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 | |
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For the quarterly period ended June 30, 2002 | ||
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OR | ||
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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For the transition period from to | ||
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Commission file number 1-7335 |
LEE PHARMACEUTICALS | ||
(Exact name of small business issuer as specified in its charter) | ||
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California |
| 95-2680312 |
(State or other jurisdiction of incorporation |
| (I.R.S. Employer Identification No.) |
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1444 Santa Anita Avenue, South El Monte, California 91733 | ||
(Address of principal executive offices) | ||
(Zip Code) | ||
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(626) 442-3141 | ||
(Registrant’s telephone number, including area code) | ||
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N/A | ||
(Former name, former address and former fiscal year, if changed since last report) |
As of June 30, 2002 there were outstanding 4,135,162 shares of common stock of the registrant.
Transitional Small Business Disclosure Format (check one):
Yes o No ý
LEE PHARMACEUTICALS
BALANCE SHEET
JUNE 30, 2002
(Dollars in thousands)
(Unaudited)
Assets |
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Cash |
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| $ | 16 |
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Accounts and notes receivable (net of allowances: $186) |
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| 669 |
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Inventories (net of reserves: $255) |
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Raw materials |
| $ | 1,971 |
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Work in process |
| 165 |
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Finished goods |
| 604 |
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Total inventories |
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| 2,740 |
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Other current assets |
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| 336 |
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Total current assets |
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| 3,761 |
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Property, plant and equipment (less accumulated depreciation and amortization: $5,282) |
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| 533 |
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Intangibles and other assets (net of accumulated amortization: $2,082) |
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| 3,043 |
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TOTAL |
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| $ | 7,337 |
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See Accompanying Selected Information to Unaudited Condensed Financial Statements.
2
LEE PHARMACEUTICALS
BALANCE SHEET
JUNE 30, 2002
(Dollars in thousands)
(Unaudited)
LIABILITIES |
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Bank overdraft |
| $ | 50 |
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Notes payable – bank |
| 722 |
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Current portion - notes payable, other |
| 1,270 |
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Current portion - note payable related party |
| 760 |
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Accounts payable |
| 1,359 |
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Other accrued liabilities |
| 336 |
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Environmental cleanup liability |
| 366 |
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Due to related parties |
| 899 |
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Deferred income |
| 108 |
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Total current liabilities |
| 5,870 |
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Long-term notes payable to related parties |
| 1,963 |
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Long-term notes payable, other |
| 1,757 |
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Environmental cleanup liability - Casmalia Site |
| 374 |
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Deferred income |
| 115 |
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Total long-term liabilities |
| 4,209 |
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Total liabilities |
| 10,079 |
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COMMITMENTS AND CONTINGENCIES |
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STOCKHOLDERS’ (DEFICIT) |
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Common stock, $.10 par value; authorized, 7,500,00 shares; issued and outstanding, 4,135,162 shares |
| 413 |
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Additional paid-in capital |
| 4,222 |
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Accumulated (deficit) |
| (7,377 | ) | |
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Total stockholders’ (deficit) |
| (2,742 | ) | |
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TOTAL |
| $ | 7,337 |
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See Accompanying Selected Information to Unaudited Condensed Financial Statements.
3
LEE PHARMACEUTICALS
STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
(Unaudited)
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| For the Three Months |
| For the Nine Months |
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| 2001 |
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Gross revenues |
| $ | 2,440 |
| $ | 2,074 |
| $ | 7,620 |
| $ | 7,157 |
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Less: Sales returns |
| (202 | ) | (71 | ) | (648 | ) | (619 | ) | ||||
Cash discounts and others |
| (29 | ) | (18 | ) | (70 | ) | (58 | ) | ||||
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Net revenues |
| 2,209 |
| 1,985 |
| 6,902 |
| 6,480 |
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Costs and expenses: |
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Cost of sales |
| 1,136 |
| 1,072 |
| 3,499 |
| 3,311 |
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Selling and advertising expense |
| 805 |
| 510 |
| 2,205 |
| 1,796 |
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General and administrative expense |
| 281 |
| 313 |
| 896 |
| 859 |
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Interest expense |
| 193 |
| 182 |
| 559 |
| 603 |
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Total costs and expenses |
| 2,415 |
| 2,077 |
| 7,159 |
| 6,569 |
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Income (loss) from operations |
| (206 | ) | (92 | ) | (257 | ) | (89 | ) | ||||
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Other income |
| 39 |
| 107 |
| 92 |
| 133 |
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Net income (loss) |
| $ | (167 | ) | $ | 15 |
| $ | (165 | ) | $ | 44 |
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Per share: |
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Basic and diluted income (loss) per share |
| $ | (.04 | ) | $ | .00 |
| $ | (.04 | ) | $ | .01 |
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See Accompanying Selected Information to Unaudited Condensed Financial Statements.
