**SECURITIES AND EXCHANGE COMMISSION**

**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 December 31, 2002**                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                             |                                                                                          |
| **OR**                                                                                                                                                                                                                                                                           |
|                                                                                                                                                                                                                                                                             |                                                                                          |
| o                                                                                                                                                                                                                                                                                | **TRANSITION REPORT PURSUANT TO SECTION  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For  the transition period  from                   to                    ** |
|                                                                                                                                                                                                                                                                             |
| **Commission  file number   1-7335**                                                                                                                                                                                                                                        |

 

**LEEPHARMACEUTICALS**

(Exact name of small business issuer as specified inits 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 9173 3**                     |
| (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  December 31, 2002 there were outstanding4,135,162 shares of common stock of the registrant.

 

Transitional SmallBusiness Disclosure Format (check one):

 

Yes   o       No   ý

 

 

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**LEE PHARMACEUTICALS**

**BALANCE SHEET**

**DECEMBER 31, 2002**

**(Dollars in thousands)**

**(Unaudited)**

 
| **Assets**                                                                              |   |    |      |      |       |
|-----------------------------------------------------------------------------------------|--------|---------|-----------|-----------|------------|
|                                                                                    |   |    |      |      |       |
| Cash                                                                                    |   |    |      | **$**     | **41**     | ** ** |
|                                                                                    |   |    |      |      |       |
| Accounts  and notes receivable (net of allowances: $197)                                |   |    |      | **848**   | ** ** |
|                                                                                    |   |    |      |      |       |
| Inventories  (net of reserves: $362)                                                    |   |    |      |      |       |
| Raw  materials                                                                          |   | **$**   | **2,022** |      |       | ** ** |
| Work  in process                                                                        |   | **190** |      |      | ** ** |
| Finished  goods                                                                         |   | **293** |      |      | ** ** |
|                                                                                    |   |    |      |      |       |
| Total  inventories                                                                      |   |    |      | **2,505** | ** ** |
|                                                                                    |   |    |      |      |       |
| Other  current assets                                                                   |   |    |      | **532**   | ** ** |
|                                                                                    |   |    |      |      |       |
| Total  current assets                                                                   |   |    |      | **3,926** | ** ** |
|                                                                                    |   |    |      |      |       |
| Property,  plant and equipment (less accumulated depreciation and amortization: $5,360) |   |    |      | **595**   | ** ** |
|                                                                                    |   |    |      |      |       |
| Investment                                                                              |   |    |      | **801**   | ** ** |
|                                                                                    |   |    |      |      |       |
| Intangibles  and other assets (net of accumulated amortization: $856)                   |   |    |      | **2,287** | ** ** |
|                                                                                    |   |    |      |      |       |
| **TOTAL**                                                                               |   |    |      | **$**     | **7,609**  | ** ** |
|                                                                                         |        |         |           |           |            |  |  |

 

See AccompanyingSelected Information to Unaudited Condensed Financial Statements.

 

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**LEE PHARMACEUTICALS**

**BALANCE SHEET**

**DECEMBER 31, 2002**

**(Dollars in thousands)**

**(Unaudited)**

 

 

 

 
| **LIABILITIES**                                                                                       |   |       |       |
|-------------------------------------------------------------------------------------------------------|--------|------------|------------|
|                                                                                                  |   |       |       |
| Bank  overdraft                                                                                       |   | **$**      | **26**     | ** ** |
| Notes  payable - bank                                                                                 |   | **914**    | ** ** |
| Current  portion - notes payable, other                                                               |   | **1,360**  | ** ** |
| Current  portion - note payable related party                                                         |   | **820**    | ** ** |
| Due  on investment acquisition                                                                        |   | **326**    | ** ** |
| Accounts  payable                                                                                     |   | **1,213**  | ** ** |
| Other  accrued liabilities                                                                            |   | **337**    | ** ** |
| Environmental  cleanup liability                                                                      |   | **366**    | ** ** |
| Due  to related parties                                                                               |   | **924**    | ** ** |
| Deferred  income                                                                                      |   | **151**    | ** ** |
|                                                                                                  |   |       |       |
| Total  current liabilities                                                                            |   | **6,437**  | ** ** |
|                                                                                                  |   |       |       |
| Long-term  notes payable - bank                                                                       |   | **235**    | ** ** |
| Long-term  notes payable to related parties                                                           |   | **1,811**  | ** ** |
| Long-term  notes payable, other                                                                       |   | **2,086**  | ** ** |
| Environmental  cleanup liability - Casmalia Site                                                      |   | **374**    | ** ** |
| Deferred  income                                                                                      |   | **138**    | ** ** |
|                                                                                                  |   |       |       |
| Total  long-term liabilities                                                                          |   | **4,644**  | ** ** |
|                                                                                                  |   |       |       |
| Total  liabilities                                                                                    |   | **11,081** | ** ** |
|                                                                                                  |   |       |       |
| **COMMITMENTS  AND CONTINGENCIES**                                                                    |   |       |       |
|                                                                                                  |   |       |       |
| **STOCKHOLDERS’  (DEFICIT)**                                                                     |   |       |       |
|                                                                                                  |   |       |       |
| Common  stock, $.10 par value; authorized, 7,500,00 shares; issued and outstanding,  4,135,162 shares |   | **413**    | ** ** |
|                                                                                                  |   |       |       |
| Additional  paid-in capital                                                                           |   | **4,222**  | ** ** |
|                                                                                                  |   |       |       |
| Accumulated  (deficit)                                                                                |   | **(8,107** | **)**      |
|                                                                                                  |   |       |       |
| Total  stockholders’ (deficit)                                                                   |   | **(3,472** | **)**      |
|                                                                                                  |   |       |       |
| **TOTAL**                                                                                             |   | **$**      | **7,609**  | ** ** |

