**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**FORM10-QSB**

 

ý                                  **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period ended****                                                                                                                                                    March31, 2005**

 

**OR**

 

o                                  **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For thetransition period from                                                 to                                                 **

 

**Commission file number****                                                                                                                                                                                  1- 7335**

 

**LEE PHARMACEUTICALS**

(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 91733**                      |
| (Address of  principal executive offices)                                           |
|                                                                                |
| **(626)  442 - 3141**                                                               |
| (Issuer’s  telephone number)                                                   |
|                                                                                |
| **N/A**                                                                             |
| (Former name,  former address and former fiscal year, if changed since last report) |

 

As of March 31, 2005there were outstanding 4,135,162 shares of common stock of the registrant.

 

Transitional SmallBusiness Disclosure Format (check one):

Yes    o    No    ý    

 

 

----

 

**LEE PHARMACEUTICALS**

**BALANCE SHEET**

**MARCH 31, 2005**

**(Dollars in thousands)**

**(Unaudited)**

 
| **ASSETS**                                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Cash                                                                                           | ** ** | ** ** | ** ** | **$**      | **97**     | ** ** |
|                                                                                           |       |       |       |       |       |
| Accounts and  notes receivable (net of allowances: $204)                                       | ** ** | ** ** | ** ** | **921**    | ** ** |
|                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Inventories (net  of reserves: $841)                                                           |       |       |       |       |       |
| Raw materials                                                                                  | ** ** | **$**      | **1,458**  | ** ** | ** ** | ** ** |
| Work in process                                                                                | ** ** | **53**     | ** ** | ** ** | ** ** |
| Finished goods                                                                                 | ** ** | **484**    | ** ** | ** ** | ** ** |
| Total  inventories                                                                             | ** ** | ** ** | ** ** | **1,995**  | ** ** |
|                                                                                           |       |       |       |       |       |
| Other current  assets                                                                          | ** ** | ** ** | ** ** | **509**    | ** ** |
| Total current  assets                                                                          | ** ** | ** ** | ** ** | **3,522**  | ** ** |
|                                                                                           |       |       |       |       |       |
| Property, plant  and equipment (less accumulated depreciation and amortization: $5,741)        | ** ** | ** ** | ** ** | **804**    | ** ** |
|                                                                                           |       |       |       |       |       |
| Intangibles and  other assets (net of accumulated amortization: $1,476 and impairment: $2,202) | ** ** | ** ** | ** ** | **1,518**  | ** ** |
|                                                                                           |       |       |       |       |       |
| **TOTAL**                                                                                      | ** ** | ** ** | ** ** | **$**      | **5,844**  | ** ** |
|                                                                                                |            |            |            |            |            |  |  |

 

See Accompanying Notes toFinancial Statements.

 

2

----

 

**LEE PHARMACEUTICALS**

**BALANCE SHEET**

**MARCH 31, 2005**

**(Dollars in thousands)**

**(Unaudited)**

 
| **LIABILITIES**                                                                                       | ** ** | ** **  | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------|------------|
|                                                                                                  |       |        |       |
| Notes payable -  finance company                                                                      | ** ** | **$**       | **928**    | ** ** |
| Current portion  - notes payable, other                                                               | ** ** | **3,272**   | ** ** |
| Current portion  - note payable related party                                                         | ** ** | **1,404**   | ** ** |
| Accounts payable  - trade                                                                             | ** ** | **1,049**   | ** ** |
| Accounts payable - other                                                                              | ** ** | **335**     | ** ** |
| Accrued  liabilities                                                                                  | ** ** | **593**     | ** ** |
| Environmental  cleanup liability                                                                      | ** ** | **366**     | ** ** |
| Due to related parties                                                                                | ** ** | **1,571**   | ** ** |
| Deferred income                                                                                       | ** ** | **149**     | ** ** |
|                                                                                                  |       |        |       |
| Total current  liabilities                                                                            | ** ** | **9,667**   | ** ** |
|                                                                                                  |       |        |       |
| Long-term notes  payable to related parties                                                           | ** ** | **1,405**   | ** ** |
| Long-term notes  payable, other                                                                       | ** ** | **175**     | ** ** |
| Environmental  cleanup liability - Casmalia Site                                                      | ** ** | **374**     | ** ** |
| Deferred income                                                                                       | ** ** | **63**      | ** ** |
|                                                                                                  |       |        |       |
| Total long-term  liabilities                                                                          | ** ** | **2,017**   | ** ** |
|                                                                                                  |       |        |       |
| Total  liabilities                                                                                    | ** ** | **11,684**  | ** ** |
|                                                                                                  |       |        |       |
| **COMMITMENTS  AND CONTINGENCIES**                                                                    |       |        |       |
|                                                                                                  |       |        |       |
| **STOCKHOLDERS’  (DEFICIT)**                                                                     |       |        |       |
|                                                                                                  |       |        |       |
| Common stock,  $.10 par value; authorized, 7,500,00 shares; issued and outstanding, 4,135,162  shares | ** ** | **413**     | ** ** |
|                                                                                                  |       |        |       |
| Additional  paid-in capital                                                                           | ** ** | **4,222**   | ** ** |
|                                                                                                  |       |        |       |
| Accumulated  (deficit)                                                                                | ** ** | **(10,475** | **)**      |
|                                                                                                  |       |        |       |
| Total  stockholders’ (deficit)                                                                   | ** ** | **(5,840**  | **)**      |
|                                                                                                  |       |        |       |
| **TOTAL**                                                                                             | ** ** | **$**       | **5,844**  | ** ** |

 

See Accompanying Notes toFinancial Statements.

