**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 quarterlyperiod ended December 31, 2001**

 

**OR**

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

 

**For the transitionperiod from           to**

 

 

**Commission file number 1-7335**

 

**LEE PHARMACEUTICALS**

(Exactname of small business issuer as specified in its charter)

 
| **California**                                 |   | **95-2680312**                        |
|------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of incorporation |   | (I.R.S.  Employer Identification No.) |
| or  organization)                              |   |                                  |

 

**1444Santa Anita Avenue, South El Monte, California 91733**

(Address of principalexecutive offices)

(Zip Code)

 

**(626)442-3141**

(Registrant's telephonenumber, including area code)

 

**N/A**

(Former name, formeraddress and former fiscal year, if changed since last report)

 

Asof December 31, 2001 there were outstanding 4,135,162 shares of common stock ofthe registrant.

 

TransitionalSmall Business Disclosure Format (check one):

Yes   o   No  ý

 

 

**LEEPHARMACEUTICALS**

**BALANCESHEET**

**DECEMBER31, 2001**

**(Dollarsin thousands)**

**(Unaudited)**

 

 
| **Assets**                                                                              |   |    |       |       |       |
|-----------------------------------------------------------------------------------------|--------|---------|------------|------------|------------|
| Cash                                                                                    |   |    | ** ** | **$**      | **9**      | ** ** |
|                                                                                    |   |    | ** ** |       | ** ** |
| Accounts and notes  receivable (net of allowances: $234)                                |   |    | ** ** | **922**    | ** ** |
| Inventories (net of  reserves: $578)                                                    |   |    | ** ** |       | ** ** |
| Raw materials                                                                           |   | **$**   | **2,019**  | ** ** |       | ** ** |
| Work in process                                                                         |   | **194** | ** ** |       | ** ** |
| Finished goods                                                                          |   | **307** | ** ** |       | ** ** |
| Total inventories                                                                       |   |    | ** ** | **2,520**  | ** ** |
|                                                                                    |   |    | ** ** |       | ** ** |
| Other current assets                                                                    |   |    | ** ** | **304**    | ** ** |
| Total current assets                                                                    |   |    | ** ** | **3,755**  | ** ** |
|                                                                                    |   |    | ** ** |       | ** ** |
| Property, plant and  equipment (less accumulated depreciation and amortization: $5,218) |   |    |       | **567**    |       |
|                                                                                    |   |    | ** ** |       | ** ** |
| Intangibles and  other assets (net of accumulated amortization: $1,832)                 |   |    |       | **2,633**  |       |
|                                                                                    |   |    | ** ** |       | ** ** |
| TOTAL                                                                                   |   |    | ** ** | **$**      | **6,955**  | ** ** |
|                                                                                         |        |         |            |            |            |  |  |

 

 

Seenotes to financial statements.

 

**LEEPHARMACEUTICALS**

**BALANCESHEET**

**DECEMBER31, 2001**

**(Dollarsin thousands)**

**(Unaudited)**

 

