LEE PHARMACEUTICALS

BALANCE SHEET

MARCH 31, 2005

(Dollars in thousands)

(Unaudited)

ASSETS
Cash			$	97

Accounts and notes receivable (net of allowances: $204)			921

Inventories (net of reserves: $841)
Raw materials	$	1,458
Work in process	53
Finished goods	484
Total inventories			1,995

Other current assets			509
Total current assets			3,522

Property, plant and equipment (less accumulated depreciation and amortization: $5,741)			804

Intangibles and other assets (net of accumulated amortization: $1,476 and impairment: $2,202)			1,518

TOTAL			$	5,844

See Accompanying Notes to Financial Statements.

LEE PHARMACEUTICALS

BALANCE SHEET

MARCH 31, 2005

(Dollars in thousands)

(Unaudited)

LIABILITIES

Notes payable - finance company	$	928
Current portion - notes payable, other	3,272
Current portion - note payable related party	1,404
Accounts payable - trade	1,049
Accounts payable - other	335
Accrued liabilities	593
Environmental cleanup liability	366
Due to related parties	1,571
Deferred income	149

Total current liabilities	9,667

Long-term notes payable to related parties	1,405
Long-term notes payable, other	175
Environmental cleanup liability - Casmalia Site	374
Deferred income	63

Total long-term liabilities	2,017

Total liabilities	11,684

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ (DEFICIT)

Common stock, $.10 par value; authorized, 7,500,00 shares; issued and outstanding, 4,135,162 shares	413

Additional paid-in capital	4,222

Accumulated (deficit)	(10,475		)

Total stockholders’ (deficit)	(5,840		)

TOTAL	$	5,844

See Accompanying Notes to Financial Statements.

LEE PHARMACEUTICALS

STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

		For the Three Months Ended March 31,						For the Six Months Ended March 31,
		2005			2004			2005			2004

Gross revenue		$	2,462		$	2,547		$	4,801		$	5,373
Other revenue		61			62			127			148
Less:	Sales returns	(140		)	(407		)	(274		)	(729		)
	Cash discounts and others	(26		)	(28		)	(52		)	(59		)

Net revenues		2,357			2,174			4,602			4,733

Costs and expenses:

Cost of sales		1,334			1,430			3,068			2,783
Selling and advertising expense		762			619			1,485			1,360
General and administrative expense		262			306			521			638
Intangible impairment expense		—			129			100			129

Total costs and expenses		2,358			2,484			5,174			4,910

Loss from operations		(1		)	(310		)	(572		)	(177		)

Other income (expense):

Interest expense		(151		)	(237		)	(300		)	(428		)
Gain on sale of product line		—			—			750			—
Miscellaneous		48			69			103			139

Total other income (expense)		(103		)	(168		)	553			(289		)

Net (loss)		$	(104	)	$	(478	)	$	(19	)	$	(466	)

Per share:

Basic and diluted (loss) per share		$	(.02	)	$	(.11	)	$	.00		$	(.11	)

See Accompanying Notes to Financial Statements.

LEE PHARMACEUTICALS

STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

	For the Six Months Ended March 31,
	2005			2004

Cash flows (used in) provided by operating activities:
Net (loss)	$	(19	)	$	(466	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	114			98
Amortization of intangibles	204			233
(Decrease) in deferred income	(97		)	(282		)
Gain on sale of product line	(750		)	—
Gain on sale of equipment	(5		)	—
Change in operating assets and liabilities:
Decrease (increase) in accounts receivable, net	91			(130		)
Decrease in inventories	184			126
(Increase) in deposits	(50		)	(46		)
Decrease (increase) in other current assets	69			(80		)
(Decrease) increase in accounts payable and accrued liabilities	(55		)	512
Increase (decrease) in due to related parties	152			(133		)
Net cash (used in) operating activities	(162		)	(168		)

Cash flows from investing activities:
Additions to property, plant and equipment	(92		)	(101		)
Gain on sale of product line	750			—
Gain on sale of equipment	5			—
Net cash provided by (used in) investing activities	663			(101		)

Cash flows from financing activities:
Proceeds from (payments on) notes payable to related party	13			(62		)
(Decrease) increase in notes payable, finance company	(298		)	129
Proceeds from notes payable, other	—			350
(Payments on) notes payable, other	(134		)	(60		)
(Decrease) in bank overdraft	(13		)	(100		)
Net cash (used in) provided by financing activities	(432		)	257

Net increase (decrease) in cash	69			(12		)
Cash, beginning of period	28			16
Cash, end of period	$	97		$	4

Supplemental disclosures of cash flow information:

Cash paid during the year for:
Interest	$	212		$	106
Taxes	$	1		$	1

See Accompanying Notes to Financial Statements.

