UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2004 |
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OR |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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) | ||
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(626) 442-3141 | ||
(Issuer’s telephone number) | ||
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N/A | ||
(Former name, former address and former fiscal year, if changed since last report) |
As of June 30, 2004 there were outstanding 4,135,162 shares of common stock of the registrant.
Transitional Small Business Disclosure Format (check one):
Yeso Noý
LEE PHARMACEUTICALS
BALANCE SHEET
JUNE 30, 2004
(Dollars in thousands)
(Unaudited)
Assets |
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Cash |
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| $ | 18 |
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Accounts and notes receivable (net of allowances: $509) |
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| 250 |
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Inventories (net of reserves: $555) |
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Raw materials |
| $ | 1,948 |
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Work in process |
| 167 |
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Finished goods |
| 560 |
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Total inventories |
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| 2,675 |
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Other current assets |
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| 372 |
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Total current assets |
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| 3,315 |
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Property, plant and equipment (less accumulated depreciation and amortization: $5,602) |
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| 689 |
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Intangibles and other assets (net of accumulated amortization: $2,470 and impairment: $952) |
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| 1,780 |
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TOTAL |
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| $ | 5,784 |
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See Accompanying Notes to Financial Statements.
2
LEE PHARMACEUTICALS
BALANCE SHEET
JUNE 30, 2004
(Dollars in thousands)
(Unaudited)
LIABILITIES |
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Bank overdraft |
| $ | 97 |
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Notes payable - finance company |
| 830 |
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Current portion - notes payable, other |
| 2,202 |
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Current portion - note payable related party |
| 1,000 |
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Accounts payable |
| 906 |
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Other accrued liabilities |
| 813 |
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Environmental cleanup liability |
| 366 |
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Due to related parties |
| 1,607 |
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Deferred income |
| 191 |
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Total current liabilities |
| 8,012 |
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Long-term notes payable to related parties |
| 1,523 |
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Long-term notes payable - finance company |
| 107 |
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Long-term notes payable, other |
| 1,091 |
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Environmental cleanup liability - Casmalia Site |
| 374 |
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Deferred income |
| 167 |
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Total long-term liabilities |
| 3,262 |
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Total liabilities |
| 11,274 |
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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) |
| (10,125 | ) | |
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Total stockholders’ (deficit) |
| (5,490 | ) | |
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TOTAL |
| $ | 5,784 |
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See Accompanying Notes to Financial Statements.
3
LEE PHARMACEUTICALS
STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
(Unaudited)
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| For the Three Months |
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| 2004 |
| 2003 |
| 2004 |
| 2003 |
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Gross revenues |
| $ | 1,810 |
| $ | 2,430 |
| $ | 7,183 |
| $ | 7,946 |
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Less: | Sales returns |
| (111 | ) | (159 | ) | (840 | ) | (708 | ) | ||||
| Cash discounts and others |
| (19 | ) | (22 | ) | (78 | ) | (85 | ) | ||||
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Net revenues |
| 1,680 |
| 2,249 |
| 6,265 |
| 7,153 |
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Costs and expenses: |
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Cost of sales |
| 979 |
| 1,348 |
| 3,762 |
| 3,931 |
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Selling and advertising expense |
| 686 |
| 666 |
| 2,175 |
| 2,133 |
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General and administrative expense |
| 322 |
| 309 |
| 960 |
| 970 |
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Interest expense |
| 219 |
| 221 |
| 647 |
| 664 |
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Total costs and expenses |
| 2,206 |
| 2,544 |
| 7,544 |
| 7,698 |
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Loss from operations |
| (526 | ) | (295 | ) | (1,279 | ) | (545 | ) | |||||
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Other income |
| 94 |
| 74 |
| 381 |
| 270 |
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Net (loss) |
| $ | (432 | ) | $ | (221 | ) | $ | (898 | ) | $ | (275 | ) | |
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Per share: |
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Basic and diluted (loss) per share |