4
LEE PHARMACEUTICALS
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
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| For the Nine Months |
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| 2002 |
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Cash flows from operating activities: |
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Net income (loss) |
| $ | (165 | ) | $ | 44 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation |
| 130 |
| 128 |
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Amortization of intangibles |
| 356 |
| 362 |
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(Decrease) in deferred income |
| (82 | ) | (11 | ) | ||
(Gain) on disposal of property, plant, and equipment |
| (1 | ) | (2 | ) | ||
Change in operating assets and liabilities: |
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Decrease in accounts receivable |
| 222 |
| 425 |
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(Decrease) increase in allowance for doubtful accounts and sales returns and allowances |
| (142 | ) | 52 |
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(Increase) in inventories |
| (331 | ) | (396 | ) | ||
Decrease (increase) in deposits |
| 53 |
| (55 | ) | ||
(Increase) in other current assets |
| (67 | ) | (89 | ) | ||
Increase in accounts payable and accrued liabilities |
| 351 |
| 467 |
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Increase in due to related parties - accrued interest |
| 45 |
| 73 |
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(Decrease) in accrued royalties |
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| (39 | ) | ||
Increase in deferred income and advance payment |
| — |
| 350 |
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Total adjustments |
| 534 |
| 1,265 |
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Net cash provided by operating activities |
| 369 |
| 1,309 |
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Cash flows from investing activities: |
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Additions to property, plant, and equipment |
| (101 | ) | (53 | ) | ||
Proceeds from sale of equipment |
| 1 |
| 7 |
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Proceeds from sale of product brand |
| 265 |
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Acquisition of product brands |
| (660 | ) | (199 | ) | ||
Increase in non-current deposit |
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Net cash (used in) investing activities |
| (495 | ) | (256 | ) | ||
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Cash flows from financing activities: |
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Proceeds from notes payable to related party |
| 53 |
| 44 |
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(Payments on) notes payable to related party |
| (133 | ) | (135 | ) | ||
Decrease in due from related party |
| — |
| 25 |
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(Decrease) in notes payable |
| (283 | ) | (142 | ) | ||
Proceeds from notes payable, other |
| 1,365 |
| 750 |
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Payments on notes payable, other |
| (830 | ) | (1,329 | ) | ||
(Decrease) in bank overdraft |
| (35 | ) | (275 | ) | ||
Net cash provided by (used in) financing activities |
| 137 |
| (1,062 | ) | ||
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Net increase (decrease) in cash |
| 11 |
| (9 | ) | ||
Cash, beginning of period |
| 5 |
| 12 |
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Cash, end of period |
| $ | 16 |
| $ | 3 |
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Supplemental disclosures of cash flow information: |
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Cash paid during the period for: |
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Interest |
| $ | 497 |
| $ | 525 |
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Taxes |
| $ | 1 |
| $ | 1 |
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See Accompanying Selected Information to Unaudited Condensed Financial Statements.
5
SELECTED FINANCIAL INFORMATION
SUBSTANTIALLY ALL DISCLOSURES REQUIRED BY GENERALLY ACCEPTED ACCOUNTING
PRINCIPALS ARE NOT INCLUDED
Notes to Financial Information
1. Basis of presentation:
The condensed interim financial statements included herein have been prepared by Lee Pharmaceuticals without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.
These statements reflect all adjustments, consisting of normal recurring adjustments which, in the opinion of management, are necessary for fair presentation of the information contained herein. It is suggested that these condensed financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-KSB for the year ended September 30, 2001. The Company follows the same accounting policies in preparation of interim reports.
Results of operations for the interim periods may not be indicative of annual results.
The Company is involved in various matters involving environmental cleanup issues. See “Item 2. Management’s Discussion and Analysis or Plan of Operations” and Note 11 of Notes to Financial Statements included in the Company’s Form 10-KSB for the fiscal year ended September 30, 2001. The ultimate outcome of these matters cannot presently be determined. Environmental expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. The Company’s proportionate share of the liabilities are recorded when environmental remediation and/or cleanups are probable, and the costs can be reasonably estimated.
2. Continued existence:
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. Although the Company experienced nominal net income in fiscal years 2000 and 2001, past recurring losses and inability to generate sufficient cash flow from normal operations to meet its obligations as they became due, raises substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
3. Use Of Estimates
The preparation of financial statements in conformity with generally accepted accounting principals requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
4. Reclassification
Certain reclassifications have been made to the prior year financial statements to be consistent with the 2002 presentation.