 

3

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**LEEPHARMACEUTICALS**

**STATEMENTS OFOPERATIONS**

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

**(Unaudited)**

 
| ** **                          | ** **                | **For the Three Months  Ended March 31,** |       | **For the Six Months  Ended March 31,** | ** ** |
|-------------------------------------|---------------------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** **                | **2005**                                  | ** ** | **2004**                                |       | **2005** | ** ** | **2004** |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Gross revenue                       | ** **                | **$**                                     | **2,462**  | ** **                              | $          | 2,547 |   | **$** | **4,801** | ** ** | $ | 5,373 |   |
| Other revenue                       | ** **                | **61**                                    | ** ** | 62                                      |       | **127** | ** ** | 148 |   |
| Less:                               | Sales returns             |                                      | **(140**   | **)**                                   | (407       | ) | **(274** | **)** | (729 | ) |
|                                | Cash discounts and others | ** **                                | **(26**    | **)**                                   | (28        | ) | **(52** | **)** | (59 | ) |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Net revenues                        | ** **                | **2,357**                                 | ** ** | 2,174                                   |       | **4,602** | ** ** | 4,733 |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Costs and  expenses:                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Cost of sales                       | ** **                | **1,334**                                 | ** ** | 1,430                                   |       | **3,068** | ** ** | 2,783 |   |
| Selling and  advertising expense    | ** **                | **762**                                   | ** ** | 619                                     |       | **1,485** | ** ** | 1,360 |   |
| General and  administrative expense | ** **                | **262**                                   | ** ** | 306                                     |       | **521** | ** ** | 638 |   |
| Intangible  impairment expense      |                      | —                                    | ** ** | 129                                     |       | **100** | ** ** | 129 |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Total costs and  expenses           | ** **                | **2,358**                                 | ** ** | 2,484                                   |       | **5,174** | ** ** | 4,910 |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Loss from  operations               | ** **                | **(1**                                    | **)**      | (310                                    | )          | **(572** | **)** | (177 | ) |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Other income  (expense):            |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Interest expense                    | ** **                | **(151**                                  | **)**      | (237                                    | )          | **(300** | **)** | (428 | ) |
| Gain on sale of  product line       |                      | —                                    | ** ** | —                                  |       | **750** | ** ** | **—** |   |
| Miscellaneous                       | ** **                | **48**                                    | ** ** | 69                                      |       | **103** | ** ** | 139 |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Total other  income (expense)       | ** **                | **(103**                                  | **)**      | (168                                    | )          | **553** | ** ** | (289 | ) |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Net (loss)                          | ** **                | **$**                                     | **(104**   | **)**                                   | $          | (478 | ) | **$** | **(19** | **)** | $ | (466 | ) |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Per share:                          |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
|                                |                      |                                      | ** ** |                                    |       |   | ** ** |   |   |
| Basic and  diluted (loss) per share | ** **                | **$**                                     | **(.02**   | **)**                                   | $          | (.11 | ) | **$** | **.00** | ** ** | $ | (.11 | ) |

 

See Accompanying Notes toFinancial Statements.

 

4

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**LEEPHARMACEUTICALS**

**STATEMENTSOF CASH FLOWS**

**(Dollarsin thousands)**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **For the Six Months  Ended March 31,** |       |
|------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                | ** ** | **2004** |   |
|                                                                               |       |                                    | ** ** |   |   |
| Cash flows (used  in) provided by operating activities:                            |       |                                    | ** ** |   |   |
| Net (loss)                                                                         | ** ** | **$**                                   | **(19**    | **)** | $ | (466 | ) |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                    | ** ** |   |   |
| Depreciation                                                                       | ** ** | **114**                                 | ** ** | 98 |   |
| Amortization of  intangibles                                                       | ** ** | **204**                                 | ** ** | 233 |   |
| (Decrease) in  deferred income                                                     | ** ** | **(97**                                 | **)**      | (282 | ) |
| Gain on sale of  product line                                                      | ** ** | **(750**                                | **)**      | — |   |
| Gain on sale of  equipment                                                         | ** ** | **(5**                                  | **)**      | — |   |
| Change in  operating assets and liabilities:                                       |       |                                    | ** ** |   |   |
| Decrease  (increase) in accounts receivable, net                                   | ** ** | **91**                                  | ** ** | (130 | ) |
| Decrease in  inventories                                                           | ** ** | **184**                                 | ** ** | 126 |   |
| (Increase) in  deposits                                                            | ** ** | **(50**                                 | **)**      | (46 | ) |
| Decrease  (increase) in other current assets                                       | ** ** | **69**                                  | ** ** | (80 | ) |
| (Decrease)  increase in accounts payable and accrued liabilities                   | ** ** | **(55**                                 | **)**      | 512 |   |
| Increase  (decrease) in due to related parties                                     | ** ** | **152**                                 | ** ** | (133 | ) |
| Net cash (used  in) operating activities                                           | ** ** | **(162**                                | **)**      | (168 | ) |
|                                                                               |       |                                    | ** ** |   |   |
| Cash flows from  investing activities:                                             |       |                                    | ** ** |   |   |
| Additions to  property, plant and equipment                                        | ** ** | **(92**                                 | **)**      | (101 | ) |
| Gain on sale of  product line                                                      | ** ** | **750**                                 | ** ** | — |   |
| Gain on sale of  equipment                                                         | ** ** | **5**                                   | ** ** | — |   |
| Net cash  provided by (used in) investing activities                               | ** ** | **663**                                 | ** ** | (101 | ) |
|                                                                               |       |                                    | ** ** |   |   |
| Cash flows from  financing activities:                                             |       |                                    | ** ** |   |   |
| Proceeds from  (payments on) notes payable to related party                        | ** ** | **13**                                  | ** ** | (62 | ) |
| (Decrease)  increase in notes payable, finance company                             | ** ** | **(298**                                | **)**      | 129 |   |
| Proceeds from  notes payable, other                                                |       | —                                  | ** ** | 350 |   |
| (Payments on)  notes payable, other                                                | ** ** | **(134**                                | **)**      | (60 | ) |
| (Decrease) in  bank overdraft                                                      | ** ** | **(13**                                 | **)**      | (100 | ) |
| Net cash (used  in) provided by financing activities                               | ** ** | **(432**                                | **)**      | 257 |   |
|                                                                               |       |                                    | ** ** |   |   |
| Net increase  (decrease) in cash                                                   | ** ** | **69**                                  | ** ** | (12 | ) |
| Cash, beginning  of period                                                         | ** ** | **28**                                  | ** ** | 16 |   |
| Cash, end of  period                                                               | ** ** | **$**                                   | **97**     | ** ** | $ | 4 |   |
|                                                                               |       |                                    | ** ** |   |   |
| **Supplemental  disclosures of cash flow information:**                            |       |                                    | ** ** |   |   |
|                                                                               |       |                                    | ** ** |   |   |
| Cash paid during  the year for:                                                    |       |                                    | ** ** |   |   |
| Interest                                                                           | ** ** | **$**                                   | **212**    | ** ** | $ | 106 |   |
| Taxes                                                                              | ** ** | **$**                                   | **1**      | ** ** | $ | 1 |   |

 

See Accompanying Notes toFinancial Statements.