 

See AccompanyingSelected Information to Unaudited Condensed Financial Statements.

 

3

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**LEEPHARMACEUTICALS**

**STATEMENTS OFOPERATIONS**

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

**(Unaudited)**

** **

 
|                                  |       | **For  the Three Months  Ended December 31,** |      |
|---------------------------------------|------------|-----------------------------------------------|-----------|
|                                  |       | **2002**                                      |      | **2001** |   |
|                                  |       |                                          |      |   |   |
| Gross  revenues                       |       | **$**                                         | **2,691** |   | $ | 2,434 |   |
| Less:    Sales returns | ** ** | **(280**                                      | )         | (181 | ) |
| Cash  discounts and others            |       | **(26**                                       | )         | (21 | ) |
|                                  |       |                                          |      |   |   |
| Net  revenues                         |       | **2,385**                                     |      | 2,232 |   |
|                                  |       |                                          |      |   |   |
| Costs  and expenses:                  |       |                                          |      |   |   |
|                                  |       |                                          |      |   |   |
| Cost  of sales                        |       | **1,237**                                     |      | 1,162 |   |
| Selling  and advertising expense      |       | **721**                                       |      | 608 |   |
| General  and administrative expense   |       | **305**                                       |      | 296 |   |
| Interest  expense                     |       | **203**                                       |      | 182 |   |
|                                  |       |                                          |      |   |   |
| Total  costs and expenses             |       | **2,466**                                     |      | 2,248 |   |
|                                  |       |                                          |      |   |   |
| (Loss)  from operations               |       | **(81**                                       | )         | (16 | ) |
|                                  |       |                                          |      |   |   |
| Other  income                         |       | **97**                                        |      | 26 |   |
|                                  |       |                                          |      |   |   |
| Net  income                           |       | **$**                                         | **16**    |   | $ | 10 |   |
|                                  |       |                                          |      |   |   |
| Per  share:                           |       |                                          |      |   |   |
|                                  |       |                                          |      |   |   |
| Basic  and diluted income per share   |       | **$**                                         | **.00**   |   | $ | .00 |   |
|                                       |            |                                               |           |  |  |  |  |  |  |  |

 

See AccompanyingSelected Information to Unaudited Condensed Financial Statements.

 