 
| **LIABILITIES**                                                                                       |   |       | ** **        |
|-------------------------------------------------------------------------------------------------------|--------|------------|-------------------|
| Bank overdraft                                                                                        |   | **$**      | **110**           | ** ** |
| Notes payable - bank                                                                                  |   | **886**    | ** **        |
| Current portion -  notes payable, other                                                               |   | **912**    | ** **        |
| Current portion -  note payable related party                                                         |   | **700**    | ** **        |
| Accounts payable                                                                                      |   | **852**    | ** **        |
| Other accrued liabilities                                                                             |   | **401**    | ** **        |
| Environmental  cleanup liability                                                                      |   | **366**    | ** **        |
| Due to related  parties                                                                               |   | **880**    | ** **        |
| Deferred income                                                                                       |   | **108**    | ** **        |
|                                                                                                  |   |       | ** **        |
| Total current  liabilities                                                                            |   | **5,215**  | ** **        |
|                                                                                                  |   |       | ** **        |
| Long-term notes  payable - bank                                                                       |   | **445**    | ** **        |
|                                                                                                  |   |       | ** **        |
| Long-term notes  payable to related parties                                                           |   | **2,053**  | ** **        |
|                                                                                                  |   |       | ** **        |
| Long-term notes  payable, other                                                                       |   | **1,266**  | ** **        |
|                                                                                                  |   |       | ** **        |
| Deferred income                                                                                       |   | **169**    | ** **        |
|                                                                                                  |   |       | ** **        |
| Environmental  cleanup liability - Casmalia Site                                                      |   | **374**    | ** **        |
|                                                                                                  |   |       | ** **        |
| Total liabilities                                                                                     |   | **9,522**  | ** **        |
|                                                                                                  |   |       | **   ** |
| **COMMITMENTS AND CONTINGENCIES**                                                                     |   |       | ** **        |
|                                                                                                  |   |       | **   ** |
| **STOCKHOLDERS' (DEFICIT)**                                                                           |   |       | ** **        |
|                                                                                                  |   |       | ** **        |
| Common stock, $.10  par value; authorized, 7,500,00 shares; issued and outstanding, 4,135,162  shares |   | **413**    |              |
|                                                                                                  |   |       | ** **        |
| Additional paid-in  capital                                                                           |   | **4,222**  | ** **        |
|                                                                                                  |   |       | ** **        |
| Accumulated  (deficit)                                                                                |   | **(7,202** | **)**             |
|                                                                                                  |   |       | ** **        |
| Total stockholders'  (deficit)                                                                        |   | **(2,567** | **)**             |
|                                                                                                  |   |       | ** **        |
| TOTAL                                                                                                 |   | **$**      | **6,955**         | ** ** |

 

 

Seenotes to financial statements.

 

**LEEPHARMACEUTICALS**

**STATEMENTSOF OPERATIONS**

**(Dollarsin thousands, except per share amounts)**

** **

 
|                               |                      | **For  the Three Months  Ended December 31,** |           |
|------------------------------------|---------------------------|-----------------------------------------------|----------------|
|                               |                      | **2001**                                      |           | **2000** |   |
|                               |                      | **(unaudited)**                               |           | **(unaudited)** |   |
|                               |                      |                                          |           |   |   |
| Gross revenues                     |                      | **$**                                         | **2,434**      |   | $ | 2,163 |   |
| Less:                         | Sales  returns            |                                          | **(181**       | **)** | (99 | ) |
|                               | Cash discounts and others |                                          | **(21**        | **)** | (22 | ) |
|                               |                      |                                          |      |   |      |
| Net revenues                       |                      | **2,232**                                     |           | 2,042 |   |
|                               |                      |                                          |           |   |   |
| Costs and expenses:                |                      |                                          |           |   |   |
|                               |                      |                                          |           |   |   |
| Cost of sales                      |                      | **1,162**                                     |           | 1,002 |   |
| Selling and advertising expense    |                      | **608**                                       |           | 595 |   |
| General and administrative expense |                      | **296**                                       |           | 258 |   |
| Interest expense                   |                      | **182**                                       |           | 202 |   |
|                               |                      |                                          |      |   |      |
| Total costs and expenses           |                      | **2,248**                                     |           | 2,057 |   |
|                               |                      |                                          |      |   |      |
| (Loss) from operations             |                      | **(16**                                       | **)**          | (15 | ) |
|                               |                      |                                          |           |   |   |
| Other income                       |                      | **26**                                        |           | 24 |   |
|                               |                      |                                          |      |   |      |
| Net income                         |                      | **$**                                         | **10**         |   | $ | 9 |   |
|                               |                      |                                          |           |   |   |
| Per share:                         |                      |                                          |           |   |   |
|                               |                      |                                          |           |   |   |
| Basic and diluted income per share |                      | **$**                                         | **.00**        |   | $ | .00 |   |

 

 

Seenotes to financial statements.