5. Impairment Of Long-Lived Assets And Long-Lived Assets To Be Disposed Of
The Company evaluates is long-lived assets, including goodwill and certain identifiable intangibles, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment
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SELECTED FINANCIAL INFORMATION
SUBSTANTIALLY ALL DISCLOSURES REQUIRED BY GENERALLY ACCEPTED ACCOUNTING
PRINCIPALS ARE NOT INCLUDED
to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. If an asset is to be disposed of, it is reported at the lower of the carrying amount or fair value less costs to sell. To date, there has been no impairment of long-lived assets.
6. Earnings per share:
The Company has a simple capital structure, and there were no changes under the SFAS 128 methodology to the previously reported earnings (loss) per share amounts for any of the fiscal years. Basic earnings per share under SFAS 128 were computed using the weighted average number of shares outstanding of 5,265,162 for the three and nine months ended June 2002 and 5,194,496 for the three and nine months ended June 2001. Differences in the weighted average number of shares outstanding for purposes of computing diluted earnings per share were due to the inclusion of the dilutive effect of stock options previously granted. These differences in the weighted average number of shares outstanding for the calculation of basic and diluted earnings per share resulted in no differences in the earnings per share.
7. Acquisitions:
On October 30, 2000, the Company purchased certain assets of the Sloans® liniment temporary pain relief product from C.B. Fleet Co., Inc. for $50,000 plus approximately $600 of inventory. The Company remitted the full $50,000 at closing. The balance of $50,000 is for a five year covenant not to compete.
On February 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 inventory and 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 purchased certain assets of the DeWitt’s® Pills product line from The Monticello Companies, Inc. for $265,000. The Company remitted the full $265,000 at closing. On October 16, 2001, the Company exercised it’s option to resell certain assets of DeWitt’s® Pills product line back to The Monticello Companies, Inc. The Company received $265,000 related to the resell of DeWitt’s® Pills.
On March 9, 2002, the Company purchased certain assets of product lines from Merz Pharmaceuticals LLC for $225,000 plus approximately $63,000 for inventory. The product lines included Cankaid®, an oral antiseptic, Medicone®, a hemorrhoidal suppository, and Sayman®, an astringent cleansing bar. The purchase price of $225,000 includes $200,000 for goodwill and $25,000 for a covenant not to compete. The full $225,000 was remitted at closing. In addition, the Company is obligated to pay a royalty as follows: for the first twelve-month period following closing (i) twenty-five percent (25%) of the net sales of Medicone® and Sayman®; (ii) twenty-five percent (25%) of the net sales of the first 4,800 dozen sold of Cankaid®, and (iii) forty percent (40%) of the Cankaid® sold in excess of the first 4,800 dozen. For the next two 12-month periods after closing (8 consecutive quarters), the royalty payments will be (i) twenty percent (20%) of the net sales of Medicone® and Sayman®; (ii) twenty percent (20%) of the net sales of the first 4,800 dozen sold per 12-month period of Cankaid®, and (iii) forty percent (40%) of the Cankaid® units sold in excess of the first 4,800 dozen per 12-month period. Notwithstanding the above, no royalty shall be due on Lee’s sales of Cankaid® inventory with 10/02 or 11/02 expirations to closeout/dollar store/off-price retailers at wholesale prices of less than seventy cents ($.70). The minimum royalty due is $75,000 per year for the next three years. As of June 30, 2002, $33,542 of royalties related to the above agreement have been accrued.
On April 5, 2002, the Company purchased certain assets of the One Step at a Time®, a nicotine addiction withdrawal system, and lite’n® Up, a reusable cigarette filter, product lines from Category One Products, L.L.C., for $350,000 plus inventory. A clause in the agreement stipulates that if certain customers delete one of the product lines, the purchase price will be adjusted downward. The full $350,000 was remitted at the closing. The $350,000 has been recorded as goodwill and is included in intangible assets. The Company also acquired the rights to a royalty agreement for $100,000. The Company is paying $4,000 per week for this royalty obligation. As of June 30, 2002 the Company is paying $6,000 per week for inventory that is estimated to be $150,000 - $175,000 in value. The final value of the inventory has not been determined as of the date of this report.
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SELECTED FINANCIAL INFORMATION
SUBSTANTIALLY ALL DISCLOSURES REQUIRED BY GENERALLY ACCEPTED ACCOUNTING
PRINCIPALS ARE NOT INCLUDED
On April 23, 2002, the Company purchased certain assets of product lines Unguentine®, an ointment for burns, and Unguentine® Plus, a first aid antiseptic and pain relieving cream, from U.S. Dermatologics, Inc. The purchase price is $85,000 for a covenant not to compete and as yet an undetermined amount of inventory. $25,000 of the purchase price was paid at closing and a Promissory note was signed for the remaining $60,000. The note calls for a monthly payment of $3,000 plus interest at the highest prime rate published in the Wall Street Journal the prior month beginning June 15, 2002. This agreement also calls for the Company to pay a 20% royalty annually, for a period of three years, on net sales of one of the products, with a minimum payment of $6,000. As of June 30, 2002, no amount has been accrued for this royalty, as the Company sales have only been for the inventory purchased.
