  costs and expenses           |                       | **2,617**                                     | ** ** | 2,466 |   |
|                                |                       |                                          | ** ** |   |   |
| (Loss)  from operations             |                       | **(144**                                      | **)**      | (81 | ) |
|                                |                       |                                          |       |   |   |
| Other  income                       |                       | **156**                                       |       | 97 |   |
|                                |                       |                                          |       |   |   |
| Net  income                         |                       | **$**                                         | **12**     |   | $ | 16 |   |
|                                |                       |                                          |       |   |   |
| Per  share:                         |                       |                                          |       |   |   |
|                                |                       |                                          |       |   |   |
| Basic  and diluted income per share |                       | **$**                                         | **.00**    |   | $ | .00 |   |

 

See AccompanyingSelected Information to Unaudited Condensed Financial Statements.

 

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**LEE PHARMACEUTICALS**

**STATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
|                                                                               |   | **For the  Three Months  Ended December 31,** |       |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                                               |   | **2003**                                      |       | **2002** |   |
|                                                                               |   |                                          |       |   |   |
| Cash  flows provided by operating activities:                                      |   |                                          |       |   |   |
| Net  income                                                                        |   | **$**                                         | **12**     |   | $ | 16 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                                          |       |   |   |
| Depreciation                                                                       |   | **49**                                        |       | 38 |   |
| Amortization  of intangibles                                                       |   | **52**                                        |       | 49 |   |
| (Decrease)  in deferred income                                                     |   | **(70**                                       | **)**      | (82 | ) |
| Change  in operating assets and liabilities:                                       |   |                                          | ** ** |   |   |
| (Increase)  decrease in accounts receivable, net                                   |   | **(598**                                      | **)**      | 238 |   |
| Decrease  (increase) in inventories                                                |   | **141**                                       | ** ** | (87 | ) |
| (Increase)  decrease in deposits                                                   |   | **(26**                                       | **)**      | 15 |   |
| (Increase)  in other current assets                                                |   | **(201**                                      | **)**      | (43 | ) |
| Increase  (decrease) in bank overdraft                                             |   | **44**                                        | ** ** | (47 | ) |
| Increase  in accounts payable and accrued liabilities                              |   | **277**                                       | ** ** | 112 |   |
| (Decrease)  increase in due to related parties                                     |   | **(219**                                      | **)**      | 22 |   |
| Net  cash provided by (used in) operating activities                               |   | **(539**                                      | **)**      | 231 |   |
|                                                                               |   |                                          | ** ** |   |   |
| Cash  flows from investing activities:                                             |   |                                          | ** ** |   |   |
| Additions  to property , plant and equipment                                       |   | **(15**                                       | **)**      | (115 | ) |
| (Decrease)  in due on investment acquisitions                                      |   | —                                        | ** ** | (30 | ) |
| Net  cash provided by (used in) investing activities                               |   | **(15**                                       | **)**      | (145 | ) |
|                                                                               |   |                                          | ** ** |   |   |
| Cash  flows from financing activities:                                             |   |                                          | ** ** |   |   |
| Proceeds  from notes payable to related party                                      |   | —                                        | ** ** | 3 |   |
| (Payments  on) notes payable to related party                                      |   | **(43**                                       | **)**      | (51 | ) |
| Increase  (decrease) in notes payable, finance company                             |   | **523**                                       | ** ** | (85 | ) |
| Proceeds  from notes payable, other                                                |   | **150**                                       | ** ** | 300 |   |
| (Payments  on) notes payable, other                                                |   | **(36**                                       | **)**      | (238 | ) |
| Net  cash provided by (used in) financing activities                               |   | **594**                                       | ** ** | (71 | ) |
|                                                                               |   |                                          | ** ** |   |   |
| Net  increase in cash                                                              |   | **40**                                        |       | 15 |   |
| Cash,  beginning of period                                                         |   | **16**                                        |       | 26 |   |
| Cash,  end of period                                                               |   | **$**                                         | **56**     |   | $ | 41 |   |
|                                                                               |   |                                          |       |   |   |
| **Supplemental  disclosures of cash flow information:**                            |   |                                          |       |   |   |
|                                                                               |   |                                          |       |   |   |
| Cash  paid during the year for:                                                    |   |                                          |       |   |   |
| Interest                                                                           |   | **$**                                         | **170**    |   | $ | 182 |   |
| Taxes                                                                              |   | **$**                                         | **—** |   | $ | 1 |   |
|                                                                               |   |                                          |       |   |   |
| Acquisition  of investment:                                                        |   |                                          |       |   |   |
| Investment  acquired by debt                                                       |   | **$**                                         | **—** |   | $ | (801 | ) |