 

5

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LEEPHARMACEUTICALS

 

**Notes to Financial Statements**

**(Unaudited)**

 

1.               Basis of presentation:

 

The condensed interimfinancial statements included herein have been prepared by Lee Pharmaceuticalswithout audit, pursuant to the rules and regulations of the Securities andExchange Commission.  Certain informationand footnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations, although the Company believesthat the disclosures are adequate to make the information presented notmisleading.

 

These statements reflectall adjustments, consisting of normal recurring adjustments (except as setforth in Note 5) which, in the opinion of management, are necessary for fairpresentation of the information contained herein.  It is suggested that these condensedfinancial statements be read in conjunction with the financial statements andnotes thereto included in the Company’s Annual Report on Form 10-KSB for theyear ended September 30, 2004.  TheCompany follows the same accounting policies in preparation of interim reports.

 

Results of operations forthe interim periods may not be indicative of annual results.

 

The Company is involvedin various matters involving environmental cleanup issues.  See “Item 2. Management’s Discussionand Analysis or Plan of Operations” and Note 13 of Notes to FinancialStatements included in the Company’s Form 10-KSB for the fiscal year endedSeptember 30, 2004.  The ultimate outcomeof 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 theliabilities are recorded when environmental remediation and/or cleanups areprobable, and the costs can be reasonably estimated.  As of March 31, 2005, no settlements havebeen reached.

 

Shipping and handlingexpenses are included in selling expenses. Shipping expenses for the three and six months are set forth below:

 
| ** **                 | ** ** | **For the Three Months  Ended March 31,** | ** **  | **For the Six Months  Ended March 31,** | ** ** |
|----------------------------|------------|-------------------------------------------|-------------|-----------------------------------------|------------|
| ** **                 | ** ** | **2005**                                  | ** **  | **2004**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|                       |       |                                      |        |                                    |       |   |   |   |   |
| Labor and fringe  benefits | ** ** | **$**                                     | **23,000**  |                                    | $          | 23,000 | ** ** | **$** | **39,000** |   | $ | 43,000 |   |
| Freight                    | ** ** | **148,000**                               |        | 110,000                                 | ** ** | **253,000** |   | 219,000 |   |
| Building rental            | ** ** | **17,000**                                |        | 30,000                                  | ** ** | **47,000** |   | 60,000 |   |
| Utilities and  supplies    | ** ** | **1,000**                                 |        | 8,000                                   | ** ** | **6,000** |   | 9,000 |   |
|                       |       |                                      |        |                                    |       |   |   |   |   |
| Totals                     | ** ** | **$**                                     | **189,000** |                                    | $          | 171,000 | ** ** | **$** | **345,000** |   | $ | 331,000 |   |
|                            |            |                                           |             |                                         |            |  |  |  |  |  |  |  |  |  |  |

 

There are only twopatents that currently offer the Company protection.  The following table sets forth informationregarding the two patents:

 
| **Name**                                | ** ** | **Patent Number** | ** ** | **Duration**       | ** ** |
|-----------------------------------------|------------|-------------------|------------|--------------------|------------|
|                                    |       |              |       |               |       |
| Dental  Restoration System & Method |       | US 5,695,340      |       | 17 years from 1997 |       |
| Sculptured Nails                        |       | US 5,127,414      |       | 17 years from 1992 |       |

 

6

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The Company’s marketingefforts have, in more recent years, been primarily directed at health andbeauty aids, which depend more on manufacturing capabilities and marketingskills than patent protection.  Hence,the Company has not filed applications in recent years.

 

The Company has a serviceagreement with Monticello Drug Company (MDC). Under this agreement, the Company provides the warehousing, shipping,billing and collection for several MDC owned and supplied products.  Weekly, the net sales of these products minuscertain agreed upon fees are calculated, and the proceeds are remitted to MDCsix weeks later.  MDC is responsible forall sales, returns, advertising and possible liability claims for these products.

 

The shipments and returnsof MDC are compiled on a weekly basis. From that net figure, a set percentage of gross sales for cashdiscounts, freight and the Company’s fees are deducted, and the balance due MDCis recorded as a payable.  It is paid sixweeks later.  At the end of a quarter, oryear end, a work sheet entry is made, removing MDC’s net invoicing for thatmonth from the Company’s accounts receivable balance, and 85% of that figure isremoved from the Company’s payable balance to MDC.  The remaining 15%, which is the approximateamount of the above mentioned deductions, is set up as a current asset.

 

The policy for salesreturn allowances is the same for all of the Company’s products, includingprivate label.  Each month the amount ofactual returns is deducted from the allowances. At the same time a provision for approximately the same amount is addedto the allowances.  If, from time totime, a customer indicates a desire to return a large amount, such as adiscontinuance of a product line, an additional provision is recorded.  As the returns are received, the amount isdeducted from the allowances, with no offsetting provision.  The sales return allowances at year end were$163,000.

 

In NOTE 1 Segmentreporting, page 20, of the Company’s Form 10-KSB for the year endedSeptember 30, 2004, the Company reported two segments of business; namely,consumer personal care products and professional dental products.  The consumer personal care products consists ofapproximately fifty (50) different brand names and many more private labelitems.  Management feels that it isimpracticable to report revenues from each of the products in the Company’s twosegments.

 

Cooperative advertisingexpenses are included in selling and advertising.  The Company’s customers accrue 5% of grosssales as a cooperative advertising allowance. This allowance can only be collected by running the ad or performing thepromotional event and by providing proof of performance.  The Company’s credit terms are 1% 20 days,net 30 days.  The Company does notparticipate in coupons or buydowns and does not use rebates.  Slotting fees are paid veryinfrequently.  Slotting expenditures inrecent years have been less than $25,000 per year.

 

2.               Continuedexistence:

 

The financial statementshave been prepared assuming that the Company will continue as a goingconcern.  The Company has an accumulateddeficit of $10,475,000.  The Company’srecurring losses from operations and inability to generate sufficient cash flowfrom normal operations to meet its obligations as they come due raisesubstantial 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.  Management’s plans in regard to these mattersare to increase profitability by increasing sales, control expenses and seekadditional financing from outside lenders. The financial statements do not include any adjustments to reflect thepossible future effects of the recoverability and classification of assets orthe amounts and classification of liabilities that may result from the possibleinability of the Company to continue as a going concern.

 

7

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3.               Use of estimates:

 

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

 

4.               Reclassification:

 

Certain reclassificationshave been made to the prior year financial statements to be consistent with the2005 presentation.

 

5.               Impairment ofintangible assets:

 

At March 31, 2005, theCompany 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 as ofDecember 31, 2004 and March 31, 2005, using a twelve month moving average.  There was an impairment charge of $100,000 atDecember 31, 2004 and no impairment charge at March 31, 2005.