8. Income taxes:
As of June 30, 2002, the Company had net operating loss (NOL) carryforwards of approximately $10,300,000 for Federal and $1,600,000 for California tax purposes which can be used to offset future Federal and California income taxes. The differences in the state carryforwards relate primarily to the treatment of loss carryforwards and depreciation of property, plant and equipment. The Federal carryforwards expire from 2005 through 2020; California expires from 2001 through 2005. The Company has provided an allowance for the entire amount of the deferred asset applicable to the NOL.
9. Other income:
For the nine months ended June 30, 2002, the Company realized a gain of approximately $82,000 related to the sale of the Klutch® product line. The realized gain pertains to the recognition of the earned portion of the deferred income of the consulting agreements arising from the sale of the Klutch® brand. Also included in other income is $10,000 in property tax refunds paid in prior years.
The other income for the nine months ended June 30, 2001 consisted of $18,000 related to the sale of the Klutch® product line, $11,000 for the final amortization of the prior sale of two buildings, $11,000 for the sale of a trademark and $82,000 recorded as relief of debt, as well as gain from the sale of equipment.
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Item 2.
Management’s Discussion and Analysis or Plan of Operations
Material Changes in Results of Operations
Three Months Ended June 30, 2002, and June 30, 2001
Gross revenues for the three months ended June 30, 2002, were $2,440,000, an increase of approximately $366,000, or 18%, from the comparable three months ended June 30, 2001. The Company reported increased volume in several products. The primary increase in revenues was related to Lactona® ($65,000), depilatories ($33,000) and other over-the-counter (OTC) brands ($116,000). In addition, the Company had added sales of newly acquired brands ($247,000) and the private label line of business ($253,500). The above increases were partially offset by lower sales volume of existing brands namely; Lee® Lip-Ex® line of products ($95,000), nail category ($77,000), Aquafilter® ($50,000), and several personal care category of brands ($166,000).
Net revenues increased approximately $224,000, or 11%, for the three months ended June 30, 2002, as compared to the three months ended June 30, 2001. The Company reported increased volume in several products. The primary increase in revenues was related to Lactona® ($65,000), depilatories ($72,000) and other OTC brands ($125,000). In addition, the Company had added sales of newly acquired brands ($226,000) and the private label line of business ($247,400). The aforementioned increases were partially offset by lower sales volume of existing brands namely; Lee® Lip-Ex® line of products ($95,000), nail category ($77,000), Aquafilter® ($50,000), and several personal care category of brands ($157,000). Also, sales returns decreased approximately $21,000 or 9% when comparing the three months ended June 30, 2002 ($202,000) and the three months ended June 30, 2001 ($223,000). During the quarter ended June 30, 2001, the Company made an adjustment lowering its sales returns and allowances reserve account by $152,000, bringing the balance shown for sales returns on the statement of operations to $71,000.
Cost of sales as a percentage of gross revenues was 47% for the three months ended June 30, 2002, as compared to 52% for the three months ended June 30, 2001. The decreased cost of sales percentage was due to the product mix which was more favorable because the recently acquired brands had a lower cost of sales than the Company’s overall average.
Selling and advertising expenses increased $295,000, or 58%, when comparing the three months ended June 30, 2002 with the three months ended June 30, 2001. The increase in expenses were due to the following factors: (1) increase in the bad debt expense ($99,000), (2) higher salesmen salaries and related fringe benefits due to the hiring of a higher salaried salesman who replaced lower salaried sales personnel plus added temporary help ($43,000), (3) increased freight costs ($39,000), (4) higher amortization expense as a result of recent product brand acquisitions ($33,000), (5) higher sales force commission/bonuses resulting from increased sales to convenience store accounts and private label business ($17,000), (6) added royalty expense from new acquisitions ($45,000), and (7) higher commission ($9,000) due to added manufacturer representatives covering territories that were previously open.
General and administrative expenses decreased $32,000, or 10%, when comparing the three months ended June 30, 2002, with the three months ended June 30, 2001. This decrease included lower general legal fees ($16,000), reduction in general supplies expense ($20,000), and reduced building rental expenses ($10,000). The rental income from subleasing three of the Company’s facilities, offsets the rental expense on the master lease.
Interest expense increased $11,000, or 6%, when comparing the three months ended June 30, 2002, with the three months ended June 30, 2001. The increase was due to a higher borrowings (principal) from the Company’s related party. The above was somewhat offset by a lower average prime interest rate (4.75% vs. 7.16%) in reference to certain loans which are tied to prime.