 

See AccompanyingSelected Information to Unaudited Condensed Financial Statements.

 

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SELECTED FINANCIALINFORMATION

Substantially AllDisclosures Required By Generally Accepted Accounting Principals Are NotIncluded

 

**Notes to Financial Information**

 

1.               Basisof presentation:

 

The condensedinterim financial statements included herein have been prepared by LeePharmaceuticals without audit, pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to such rules andregulations, although the Company believes that the disclosures are adequate tomake the information presented not misleading.

 

These statements reflectall adjustments, consisting of normal recurring adjustments which, in theopinion of management, are necessary for fair presentation of the informationcontained herein.  It is suggested thatthese condensed financial statements be read in conjunction with the financialstatements and notes thereto included in the Company’s Annual Report on Form10-KSB for the year ended September 30, 2003. The Company follows the same accounting policies in preparation of interimreports.

 

Results ofoperations for the interim periods may not be indicative of annual results.

 

The Company isinvolved in various matters involving environmental cleanup issues.  See “Item 2. Management’s Discussionand Analysis or Plan of Operations” and Note 13 of Notes to Financial Statementsincluded in the Company’s Form 10-KSB for the fiscal year ended September 30,2003.  The ultimate outcome of thesematters cannot presently be determined. Environmental expenditures that relate to an existing condition causedby past operations, and which do not contribute to current or future revenuegeneration, are expensed.  The Company’sproportionate share of the liabilities are recorded when environmentalremediation and/or cleanups are probable, and the costs can be reasonablyestimated.  As of December 31, 2003, nosettlements have been reached.

 

2.               Continuedexistence:

 

The financialstatements have been prepared assuming that the Company will continue as agoing concern.  The Company has anaccumulated deficit of $9,215,000.  TheCompany’s recurring losses from operations and inability to generate sufficientcash flow from normal operations to meet its obligations as they come due raisesubstantial doubt about the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due. Management’s plans in regard to these matters are to increaseprofitability by increasing sales, control expenses and seek additionalfinancing from outside lenders.  Thefinancial statements do not include any adjustments to reflect the possiblefuture effects of the recoverability and classification of assets or theamounts and classification of liabilities that may result from the possibleinability of the Company to continue as a going concern.

 

3.               Useof estimates:

 

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

 

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4.               Reclassification:

 

Certainreclassifications have been made to the prior year financial statements to beconsistent with the 2004 presentation.

 

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5.               Impairmentof intangible assets:

 

At December 31,2003, the Company had $5.1 million of product line and certain identifiableintangibles.  In assessing therecoverability of these intangibles, the Company must make assumptionsregarding estimated future cash flows and other factors to determine the fairvalue of the respective assets.  If theestimates or their related assumptions change in the future, the Company may berequired to record impairment charges for these assets not previouslyrecorded.  In connection with theadoption of SFAS 142 issued in July 2001, the Company performed an impairmentassessment for the three months ended December 31, 2003, and deemed that noimpairment charge is necessary.