 

**LEEPHARMACEUTICALS**

**STATEMENTSOF CASH FLOWS**

**(Dollarsin thousands)**

 

 
|                                                                               |   | **For  the Three Months  Ended December 31,** |       |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                                               |   | **2001**                                      |       | **2000** |   |
|                                                                               |   | **(unaudited)**                               |       | **(unaudited)** |   |
|                                                                               |   |                                          |       |   |   |
| Cash flows from operating activities:                                              |   |                                          |       |   |   |
| Net income                                                                         |   | **$**                                         | **10**     |   | $ | 9 |   |
| Adjustments to reconcile net income to  net cash provided by operating activities: |   |                                          |       |   |   |
| Depreciation                                                                       |   | **45**                                        |       | 43 |   |
| Amortization of intangibles                                                        |   | **106**                                       |       | 136 |   |
| (Decrease) in deferred income                                                      |   | **(28**                                       | **)**      | (11 | ) |
| (Gain) on disposal of property, plant,  and equipment                              |   | –                                        |       | (1 | ) |
| Change in operating assets and  liabilities:                                       |   |                                          |       |   |   |
| (Increase) decrease  in accounts receivable                                   |   | **(79**                                       | **)**      | 449 |   |
| (Decrease) in allowance for doubtful  accounts and sales returns and allowances    |   | **(94**                                       | **)**      | (75 | ) |
| (Increase) in inventories                                                          |   | **(111**                                      | **)**      | (138 | ) |
| Decrease (increase) in deposits                                                    |   | **113**                                       | ** ** | (8 | ) |
| (Increase) in other current assets                                                 |   | **(95**                                       | **)**      | (43 | ) |
| (Decrease) increase in accounts payable  and accrued liabilities                   |   | **(90**                                       | **)**      | 107 |   |
| Increase in due to related parties -  accrued interest                             |   | **26**                                        | ** ** | 37 |   |
| (Decrease) in accrued royalties                                                    |   | –                                        | ** ** | (9 | ) |
| Total adjustments                                                                  |   | **(207**                                      | **)**      | 487 |   |
| Net cash (used in) provided by  operating activities                               |   | **(197**                                      | **)**      | 496 |   |
|                                                                               |   |                                          |       |   |   |
| Cash flows from investing activities:                                              |   |                                          |       |   |   |
| Additions to property, plant, and  equipment                                       |   | **(51**                                       | **)**      | (33 | ) |
| Proceeds from sale of equipment                                                    |   | –                                        |       | 1 |   |
| Proceeds from sale of product brand                                                |   | **265**                                       |       | – |   |
| Acquisition of product brand                                                       |   | –                                        |       | (50 | ) |
| Increase in non-current deposit                                                    |   | –                                        |       | (11 | ) |
| Net cash provided by (used in)  investing activities                               |   | **214**                                       |       | (93 | ) |
|                                                                               |   |                                          |       |   |   |
| Cash flows from financing activities:                                              |   |                                          |       |   |   |
| Proceeds from notes payable to related  party                                      |   | –                                        |       | 39 |   |
| (Payments on) notes payable to related  party                                      |   | **(50**                                       | **)**      | (102 | ) |
| Decrease in due from related party                                                 |   | –                                        | ** ** | 25 |   |
| (Decrease) in notes payable                                                        |   | **(19**                                       | **)**      | (156 | ) |
| Proceeds from notes payable, other                                                 |   | **300**                                       | ** ** | 350 |   |
| Payments on notes payable, other                                                   |   | **(269**                                      | **)**      | (314 | ) |
| Increase (decrease) in bank overdraft                                              |   | **25**                                        | ** ** | (227 | ) |
| Net cash (used in) financing activities                                            |   | **(13**                                       | **)**      | (385 | ) |
|                                                                               |   |                                          |       |   |   |
| Net increase in cash                                                               |   | **4**                                         |       | 18 |   |
| Cash, beginning of year                                                            |   | **5**                                         |       | 12 |   |
|                                                                               |   |                                          |       |   |   |
| Cash, end of year                                                                  |   | **$**                                         | **9**      |   | $ | 30 |   |
|                                                                               |   |                                          |       |   |   |
| **Supplemental disclosures of cash flow information:**                             |   |                                          |       |   |   |
|                                                                               |   |                                          |       |   |   |
| Cash paid during the year for:                                                     |   |                                          |       |   |   |
| Interest                                                                           |   | **$**                                         | **158**    |   | $ | 135 |   |
| Taxes                                                                              |   | **$**                                         | **1**      |   | $ | – |   |

 

 

Seenotes to financial statements.