 

6.               Debt maturitiesschedule:

 

At March 31, 2005, theCompany was committed to the following minimum principal payments:

 
| **Year ending  September 30,** | ** ** | **Notes payable  finance company** | ** ** | **Related  parties** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------------------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
|                           |       |                               |       |                 |       |      |       |      |       |
| 2005                           |       | $                                  | 798,000    |                 | $          | 1,347,000 |       | $         | 502,000    |   | $ | 2,647,000 |   |
| 2006                           |       | 130,000                            |       | 120,000              |       | 2,800,000 |       | 3,050,000 |       |
| 2007                           |       | —                             |       | 120,000              |       | 60,000    |       | 180,000   |       |
| 2008                           |       | —                             |       | 120,000              |       | 60,000    |       | 180,000   |       |
| 2009                           |       | —                             |       | 50,000               |       | 25,000    |       | 75,000    |       |
| 2010                           |       | —                             |       | 1,052,000            |       | —    |       | 1,052,000 |       |
|                           |       |                               |       |                 |       |      |       |      |       |
| Total                          |       | $                                  | 928,000    |                 | $          | 2,809,000 |       | $         | 3,447,000  |   | $ | 7,184,000 |   |
|                                |            |                                    |            |                      |            |           |            |           |            |  |  |  |  |  |  |  |

 

7.               Earnings (loss) pershare:

 

The Company has a simplecapital structure, and there were no changes under the SFAS 128 methodology tothe previously reported earnings (loss) per share amounts for any of the fiscalyears.  Basic earnings (loss) per shareunder SFAS 128 were computed using the weighted average number of sharesoutstanding of 4,135,162 for the three months and six months ended March 31,2005 and March 31, 2004.

 

8

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8.               Other income:

 

For the six months endedMarch 31, 2005, other income included realized gains of approximately $98,000related to the sale of three product lines. These realized gains pertain to the recognition of the earned portion ofthe deferred income of the consulting agreements arising from the sale of theseproduct lines.  Also included is $5,000arising from the sale of equipment retired in prior years.  For the six months ended March 31, 2004,other income consisted of realized gains as described above of $139,000.

 

For the three monthsended March 31, 2005, other income included realized gains of approximately$49,000 related to the sale of the three product lines as described above.  For the three months ended March 31, 2004, otherincome included approximately $69,000 of realized gains as described above.

 

9.               Income taxes:

 

At September 30, 2004,the Company has a Federal net operating loss (NOL) carry forward ofapproximately $14,775,000 for which it has recorded a valuation allowance forthe entire NOL.

 

                        Theexpiration dates of Company’s Federal net operating loss carryforwards are:

 

| 2005            |   | $ | 2,567,104 |   |
|-----------------|--------|---|-----------|--------|
| 2006            |   | $ | 837,727   |   |
| 2007            |   | $ | 416,740   |   |
| 2008            |   | $ | 689,503   |   |
| 2009            |   | $ | 1,458,800 |   |
| 2010 thereafter |   | $ | 8,805,126 |   |

 

10.         Subsequent event:

 

Subsequent to the currentreporting date of March 31, 2005, the Company purchased from NumarkLaboratories, Inc. the product lines Acryline® 2, a temporary denture reliner,and Plate Weld®, a temporary denture repair kit.  The total purchase price is $100,000, ofwhich $60,000 was paid in cash at the time of closing, with the remaining$40,000 to be paid at the rate of $2,000 per week commencing April 29,2005.  Of the $100,000 purchase price,$15,000 will be allocated to equipment acquired and the remaining $85,000recorded as a product line intangible asset. The Company is also acquiring inventory yet to be determined.

 

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

 

**Critical Accounting Policies**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of liabilities, expenses and related disclosures ofcontingent assets and liabilities.  Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances. Actual results maydiffer from these estimates under different assumptions or conditions; however,we believe that our estimates are responsible.

 

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***Revenue and Expense Recognition***

 

Income and expenses are recorded on the accrual basis ofaccounting.  The Company recognizesrevenues from sales when goods have been shipped, there are no materialuncertainties regarding customer acceptance, collection of the resultingreceivable is deemed probable and no other significant vendor obligationsexist.  Expenses are recognized whenservices have been performed or inventory items have been used.  Chemical items are recognized as inventoryonce Quality Control testing is in compliance with the Company specifications.

 

***Deferred Income***

 

Deferred income relates to certain consulting agreements arising fromthe sale of several product lines.  Thedeferred income is recognized over the terms of the contracts.

 

***Inventory Obsolescence Allowance***

 

Inventory allowances for obsolescence are recorded based upon aperiodic review by the Company’s management of its inventory.  The Company’s management will evaluateobsolete and slow moving inventory and determine their overall futuresalability and use in manufactured products. If the future salability and use in manufactured products of slow movinginventory are questionable, then an allowance is recorded based upon the lowerof cost or market.  If such inventory isdetermined to have no future salability or use, then such inventory will bewritten off.  Changes in customer demandfor certain products could impact the allowance for obsolete inventory.

 

***Intangible Assets***

 

Intangible assets consist of product lines and covenants not tocompete.  In accordance with SFAS No.142, “Goodwill and Other Intangible Assets,” we evaluate intangible assets andother long-lived assets for impairment, at least on an annual basis andwhenever events or changes in circumstances indicate that the carrying valuemay not be recoverable from its estimated future cash flows.  Recoverability of intangible assets and otherlong-lived assets is measured by comparing their net book value to the relatedundiscounted cash flows from these assets. Any change in the  undiscountedcash flows from these assets, as a result of changes in the Company’soperations or prospects, could alter this analysis.  If the net book value of the asset exceedsthe related undiscounted cash flows, the asset is considered impaired, and asecond test is performed to measure the amount of impairment loss.  Amortization is computed using thestraight-line method over the estimated useful life of the covenants not tocompete.

 

**MaterialChanges in Results of Operations**

**ThreeMonths Ended March 31, 2005, and March 31, 2004**

 

Gross revenues for thethree months ended March 31, 2005, were $2,462,000, a decrease of approximately$85,000, or 3%, from the comparable three months ended March 31, 2004.  The Company reported declining sales volumeassociated with several product line categories.  More specifically, the Company experiencedlower sales in the over-the-counter (OTC) products (approximately $134,000),depilatories ($33,000), Lee Nails® category ($20,000) and the private labelsegment ($88,000).  The above decreasesin gross revenues was somewhat offset by the increases in Lee® Lip-Ex®($158,000) and personal care items (approximately $43,000).