 

6.               Earningsper share:

 

The Company has asimple capital structure, and there were no changes under the SFAS 128methodology to the previously reported earnings (loss) per share amounts forany of the fiscal years.  Basic earningsper share under SFAS 128 were computed using the weighted average number ofshares outstanding of 4,135,162 for the three months ended December 31, 2003and 4,347,162 for the three months ended December 31 2002.  Differences in the weighted average numberof shares outstanding for purposes of computing diluted earnings per share weredue to the inclusion of the dilutive effect of stock options previouslygranted.  These differences in the weightedaverage number of shares outstanding for the calculation of basic and dilutedearnings per share resulted in no differences in the earnings per share.

 

7.               Otherincome:

 

For the quarterended December 31, 2003, other income included realized gains of approximately$70,000 related to the sale of three products. These realized gains pertain to the recognition of the earned portion ofthe deferred income of the consulting agreements arising from the sale of theseproducts.  Also included is $86,000arising from a service agreement with Monticello Drug Company.  For the quarter ended December 31, 2002,other income consisted of realized gains as described above of $37,000, jointventure income of $45,000 and $15,000 in property tax refunds.

 

8.               Incometaxes:

 

At December 31,2003, the Company has a Federal net operating loss (NOL) carry forward ofapproximately $12,000,000 for which it has recorded a valuation allowance forthe entire NOL.

 

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**Item 2.****                                   Management’sDiscussion and Analysis or Plan of Operations.**

 

**Material Changes in Results ofOperations**

**Three Months Ended December 31, 2003,and December 31, 2002**

 

Gross revenues for thethree months ended December 31, 2003, were $2,826,000, an increase ofapproximately $135,000, or 5%, from the comparable three months ended December31, 2002.  The Company reportedincreased sales volume associated with several product categories.  Specifically, the Company experienced highersales in the private label segment ($129,000), depilatories ($57,000), over-thecounter (OTC) products (approximately $381,000) along with the added volumefrom a newly acquired brand ($54,000). The increases in gross revenues was partially offset by the decreases inLee® Lip-Ex® ($109,000), Lee Nails® category ($38,000) as well as other OTCbrands ($339,000).

 

Net revenues increasedapproximately $88,000, or 4%, for the three months ended December 31, 2003, ascompared to the three months ended December 31, 2002.  The change in net revenues was due primarily to the sales volume explanationsdiscussed above.  The Company’s salesreturns increased approximately $42,000, or 15%, when comparing the threemonths ended December 31, 2003 and 2002. Included in the increase was an adjustment ($112,000) for sales returnsand allowance due to the anticipated discontinuance of one of the Company’sSKUs (stock keeping units) at the retail store level.  There was no comparable adjustment during the quarter endedDecember 31, 2002.

 

Cost of sales as apercentage of gross revenues was 48% for the three months ended December 31,2003, compared to 46% for the three months ended December 31, 2002.  The slight increase in cost of salespercentage was due to the continued change in the product mix and lower pricedcommodity-type goods with an accompanying higher cost of goods attached tothem, thereby generating lower gross margins on sales of these relatedproducts.

 

Selling and advertisingexpenses increased approximately $20,000, or 3%, when comparing the threemonths ended December 31, 2003 with the three months ended December 31,2002.  The increased expenses wereprimarily due to the following factors: (1) increased advertising expense($52,000),  (2) increased productliability insurance premiums ($36,000), (3) higher building rent due to the Company re-occupying a buildingwhich was previously subleased ($22,000) and (4) higher commissions/bonusespaid to salesmen ($16,000).  The aboveincreases were partially offset by (1) lower salesmen’s salaries due to theresignation of a sales person who was not replaced ($18,000),  (2) lower freight costs ($19,000),  (3) reduced charges for artwork andpackaging changes ($22,000)  and  (4) less royalty expense from product lineacquisitions which are tied to gross sales ($44,000).

 

General andadministrative expenses increased approximately $27,000, or 9%, when comparingthe three months ended December 31, 2003, with the three months ended December31, 2002.  This increase was basicallydue to  (1) higher temporary help costs($5,000),  (2) increased repair,building and supplies expenses ($10,000) and  (3) added accounting andauditing fees ($18,000).  These expenseswere partially offset by lower legal expenses specifically related to the CarmaLaboratories, Inc. legal action which was settled during the quarter endedDecember 31, 2002 ($21,000).