 

**Notesto Financial Information**

 

1.               Basisof presentation:

 

Thecondensed interim financial statements included herein have been prepared byLee Pharmaceuticals 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.

 

Thesestatements reflect all adjustments, consisting of normal recurring adjustmentswhich, in the 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, 2001.  The Company follows the same accountingpolicies in preparation of interim reports.

 

Resultsof operations for the interim periods may not be indicative of annual results.

 

TheCompany is involved in various matters involving environmental cleanupissues.  See "Item 2.Management's Discussion and Analysis or Plan of Operations" and Note 11 ofNotes to Financial Statements included in the Company's Form 10-KSB for thefiscal year ended September 30, 2001. The ultimate outcome of these matters cannot presently bedetermined.  Environmental expendituresthat relate to an existing condition caused by past operations, and which donot contribute to current or future revenue generation, are expensed.  The Company's proportionate share of theliabilities are recorded when environmental remediation and/or cleanups areprobable, and the costs can be reasonably estimated.

 

2.               Continuedexistence:

 

Theaccompanying financial statements have been prepared assuming that the Companywill continue as a going concern. Although the Company experienced nominal net income in fiscal years 2000and 2001, past recurring losses and inability to generate sufficient cash flowfrom normal operations to meet its obligations as they became due, raisessubstantial doubt about its ability to continue as a going concern.  The financial statements do not include anyadjustments to reflect the possible future effects on the recoverability andclassification of assets or the amounts and classification of liabilities thatmay result from the possible inability of the Company to continue as a goingconcern.

 

3.               Earningsper share:

 

TheCompany has a simple capital structure, and there were no changes under theSFAS 128 methodology to the previously reported earnings (loss) per shareamounts for any of the fiscal years. Basic earnings per share under SFAS 128 were computed using the weightedaverage number of shares outstanding of 5,265,162 in December 2001 and5,194,496 in December 2000.  Differencesin the weighted average number of shares outstanding for purposes of computingdiluted earnings per share were due to the inclusion of the dilutive effect of stockoptions previously granted.  These differencesin the weighted average number of shares outstanding for the calculation ofbasic and diluted earnings per share resulted in no differences in the earningsper share.

 

4.               Acquisitions:

 

OnOctober 30, 2000, the Company purchased certain assets of the Sloans® liniment temporary painrelief product from C.B. Fleet Co., Inc. for $50,000 plus approximately $600 ofinventory.  The Company remitted thefull $50,000 at closing.  The balance of$50,000 is for a five year covenant not to compete.

 

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

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

 

5.               Incometaxes:

 

Asof December 31, 2001, the Company had net operating loss (NOL) carryforwards ofapproximately $10,300,000 for Federal and $1,600,000 for California taxpurposes which can be used to offset future Federal and California incometaxes.  The differences in the statecarryforwards relate primarily to the treatment of loss carryforwards anddepreciation of property, plant and equipment. The Federal carryforwards expire from 2005 through 2020; Californiaexpires from 2001 through 2005.  TheCompany has provided an allowance for the entire amount of the deferred assetapplicable to the NOL.

 

6.               Otherincome:

 

Forthe three months ended December 31, 2001, the Company realized a gain ofapproximately $26,000 related to the sale of the Klutch® product line.  The realized gain pertains to theamortization of three consulting agreements arising from the sale of theKlutch® brand.  The other income for thethree months ended December 31, 2000, consisted of $11,000 for the finalamortization of the prior sale of two buildings, $11,000 for the sale of atrademark, as well as a gain from the sale of equipment.

 

**Item 2.**

 

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

 

**MaterialChanges in Results of Operations**

**ThreeMonths Ended December 31, 2001, and December 31, 2000**

 

Grossrevenues for the three months ended December 31, 2001, were $2,434,000, anincrease of approximately $271,000, or 13%, from the comparable three monthsended December 31, 2000.  The Companyreported increased volume in several products. The major increase in revenueswas attributed to the Lee® Lip-Ex®line of products ($274,000), plus the added sales of the newly acquired brands($64,000).  These increases werepartially offset by lower sales volume of existing brands such as Zip®,Take-Off®, Cope®,Astring-o-Sol®,as well as other over-the-counter (OTC) brands and prescription drugproducts.  In addition, with the sale ofthe Klutch product line during fiscal year 2001, there was a decline in salesof approximately $54,000 because there was no comparable volume during thethree months ended December 31, 2001.