Material Changes in Results of Operations
Nine Months Ended June 30, 2002, and June 30, 2001
Gross revenues for the nine months ended June 30, 2002, were $7,620,000, an increase of approximately $463,000 or 6% from the comparable nine months ended June 30, 2001. The increase in gross revenues was due to the higher sales volume of the Lee® Lip-Ex® line of products, the added volume of newly acquired brands along with the introduction of private label sales revenue.
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The above increases were partially offset by the lower sales volume of depilatories ($86,000), Nosebetter® ($137,000), Take-Off® ($87,000) and other over-the-counter items.
Net revenues for the nine months ended June 30, 2002 were $6,902,000, an increase of $422,000 or 7% from the comparable nine months ended June 30, 2001. The increase in net revenues was due to the higher sales volume of the Lee® Lip-Ex® line of products, the added volume of newly acquired brands along with the introduction of private label sales revenue. The above increases were partially offset by the lower sales volume of depilatories ($128,000), Nosebetter® ($150,000), Take-Off® ($81,000), and other OTC items. The Company’s sales returns increased $29,000 or 5% when comparing fiscal years 2002 and 2001. The Company experienced the discontinuance of a few of its SKU’s (stock keeping units) at the retail store level in certain territories of the country.
Cost of sales as a percentage of gross revenues for the nine months ended June 30, 2002, as compared to the nine months ended June 30, 2001, remained consistant at 46%.
Selling and advertising expenses increased $409,000, or 23% when comparing the nine months ended June 30, 2002 with the nine months ended June 30, 2001. The increase in expenses was due to the following factors: 1) increase in bad debt expense ($108,000), (2) higher salesmen salaries and related fringe benefits due to the hiring of a higher salaried salesman who replaced lower salaried sales personnel plus added temporary help ($82,000), (3) increased freight costs ($65,000), (4) higher sales force commissions/bonuses resulting from increased sales to convenience store accounts and private label business ($39,000), and (5) added commissions ($47,000) due to added manufacturer representatives covering territories that were previously open, and higher royalty expenses from new acquisitions ($45,000).
General and administrative expenses increased $37,000, or 4%, when comparing the nine months ended June 30, 2002, with the nine months ended June 30, 2001. The increase in expense was related to higher consulting service fees ($42,000), increased general supplies expense ($31,000) and higher costs related to stockholders meeting, annual reports, etc. ($9,000). The above increases were partially offset by lower general legal fees ($29,000) and reduced building rental expenses ($23,000). The rental income from subtenants, subleasing three of the Company’s facilities, offsets the rental expense on the master lease.
Interest expense decreased $44,000, or 7%, when comparing the nine months ended June 30, 2002, with the nine months ended June 30, 2001. The decrease was due to lower average prime interest rate (4.86% vs. 8.44%) in reference to certain loans which are tied to prime.
Liquidity and Capital Resources
At June 30, 2002, working capital was a negative $2,109,000 compared with a negative $1,750,000 as of September 30, 2001. The ratio of current assets to current liabilities was .6 to 1 at June 30, 2002, and .7 to 1 at September 30, 2001. The increase in the Company’s negative working capital was primarily due to a decrease in accounts receivable and an increase in the current portion of long term borrowings and accounts payable.
The Company has an accumulated deficit of $7,377,000. Although the Company experienced nominal net income in fiscal years 2000 and 2001, past recurring losses and inability to generate sufficient cash flow from normal operations to meet its obligations as they become due, raises substantial doubt about the Company’s ability to continue as a going concern. The Company’s ability to continue in existence is dependent upon future developments, including retaining current financing and achieving a level of profitable operations sufficient to enable it to meet its obligations as they become due.
Environmental Matters
The Company owns a manufacturing facility located in South El Monte, California. The California Regional Water Quality Control Board (The “RWQCB”) ordered the Company in 1988 and 1989 to investigate the contamination on its property (relating to soil and groundwater contamination). The Company engaged a consultant who performed tests and reported to the then Chairman of the Company. The Company resisted further work on its property until the property upgradient was tested in greater detail since two “apparent source” lots had not been tested. On August 12, 1991, the RWQCB issued a “Cleanup and Abatement Order” directing the Company to conduct further testing and cleanup the site. In October 1991, the Company received from an environmental consulting firm an estimate of $465,200 for investigation and cleanup costs. The Company believed
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that this estimate was inconclusive and overstated the contamination levels. The Company believes that subsequent investigations will support the Company’s conclusions about that estimate. The Company did not complete the testing for the reasons listed above as well as “financial constraints”. In June 1992, the RWQCB requested that the EPA evaluate the contamination and take appropriate action. At the EPA’s request, Ecology & Environment, Inc. conducted an investigation of soil and groundwater on the Company’s property. Ecology & Environment Inc.’s Final Site Assessment Report, which was submitted to the EPA in June 1994, did not rule out the possibility that some of the contamination originated on-site, and resulted from either past or current operations on the property.