4

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**LEE PHARMACEUTICALS**

**STATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
|                                                                                           |   | **For the  Three Months  Ended December 31,** |       |
|------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                                                           |   | **2002**                                      |       | **2001** |   |
|                                                                                           |   |                                          |       |   |   |
| Cash  flows provided by (used in) operating activities:                                        |   |                                          |       |   |   |
| Net  income                                                                                    |   | **$**                                         | **16**     |   | $ | 10 |   |
| Adjustments  to reconcile net income to   net cash provided by (used in) operating activities: |   |                                          |       |   |   |
| Depreciation                                                                                   |   | **38**                                        |       | 45 |   |
| Amortization  of intangibles                                                                   |   | **49**                                        |       | 106 |   |
| Other  (income)                                                                                |   | **(82**                                       | )          | (28 | ) |
|                                                                                           |   |                                          |       |   |   |
| Change  in operating assets and liabilities:                                                   |   |                                          |       |   |   |
| Decrease  (increase)  in accounts receivable                                              |   | **240**                                       |       | (79 | ) |
| (Decrease)  in allowance for doubtful accounts  and sales returns and allowances               |   | **(2**                                        | )     | (94 | ) |
| (Increase)  in inventories                                                                     |   | **(73**                                       | )          | (103 | ) |
| (Decrease)  increase in inventory reserve                                                      |   | **(14**                                       | )          | (8 | ) |
| Decrease  in deposits                                                                          |   | **15**                                        |       | 113 |   |
| (Increase)  in other current assets                                                            |   | **(43**                                       | )          | (95 | ) |
| Increase  (decrease) in accounts payable and accrued liabilities                               |   | **112**                                       |       | (90 | ) |
| Increase  in due to related parties - accrued interest                                         |   | **22**                                        |       | 26 |   |
| Net  cash provided by (used in) operating activities                                           |   | **278**                                       |       | (197 | ) |
|                                                                                           |   |                                          |       |   |   |
| Cash  flows from investing activities:                                                         |   |                                          |       |   |   |
| Additions  to property, plant, and equipment                                                   |   | **(115**                                      | )          | (51 | ) |
| Proceeds  from sale of product brand                                                           |   | —                                        |       | 265 |   |
| (Decrease)  in due on investment acquisition                                                   |   | **(30**                                       | **)**      | **—** | ** ** |
| Net  cash (used in) provided by investing activities                                           |   | **(145**                                      | )          | 214 |   |
|                                                                                           |   |                                          |       |   |   |
| Cash  flows from financing activities:                                                         |   |                                          |       |   |   |
| Proceeds  from notes payable to related party                                                  |   | **3**                                         |       | — |   |
| (Payments  on) notes payable to related party                                                  |   | **(51**                                       | )          | (50 | ) |
| (Payments  on) notes payable                                                                   |   | **(85**                                       | )          | (19 | ) |
| Proceeds  from notes payable, other                                                            |   | **300**                                       |       | 300 |   |
| (Payments  on) notes payable, other                                                            |   | **(238**                                      | )          | (269 | ) |
| (Decrease)  increase in bank overdraft                                                         |   | **(47**                                       | )          | 25 |   |
| Net  cash (used in) financing activities                                                       |   | **(118**                                      | )          | (13 | ) |
|                                                                                           |   |                                          |       |   |   |
| Net  increase in cash                                                                          |   | **15**                                        |       | 4 |   |
| Cash,  beginning of period                                                                     |   | **26**                                        |       | 5 |   |
|                                                                                           |   |                                          |       |   |   |
| Cash,  end of period                                                                           |   | **$**                                         | **41**     |   | $ | 9 |   |
|                                                                                           |   |                                          |       |   |   |   |   |
| **Supplemental  disclosures of cash flow information:**                                        |   |                                          | ** ** |   | ** ** |
| Cash  paid during the period for:                                                              |   |                                          |       |   |   |
| Interest                                                                                       |   | **$**                                         | **182**    |   | $ | 158 |   |
| Taxes                                                                                          |   | **$**                                         | **1**      |   | $ | 1 |   |
|                                                                                           |   |                                          |       |   |   |
| **Acquisition  of investment:**                                                                |   |                                          |       |   |   |
| Investment  acquired by debt                                                                   |   | $                                             | **(801**   | **)** | $ | — |   |

 

See AccompanyingSelected Information to Unaudited Condensed Financial Statements.

 

5

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**SELECTEDFINANCIAL INFORMATION**

** **

Substantially AllDisclosures Required By Generally Accepted Accounting Principals Are NotIncluded

 

**Notes to Financial Information**

 

1.     Basis ofpresentation:

 

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 statementsreflect all adjustments, consisting of normal recurring adjustments which, inthe opinion of management, are necessary for fair presentation of theinformation contained herein.  It issuggested that these condensed financial statements be read in conjunction withthe financial statements and notes thereto included in the Company’s AnnualReport on Form 10-KSB for the year ended September 30, 2002.  The Company follows the same accountingpolicies in preparation of interim reports.

 

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 12 of Notes to FinancialStatements included in the Company’s Form 10-KSB for the fiscal year endedSeptember 30, 2002.  The ultimateoutcome of these matters cannot presently be determined.  Environmental expenditures that relate to anexisting condition caused by past operations, and which do not contribute tocurrent or future revenue generation, are expensed.  The Company’s proportionate share of the liabilities are recordedwhen environmental remediation and/or cleanups are probable, and the costs canbe reasonably estimated.  As of December31, 2002, no settlements have been reached.

 

2.     Continuedexistence:

 

The accompanyingfinancial statements have been prepared assuming that the Company will continueas a going concern.  Although theCompany experienced nominal net income in fiscal years 2000 and 2001, and thethree months ended December 31, 2002, 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.     Use ofestimates:

 

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 those estimates.

 

4.     Reclassification:

 

Certainreclassifications have been made to the prior year financial statements to beconsistent with the 2003 presentation.