 

Netrevenues increased approximately $190,000, or 9%, for the three months endedDecember 31, 2001, as compared to the three months ended December 31, 2000.  The change in net revenues was due to thesales volume explanations discussed above. The Company's sales returns increased approximately $82,000, or 83%,when comparing the three months ended December 31, 2001 and 2000.  The Company continued to experience thediscontinuance of a few of its SKU's (stock keeping units) at the retail storelevel.

 

Costof sales as a percentage of gross revenues was 48% for the three months endedDecember 31, 2001, compared to 46% for the three months ended December 31, 2000.  The increased cost of sales percentage wasdue to a change in the product mix and lower priced commodity-type goods withan accompanying higher cost of goods attached to them, thereby generating lowergross margins on sales of these related products.  In addition, the Company incurred higher raw material costs andincreased direct labor as a result of a rise in the minimum hourly wage ($6.25effective January 1, 2001 versus $5.75).

 

Sellingand advertising expenses increased $13,000, or 2%, when comparing the threemonths ended December 31, 2001 with the three months ended December 31,2000.  The increase in expenses were dueto the following factors: (1) higher commissions ($19,000) due to addedmanufacturers representatives covering territories that were previously open,(2) higher salesmen salaries & related fringe benefits due to the hiring ofa higher salaried salesman who replaced lower salaried sales personnel($14,000), and (3) increased convention/show expense ($7,000) as a result ofmore shows attended.  The aboveincreases were partially offset by lower amortization expenses ($29,000)because of the finalization of several write-off periods associated with priorproduct brand acquisitions.

Generaland administrative expenses increased $38,000, or 15%, when comparing the threemonths ended December 31, 2001, with the three months ended December 31,2000.  This increase was principally dueto: (1) data processing consulting services ($18,000) which was nonexistent infiscal 2000, and (2) increased printing material and supply costs($23,000).  The above increases werepartially offset by reduced building rental expenses ($6,000).  The rental income from a new tenant, subleasingone of the Company's facilities, offset the rental expense on the master lease.

 

Interestexpense decreased $20,000, or 10%, when comparing the three months endedDecember 31, 2001, with the three months ended December 31, 2000.  The decrease was due to lower average primeinterest rate (5.08 % vs. 9.5%) in reference to certain loans which are tied toprime.

 

**Liquidityand Capital Resources**

 

AtDecember 31, 2001, working capital was a negative $1,460,000 compared with anegative $1,750,000 as of September 30, 2001. The ratio of current assets to current liabilities was .7 to 1 atDecember 31, 2001, and September 30, 2001. The decrease in the Company's negative working capital was primarily dueto increases in accounts receivable and inventory, as well as decreases inaccounts payable and the current portion of notes payable - other (the loweringof current debt associated with acquisitions).

 

TheCompany has an accumulated deficit of $7,202,000.  Although the Company experienced nominal net income in fiscalyears 2000 and 2001, past recurring losses and inability to generate sufficientcash flow from normal operations to meet its obligations as they became due,raises substantial doubt about the Company's ability to continue as a goingconcern.  The Company's ability tocontinue in existence is dependent upon future developments, includingretaining current financing and achieving a level of profitable operationssufficient to enable it to meet its obligations as they become due.

 

**EnvironmentalMatters**

 

TheCompany owns a manufacturing facility located in South El Monte, California.  The California Regional Water QualityControl Board (The "RWQCB") ordered the Company in 1988 and 1989 toinvestigate the contamination on its property (relating to soil and groundwatercontamination).  The Company engaged aconsultant who performed tests and reported to the then Chairman of theCompany.  The Company resisted furtherwork on its property until the property upgradient was tested in greater detailsince two "apparent source" lots had not been tested.  On August 12, 1991, the RWQCB issued a"Cleanup and Abatement Order" directing the Company to conductfurther testing and cleanup the site. In October 1991, the Company received from an environmental consultingfirm an estimate of $465,200 for investigation and cleanup costs.  The Company believed that this estimatewas  inconclusive and overstated thecontamination levels.  The Companybelieves that subsequent investigations will support the Company’s conclusions  about that estimate.  The Company did not complete the testing forthe reasons listed above as well as "financial constraints".  In June 1992, the RWQCB requested that theEPA evaluate the contamination and take appropriate action.  At the EPA's request, Ecology &Environment, Inc. conducted an investigation of soil and groundwater on theCompany's property.  Ecology &Environment Inc.'s Final Site Assessment Report, which was submitted to the EPAin June 1994, did not rule out the possibility that some of the contaminationoriginated on-site, and resulted from either past or current operations on theproperty.  The Company may be liable forall or part of the costs of remediating the contamination on its property.  The EPA has not taken any further action inthis matter, but may do so in the future.