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, 2004. 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, 2004. 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 March 31, 2005, no settlements have been reached.

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

	For the Three Months Ended March 31,						For the Six Months Ended March 31,
	2005			2004			2005		2004

Labor and fringe benefits	$		23,000	$		23,000	$	39,000	$	43,000
Freight	148,000			110,000			253,000		219,000
Building rental	17,000			30,000			47,000		60,000
Utilities and supplies	1,000			8,000			6,000		9,000

Totals	$	189,000		$	171,000		$	345,000	$	331,000

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

Name	Patent Number	Duration

Dental Restoration System & Method	US 5,695,340	17 years from 1997
Sculptured Nails	US 5,127,414	17 years from 1992

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

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

The shipments and returns of MDC are compiled on a weekly basis. From that net figure, a set percentage of gross sales for cash discounts, freight and the Company’s fees are deducted, and the balance due MDC is recorded as a payable. It is paid six weeks later. At the end of a quarter, or year end, a work sheet entry is made, removing MDC’s net invoicing for that month from the Company’s accounts receivable balance, and 85% of that figure is removed from the Company’s payable balance to MDC. The remaining 15%, which is the approximate amount of the above mentioned deductions, is set up as a current asset.

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

In NOTE 1 Segment reporting, page 20, of the Company’s Form 10-KSB for the year ended September 30, 2004, the Company reported two segments of business; namely, consumer personal care products and professional dental products. The consumer personal care products consists of approximately fifty (50) different brand names and many more private label items. Management feels that it is impracticable to report revenues from each of the products in the Company’s two segments.

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

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 $10,475,000. 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.

4. Reclassification:

Certain reclassifications have been made to the prior year financial statements to be consistent with the 2005 presentation.

5. Impairment of intangible assets:

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

6. Debt maturities schedule:

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

Year ending September 30,	Notes payable finance company		Related parties			Other			Total

2005	$	798,000	$		1,347,000	$	502,000		$	2,647,000
2006	130,000		120,000			2,800,000			3,050,000
2007	—		120,000			60,000			180,000
2008	—		120,000			60,000			180,000
2009	—		50,000			25,000			75,000
2010	—		1,052,000			—			1,052,000

Total	$	928,000	$	2,809,000		$		3,447,000	$		7,184,000

7. Earnings (loss) 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 three months and six months ended March 31, 2005 and March 31, 2004.

8. Other income:

For the six months ended March 31, 2005, other income included realized gains of approximately $98,000 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 $5,000 arising from the sale of equipment retired in prior years. For the six months ended March 31, 2004, other income consisted of realized gains as described above of $139,000.

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

9. Income taxes:

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

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

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

10. Subsequent event:

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

Item 2. Management’s Discussion and Analysis or Plan of Operations

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of liabilities, expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates are responsible.

Revenue and Expense Recognition

Income and expenses are recorded on the accrual basis of accounting. The Company recognizes revenues from sales when goods have been shipped, there are no material uncertainties regarding customer acceptance, collection of the resulting receivable is deemed probable and no other significant vendor obligations exist. Expenses are recognized when services have been performed or inventory items have been used. Chemical items are recognized as inventory once Quality Control testing is in compliance with the Company specifications.

Deferred Income

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

Inventory Obsolescence Allowance

Inventory allowances for obsolescence are recorded based upon a periodic review by the Company’s management of its inventory. The Company’s management will evaluate obsolete and slow moving inventory and determine their overall future salability and use in manufactured products. If the future salability and use in manufactured products of slow moving inventory are questionable, then an allowance is recorded based upon the lower of cost or market. If such inventory is determined to have no future salability or use, then such inventory will be written off. Changes in customer demand for certain products could impact the allowance for obsolete inventory.

Intangible Assets

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

Material Changes in Results of Operations

Three Months Ended March 31, 2005, and March 31, 2004

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

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

The cost of sales line item consists of material (including a provision for obsolete inventory if required), direct and indirect labor (and related fringe benefits) and related manufacturing overhead expenses. It also includes purchasing, receiving, inspection (quality control functions), warehousing costs and inbound freight.

Cost of sales as a percentage of gross revenues was 54% for the three months ended March 31, 2005, as compared to 56% for the three months ended March 31, 2004. This decrease was due primarily to a $132,000 increase in the inventory obsolescence reserve in March 2004 with no corresponding adjustment in 2005. The Company also incurred lower analytical testing costs of $38,000. Offsetting these decreases were increases in: (1) direct labor (additional temporary help) and overtime costs ($36,000), (2) depreciation ($10,000) and (3) workers’ compensation insurance premiums ($7,000). In addition, the continued change in the product mix to higher cost of goods products resulted in lower gross margins on sales of these related products.