 

6

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5.     Impairmentof intangible assets:

 

At December 31,2002, 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 previously recorded.  In connection with the adoption of SFAS 142issued in July 2001, the Company performed an impairment assessment for threemonths ended December 31, 2002, and deemed that no impairment 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 4,347,162 for the three months ended December 2002 and5,265,162 for the three months ended December 2001.  Differences in the weighted average number of shares outstandingfor purposes of computing diluted earnings per share were due to the inclusionof the 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.

 

7.     Acquisition:

 

In December 2002,the Company signed an agreement with The Monticello Companies, Inc. that givesLee Pharmaceuticals a 40% interest in a separate agreement between TheMonticello Companies, Inc. and a large pharmaceutical company.  The agreement between The MonticelloCompanies, Inc. and the other pharmaceutical company is for an over-the-counterproduct.  There is a transition servicesagreement with the seller that expires June 30, 2003.  During the transition services agreement, Lee Pharmaceuticalswill be entitled to 40% of the net product sales as a monthly royalty untilJune 30, 2003.  After June 30, 2003, theCompany will take over the sales, marketing, warehouse, shipping, invoicing andcollection of the brand after receiving a seven percent (7%) fee.  The net earnings of the brand will be split60% to The Monticello Companies, Inc. and 40% to the Company.  Lee Pharmaceuticals is paying The MonticelloCompanies, Inc. $801,000 for their 40% interest.  Lee Pharmaceuticals has paid $430,000, with the balance due of$371,000 on June 30, 2003.  As ofDecember 31, 2002, Lee Pharmaceuticals has recognized $45,000 of income fromits share of the profits, which has been offset against the balance due.  The $801,000 has been recorded on thebalance sheet as an asset called investment. The remaining balance due of $326,000 has been recorded as a currentliability.

 

8.     Otherincome:

 

For the threemonths ended December 31, 2002, the Company realized gains of approximately$11,000 related to the sale of the Astring-o-Sol® product line and approximately$26,000 related to the sale of the Klutch® product line.  Therealized gains pertain to the recognition of the earned portion of the deferredincome of the consulting agreements arising from the sale of the Astring-o-Sol® and Klutch® brands.  These amounts are included in other incomeon the statements of operations.  Alsoincluded in other income is $15,000 in property tax refunds paid in prior yearsand approximately $45,000, which is the Company’s portion of the net profitsfrom their new investment with The Monticello Companies, Inc.

 

7

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**Item 2.            Management’s Discussion and Analysisor Plan of Operations**

**                        Material Changes inResults of Operations**

**                        Three Months EndedDecember 31, 2002, and December 31, 2001**

 

Gross revenues forthe three months ended December 31, 2002, were $2,691,000, an increase ofapproximately $257,000, or 11%, from the comparable three months ended December31, 2001.  The Company reportedincreased volume in the newly acquired brands ($274,000) plus the added salesfrom the private label ($208,000) segment. In addition, the Company reported nominal volume increases fromdepilatories and nasal spray products. The increase in gross revenues was partially offset by lower sales volumeof existing brands such as Lee® Lip-Ex®($55,000), Cheracol®,Aquafilter®, Take-Off®, as well as otherover-the-counter (OTC) brands and prescription drug products ($145,000).

 

Net revenuesincreased approximately $153,000, or 7%, for the three months ended December31, 2002, as compared to the three months ended December 31, 2001.  The change in net revenues was due to thesales volume explanations discussed above. The Company’s sales returns increased approximately $99,000, or 55%,when comparing the three months ended December 31, 2002 and 2001.  The Company continued to experience thediscontinuance of a few of the Company’s SKUs (stock keeping units) along withshort dated product at the retail store level. In addition, the Company had a recall of a few of its brands.

 

Cost of sales as apercentage of gross revenues was 46% for the three months ended December 31,2002, compared to 48% for the three months ended December 31, 2001.  The decreased cost of sales percentage wasbasically due to a change in the product mix.

 

Selling andadvertising expenses increased $113,000, or 19%, when comparing the threemonths ended December 31, 2002 with the three months ended December 31,2001.  The increase in expenses was dueto the following factors: (1) added royalty expense from new acquisitions($67,000), (2) higher insurance expense because of increased premiums forproduct liability coverage ($15,000), (3) increased commissions ($24,000) dueto higher sales volume along with additional manufacturer representativescovering territories that were previously open, and (4) added cooperativeadvertising ($54,000).  The aboveincreases were partially offset by a reduction in amortization expense($55,000), the result of the Financial Accounting Standards Board issuance ofStatement of Financial Accounting Standards No. 142 (FAS-142), Goodwill andOther Intangible Assets.  In connectionwith the adoption of this standard, the Company’s unamortized goodwill balance(product line) will no longer be amortized over its estimated useful life.