 

TheCompany and nearby property owners, in consort with their comprehensive generalliability (CGL) carriers, engaged a consultant to perform a site investigationwith respect to soil and shallow groundwater contamination over the entire cityblock.  The CGL carriers provided$290,000 in funding which paid for the $220,000 study, $20,000 in legal feesfor project oversight, and a $50,000 balance in the operating fund.  Earlier the Company had accrued $87,500 asits proportionate share of the earlier quote of $175,000. Since that time, theoverall scope of the project was increased to $205,000 plus $15,000 for wastewater disposal, bringing the total to the above listed $220,000.  The $87,500 accrual was not spent on thisproject (as the entire cost was borne by the CGL carriers), but remains on thebooks as an accrual against the cost of remediation of the same site that wasincluded in the study.

Thetenants of nearby properties upgradient have sued the Company alleging thathazardous materials from the Company's property caused contamination on theproperties leased by the tenants.  Thecase name is Del Ray Industrial Enterprises, Inc. v. Robert Malone,et al., Los Angeles County Superior Court, Northwest District, commencedAugust 21, 1991.  In this action, theplaintiff alleges environmental contamination by defendants of its property,and seeks a court order preventing further contamination and monetarydamages.  The Company does not believethere is any basis for the allegations and is vigorously defending the lawsuit.

 

TheCompany's South El Monte manufacturing facility is also located over a largearea of possibly contaminated regional groundwater which is part of the SanGabriel Valley Superfund Site.  TheCompany has been notified that it is a potentially responsible party  ("PRP")  for the contamination.  In 1995, the Company was informed that the EPA estimated the cleanupcosts for the South El Monte’s portion of the San Gabriel Valley Superfund Siteto be $30 million.  The Company’spotential share of such amount has not been determined.  Superfund PRPs are jointly and severallyliable for superfund site costs, and are responsible for negotiating amongthemselves the allocation of the costs based on, among other things, theoutcome of environmental investigation.

 

InAugust 1995, the Company was informed that the EPA entered into anAdministrative Order of Consent with Cardinal Industrial Finishes("Cardinal") for a PRP lead remedial investigation and feasibilitystudy (the "Study") which, the EPA states, will both characterize theextent of groundwater contamination in South El Monte and analyze alternativesto control the spread of contamination. The Company and others entered into the South El Monte Operable UnitSite Participation Agreement with Cardinal pursuant to which, among otherthings, Cardinal contracted with an environmental firm to conduct theStudy.  The Study has beencompleted.  The Company's share of thecost of the Study was $15,000 and was accrued for in the financial statementsas of September 30, 1995.  The South ElMonte Operable Unit (SEMOU) participants developed four remedialalternatives.  The capital cost of thefour alternatives range from $0 (no action) up to $3.49 million.  The estimated annual operating cost for thefour alternatives range from $0 (no action) to $770,300.  Over a 30-year period, the total cost of thefour alternatives range from $0 (no action) up to $13.05 million.  The EPA prefers an alternative which estimatesthe capital cost up to $3.08 million, the annual operating cost at $.48 million,and the 30-year period total cost up to approximately $9.09 million.  The selection of the actual alternativeimplemented is subject to public comment. At the present time, the Company does not know what its share of thecost may be, if any.  Therefore, noadditional accrual has been recognized as a liability on the Company'sbooks.  The Company requested that theEPA conduct an "ability-to-pay evaluation" to determine whether theCompany is entitled to an early settlement of this matter based upon a limitedability to pay costs associated with site investigation and remediation.  In August 2000, the EPA informed the Companythat it does not qualify for an early settlement at this time.