| $ | (.11 | ) | $ | (.05 | ) | $ | (.22 | ) | $ | (.07 | ) |
See Accompanying Notes to 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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| 2004 |
| 2003 |
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Cash flows (used in) provided by operating activities: |
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Net (loss) |
| $ | (898 | ) | $ | (275 | ) |
Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation |
| 147 |
| 123 |
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Amortization of intangibles |
| 195 |
| 149 |
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(Decrease) in deferred income |
| (195 | ) | (113 | ) | ||
Change in operating assets and liabilities: |
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Decrease in accounts receivable, net |
| 330 |
| 104 |
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(Increase) in inventories |
| (169 | ) | (153 | ) | ||
(Increase) decrease in deposits |
| (16 | ) | 35 |
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(Increase) decrease in other current assets |
| (27 | ) | 22 |
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(Decrease) increase in bank overdraft |
| (3 | ) | 152 |
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Increase in accounts payable and accrued liabilities |
| 286 |
| 494 |
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(Decrease) increase in due to related parties |
| (112 | ) | 21 |
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Net cash (used in) provided by operating activities |
| (462 | ) | 559 |
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Cash flows from investing activities: |
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Additions to property , plant and equipment |
| (181 | ) | (273 | ) | ||
(Decrease) in due on investment acquisitions |
| — |
| (215 | ) | ||
Net cash (used in) investing activities |
| (181 | ) | (488 | ) | ||
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Cash flows from financing activities: |
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Proceeds from notes payable to related party |
| 330 |
| 93 |
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(Payments on) notes payable to related party |
| (112 | ) | (89 | ) | ||
(Decrease) in notes payable, finance company |
| (39 | ) | (256 | ) | ||
Proceeds from notes payable, other |
| 550 |
| 800 |
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(Payments on) notes payable, other |
| (84 | ) | (617 | ) | ||
Net cash provided by (used in) financing activities |
| 645 |
| (69 | ) | ||
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Net increase in cash |
| 2 |
| 2 |
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Cash, beginning of period |
| 16 |
| 26 |
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Cash, end of period |
| $ | 18 |
| $ | 28 |
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Supplemental disclosures of cash flow information: |
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Cash paid during the year for: |
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Interest |
| $ | 184 |
| $ | 593 |
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Taxes |
| $ | 1 |
| $ | 1 |
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See Accompanying Notes to Financial Statements.
5
LEE PHARMACEUTICALS
Notes to Financial Statements
(Unaudited)
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 (except as set forth in Note 5) 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, 2003. 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 13 of Notes to Financial Statements included in the Company’s Form 10-KSB for the fiscal year ended September 30, 2003. 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. As of June 30, 2004, no settlements have been reached.
2. Continued existence:
The financial statements have been prepared assuming that the Company will continue as a going concern. The Company has an accumulated deficit of $10,125,000. The Company’s recurring losses from operations and inability to generate sufficient cash flow from normal operations to meet its obligations as they come due raise 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. Management’s plans in regard to these matters are to increase profitability by increasing sales, control expenses and seek additional financing from outside lenders. The financial statements do not include any adjustments to reflect the possible future effects of 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.
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4. Reclassification:
Certain reclassifications have been made to the prior year financial statements to be consistent with the 2004 presentation.
5. Impairment of intangible assets:
At June 30, 2004, the Company had $5.1 million of product line and certain identifiable intangibles. In assessing the recoverability of these intangibles, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If the estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets not previously recorded. In connection with the adoption of SFAS 142 issued in July 2001, the Company performed an impairment assessment for the nine months ended June 30, 2004, using a twelve month moving average, and determined that an incorrect formula was used during the quarter ended March 31, 2004 resulting in a $90,000 overcharge. This was adjusted in the quarter ended June 30, 2004.
6. Loss 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 (loss) per share under SFAS 128 were computed using the weighted average number of shares outstanding of 4,135,162 for the nine months ended June 30, 2004 and June 30, 2003.
7. Other income:
For the nine months ended June 30, 2004, other income included realized gains of approximately $195,000 related to the sale of three product lines. These realized gains pertain to the recognition of the earned portion of the deferred income of the consulting agreements arising from the sale of these product lines. Also included is $187,000 arising from a service agreement with Monticello Drug Company. For the nine months ended June 30, 2003, other income consisted of realized gains as described above of $112,000, joint venture income of $143,000 and $15,000 in property tax refunds.