 

Interest expensedecreased $12,000, or 6%, when comparing the three months ended December 31,2003, with the three months ended December 31, 2002.  This slight decrease was the result of lower average prime interestrate  (4.45% versus 4.00%) in referenceto certain loans which are tied to prime.

 

The Company realizedother income of approximately $156,000 for the three months ended December 31,2003, as compared to $97,000 for the comparable three months ended December 31,2002.  Of this income, $70,000 pertainsto realized gains related to the sale of the Klutch® product line ($27,000),the sale of the Astring-o-Sol® product line ($11,000) and the sale of theiodex® product line ($32,000).  Therealized gains pertain to the recognition of the earned portion of the deferredincome of the consulting agreements arising from the sale of the Klutch®,Astring-o-Sol® and iodex® brands.  Alsoincluded in other income is approximately $86,000 arising from the serviceagreement with Monticello Drug Company. For the three months ended December 31, 2002, the Company realized otherincome related to the sale of Klutch® ($27,000) and Astring-o-Sol® ($11,000)product lines along with $44,000 which was the Company’s portion of the netprofits from its investment with

 

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Monticello Drug Companyplus  $15,000 of property tax refunds.

 

**Liquidity and Capital Resources**

 

At December 31, 2003,working capital was a negative $3,511,000 compared with a negative $3,525,000as of September 30, 2003.  The ratio ofcurrent assets to current liabilities was 0.5 to 1 at December 31, 2003  and at September 30, 2003.

 

The Company has anaccumulated deficit of $9,215,000.  Pastrecurring losses and inability to generate sufficient cash flow from normaloperations to meet its obligations as they become due, raises substantial doubtabout the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due.

 

**Environmental Matters**

 

The Company owns a manufacturing facility located in SouthEl Monte, California.  The CaliforniaRegional Water Quality Control Board (The “RWQCB”) ordered the Company in 1988and 1989 to investigate the contamination on its property (relating to soil andgroundwater contamination).  The Companyengaged a consultant who performed tests and reported to the then Chairman ofthe Company.  The Company resistedfurther work on its property until the property upgradient was tested ingreater detail since two “apparent source” lots had not been tested.  On August 12, 1991, the RWQCB issued a“Cleanup and Abatement Order” directing the Company to conduct further testingand cleanup the site.  In October 1991,the Company received from an environmental consulting firm an estimate of$465,200 for investigation and cleanup costs. The Company believed that this estimate was inconclusive and overstatedthe contamination levels.  The Companybelieves that subsequent investigations will support the Company’s conclusionsabout that estimate.  The Company didnot complete the testing for the reasons listed above as well as “financialconstraints”.  In June 1992, the RWQCBrequested that the EPA evaluate the contamination and take appropriateaction.  At the EPA’s request, Ecology& Environment, Inc. conducted an investigation of soil and groundwater onthe Company’s property.  Ecology &Environment Inc.’s Final Site Assessment Report, which was submitted to the EPAin June 1994, did not rule out the possibility that some of the contaminationoriginated on-site, and resulted from either past or current operations on theproperty.

 

On April 24, 2002, the RWQCB notified the Company thatthe detection of emergent chemicals in groundwater, above State and Federalmaximum containment levels or action levels, has caused the RWQCB and the EPAto reassess the threat posed to groundwater resources used for domesticsupply.  The RWQCB directed the Companyto test for the presence of emergent chemicals in its groundwater monitoringwells.  The groundwater monitoringanalytical results were due by July 15, 2002. On May 24, 2002, the Company informed RWQCB that it could not complywith the requirement to conduct groundwater sampling due to ongoing financialdifficulties.