 

TheEPA has informed the Company that it has learned that the intermediate zonegroundwater contamination in the western portion of the SEMOU has migratedfurther west and has now impacted the City of Monterey Park and SouthernCalifornia Water Company production wells. The EPA stated that the City of Monterey Park Water Department, SanGabriel Valley Water Company and Southern California Water Company are planningto build treatment 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.

 

Byletter dated November 13, 2000, the Company was notified that the City ofMonterey Park, San Gabriel Valley Water Company and Southern California WaterCompany intend to bring suit under the Safe Drinking Water and ToxicEnforcement Act of 1986 alleging that the Company has knowingly releasedvolatile organic compounds in the soil and shallow groundwater beneath theCompany'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.

TheCity of South El Monte, the city in which the Company has its manufacturingfacility, is located in the San Gabriel Valley.  The San 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 pastagricultural activities.  In addition,the Plan noted that hundreds of underground storage tanks leaking gasoline andother toxic chemicals have existed in the San Gabriel Valley.  The California Department of Toxic SubstanceControl has declared large areas of the San Gabriel Valley to beenvironmentally hazardous and subject to cleanup work.

 

TheCompany believes the City of South El Monte does not appear to be located overany of the major plumes.  However, theEPA has announced it is studying the possibility that, although the vadose soiland groundwater, while presenting cleanup problems, there may be acontamination by DNAPs (dense non-aqueous phase liquids), i.e.,"sinkers", usually chlorinated organic cleaning solvents.  The EPA has proposed to drill six "deepwells" throughout the City of South El Monte at an estimated cost of$1,400,000.  The EPA is conferring withSEMPOA (South El Monte Property Owners Association) as to cost sharing on this project.  SEMPOA has obtained much lower preliminarycost estimates.  The outcome cost andexact scope of this are unclear at this time.

 

TheCompany and other property owners engaged Geomatrix Consultants, Inc., to do asurvey of vadose soil and shallow groundwater in the "hot spots"detected in the previous studies. Geomatrix issued a report dated December 1, 1997 (the “Report”), on theimpact of volatile organic compounds on the soil and groundwater at theLidcombe and Santa Anita Avenue site located in South El Monte, California(which includes the Company’s facilities). The Report indicated generally low concentrations of tetrachloroethene,trichloaethene and trichloroethane in the groundwater of the upgradientneighbor.  The Report was submitted tothe RWQCB for its comments and response. A meeting with the parties and RWQCB was held on February 10, 1998.  The RWQCB had advised companies that vadosesoil contamination is minimal and requires no further action.  However, there is an area of shallowgroundwater which has a higher than desired level of chlorinated solvents, andthe RWQCB requested a proposed work plan be submitted by Geomatrix.  Geomatrix has submitted a "FocusedFeasibility Study" which concludes that there are five possible methodsfor cleanup.  The most expensive are fora 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 $122,000 liability.  Accordingly, the Company recorded anadditional accrual of $122,000 in the third quarter of fiscal 1998.  The $122,000 accrual is in addition to the$79,000 accrual for the Monterey Site as will be explained in the followingparagraph.  The $79,000 accrual, in thethird quarter of fiscal 1998, related to the Monterey Site is not included inthe $287,000 figure above.  In April2000, the Company received a Notice of Violation from the RWQCB.  The Notice of Violation states that theCompany and other property owners were required to submit a groundwaterremedial action plan by November 1, 1999, and that the RWQCB has been advisedthat the Company and the other property owners were unable to submit therequired remedial action plan because the Company and the other property ownerscould not agree on the allocation of financial responsibility to prepare theaction plan.  The RWQCB stated that itwill no longer encourage the cooperative approach among the Company and theother property owners in completing the cleanup requirements and will pursueappropriate measures, 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 offiscal 1998).