For the quarter ended June 30, 2004, other income included realized gains of approximately $56,000 related to the sale of three product lines. These realized gains pertain to the recognition of the earned portion of the deferred income of the consulting agreements arising from the sale of these product lines. Also included is $39,000 arising from a service agreement with Monticello Drug Company. For the quarter ended June 30, 2003, other income consisted of realized gains as described above of $37,000 and joint venture income of $39,000.
8. Income taxes:
At June 30, 2004, the Company has a Federal net operating loss (NOL) carry forward of approximately $14,750,000 for which it has recorded a valuation allowance for the entire NOL.
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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, 2004, and June 30, 2003
Gross revenues for the three months ended June 30, 2004, were $1,810,000, a decrease of $620,000, or 26%, from the comparable three months ended June 30, 2003. The decrease was due to lower sales of various over-the-counter items ($292,000), the Lee® Lip-Ex® line ($213,000), private label segment ($104,000), depilatories ($26,000) and Lee Nails® category ($54,000). These decreases were somewhat offset by increases in other over-the-counter items ($66,000) along with a newly acquired brand ($46,000).
Net revenues declined approximately $569,000, or 25%, for the three months ended June 30, 2004, as compared to the three months ended June 30, 2003. The change in net revenues was primarily due to the explanations given above. The Company’s sales returns decreased $48,000, or 30%, when comparing the three months ended June 30, 2004 and 2003. The Company experienced lower product returns during the June 30, 2004 quarter when compared to the June 30, 2003 quarter because many of the overstocked items related to the over-the-counter items were returned during the quarter ended June 30, 2003.
Cost of sales as a percentage of gross revenues was 54% for the three months ended June 30, 2004, compared to 55% for the three months ended June 30, 2003. This decrease was primarily due to lower analytical testing costs, the result of more testing being done in house ($24,000) and lower equipment maintenance costs ($20,000). These reductions were somewhat offset by higher laboratory supplies due to additional in-house testing ($5,000), higher depreciation ($4,000) due to additional equipment, higher freight costs ($8,000) and higher workers’ compensation insurance premiums ($3,000). The continued change in the overall product mix, particularly pertaining to lower gross margin items, has caused fluctuations in the Company’s cost of sales percentage.
Selling and advertising expenses increased $20,000, or 3%, when comparing the three months ended June 30, 2004 and June 30, 2003. This increase was due primarily to higher advertising costs ($78,000), higher salaries and related fringe benefits due to the hiring of an additional salesman ($33,000), higher insurance expense due to increased premiums for product liability insurance ($25,000) and higher building rent due to a building previously subleased now being used for warehouse and shipping $21,000). Somewhat offsetting these increases were lower freight costs due to lower sales volume ($23,000) and lower bad debt expense due to an increase in the reserve of $25,000 in the quarter ended June 30, 2003, with no similar increases in the quarter ended June 30, 2004. Also, the Company overstated the recognition of its asset impairment adjustment during the March 31, 2004 quarter due to the incorrect application of an impairment formula. The Company reversed a portion of the overstated charge to expense ($90,000) during the quarter ended June 30, 2004.
General and administrative expenses increased $13,000, or 4%, when comparing the three months ended June 30, 2004 and June 30, 2003. The increase was due to higher labor costs and related fringe benefits for annual salary reviews and additional personnel ($9,000) and increased travel and entertainment expenses ($6,000).
Interest expense was relatively constant when comparing the three months ended June 30, 2004 with the three months ended June 30, 2003.
The Company realized other income of approximately $94,000 for the three months ended June 30, 2004, as compared to $74,000 for the comparable three months ended June 30, 2003. Of this income for the three months ended June 30, 2004, $56,000 pertains to realized gains related to the sale of the Klutch® product line ($13,000), the sale of the Astring-o-Sol® product line ($11,000) and the sale of the iodex® product line ($32,000). The realized gains pertain to the recognition of the earned portion of the deferred income of the consulting agreements arising from the sale of the Klutch®, Astring-o-Sol® and iodex® brands. Also included in other income in 2004 is approximately $39,000 arising from the service agreement with Monticello Drug Company. For the three months ended June 30, 2003, the Company realized other income related to the sale of Klutch® ($26,000) and Astring-o-Sol® ($11,000) product lines along with $39,000 which was the Company’s portion of the net profits from its investment with Monticello Drug Company.