On April 24, 2002, the RWQCB notified the Company that the detection of emergent chemicals in groundwater, above State and Federal maximum containment levels or action levels, has caused the RWQCB and the EPA to reassess the threat posed to groundwater resources used for domestic supply. The RWQCB directed the Company to test for the presence of emergent chemicals in its groundwater monitoring wells. The groundwater monitoring analytical results were due by July 15, 2002. On May 24, 2002, the Company informed RWQCB that it could not comply with the requirement to conduct groundwater sampling due to ongoing financial difficulties.
On July 8, 2002, the RWQCB sent a “Second Notice of Violation” to the Company directing the Company to comply with the requirement to prepare a groundwater remedial action plan (RAP). The Company previously notified the RWQCB that it could not comply with the requirement to submit a RAP because of ongoing financial difficulties. The RWQCB requested that the Company submit certain financial information by July 29, 2002 to “substantiate any alleged financial losses and determine whether any suspension of implementating the...(Cleanup and Abatement Order) is warranted.” The Company has received an extension to submit the required financial information to August 19, 2002. The Company may be liable for all or part of the costs of remediating the contamination on its property and could be subject to enforcement action by the RWQCB, including injunctive and civil monetary remedies.
The Company and nearby property owners, in consort with their comprehensive general liability (CGL) carriers, engaged a consultant to perform a site investigation with respect to soil and shallow groundwater contamination over the entire city block. The CGL carriers provided $290,000 in funding which paid for the $220,000 study, $20,000 in legal fees for project oversight, and a $50,000 balance in the operating fund. Earlier the Company had accrued $87,500 as its proportionate share of the earlier quote of $175,000. Since that time, the overall scope of the project was increased to $205,000 plus $15,000 for waste water disposal, bringing the total to the above listed $220,000. The $87,500 accrual was not spent on this project (as the entire cost was borne by the CGL carriers), but remains on the books as an accrual against the cost of remediation of the same site that was included in the study.
The tenants of nearby properties upgradient have sued the Company alleging that hazardous materials from the Company’s property caused contamination on the properties leased by the tenants. The case name is Del Ray Industrial Enterprises, Inc. v. Robert Malone, et al., Los Angeles County Superior Court, Northwest District, commenced August 21, 1991. In this action, the plaintiff alleges environmental contamination by defendants of its property, and seeks a court order preventing further contamination and monetary damages. The Company does not believe there is any basis for the allegations and is vigorously defending the lawsuit.
The Company’s South El Monte manufacturing facility is also located over a large area of possibly contaminated regional groundwater which is part of the San Gabriel Valley Superfund Site. The Company 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 cleanup costs for the South El Monte’s portion of the San Gabriel Valley Superfund Site to be $30 million. The Company’s potential share of such amount has not been determined. Superfund PRPs are jointly and severally liable for superfund site costs, and are responsible for negotiating among themselves the allocation of the costs based on, among other things, the outcome of environmental investigation.
In August 1995, the Company was informed that the EPA entered into an Administrative Order of Consent with Cardinal Industrial Finishes (“Cardinal”) for a PRP lead remedial investigation and feasibility study (the “Study”) which, the EPA states, will both characterize the extent of groundwater contamination in South El Monte and analyze alternatives to control the spread of contamination. The Company and others entered into the South El Monte Operable Unit Site Participation Agreement with Cardinal pursuant to which, among other things, Cardinal contracted with an environmental firm to conduct the Study. The Study has been completed. The Company’s share of the cost of the Study was $15,000 and was accrued for in the financial statements as of September 30, 1995. The South El
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Monte Operable Unit (SEMOU) participants developed four remedial alternatives. The capital cost of the four alternatives range 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 a 30-year period, the total cost of the four alternatives range from $0 (no action) up to $13.05 million. The EPA prefers 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 up to approximately $9.09 million. The selection of the actual alternative implemented is subject to public comment. At the present time, the Company does not know what its share of the cost may be, if any. Therefore, no additional accrual has been recognized as a liability on the Company’s books. The Company requested that the EPA conduct an “ability-to-pay evaluation” to determine whether the Company is entitled to an early settlement of this matter based upon a limited ability to pay costs associated with site investigation and remediation. In August 2000, the EPA informed the Company that it does not qualify for an early settlement at this time.