 

On July 8, 2002, the RWQCB sent a “Second Notice ofViolation” to the Company directing the Company to comply with the requirementto prepare a groundwater remedial action plan (RAP).  The Company previously notified the RWQCB that it could notcomply with the requirement to submit a RAP because of ongoing financialdifficulties.  The RWQCB requested thatthe Company submit certain financial information by July 29, 2002 to“substantiate any alleged financial losses and determine whether any suspensionof implementing the...(Cleanup and Abatement Order) is warranted.”  The Company has received an extension tosubmit the required financial information to August 19, 2002.  The Company submitted the requestedfinancial information on August 16, 2002. The Company received a response whereby their request for financialhardship was denied.  The Company is inthe process of appealing this decision based primarily upon the continueddeterioration in the Company finances since the original filing.  The Company may be liable for all or part ofthe costs of remediating the contamination on its property and could be subjectto enforcement action by

 

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the RWQCB, including injunctive and civil monetaryremedies.  As of the date of thefinancial statements, the Company’s share of the costs have not beendetermined.

 

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The Company and nearby property owners, in consortwith their comprehensive general liability (CGL) carriers, engaged a consultantto perform a site investigation with respect to soil and shallow groundwatercontamination 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, the overall scope of the project was increased to$205,000 plus $15,000 for waste water disposal, bringing the total to the abovelisted $220,000.  The $87,500 accrualwas not spent on this project (as the entire cost was borne by the CGLcarriers), but remains on the books as an accrual against the cost ofremediation of the same site that was included in the study.

 

The tenants of nearby properties upgradient have suedthe Company alleging that hazardous materials from the Company’s propertycaused contamination on the properties leased by the tenants.  The case name is Del Ray IndustrialEnterprises, Inc. v. Robert Malone, et al., Los Angeles County SuperiorCourt, Northwest District, commenced August 21, 1991.  In this action, the plaintiff alleges environmental contaminationby defendants of its property, and seeks a court order preventing furthercontamination and monetary damages.  TheCompany does not believe there is any basis for the allegations and isvigorously defending the lawsuit.

 

The Company’s South El Monte manufacturing facility isalso located over a large area of possibly contaminated regional groundwaterwhich 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, the Company was informed that theEPA estimated the cleanup costs for the South El Monte’s portion of the SanGabriel Valley Superfund Site to be $30 million.  The Company’s potential share of such amount has not beendetermined.  Superfund PRPs are jointlyand severally liable for superfund site costs, and are responsible fornegotiating among themselves the allocation of the costs based on, among otherthings, the outcome of environmental investigation.

 

In August 1995, the Company was informed that the EPAentered into an Administrative Order of Consent with Cardinal IndustrialFinishes (“Cardinal”) for a PRP lead remedial investigation and feasibilitystudy (the “Study”) which, the EPA states, will both characterize the extent ofgroundwater contamination in South El Monte and analyze alternatives to controlthe spread of contamination.  TheCompany and others entered into the South El Monte Operable Unit SiteParticipation Agreement with Cardinal pursuant to which, among other things,Cardinal contracted with an environmental firm to conduct the Study.  The Study has been completed.  The Company’s share of the cost of the Studywas $15,000 and 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 alternativesrange from $0 (no action) up to $3.49 million. The estimated annual operating cost for the four alternatives range from$0 (no action) to $770,300.  Over a30-year period, the total cost of the four alternatives range from $0 (noaction) up to $13.05 million.  The EPAprefers an alternative which estimates the capital cost up to $3.08 million,the annual operating cost at $.48 million, and the 30-year period total cost upto approximately $9.09 million.  Theselection of the actual alternative implemented is subject to public comment.  At the present time, the Company does notknow what its share of the cost may be, if any.  Therefore, no additional accrual has been recognized as aliability on the Company’s books.  TheCompany requested that the EPA conduct an “ability-to-pay evaluation” todetermine whether the Company is entitled to an early settlement of this matterbased upon a limited ability to pay costs associated with site investigationand remediation.  In August 2000, theEPA informed the Company that it does not qualify for an early settlement atthis time.