 

General andadministrative expenses increased $9,000, or 3%, when comparing the threemonths ended December 31, 2002, with the three months ended December 31,2001.  This increase was principally dueto higher MIS (Management Information Systems) expenses for consulting services($31,000), and higher legal fees ($11,000). These expenses were partially offset by (1) lower salary and relatedfringe benefits due to the termination of an employee ($4,000), (2) reducedprinting materials and supplies expense ($22,000), and (3) lower buildingrental expense because the facility is currently occupied by the productiondepartment ($4,000).

 

Interest expenseincreased $21,000, or 12%, when comparing the three months ended December 31,2002, with the three months ended December 31, 2001.  The increase was due to higher overall borrowings (principal) bythe Company.  The above was somewhatoffset by a lower average prime interest rate (4.25% vs. 4.75%) in reference tocertain loans which are tied to prime.

 

**Liquidity and Capital Resources**

 

At December 31,2002, working capital was a negative $2,511,000 compared with a negative$1,883,000 as of September 30, 2002. The ratio of current assets to current liabilities was .6 to 1 atDecember 31, 2002, and .7 to 1 at September 30, 2002.  The increase in the Company’s negative working capital wasprimarily due to a decrease in accounts receivable and an increase in payablesfor an investment acquisition.

 

8

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The Company has anaccumulated deficit of $8,107,000. Although the Company experienced nominal net income in fiscal years 2000and 2001, and the three months ended December 31, 2002, past recurring lossesand inability to generate sufficient cash flow from normal operations to meetits 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 existence is dependent uponfuture developments, including retaining current financing and achieving alevel of profitable operations sufficient to enable it to meet its obligationsas they become due.

 

**Environmental Matters**

 

The Company owns amanufacturing facility located in South El Monte, California.  The California Regional Water QualityControl Board (The “RWQCB”) ordered the Company in 1988 and 1989 to investigatethe contamination on its property (relating to soil and groundwatercontamination).  The Company engaged aconsultant who performed tests and reported to the then Chairman of theCompany.  The Company resisted furtherwork on its property until the property upgradient was tested in greater detailsince two “apparent source” lots had not been tested.  On August 12, 1991, the RWQCB issued a “Cleanup and AbatementOrder” directing the Company to conduct further testing and cleanup thesite.  In October 1991, the Companyreceived from an environmental consulting firm an estimate of $465,200 forinvestigation and cleanup costs.  TheCompany believed that this estimate was inconclusive and overstated the contamination levels.  The Company believes that subsequentinvestigations will support the Company’s conclusions  about that estimate.  TheCompany did not complete the testing for the reasons listed above as well as“financial constraints”.  In June 1992,the RWQCB requested that the EPA evaluate the contamination and takeappropriate action.  At the EPA’srequest, Ecology & Environment, Inc. conducted an investigation of soil andgroundwater on the Company’s property. Ecology & Environment Inc.’s Final Site Assessment Report, which wassubmitted to the EPA in June 1994, did not rule out the possibility that someof the contamination originated on-site, and resulted from either past orcurrent operations on the property.

 

On April 24, 2002,the RWQCB notified the Company that the detection of emergent chemicals ingroundwater, above State and Federal maximum containment levels or actionlevels, has caused the RWQCB and the EPA to reassess the threat posed to groundwaterresources used for domestic supply.  TheRWQCB directed the Company to test for the presence of emergent chemicals inits groundwater monitoring wells.  Thegroundwater monitoring analytical results were due by July 15, 2002.  On May 24, 2002, the Company informed RWQCBthat it could not comply with the requirement to conduct groundwater samplingdue to ongoing financial difficulties.

 

On July 8, 2002,the RWQCB sent a “Second Notice of Violation” to the Company directing theCompany to comply with the requirement to prepare a groundwater remedial actionplan (RAP).  The Company previouslynotified the RWQCB that it could not comply with the requirement to submit aRAP because of ongoing financial difficulties. The RWQCB requested that the Company submit certain financialinformation by July 29, 2002 to “substantiate any alleged financial losses anddetermine whether any suspension of implementing the...(Cleanup and AbatementOrder) is warranted.”  The Company hasreceived an extension to submit the required financial information to August19, 2002.  The Company submitted therequested financial information on August 16, 2002.  As of the date of the financial statements, no response has beenreceived.  The Company may be liable forall or part of the costs of remediating the contamination on its property andcould be subject to enforcement action by the RWQCB, including injunctive andcivil monetary remedies.  As of the dateof the financial statements, the Company’s share of the costs have not been determined.