 

Net revenues increasedapproximately $183,000, or 8%, for the three months ended March 31, 2005, ascompared to the three months ended March 31, 2004.  The change in net revenues was dueprincipally to a decrease in sales returns of approximately $267,000, or 66%,when comparing the three months ended March 31, 2005 and 2004.  The Company experienced fewer reductions oftheir SKUs (stock keeping units) at the retail store level during the threemonths ended March 31, 2005.  Also, theCompany increased its allowance for sales returns ($160,000) during the three monthsended March 31, 2004, with no corresponding adjustment for the three monthsended March 31, 2005.

 

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The cost of sales lineitem consists of material (including a provision for obsolete inventory ifrequired), direct and indirect labor (and related fringe benefits) and relatedmanufacturing overhead expenses.  It alsoincludes purchasing, receiving, inspection (quality control functions),warehousing costs and inbound freight.

 

Cost of sales as a percentage of gross revenues was54% for the three months ended March 31, 2005, as compared to 56% for the threemonths ended March 31, 2004.  Thisdecrease was due primarily to a $132,000 increase in the inventory obsolescencereserve in March 2004 with no corresponding adjustment in 2005.  The Company also incurred lower analyticaltesting costs of $38,000.  Offsettingthese decreases were increases in: (1) direct labor (additional temporary help)and overtime costs ($36,000), (2) depreciation ($10,000) and (3) workers’compensation insurance premiums ($7,000). In addition, the continued change in the product mix to higher cost ofgoods products resulted in lower gross margins on sales of these relatedproducts.

 

Selling and advertisingexpenses include salesmen’s and clerical salaries (and related fringe benefits)and commissions, commissions to outside representatives, travel, entertainmentand expenses for various trade shows attended. Also included are royalty expense on sale of certain products, coop advertisingexpenses, amortization of several covenants not to compete agreements andimpairment of certain product lines if applicable.  Distribution costs are also included in thiscategory.

 

Selling and advertisingexpenses increased $143,000, or 23%, when comparing the three months endedMarch 31, 2005 with the three months ended March 31, 2004.  Included in selling and advertising areshipping and handling expenses of $189,000 for the three months ended March 31,2005 and $171,000 for the three months ended March 31, 2004.  The $143,000 increase in expenses wasprimarily due to: (1) higher coop advertising costs ($138,000) and (2) the$18,000 increase in shipping and handling expenses mentioned above.  These increases were offset by a $13,000decrease in royalty expense.

 

General and administrativeexpenses include executive and clerical salaries (and related fringe benefits),auditing and legal expenses, Management Information System expenses andshareholder costs.

 

General andadministrative expenses decreased approximately $44,000, or 14%, when comparing the three months endedMarch 31, 2005, with the three months ended March 31, 2004.  The decrease was primarily due to: (1) lowersalaries and related fringe benefits ($36,000), (2) lower MIS (Management InformationSystems) consulting fees ($12,000) and (3) lower auditing fees ($3,000).  These decreases were offset by higher legalfees ($8,000).

 

An intangible impairmentcharge of $129,000 was recorded for the three months ended March 31, 2004.  There was no comparable charge for the threemonths ended March 31, 2005.

 

Other expense wasapproximately $103,000 for the three months ended March 31, 2005, as comparedto other expense of $168,000 for the comparable three months ended March 31,2004.  Interest expense for the threemonths ended March 31, 2005 was $151,000, a decrease of $86,000, or 36%, whencomparing the three months ended March 31, 2005, with the three months endedMarch 31, 2004.  The primary reason forthis decrease was that in September 2004, the Company reached an agreement witha non-related party to consolidate eleven (11) of its notes payable and relatedunpaid interest totaling $2,176,000 with interest rates from 20% to 24% intoone new note.  The interest rate on thenew note is the one month LIBOR (London Interbank Offered Rate) rate.  The LIBOR rate at March 31, 2005 was2.85%.  Also included in other income is$48,000 pertaining to realized gains related to the sale of the Klutch® productline ($6,000), the sale of the Astring-o-Sol® product line ($10,000) and thesale of the iodex® product line ($32,000). The realized gains pertain to the recognition of the earned portion ofthe deferred income of the consulting agreements arising from the sale of theseproduct lines.

 

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Other expense for the three months ended March 31,2004, included interest expense of approximately $237,000 and other income ofapproximately $69,000 which pertains to realized gains related to the sale ofthe Klutch® product line ($27,000), the sale of the Astring-o-Sol® product line($10,000) and the sale of the iodex® product line ($32,000).

 

**MaterialChanges in Results of Operations**

**SixMonths Ended March 31, 2005, and March 31, 2004**

 

Gross revenues for thesix months ended March 31, 2005, were $4,801,000, a decrease of $572,000, or11%, from the comparable six months ended March 31, 2004.  The decrease was due to lower sales invarious over-the-counter brand products ($452,000), private label segment($145,000), depilatories ($132,000) and personal care items ($248,000).  Partially offsetting these decreases was anincrease in the Lee® Lip-Ex® lip balm category ($439,000).

 

Net revenues decreasedapproximately $131,000, or 3%, for the six months ended March 31, 2005, ascompared to the six months ended March 31, 2004.  The change in net revenues was due to thesales volume explanations given above and a decrease in the Company’s salesreturns of approximately $455,000, or 62%, when comparing the six months endedMarch 31, 2005 and 2004.  The Companyexperienced fewer returns of their SKUs (stock keeping units) at the retailstore level during the six months ended March 31, 2005.  Also, the Company increased its allowance forsales returns ($272,000) during the six months ended March 31, 2004, with nocorresponding adjustment for the six months ended March 31, 2005.  In addition, the Company reported a reductionin other revenue of $21,000, or 14%, when comparing the six months ended March31, 2005 versus March 31, 2004.  TheCompany reports its service distribution fee income related to a distributionagreement, with another company, as other revenue.  The lower service distribution fee income,which is a percentage of the gross volume shipped on certain products, was lessfor the six months ended March 31, 2005, versus the comparable period endedMarch 31, 2004.

 

Cost of sales as apercentage of gross revenues was 64% for the six months ended March 31, 2005,as compared to 52% for the six months ended March 31, 2004.  The continued change in the product mix tohigher cost of goods products resulted in lower gross margins on sales of theseproducts.  In addition, the Companyincreased its inventory obsolescence reserve $266,000 in the six months endedMarch 31, 2005, as compared to $156,000 in the corresponding period of 2004,and incurred increased expenses in: (1) depreciation ($22,000) and (2) workers’compensation insurance premiums ($11,000). Offsetting these increases were decreases in: (1) analytical testingcosts ($70,000) and (2) lower labor and related fringe benefit costs ($59,000).