 

The EPA has informed the Company that it has learnedthat the intermediate zone groundwater contamination in the western portion ofthe SEMOU has migrated further west and has now impacted the City of MontereyPark 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

 

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has reached a general agreement with the waterpurveyors to fund the development of treatment facilities and use the waterpurveyors’ wells in an attempt to contain the groundwater contamination to

 

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meet EPA’s goals. At this time, the EPA has not reviewed or approved any specific plan toaddress contamination at the purveyor wells, nor has the EPA compromised itsright to recover response costs from any person who is legally responsible forcontamination within the SEMOU.  As ofthe date of this report, the Company has not been contacted by the South ElMonte Cooperative Group in respect to its participation in any proposed cleanupactivity.  As a result, the Company isnot able to determine what contribution, if any, it may be assessed inconnection with this cleanup activity.

 

By letter dated November 13, 2000, the Company wasnotified that the City of Monterey Park, San Gabriel Valley Water Company andSouthern California Water Company intend to bring suit under the Safe DrinkingWater and Toxic Enforcement Act of 1986 alleging that the Company has knowinglyreleased volatile organic compounds in the soil and shallow groundwater beneaththe Company’s property between at least on or before November 8, 1996 and thepresent and has failed to promptly clean up all of the contamination.  As of the date of this report, the Companyhas not been served with this lawsuit.

 

The City of South El Monte, the city in which theCompany 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 El Monte doesnot 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.

 

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 and response.  A meeting with the parties and RWQCB washeld on February 10, 1998.  The RWQCBhad advised companies that vadose soil contamination is minimal and requires nofurther action.  However, there is anarea of shallow groundwater which has a higher than desired level ofchlorinated solvents, and the RWQCB requested a proposed work plan be submittedby Geomatrix.  Geomatrix has submitted a“Focused Feasibility Study” which concludes that there are five possiblemethods for cleanup.  The most expensiveare for a pump and sewer remediation which would cost between $1,406,000 and$1,687,000.  The Company is activelyexploring the less expensive alternative remediation methods, of which the twoproposed alternatives range in cost between $985,000 and $1,284,000.  Since there are four economic entitiesinvolved, the Company’s best estimate at this time, in their judgment, would bethat their forecasted share would be $287,000 less the liability alreadyrecognized on the books of $165,000 thereby requiring an additional $122,000liability.  Accordingly, the Companyrecorded an additional accrual of $122,000 in the third quarter of fiscal1998.  The $122,000 accrual is inaddition to the $79,000 accrual for the Monterey Site as will be explained inthe following paragraph.  The $79,000accrual, in the third quarter of fiscal 1998, related to the Monterey Site isnot included in the $287,000 figure above. In April 2000, the Company received a Notice of Violation from theRWQCB.  The Notice of Violation statesthat the Company and other property owners were required to submit 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

 

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responsibility to prepare the action plan.  The RWQCB stated that it will no longerencourage the cooperative approach among the Company and the other propertyowners in completing the cleanup requirements and will pursue appropriatemeasures, including when necessary, enforcement actions.  The RWQCB states that it may impose civilliability penalties of up to $1,000 per day from November 1, 1999 for failureto file the action plan.  In light ofthese events, no assurances can be given that the cleanup costs and possiblepenalties will not exceed the amount of the Company’s current accruals of$287,000 (which includes the $122,000 charge to income in the third quarter of fiscal1998).

 

In July 2000, the property owners formed the Lidcombe& Santa Anita Avenue Work Group (LSAAW) in response to the RWQCB requestfor 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 Quality Authority (WQA)is willing and able to reauthorize its grant for one-half (1/2) of the capitalcosts of its remediation system construction not to exceed $150,000.  It is estimated at this time that the reservesfor the Company’s share of this cost proposal are adequate since its prioraccrual was based on the higher cost estimate from Geomatrix.

 

Without any prior correspondence or inkling of theCompany’s potential liability, the EPA informed the Company that the Companymay 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 1948to 1984, in which the Company disposed of non toxic pH balanced waste water onsix occasions between 1974 and 1978. Over 4,000 companies have been identified as having contributed waste tothe Monterey 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 elected to file for relief from these obligations under thefinancial hardship option in the EPA’s response form.  On June 30, 2000, the EPA informed the Company that the EPAbelieved the Company is able to pay the full settlement cost, but offered toreduce the amount of the settlement to $75,271.