 

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

 

9

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The tenants ofnearby properties upgradient have sued the Company alleging that hazardousmaterials from the Company’s property caused contamination on the propertiesleased by the tenants.  The case name isDel Ray Industrial Enterprises, Inc. v. Robert Malone, et al.,Los Angeles County Superior Court, Northwest District, commenced August 21,1991.  In this action, the plaintiffalleges environmental contamination by defendants of its property, and seeks acourt order 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’sSouth El Monte manufacturing facility is also located over a large area ofpossibly contaminated regional groundwater which is part of the San GabrielValley Superfund Site.  The Company hasbeen notified that it is a potentially responsible party  (“PRP”) for the contamination.   In 1995,the Company was informed that the EPA estimated the cleanup costs for the SouthEl Monte’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 site costs,and are responsible for negotiating among themselves the allocation of the costsbased on, among other things, the outcome of environmental investigation.

 

In August 1995,the Company was informed that the EPA entered into an Administrative Order ofConsent with Cardinal Industrial Finishes (“Cardinal”) for a PRP lead remedialinvestigation and feasibility study (the “Study”) which, the EPA states, willboth characterize the extent of groundwater contamination in South El Monte andanalyze alternatives to control the spread of contamination.  The Company and others entered into theSouth El Monte Operable Unit Site Participation Agreement with Cardinalpursuant to which, among other things, Cardinal contracted with anenvironmental firm to conduct the Study. The Study has been completed. The Company’s share of the cost of the Study was $15,000 and was accruedfor in the financial statements as of September 30, 1995.  The South El Monte Operable Unit (SEMOU)participants developed four remedial alternatives.  The capital cost of the four alternatives range from $0 (noaction) up to $3.49 million.  Theestimated annual operating cost for the four alternatives range from $0 (noaction) to $770,300.  Over a 30-yearperiod, the total cost of the four alternatives range from $0 (no action) up to$13.05 million.  The EPA prefers analternative which estimates the capital cost up to $3.08 million, the annualoperating cost at $.48 million, and the 30-year period total cost up toapproximately $9.09 million.  Theselection of the actual alternative implemented is subject to publiccomment.  At the present time, theCompany does not know what its share of the cost may be, if any.  Therefore, no additional accrual has beenrecognized as a liability on the Company’s books.  The Company requested that the EPA conduct an “ability-to-payevaluation” to determine whether the Company is entitled to an early settlementof this matter based upon a limited ability to pay costs associated with siteinvestigation and remediation.  InAugust 2000, the EPA informed the Company that it does not qualify for an earlysettlement at this time.

 

The EPA hasinformed the Company that it has learned that the intermediate zone groundwatercontamination in the western portion of the SEMOU has migrated further west andhas now impacted the City of Monterey Park and Southern California WaterCompany production wells.  The EPAstated that the City of Monterey Park Water Department, San Gabriel ValleyWater Company and Southern California Water Company are planning to buildtreatment facilities for their wells. The EPA stated that these three water purveyors contacted some of theSEMOU PRPs, other than the Company, to seek funding to develop groundwatertreatment facilities for the contaminated wells.  A group of these PRPs calling themselves the “South El MonteCooperative Group” has been formed and purportedly has reached a generalagreement with the water purveyors to fund the development of treatmentfacilities and use the water purveyors’ wells in an attempt to contain thegroundwater contamination to 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.

 

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By letter datedNovember 13, 2000, the Company was notified that the City of Monterey Park, SanGabriel Valley Water Company and Southern California Water Company intend tobring suit under the Safe Drinking Water and Toxic Enforcement Act of 1986alleging that the Company has knowingly released volatile organic compounds inthe soil and shallow groundwater beneath the Company’s property between atleast on or before November 8, 1996 and the present and has failed to promptlyclean up all of the contamination.  Asof the date of this report, the Company has not been served with this lawsuit.

 