 

Selling and advertisingexpenses increased $125,000, or 9%, when comparing the six months ended March31, 2005 with the six months ended March 31, 2004.  Included in selling and advertising areshipping and handling expenses of $345,000 for the six months ended March 31,2005 and $331,000 for the six months ended March 31, 2004.  The increased expenses of $125,000 wascomposed of: (1) an increase of $169,000 in coop advertising and (2) the highershipping costs, primarily freight, of $14,000 mentioned above.  These increases were somewhat offset by: (1)lower product liability premiums ($22,000), (2) lower royalty expense ($21,000)and (3) lower salesmen’s samples ($7,000).

 

General andadministrative expenses decreased $117,000, or 18%, when comparing the sixmonths ended March 31, 2005, with the six months ended March 31, 2004.  The decrease was primarily due to: (1) lowersalaries and related fringe benefits ($87,000), (2) lower MIS consulting fees($37,000), (3) lower auditing fees ($20,000) and (4) lower bank and credit cardfees ($6,000).  These decreases wereoffset by higher legal fees ($35,000).

 

An intangible impairmentcharge of $100,000 was recorded for the six months ended March 31, 2005, ascompared to a $129,000 charge for the six months ended March 31, 2004.

 

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For the six months endedMarch 31, 2005, the Company realized other income of $553,000, as compared toother expense of $289,000 for the six months ended March 31, 2004.  The primary reason for this difference is a$750,000 gain from the sale of the Nose Better® product line in October 2004(fiscal 2005).  Interest expense for thesix months ended March 31, 2005 was $300,000, a decrease of $128,000, or 30%,when comparing the six months ended March 31, 2005 with the six months endedMarch 31, 2004.  The primary reason forthis decrease is the same as outlined above for the three months period.  Also included for the six months ended March31, 2005 is $98,000 pertaining to the realized gains related to the sale of theKlutch® product line ($13,000), the sale of the Astring-o-Sol® product line($21,000), the sale of the iodex® product line ($64,000) and $5,000 arisingfrom the sale of some equipment retired in prior years.

 

Other expense for the sixmonths ended March 31, 2004 included interest expense of $428,000 and otherincome of $139,000 related to the sale of the Klutch® product line ($54,000),the sale of the Astring-o-Sol® product line ($21,000) and the sale of theiodex® product line ($64,000).

 

**Liquidityand Capital Resources**

 

At March 31, 2005,working capital was a negative $6,145,000, as compared with a negative$3,519,000 as of September 30, 2004.  Theratio of current assets to current liabilities was 0.4 to 1 at March 31, 2005and 0.5 to 1 at September 30, 2004.  Theincrease in current liabilities was principally due to the maturity date ofcertain long-term liabilities becoming current in December 2004.

 

The Company has anaccumulated deficit of $10,475,000.  Pastrecurring losses and inability to generate sufficient cash flow from normaloperations to meet its obligations as they become due, raises substantial doubtabout the Company’s ability to continue as a going concern.  The Company’s ability to continue inexistence is dependent upon future developments, including retaining currentfinancing and achieving a level of profitable operations sufficient to enableit to meet its obligations as they become due.

 

The Company expects toincrease its source of cash by a combination of increased sales, lower costsand perhaps additional financing from outside lenders.  Any increase in cash will be used to payaccrued interest and notes payable. Projected interest payments and capital expenditures will have an impacton the Company’s liquidity.

 

The Company implementedcost reduction programs since September 2004. They include personnel layoffs, salary cuts, wage freezes, lowerproducts liability premium, lower interest rate paid to a lender and the vacatingof a building.  In addition, on March 8,2005, a royalty expense expired.  Theexpiration of the royalty expense saves the Company approximately $5,000 permonth.  Vacating one of the facilities,effective February 28, 2005, will save the Company approximately $7,500 permonth in rent and utilities combined.

 

In comparing the sixmonths ended March 31, 2005 and March 31, 2004, the number of days’ sales werein average accounts receivable was 32 days versus 21 days.  Due to the anticipation of a price increase,many customers were doing some hedge buying, which distorted the number ofaverage days’ sales would normally be in accounts receivable.

 

It should be noted thatincluded in the Company’s total liabilities of $11,684,000, the Lee familyaffiliates constitute $4,380,000, environmental $740,000 (subject tonegotiation) and deferred income $212,000, for a total of $5,332,000, whichrepresents 46% of the total liabilities. This liability gives the Company a certain amount of latitude as to whenpayment of principal and/or interest are made.

 

All of the Company’sbuilding leases are with two individuals, one of whom is the President andChairman of the Company.  The Company isin the process of exercising its option to extend the terms of the leases, whichcurrently expire in November 2005.  Whenthe options are exercised, the leases will be extended to November 2010.

 

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**EnvironmentalMatters**

 

The Company owns amanufacturing facility located in South El Monte, California.  The California Regional Water Quality ControlBoard (The “RWQCB”) ordered the Company in 1988 and 1989 to investigate thecontamination 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 “Cleanupand Abatement Order” directing the Company to conduct further testing and cleanup the site.  In October 1991, theCompany received from an environmental consulting firm an estimate of $465,200for investigation 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.  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.

 

On April 24, 2002, theRWQCB 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 togroundwater resources used for domestic supply. The RWQCB directed the Company to test for the presence of emergentchemicals in its groundwater monitoring wells. The groundwater monitoring analytical results were due by July 15,2002.  On May 24, 2002, the Companyinformed RWQCB that it could not comply with the requirement to conductgroundwater sampling due to ongoing financial difficulties.

 

On July 8, 2002, theRWQCB sent a “Second Notice of Violation” to the Company directing the Companyto comply with the requirement to prepare a groundwater remedial action plan(RAP).  The Company previously notifiedthe RWQCB that it could not comply with the requirement to submit a RAP becauseof ongoing financial difficulties.  TheRWQCB requested that the Company submit certain financial information by July29, 2002 to “substantiate any alleged financial losses and determine whetherany suspension of implementing the...(Cleanup and Abatement Order) iswarranted.”  The Company has received anextension to submit the required financial information to August 19, 2002.  The Company submitted the requested financialinformation on August 16, 2002.  TheCompany received a response whereby their request for financial hardship wasdenied.  The Company is in the process ofappealing this decision based primarily upon the continued deterioration in theCompany finances since the original filing. The Company may be liable for all or part of the costs of remediatingthe contamination on its property and could be subject to enforcement action bythe RWQCB, including injunctive and civil monetary remedies.  As of the date of 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 in fundingwhich paid for the $220,000 study, $20,000 in legal fees for project oversight,and a $50,000 balance in the operating fund. Earlier the Company had accrued $87,500 as its proportionate share ofthe 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 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.