 

The Company was notified by the EPA that the Companymay have potential liability for waste material it disposed of at the CasmaliaDisposal Site (“Site”) located on a 252 acre parcel in Santa Barbara County,California.  The Site was operationalfrom 1973 to 1989, and over 10,000 separate parties disposed of wastethere.  The EPA stated that federal,state and local governmental agencies along with the numerous private entitiesthat used the Site for waste disposal will be expected to pay their share aspart of this settlement.  The U.S. EPAis 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 environmental investigation andcleanup costs that the Company may incur with respect to the foregoing is notknown at this time.  However, based uponinformation available to the Company at this time, the Company has expensedsince 1988 a total of $860,000, of which $89,000 were legal fees, exclusive oflegal fees expended in connection with the Securities and Exchange Commissionenvironmental investigation.  The actualcosts could differ materially from the amounts expensed for environmentalinvestigation and cleanup costs to date.

 

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As of December 31, 2003, no settlements have beenreached.  The total amount expensed inprior years relating to this environmental issue is $860,000.  As of December 31, 2003, no additionalamounts have been expensed or accrued. The Company has an accrued liability on the books at December 31, 2003of $740,000 for the environmental cleanup.

 

**Item 3.****                                   Controlsand Procedures**

 

The chiefexecutive officer and chief financial officer of the Company (the “certifyingofficer”) evaluated the effectiveness of the Company’s disclosure controls andprocedures as of the end of the period covered by this report.  These disclosure controls and procedures aredesigned to ensure that the information required to be disclosed by the Companyin its periodic reports filed with the Securities and Exchange Commission (the“Commission”) is recorded, processed, summarized and reported, within the timeperiods specified by the Commission’s rules and forms, and that the informationis communicated to the certifying officer on a timely basis.

 

The certifyingofficer concluded, based on his evaluation, that the Company’s disclosurecontrols and procedures are effective for the Company.

 

There were nochanges in the Company’s internal control over financial reporting thatoccurred during the Company’s most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**PART II - Other Information**

 

**Item 1.****                                   LegalProceedings**

 

The informationset forth under Part I, Item 2, “Management’s Discussion and Analysis or Planof Operations - Environmental Matters” is incorporated herein byreference.  See also “LegalProceedings” in the Company’s Form 10-KSB for the fiscal year ended September30, 2003.

 

**Item 6.****                                   Exhibitsand Reports on Form 8-K:**

 
| The following exhibits  are filed herewith:                        |
|--------------------------------------------------------------------|
|                                                               |   |   |
| 10.1                                                               | - | Promissory note  evidencing advance made to Registrant |
|                                                               |   |   |
| 10.2                                                               | - | Promissory note which  was amended (modified) in November 2003, evidencing advance made to  Registrant |
|                                                               |   |   |
| 31.1                                                               | - | Certification by Chief  Executive Officer and Chief Financial Officer |
|                                                               |   |   |
| 32.1                                                               | - | Section 1350 Certification |
|                                                               |   |   |
| 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. |

 

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| (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. |

 

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SIGNATURES

 

In accordance with therequirements of the Securities Exchange Acts of 1934, the registrant has causedthis report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |                    |                                                                         | LEE  PHARMACEUTICALS |   |
|--------|-------------------------|------------------------------------------------------------------------------|----------------------|--------|
|   |                    | (Registrant)                                                                 |
|   |                    |                                                                         |
|   |                    |                                                                         |
| Date:  |  FEBRUARY 11, 2004 |                                                                         | RONALD G. LEE        |
|   |                    | Ronald G. Lee                                                                |
|   |                    | Chairman of the Board, President and  Chief Financial and Accounting Officer |
|        |                         |                                                                              |                      |        |  |

 

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