The City of SouthEl Monte, the city in which the Company has its manufacturing facility, islocated in the San Gabriel Valley.  TheSan Gabriel Valley has been declared a Superfund site.  The 1995 Water Quality Control Plan issuedby the California Regional Water Quality Control Board states that the primarygroundwater basin pollutants in the San Gabriel Valley are volatile organiccompounds from industry, nitrates from subsurface sewage disposal  and 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 believesthe City of South El Monte does not appear to be located over any of the majorplumes.  However, the EPA has announcedit is studying the possibility that, although the vadose soil and groundwater,while presenting cleanup problems, there may be a contamination by DNAPs (densenon-aqueous phase liquids), i.e., “sinkers”, usually chlorinated 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 andother property owners engaged Geomatrix Consultants, Inc., to do a survey ofvadose soil and shallow groundwater in the “hot spots” detected in the previousstudies.  Geomatrix issued a reportdated December 1, 1997 (the “Report”), on the impact of volatile organiccompounds on the soil and groundwater at the Lidcombe and Santa Anita Avenuesite located in South El Monte, California (which includes the Company’sfacilities).  The Report indicatedgenerally low concentrations of tetrachloroethene, trichloaethene andtrichloroethane in the groundwater of the upgradient neighbor.  The Report was submitted to the RWQCB forits comments and response.  A meetingwith the parties and RWQCB was held on February 10, 1998.  The RWQCB had advised companies that vadosesoil contamination is minimal and requires no further action.  However, there is an area of shallowgroundwater which has a higher than desired level of chlorinated solvents, andthe RWQCB requested a proposed work plan be submitted by Geomatrix.  Geomatrix has submitted a “FocusedFeasibility Study” which concludes that there are five possible methods forcleanup.  The most expensive are for apump and sewer remediation which would cost between $1,406,000 and $1,687,000.  The Company is actively exploring the lessexpensive alternative remediation methods, of which the two proposedalternatives 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 agroundwater remedial action plan by November 1, 1999, and that the RWQCB hasbeen advised that the Company and the other property owners were unable tosubmit the required remedial action plan because the Company and the otherproperty owners could not agree on the allocation of financial responsibilityto prepare the action plan.  The RWQCBstated that it will no longer encourage the cooperative approach among theCompany and the other property owners in completing the cleanup requirementsand will pursue appropriate measures, including when necessary, enforcementactions.  The RWQCB states that it mayimpose civil liability penalties of up to $1,000 per day from November 1, 1999for failure to file the action plan.  Inlight of these events, no assurances can be given that the cleanup costs andpossible penalties will not exceed the amount of the Company’s current accrualsof $287,000 (which includes the $122,000 charge to income in the third quarterof fiscal 1998).

 

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

 

The LSAAW ishopeful the Water Quality Authority (WQA) is willing and able to reauthorizeits grant for one-half (1/2) of the capital costs of its remediation systemconstruction not to exceed $150,000.  Itis estimated at this time that the reserves for the Company’s share of thiscost proposal are adequate since its prior accrual was based on the higher costestimate from Geomatrix.

 

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

 

The Company wasnotified by the EPA that the Company may have potential liability for wastematerial it disposed of at the Casmalia Disposal Site (“Site”) located on a 252acre parcel in Santa Barbara County, California.  The Site was operational from 1973 to 1989, and over 10,000 separateparties disposed of waste there.  TheEPA stated that federal, state and local governmental agencies along with thenumerous private entities that used the Site for waste disposal will beexpected to pay their share as part of this settlement.   The U.S. EPA is also pursuing theowner(s)/operator(s) of the Site to pay for Site remediation.  The EPA has a settlement offer to theCompany with respect to the Site for a cost of $373,950.  The Company accrued a $374,000 charge in thefirst quarter of fiscal 1999 with respect to this possible liability.  The Company has elected to file for relieffrom these obligations under the financial hardships option in the EPA’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 Company pay$113,000, as a result of their findings on the application for waiver due tofinancial hardship.  The Company isconsidering the EPA’s request.

 

The total amountof environmental investigation and cleanup costs that the Company may incurwith respect to the foregoing is not known at this time.  However, based upon information available tothe Company at this time, the Company has expensed since 1988 a total of$860,000, of which $89,000 were legal fees, exclusive of legal fees expended inconnection with the SEC environmental investigation.  The actual costs could differ materially from the amountsexpensed for environmental investigation and cleanup costs to date.

 

As of December 31,2002, no settlements have been reached. The total amount expensed in prior years relating to this environmentalissue is $860,000.  As of December 31,2002, no additional amounts have been expensed or accrued.  The Company has an accrued liability on thebooks at December 31, 2002 of $740,000 for the environmental cleanup.

 

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**Item 3.            Controls and Procedures**

 

In the ninety dayperiod before the filing of the report, the chief executive officer and chieffinancial officer of the Company (the “certifying officer”) evaluated theeffectiveness of the Company’s disclosure controls and procedures.  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.

 

No significantchanges in the Company’s internal controls or in other factors were detectedthat could significantly affect the Company’s internal controls subsequent tothe date when the internal controls were evaluated.