 

InJuly 2000, the property owners formed the Lidcombe & Santa Anita AvenueWork Group (LSAAW) in response to the RWQCB request for the preparation of anaction plan.  The LSAAW submitted aFocused Feasibility Study to the RWQCB for their review and approval of theselected remedial action method for the site. After receiving RWQCB approval, LSAAW obtained three cost proposals toimplement the RWQCB approved pump and treat remedial method.  According to these cost proposals, thelowest estimated costs for an assumed five (5) years of pump and treatremediation is $600,000.  This cost islower than the previous cost proposed work plan, discussed above, fromGeomatrix  Consultants,  Inc. The  capital  costs including  contingencies are approximately $300,000.

TheLSAAW is hopeful the Water Quality Authority (WQA) is willing and able toreauthorize its grant for one-half (1/2) of the capital costs of itsremediation 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.

 

Withoutany prior correspondence or inkling of the Company's potential liability, theEPA informed the Company that the Company may have potential liability for theongoing remediation of Operating Industries, Inc. (as they have gone out ofbusiness) Landfill Superfund Site in Monterey Park, California (the"Monterey Site").  TheMonterey Site is a 190 acre landfill that operated from 1948 to 1984, in whichthe Company disposed of non toxic pH balanced waste water on six occasionsbetween 1974 and 1978.  Over 4,000companies have been identified as having contributed waste to the MontereySite.  The EPA has offered to settle theCompany's potential liability with respect to the Monterey Site for a cost tothe Company of $79,233.  The Companyaccrued a $79,000 charge in the third quarter of fiscal 1998 with respect tothis possible liability.  The Companyhas elected to file for relief from these obligations under the financialhardship option in the EPA's response form. On June 30, 2000, the EPA informed the Company that the EPA believed theCompany is able to pay the full settlement cost, but offered to reduce theamount of the settlement to $75,271.

 

TheCompany was notified by the EPA that the Company may have potential liabilityfor waste material it disposed of at the Casmalia Disposal 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." Improvements in the bidding process has lowered the Company's estimatedshare down to $245,000 (from $374,000) and of that, the EPA was requesting thatthe Company pay $113,000, as a result of their findings on the application forwaiver due to financial hardship.  TheCompany is considering the EPA's request.

 

Thetotal amount of environmental investigation and cleanup costs that the Companymay incur with 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.

 

Asof December 31, 2001, no additional amounts have been incurred and nosettlements have been reached.

 

** **

**PARTII - Other Information**

 

Item1.            Legal Proceedings

 

Theinformation set forth under Part I, Item 2, "Management's Discussion andAnalysis or Plan of Operations - Environmental Matters" is incorporatedherein by reference.  See also"Legal Proceedings" in the Company's Form 10-KSB for the fiscal yearended September 30, 2001.

 

Item6.    The following exhibits are filedherewith:

 

10.1  -     Promissorynote evidencing advance made to the Registrant

 

 

Thefollowing exhibits have previously been filed by the Company:

 

3.1   -       Articlesof Incorporation, as amended (1)

 

3.4   -       By-laws,as amended December 20, 1997 (2)

 

3.5   -       Amendmentof By-laws effective March 14, 1978 (2)

 

3.6   -       Amendmentto By-laws effective November 1, 1980 (3)

 

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

 

(2)          Filedas Exhibits 3.4 and 3.5 with the Company's Form 10-K Annual Report for thefiscal year ended September 30,1978, filed with the Securities and Exchange Commission and incorporated hereinby reference.

 

(3)          Filedas an Exhibit of the same number with the Company's Form 10-K Annual Report   for the fiscal year endedSeptember 30, 1979, filed with the Securities and Exchange Commission andincorporated herein by reference.

 

 

**SIGNATURES**

 

Inaccordance with the requirements of the Securities Exchange Acts of 1934, theregistrant has caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
|   |               |   |   |   | LEE  PHARMACEUTICALS                    |
|--------|--------------------|--------|--------|--------|-----------------------------------------|
|   |               |   |   |   | (Registrant)                            |
|   |               |   |   |   |                                    |
|   |               |   |   |   |                                    |
|   |               |   |   |   |                                    |
| Date:  | FEBRUARY  12, 2002 |   |   |   | RONALD  G. LEE                          |
|   |               |   |   |   | Ronald  G. Lee                          |
|   |               |   |   |   | Chairman  of the Board, President and   |
|   |               |   |   |   | Chief  Financial and Accounting Officer |