8
Material Changes in Results of Operations
Nine Months Ended June 30, 2004, and June 30, 2003
Gross revenues for the nine months ended June 30, 2004, were $7,183,000, a decrease of $763,000, or 10%, from the comparable nine months ended June 30, 2003. The decrease was due to lower sales in various over-the-counter brand products ($890,000), the Lee® Lip-Ex® line ($359,000) and Lee Nails® category (105,000). Somewhat offsetting these decreases were increases of other over-the-counter items ($314,000), private label segment ($148,000) and a newly acquired brand ($146,000).
Net revenues declined approximately $888,000, or 12%, for the nine months ended June 30, 2004, as compared to the nine months ended June 30, 2003. The change in net revenues was primarily due to the sales volume explanations given above. The Company’s sales returns increased $132,000, or approximately 19%, when comparing the nine months ended June 30, 2004 and 2003. The higher sales returns were due to the deletion of a couple of the Company’s SKUs (stock keeping units) at the retail store level.
Cost of sales as a percentage of gross revenues was 52% for the nine months ended June 30, 2004, compared to 50% for the nine months ended June 30, 2003. The Company has continued to experience changes in the overall product mix along with lower priced commodity-type goods with an accompanying higher cost of goods attached to them. This increase is primarily due to the continued change in the product mix to higher cost of goods products resulting in lower gross margins for these products. In addition, the Company increased its inventory obsolescence reserve ($132,000) during the three months ended March 31, 2004. The Company also incurred higher manufacturing overhead expenses of $24,000 for depreciation of newly acquired equipment, $16,000 in equipment repairs and maintenance along with supplies expense and $13,000 in workers’ compensation insurance costs due to higher premium rates. These increased costs were partially offset by lower analytical testing costs ($48,000) due to more testing being performed in-house and lower freight costs ($15,000).
Selling and advertising expenses increased $42,000, or 2%, when comparing the nine months ended June 30, 2004 with the nine months ended June 30, 2003. The increase in expenses was due to the following factors: (1) higher insurance expense due to increased premiums for product liability coverage ($89,000), (2) higher building rent due to a building, previously subleased, now being used for warehousing and shipping ($64,000), (3) higher labor and related fringe benefit costs ($54,000), (4) higher amortization costs ($46,000) due to the recognition of impairment of one of the Company’s product lines in compliance with the Financial Accounting Standards Board issuance of Statement of Financial Accounting Standards No. 142 (FAS-142), Goodwill and Other Intangible Assets and (5) higher advertising costs ($43,000). These increases were somewhat offset by: (1) lower commissions to outside sales reps ($37,000), (2) lower royalty expense ($81,000), (3) lower convention expenses ($7,000), (4) lower freight costs ($86,000) and (5) lower travel and entertainment expenses ($28,000).
General and administrative expenses decreased $10,000, or 1%, when comparing the nine months ended June 30, 2004, with the nine months ended June 30, 2003. The decrease was principally due to: (1) lower legal fees ($42,000) and (2) lower MIS expenses for consulting services ($46,000). These decreases were partially offset by (1) higher audit fees ($13,000), (2) increased costs for various supplies ($40,000), (3) increased travel and entertainment expenses ($7,000), (4) increased workers’ compensation insurance premiums ($5,000) and (6) increased shareholder expenses ($4,000).
Interest expense decreased $17,000, or 3%, when comparing the nine months ended June 30, 2004, with the nine months ended June 30, 2003. This was due principally to lower borrowings.
9
The Company realized other income of approximately $381,000 for the nine months ended June 30, 2004, as compared to $270,000 for the comparable nine months ended June 30, 2003. Of this income, $194,000 pertains to realized gains related to the sale of the Klutch® product line ($67,000), the sale of the Astring-o-Sol® product line ($32,000) and the sale of the iodex® product line ($95,000). The realized gains pertain to the recognition of the earned portion of the deferred income of the consulting agreements arising from the sale of the Klutch®, Astring-o-Sol® and iodex® brands. Also included in other income is approximately $187,000 arising from the service agreement with Monticello Drug Company. For the nine months ended June 30, 2003, the Company realized other income related to the sale of Klutch® ($81,000) and Astring-o-Sol® ($32,000) product lines along with $144,000 which was the Company’s portion of the net profits from its investment with Monticello Drug Company plus $15,000 of property tax refunds.