 

** **

**PART II - Other Information**

 
| **Item  1.** | **Legal Proceedings** |   |   |   |   |   |   |
|--------------|-----------------------|--------|--------|--------|--------|--------|--------|

 

The information set forth under Part I, Item 2,“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, 2002.
|         |                                                               |   |                                                                                                            |
|--------------|--------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|
| **Item  6.** | **Exhibits and Reports on Form 8-K:**                              |
|         |                                                               |   |                                                                                                            |   |   |   |   |
|         | The following exhibits  are filed herewith:                        |   |                                                                                                            |   |   |
|         |                                                               |   |                                                                                                            |   |   |   |   |
|         | 10.1                                                               | -      | Promissory note  evidencing advance made to the Registrant                                                      |
|         |                                                               |   |                                                                                                            |   |   |   |   |
|         | 10.2                                                               | -      | Promissory note  evidencing advance made to the Registrant                                                      |
|         |                                                               |   |                                                                                                            |   |   |   |   |   |
|         | 10.3                                                               | -      | Promissory note which  was amended (modified) in November 2002, 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)                                                             |   |   |
|              |                                                                    |        |                                                                                                                 |  |  |  |  |  |  |  |  |  |  |

 

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| (1)    | Filed as an Exhibit of  the same number with the Company’s Form S-1 Registration Statement filed with  the Securities and Exchange Commission on February 5, 1973, (Registrant No.  2-47005), and incorporated herein by reference. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                     |
| (2)    | Filed as Exhibits 3.4  and 3.5 with the Company’s Form 10-K Annual Report for the fiscal year ended  September 30, 1978, filed with the Securities and Exchange Commission and  incorporated herein by reference.                   |
|   |                                                                                                                                                                                                                                     |
| (3)    | Filed as an Exhibit of  the same number with the Company’s Form 10-K Annual Report for the fiscal  year ended September 30, 1979, filed with the Securities and Exchange  Commission and incorporated herein by reference.          |

 

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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 dulyauthorized.

 

 
|   |               | LEE  PHARMACEUTICALS                                                          |
|--------|--------------------|-------------------------------------------------------------------------------|
|   |               | (Registrant)                                                                  |
|   |               |                                                                          |
|   |               |                                                                          |
| Date:  | FEBRUARY  14, 2003 | /s/ RONALD G. LEE                                                             |
|   |               | Ronald G. Lee                                                                 |
|   |               | Chairman of the  Board, President and  Chief Financial and Accounting Officer |

 

**CERTIFICATIONS***

 

I,Ronald G. Lee, certify that:

 

1.I have reviewed this quarterly report on Form 10-QSB of Lee Pharmaceuticals;

 

2.Based on my knowledge, this quarterly report does not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statementswere made, not misleading with respect to the period covered by this quarterlyreport;

 

3.Based on my knowledge, the financial statements, and other financialinformation included in this quarterly report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this quarterly report;

 

4.The registrant’s other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and have:

 

a)designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls andprocedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

c)presented in this quarterly report our conclusions about the effectiveness ofthe disclosure controls and procedures based on our evaluation as of theEvaluation Date;

 

5.The registrant’s other certifying officers and I have disclosed, based on ourmost recent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a)all significant deficiencies in the design or operation of internal controlswhich could adversely affect the registrant’s ability to record, process,summarize and report financial data and have identified for the registrant’sauditors any material weaknesses in internal controls; and

 

b)any fraud, whether or not material, that involves management or other employeeswho have a significant role in the registrant’s internal controls; and

 

6.The registrant’s other certifying officers and I have indicated in thisquarterly report whether there were significant changes in internal controls orin other factors that could significantly affect internal controls subsequentto the date of our most recent evaluation, including any corrective actionswith regard to significant deficiencies and material weaknesses.

 

 
| Date:  | FEBRUARY  14, 2003 | /s/  RONALD G. LEE                                               |
|--------|--------------------|------------------------------------------------------------------|
|   |               | Ronald  G. Lee                                                   |
|   |               | President  (Chief Executive Officer and Chief Financial Officer) |

 

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* Provide a separate certification for each principal executive officerand principal financial officer of the registrant.  See Rules 13a-14 and 15d-14. The required certification must be in the exact form set forth above.

 

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** **

**WRITTENSTATEMENT**

**PURSUANTTO**

**18U.S.C. SECTION 1350**

 

The undersigned, RONALD G. LEE, the Chief ExecutiveOfficer/Chief Financial Officer, of LEE PHARMACEUTICALS (the “Company”),pursuant to 18 U.S.C. Section 1350, hereby certifies that:

 

(i)         the FORM 10-QSB of theCompany for the quarter ended December 31, 2002 (the “Report”) fully complieswith the requirements of section 13(a) or 15(d) of the Securities Exchange Actof 1934; and

 

(ii)      the information contained inthe Report fairly presents, in all material respects, the financial conditionand results of operations of the Company.

 

 
| Dated: | FEBRUARY 14, 2003 |              |   |
|--------|-------------------|-------------------|--------|
|   |              |
|   |              |
|   |              | /s/ RONALD G. LEE |   |
|   |              | Ronald G. Lee     |   |

 

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