The EPA has informed the Company that it has learned that the intermediate zone groundwater contamination in the western portion of the SEMOU has migrated further west and has now impacted the City of Monterey Park and Southern California Water Company production wells. The EPA stated that the City of Monterey Park Water Department, San Gabriel Valley Water Company and Southern California Water Company are planning to build treatment facilities for their wells. The EPA stated that these three water purveyors contacted some of the SEMOU PRPs, other than the Company, to seek funding to develop groundwater treatment facilities for the contaminated wells. A group of these PRPs calling themselves the “South El Monte Cooperative Group” has been formed and purportedly has reached a general agreement with the water purveyors to fund the development of treatment facilities and use the water purveyors’ wells in an attempt to contain the groundwater contamination to meet EPA’s goals. At this time, the EPA has not reviewed or approved any specific plan to address contamination at the purveyor wells, nor has the EPA compromised its right to recover response costs from any person who is legally responsible for contamination within the SEMOU. As of the date of this report, the Company has not been contacted by the South El Monte Cooperative Group in respect to its participation in any proposed cleanup activity. As a result, the Company is not able to determine what contribution, if any, it may be assessed in connection with this cleanup activity.
By letter dated November 13, 2000, the Company was notified that the City of Monterey Park, San Gabriel Valley Water Company and Southern California Water Company intend to bring suit under the Safe Drinking Water and Toxic Enforcement Act of 1986 alleging that the Company has knowingly released volatile organic compounds in the soil and shallow ground water beneath the Company’s property between at least on or before November 8, 1996 and the present and has failed to promptly clean up all of the contamination. As of the date of this 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 the San Gabriel Valley. The San Gabriel Valley has been declared a Superfund site. The 1995 Water Quality Control Plan issued by the California Regional Water Quality Control Board states that the primary groundwater basin pollutants in the San Gabriel Valley are volatile organic compounds from industry, nitrates from subsurface sewage disposal and past agricultural activities. In addition, the Plan noted that hundreds of underground storage tanks leaking gasoline and other toxic chemicals have existed in the San Gabriel Valley. The California Department of Toxic Substance Control has declared large areas of the San Gabriel Valley to be environmentally hazardous and subject to cleanup work.
The Company believes the City of South El Monte does not appear to be located over any of the major plumes. However, the EPA has announced it is studying the possibility that, although the vadose soil and groundwater, while presenting cleanup problems, there may be a contamination by DNAPs (dense non-aqueous phase liquids), i.e., “sinkers”, usually chlorinated organic cleaning solvents. The EPA has proposed to drill six “deep wells” throughout the City of South El Monte at an estimated cost of $1,400,000. The EPA is conferring with SEMPOA (South El Monte Property Owners Association) as to cost sharing on this project. SEMPOA has obtained much lower preliminary cost estimates. The outcome cost and exact scope of this are unclear at this time.
The Company and other property owners engaged Geomatrix Consultants, Inc., to do a survey 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 the impact of volatile organic compounds on the soil and groundwater at the Lidcombe 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 upgradient neighbor. The Report was submitted to the RWQCB for its comments and response. A
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meeting with the parties and RWQCB was held on February 10, 1998. The RWQCB had advised companies that vadose soil contamination is minimal and requires no further action. However, there is an area of shallow groundwater which has a higher than desired level of chlorinated solvents, and the RWQCB requested a proposed work plan be submitted by Geomatrix. Geomatrix has submitted a “Focused Feasibility Study” which concludes that there are five possible methods for cleanup. The most expensive are for a pump and sewer remediation which would cost between $1,406,000 and $1,687,000. The Company is actively exploring the less expensive alternative remediation methods, of which the two proposed alternatives range in cost between $985,000 and $1,284,000. Since there are four economic entities involved, the Company’s best estimate at this time, in their judgment, would be that their forecasted share would be $287,000 less the liability already recognized on the books of $165,000 thereby requiring an additional $122,000 liability. Accordingly, the Company recorded an additional 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 following paragraph.
The $79,000 accrual, in the third quarter of fiscal 1998, related to the Monterey Site is not included in the $287,000 figure above. In April 2000, the Company received a Notice of Violation from the RWQCB. The Notice of Violation states that the Company and other property owners were required to submit a groundwater remedial action plan by November 1, 1999, and that the RWQCB has been advised that the Company and the other property owners were unable to submit the required remedial action plan because the Company and the other property owners could not agree on the allocation of financial responsibility to prepare the action plan. The RWQCB stated that it will no longer encourage the cooperative approach among the Company and the other property owners in completing the cleanup requirements and will pursue appropriate measures, including when necessary, enforcement actions. The RWQCB states that it may impose civil liability penalties of up to $1,000 per day from November 1, 1999 for failure to file the action plan. In light of these events, no assurances can be given that the cleanup costs and possible penalties will not exceed the amount of the Company’s current accruals of $287,000 (which includes the $122,000 charge to income in the third quarter of fiscal 1998).
In July 2000, the property owners formed the Lidcombe & Santa Anita Avenue Work Group (LSAAW) in response to the RWQCB request for the preparation of an action plan. The LSAAW submitted a Focused Feasibility Study to the RWQCB for their review and approval of the selected remedial action method for the site. After receiving RWQCB approval, LSAAW obtained three cost proposals to implement the RWQCB approved pump and treat remedial method. According to these cost proposals, the lowest estimated costs for an assumed five (5) years of pump and treat remediation is $600,000. This cost is lower than the previous cost proposed work plan, discussed above, from Geomatrix Consultants, Inc. The capital costs including contingencies are approximately $300,000.