 

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The tenants of nearbyproperties upgradient have sued the Company, alleging that hazardous materialsfrom the Company’s property caused contamination on the properties leased bythe tenants.  The case name is Del RayIndustrial Enterprises, Inc. v. Robert Malone, et al., Los AngelesCounty Superior Court, Northwest District, and it 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’s South ElMonte manufacturing facility is also located over a large area of possiblycontaminated regional groundwater which is part of the San Gabriel ValleySuperfund Site.  The Company has beennotified that it is a potentially responsible party  (“PRP”) for the contamination.   In 1995,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 sitecosts, and are responsible for negotiating among themselves the allocation ofthe costs based on, among other things, the outcome of environmentalinvestigation.

 

In August 1995, theCompany 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 the SouthEl Monte Operable Unit Site Participation Agreement with Cardinal pursuant towhich, among other things, Cardinal contracted with an environmental firm toconduct the Study.  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 El  Monte Operable Unit (SEMOU)participants developed four remedial alternatives.  The capital cost of the four alternativesrange from $0 (no action) up to $3.49 million. The estimated annual operating cost for the four alternatives range from$0 (no action) to $770,300.  Over a30-year period, the total cost of the four alternatives range from $0 (noaction) up to $13.05 million.  The EPAprefers an alternative which estimates the capital cost up to $3.08 million,the annual operating cost at $.48 million, and the 30-year period total cost upto approximately $9.09 million.  Theselection of the actual alternative implemented is subject to public comment.  At the present time, the Company does notknow what its share of the cost may be, if any. Therefore, no additional accrual has been recognized as a liability onthe Company’s books.  The Companyrequested that the EPA conduct an “ability-to-pay evaluation” to determinewhether the Company is entitled to an early settlement of this matter basedupon a limited ability to pay costs associated with site investigation andremediation.  In August 2000, the EPAinformed the Company that it does not qualify for an early settlement at thistime.

 

The EPA has informed theCompany that it has learned that the intermediate zone groundwatercontamination in the western portion of the SEMOU has migrated further west andhas now impacted the City of Monterey Park and Southern California WaterCompany production wells.  The EPA statedthat the City of Monterey Park Water Department, San Gabriel Valley WaterCompany and Southern California Water Company are planning to build treatmentfacilities for their wells.  The EPAstated that these three water purveyors contacted some of the SEMOU PRPs, otherthan the Company, to seek funding to develop groundwater treatment facilitiesfor the contaminated wells.  A group ofthese PRPs calling themselves the “South El Monte Cooperative Group” has beenformed and purportedly has reached a general agreement with the water purveyorsto fund the development of treatment facilities and use the water purveyors’wells in an attempt to contain the groundwater contamination to meet EPA’sgoals.  The Company is not able todetermine what contribution, if any, it may be assessed in connection with thiscleanup activity.

 

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By letter dated November13, 2000, the Company was notified that the City of Monterey Park, San GabrielValley Water Company and Southern California Water Company intend to bring suitunder the Safe Drinking Water and Toxic Enforcement Act of 1986, alleging thatthe Company has knowingly released volatile organic compounds in the soil andshallow groundwater beneath the Company’s property between at least on orbefore November 8, 1996 and the present and has failed to promptly clean up allof the contamination.  As of the date ofthis report, the Company has not been served with this lawsuit.

 

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

 

The Company believes theCity 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 this time.

 

The Company and otherproperty owners engaged Geomatrix Consultants, Inc., to do a survey of vadosesoil and shallow groundwater in the “hot spots” detected in the previousstudies.  Geomatrix issued a report datedDecember 1, 1997 (the “Report”), on the impact of volatile organic compounds onthe soil and groundwater at the Lidcombe and Santa Anita Avenue site located inSouth El Monte, California (which includes the Company’s facilities).

 

The Report indicatedgenerally low concentrations of tetrachloroethene, trichloaethene andtrichloroethane in the groundwater of the upgradient neighbor.  The Report was submitted to the RWQCB for itscomments and response.  A meeting withthe 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“Focused Feasibility Study” which concludes that there are five possiblemethods for cleanup.  The most expensiveare for a pump and sewer remediation which would cost between $1,406,000 and$1,687,000.  The Company is activelyexploring the less expensive alternative remediation methods, of which the twoproposed alternatives range in cost between $985,000 and $1,284,000.  Since there are four economic entitiesinvolved, the Company’s best estimate at this time, in their judgment, would bethat their forecasted share would be $287,000 less the liability alreadyrecognized on the books of $165,000 thereby requiring an additional $122,000liability.

 

Accordingly, the Companyrecorded an additional accrual of $122,000 in the third quarter of fiscal1998.  The $122,000 accrual is inaddition to the $79,000 accrual for the Monterey Site as will be explained in afollowing paragraph.  The $79,000 accrual,in the third quarter of fiscal 1998, related to the Monterey Site is notincluded in the $287,000 figure above.

 

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In April 2000, theCompany received a Notice of Violation from the RWQCB.  The Notice of Violation states that theCompany and other property owners were required to submit a groundwaterremedial action plan by  November 1,1999,  and that the RWQCB has beenadvised that the Company and the other property owners were unable to submitthe required remedial action plan because the Company and the other propertyowners could not agree on the allocation of financial responsibility to preparethe action plan.  The RWQCB stated thatit will 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).

 

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

 

The LSAAW is hopeful theWater Quality Authority (WQA) is willing and able to reauthorize its grant forone-half (1/2) of the capital costs of its remediation system construction notto exceed $150,000.  It is estimated atthis time that the reserves for the Company’s share of this cost proposal areadequate since its prior accrual was based on the higher cost estimate fromGeomatrix.

 

Without any priorcorrespondence or inkling of the Company’s potential liability, the EPAinformed the Company that the Company may have potential liability for theongoing remediation of Operating Industries, Inc. (as they have gone out ofbusiness) Landfill Superfund Site in Monterey Park, California (the “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, the EPAinformed the Company that the EPA believed the Company is able to pay the fullsettlement cost, but offered to reduce the amount of the settlement to $75,271.