Liquidity and Capital Resources
At June 30, 2004, working capital was a negative $4,697,000 compared with a negative $3,525,000 as of September 30, 2003. The ratio of current assets to current liabilities was 0.4 to 1 at June 30, 2004 and 0.5 to 1 at September 30, 2003. The Company has failed to make principal and interest payments on certain loans. The total arrearage is principal of $2,178,000 plus interest of $1,152,000, an aggregate of $3,330,000 of which $1,889,000 is due to related parties and $1,441,000 to non related parties. The Company is negotiating the sale of one or more of its product lines. If these sales occur, an amount of $1,084,000 of principal and interest, due as of June 30, 2004, will be paid to two non related party investors. There can be no guarantee that this transaction will materialize.
The Company has an accumulated deficit of $10,125,000. 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 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.
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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 implementing the...(Cleanup and Abatement Order) is warranted.” The Company received an extension to submit the required financial information to August 19, 2002. The Company submitted the requested financial information on August 16, 2002. The Company received a response whereby their request for financial hardship was denied. The Company is in the process of appealing this decision based primarily upon the continued deterioration in the Company finances since the original filing. 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. As of the date of the financial statements, the Company’s share of the costs have not been determined.
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 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
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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. 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 groundwater 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 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,
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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 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
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$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 Company has requested a reduced financial liability or waiver on the three EPA sites: SEMOU, Operating Industries, Inc. (OII) and Casmalia Disposal Site. The Company has continued to provide the information and documentation requested by the EPA as it relates to its ability to pay. In connection with this request, the Company understands that the EPA is considering the information.
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 Securities and Exchange Commission environmental investigation. The actual costs could differ materially from the amounts expensed for environmental investigation and cleanup costs to date.
As of June 30, 2004, no settlements have been reached. The total amount expensed in prior years relating to this environmental issue is $860,000. As of June 30, 2004, no additional amounts have been expensed or accrued. The Company has an accrued liability on the books at June 30, 2004 of $740,000 for the environmental cleanup.
Item 3. Controls and Procedures
The chief executive officer and chief financial officer of the Company (the “certifying officer”) evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. These disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in its periodic reports filed with the Securities and Exchange Commission (the “Commission”) is recorded, processed, summarized and reported, within the time periods specified by the Commission’s rules and forms, and that the information is communicated to the certifying officer on a timely basis.
The certifying officer concluded, based on his evaluation, that the Company’s disclosure controls and procedures are effective for the Company.
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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, 2003.
Item 3. Defaults Upon Senior Securities
The Company has failed to make principal and interest payments on certain loans. The total arrearage is principal of $2,178,000 plus interest of $1,152,000, an aggregate of $3,330,000 of which $1,889,000 is due to related parties and $1,441,000 to non related parties. The Company is negotiating the sale of one or more of its product lines. If these sales occur, an amount of $1,084,000 of principal and interest, due as of June 30, 2004, will be paid to two non related party investors. There can be no guarantee that this transaction will materialize.
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Item 6. Exhibits and Reports on Form 8-K:
The following exhibits are filed herewith:
10.1 | - | Promissory note evidencing advance made to the Registrant |
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10.2 | - | Modification of loan and security agreement dated May 20, 2004, between Lee Pharmaceuticals and Preferred Business Credit, Inc. regarding a revolving credit facility financing |
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10.3 | - | Demand promissory note evidencing advance made to the Registrant |
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31.1 | - | Certification by Chief Executive Officer and Chief Financial Officer |
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32.1 | - | Section 1350 Certification |
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The following exhibits have previously been filed by the Company: | ||
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3.1 | - | Articles of Incorporation, as amended (1) |
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3.4 | - | By-laws, as amended December 20, 1997 (2) |
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3.5 | - | Amendment of By-laws effective March 14, 1978 (2) |
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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.
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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| (Registrant) |
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Date: | AUGUST 9, 2004 |
| RONALD G. LEE |
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| Ronald G. Lee |
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| Chairman of the Board, President and Chief Financial and Accounting Officer |
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