The LSAAW is hopeful the Water Quality Authority (WQA) is willing and able to reauthorize its grant for one-half (1/2) of the capital costs of its remediation system construction not to exceed $150,000. It is estimated at this time that the reserves for the Company’s share of this cost proposal are adequate since its prior accrual was based on the higher cost estimate from Geomatrix.
Without any prior correspondence or inkling of the Company’s potential liability, the EPA informed the Company that the Company may have potential liability for the ongoing remediation of Operating Industries, Inc. (as they have gone out of business) Landfill Superfund Site in Monterey Park, California (the “Monterey Site”). The Monterey Site is a 190 acre landfill that operated from 1948 to 1984, in which the Company disposed of non toxic pH balanced waste water on six occasions between 1974 and 1978. Over 4,000 companies have been identified as having contributed waste to the Monterey Site. The EPA has offered to settle the Company’s potential liability with respect to the Monterey Site for a cost to the Company of $79,233. The Company accrued a $79,000 charge in the third quarter of fiscal 1998 with respect to this possible liability. The Company has elected to file for relief from these obligations under the financial hardship option in the EPA’s response form. On June 30, 2000, the EPA informed the Company that the EPA believed the Company is able to pay the full settlement cost, but offered to reduce the amount of the settlement to $75,271.
The Company was notified by the EPA that the Company may have potential liability for 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 operational from 1973 to 1989, and over 10,000 separate parties disposed of waste there. The EPA stated that federal, state and local governmental agencies along with the numerous private entities that used the Site for waste disposal will be expected to pay their share as part of this settlement. The U.S. EPA is also pursuing the owner(s)/operator(s) of the Site to pay for Site remediation. The EPA has a settlement offer to the Company with respect to the Site for a
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cost of $373,950. The Company accrued a $374,000 charge in the first quarter of fiscal 1999 with respect to this possible liability. The Company has elected to file for relief from these obligations under the financial hardships option in the EPA’s response form. The Company, the EPA and certain PRPs have entered into an agreement tolling the applicable statutes of limitation. The Company has been notified 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 estimated share down to $245,000 (from $374,000) and of that, the EPA was requesting that the Company pay $113,000, as a result of their findings on the application for waiver due to financial hardship. The Company is considering the EPA’s request.
The total amount of environmental investigation and cleanup costs that the Company may incur with respect to the foregoing is not known at this time. However, based upon information available to the Company at this time, the Company has expensed since 1988 a total of $860,000, of which $89,000 were legal fees, exclusive of legal fees expended in connection with the SEC environmental investigation. The actual costs could differ materially from the amounts expensed for environmental investigation and cleanup costs to date.
As of June 30, 2002, no additional amounts have been incurred and no settlements have been reached.
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PART II - Other Information
Item 1. Legal Proceedings
The information set forth under Part I, Item 2, “Management’s Discussion and Analysis or Plan of Operations - Environmental Matters” is incorporated herein by reference. See also “Legal Proceedings” in the Company’s Form 10-KSB for the fiscal year ended September 30, 2001.
Item 6. The following exhibits are filed herewith:
10.1 - Promissory note evidencing advance made to the Registrant
10.2 - Promissory note evidencing advance made to the Registrant
10.3 - Promissory note evidencing advance made to the Registrant
10.4 - Promissory note evidencing advance made to the Registrant
10.5 - Promissory note dated April 23, 2002, betwen Lee Pharmaceuticals and U.S. Dermatologics, Inc.
The following exhibits have previously been filed by the Company:
3.1 - Articles of Incorporation, as amended (1)
3.4 - By-laws, as amended December 20, 1997 (2)
3.5 - Amendment of By-laws effective March 14, 1978 (2)
3.6 - Amendment to By-laws effective November 1, 1980 (3)
(1) Filed as an Exhibit of the same number with the Company’s Form S-1 Registration Statement filed with the Securities and Exchange Commission on February 5, 1973, (Registrant No. 2-47005), and incorporated herein by reference.
(2) Filed as Exhibits 3.4 and 3.5 with the Company’s Form 10-K Annual Report for the fiscal year ended September 30, 1978, filed with the Securities and Exchange Commission and incorporated herein by reference.
(3) Filed as an Exhibit of the same number with the Company’s Form 10-K Annual Report for the fiscal year ended September 30, 1979, filed with the Securities and Exchange Commission and incorporated herein by reference.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Acts of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| LEE PHARMACEUTICALS |
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Date: | August 14, 2002 |
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| RONALD G. LEE | ||
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| Ronald G. Lee | ||
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| Chairman of the Board, President and |
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