 

The Company was notifiedby the EPA that the Company may have potential liability for waste material itdisposed of at the Casmalia Disposal Site (“Site”) located on a 252 acre parcelin Santa Barbara County, California.  TheSite was operational from 1973 to 1989, and over 10,000 separate partiesdisposed of waste there.  The EPA statedthat federal, state and local governmental agencies along with the numerousprivate entities that used the Site for waste disposal will be expected to paytheir share as part of this settlement. The U.S. EPA is also pursuing the owner(s)/operator(s) of the Site topay for Site remediation.  The EPA has asettlement offer to the Company with respect to the Site for a cost of$373,950.  The Company accrued a $374,000charge in the first quarter of fiscal 1999 with respect to this possibleliability.  The Company has elected tofile for relief from these obligations under the financial hardships option inthe EPA’s response form.  The Company,the EPA and certain PRPs have entered into an agreement tolling the applicablestatutes of limitation.  The Company hasbeen notified by the EPA that their request for a waiver, due to financialhardship, 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.

 

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The Company has requesteda reduced financial liability or waiver on the three EPA sites: SEMOU,Operating Industries, Inc. (OII)  andCasmalia Disposal Site.  The Company hascontinued to provide the information and documentation requested by the EPA asit relates to its ability to pay.  Inconnection with this request, the Company understands that the EPA isconsidering the information.

 

The total amount ofenvironmental investigation and cleanup costs that the Company may incur withrespect to the foregoing is not known at this time.  However, based upon information available 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 Securities and Exchange Commission environmentalinvestigation.  The actual costs coulddiffer materially from the amounts expensed for environmental investigation andcleanup costs to date.

 

As of March 31, 2005, nosettlements have been reached.  The totalamount expensed in prior years relating to this environmental issue is$860,000.  As of March 31, 2005, noadditional amounts have been expensed or accrued.  The Company has an accrued liability on thebooks at March 31, 2005 of $740,000 for the environmental cleanup.

 

**Item 3.         Controlsand Procedures**

 

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

 

The certifying officerconcluded, based on his evaluation, that the Company’s disclosure controls andprocedures are effective for the Company.

 

There were no changes inthe Company’s internal control over financial reporting that occurred duringthe Company’s most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.         LegalProceedings**

 

The information set forthunder Part I, Item 2, “Management’s Discussion and Analysis or Plan ofOperations - Environmental Matters” is incorporated herein by reference.  See also “Legal Proceedings” in theCompany’s Form 10-KSB for the fiscal year ended September 30, 2004.

 

**Item 3.         DefaultsUpon Senior Securities**

 

The Company has failed tomake principal and interest payments on certain loans.  The total arrearage is principal of$1,622,000 plus interest of $1,147,000, an aggregate of $2,769,000, of which$2,048,000 is due to related parties and $721,000 to non-related parties.

 

18

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**Item 4.         Submissionof Matters to a Vote of Security Holders**

 

The Annual Meeting ofStockholders of the registrant occurred on March 8, 2005.  At that meeting, the following directors wereelected:

 
| ** **              | ** ** | **VOTES** | ** ** |
|-------------------------|------------|-----------|------------|
| **Director**            | ** ** | **FOR**   | ** ** | **WITHHELD** | ** ** |
| Henry L. Lee,  Jr.      |       | 3,423,565 |       | 220,627 |   |
| Ronald G. Lee           |       | 3,422,823 |       | 221,369 |   |
| William M.  Caldwell IV |       | 3,434,565 |       | 209,627 |   |

 
| ** **                                                      | ** ** | **VOTES** | ** ** |
|-----------------------------------------------------------------|------------|-----------|------------|
| ** **                                                      | ** ** | **FOR**   | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
| The appointment  of George Brenner, CPA, as independent auditor |       | 3,583,031 |       | 24,550 |   | 36,611 |   |

 

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

 

The following exhibitsare filed herewith:

 
| 10.1                                                               | -      | Promissory note which  was modified in February 2005, evidencing advance made to the Registrant                                         |
|--------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------|
|                                                               |   |                                                                                                                                    |
| 10.2                                                               | -      | Promissory note which  was modified in February 2005, evidencing advance made to the Registrant                                         |
|                                                               |   |                                                                                                                                    |
| 10.3                                                               | -      | Promissory note which  was modified in February 2005, evidencing advance made to the Registrant                                         |
|                                                               |   |                                                                                                                                    |
| 10.4                                                               | -      | Promissory note which  was modified in February 2005, evidencing advance made to the Registrant                                         |
|                                                               |   |                                                                                                                                    |
| 10.5                                                               | -      | Promissory note which  was modified in February 2005, evidencing advance made to the Registrant                                         |
|                                                               |   |                                                                                                                                    |
| 10.6                                                               | -      | Promissory note which  was modified in February 2005, evidencing advance made to the Registrant                                         |
|                                                               |   |                                                                                                                                    |
| 10.7                                                               | -      | Secured promissory note  dated February 10, 2005, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc. |
|                                                               |   |                                                                                                                                    |
| 10.8                                                               | -      | Secured promissory note  dated March 30, 2005, regarding equipment, between Lee Pharmaceuticals and  Preferred Business Credit, Inc.    |
|                                                               |   |                                                                                                                                    |
| 31.1                                                               | -      | Certification by Chief  Executive Officer and Chief Financial Officer                                                                   |
|                                                               |   |                                                                                                                                    |
| 32.1                                                               | -      | Section 1350  Certification                                                                                                             |
|                                                               |   |                                                                                                                                    |
| The following exhibits  have previously been filed by the Company: |
|                                                               |   |                                                                                                                                    |
| 3.1                                                                | -      | Articles of  Incorporation, as amended (1)                                                                                              |
|                                                               |   |                                                                                                                                    |
| 3.4                                                                | -      | By-laws, as amended  December 20, 1977 (2)                                                                                              |
|                                                               |   |                                                                                                                                    |
| 3.5                                                                | -      | Amendment of By-laws  effective March 14, 1978 (2)                                                                                      |
|                                                               |   |                                                                                                                                    |
| 3.6                                                                | -      | Amendment to By-laws  effective November 1, 1980 (3)                                                                                    |

 

19

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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.          |

 

 

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:  | MAY 13, 2005 |                                                                          | RONALD G. LEE |
|   |         | Ronald G. Lee                                                                 |
|   |         | Chairman of the Board,  President and  Chief Financial and Accounting Officer |
|        |              |                                                                               |               |  |  |

 

20

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