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

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

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

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

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

Other expense was approximately $103,000 for the three months ended March 31, 2005, as compared to other expense of $168,000 for the comparable three months ended March 31, 2004. Interest expense for the three months ended March 31, 2005 was $151,000, a decrease of $86,000, or 36%, when comparing the three months ended March 31, 2005, with the three months ended March 31, 2004. The primary reason for this decrease was that in September 2004, the Company reached an agreement with a non-related party to consolidate eleven (11) of its notes payable and related unpaid interest totaling $2,176,000 with interest rates from 20% to 24% into one new note. The interest rate on the new note is the one month LIBOR (London Interbank Offered Rate) rate. The LIBOR rate at March 31, 2005 was 2.85%. Also included in other income is $48,000 pertaining to realized gains related to the sale of the Klutch® product line ($6,000), the sale of the Astring-o-Sol® product line ($10,000) 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 these product lines.

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

Material Changes in Results of Operations

Six Months Ended March 31, 2005, and March 31, 2004

Gross revenues for the six months ended March 31, 2005, were $4,801,000, a decrease of $572,000, or 11%, from the comparable six months ended March 31, 2004. The decrease was due to lower sales in various over-the-counter brand products ($452,000), private label segment ($145,000), depilatories ($132,000) and personal care items ($248,000). Partially offsetting these decreases was an increase in the Lee® Lip-Ex® lip balm category ($439,000).

Net revenues decreased approximately $131,000, or 3%, for the six months ended March 31, 2005, as compared to the six months ended March 31, 2004. The change in net revenues was due to the sales volume explanations given above and a decrease in the Company’s sales returns of approximately $455,000, or 62%, when comparing the six months ended March 31, 2005 and 2004. The Company experienced fewer returns of their SKUs (stock keeping units) at the retail store level during the six months ended March 31, 2005. Also, the Company increased its allowance for sales returns ($272,000) during the six months ended March 31, 2004, with no corresponding adjustment for the six months ended March 31, 2005. In addition, the Company reported a reduction in other revenue of $21,000, or 14%, when comparing the six months ended March 31, 2005 versus March 31, 2004. The Company reports its service distribution fee income related to a distribution agreement, with another company, as other revenue. The lower service distribution fee income, which is a percentage of the gross volume shipped on certain products, was less for the six months ended March 31, 2005, versus the comparable period ended March 31, 2004.

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

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

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

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

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

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

Liquidity and Capital Resources

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

The Company has an accumulated deficit of $10,475,000. 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.

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

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

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

It should be noted that included in the Company’s total liabilities of $11,684,000, the Lee family affiliates constitute $4,380,000, environmental $740,000 (subject to negotiation) and deferred income $212,000, for a total of $5,332,000, which represents 46% of the total liabilities. This liability gives the Company a certain amount of latitude as to when payment of principal and/or interest are made.

All of the Company’s building leases are with two individuals, one of whom is the President and Chairman of the Company. The Company is in the process of exercising its option to extend the terms of the leases, which currently expire in November 2005. When the options are exercised, the leases will be extended to November 2010.

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 clean up 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.

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 has 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, and it 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 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, 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 a 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 $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 March 31, 2005, no settlements have been reached. The total amount expensed in prior years relating to this environmental issue is $860,000. As of March 31, 2005, no additional amounts have been expensed or accrued. The Company has an accrued liability on the books at March 31, 2005 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, 2004.

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 $1,622,000 plus interest of $1,147,000, an aggregate of $2,769,000, of which $2,048,000 is due to related parties and $721,000 to non-related parties.

Item 4. Submission of Matters to a Vote of Security Holders

The Annual Meeting of Stockholders of the registrant occurred on March 8, 2005. At that meeting, the following directors were elected:

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

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

Item 6. Exhibits and Reports on Form 8-K:

The following exhibits are filed herewith:

10.1	-	Promissory note which was modified in February 2005, evidencing advance made to the Registrant

10.2	-	Promissory note which was modified in February 2005, evidencing advance made to the Registrant

10.3	-	Promissory note which was modified in February 2005, evidencing advance made to the Registrant

10.4	-	Promissory note which was modified in February 2005, evidencing advance made to the Registrant

10.5	-	Promissory note which was modified in February 2005, evidencing advance made to the Registrant

10.6	-	Promissory note which was modified in February 2005, evidencing advance made to the Registrant

10.7	-	Secured promissory note dated February 10, 2005, regarding equipment, between Lee Pharmaceuticals and Preferred Business Credit, Inc.

10.8	-	Secured promissory note dated March 30, 2005, regarding equipment, between Lee Pharmaceuticals and Preferred Business Credit, Inc.

31.1	-	Certification by Chief Executive Officer and Chief Financial Officer

32.1	-	Section 1350 Certification

The following exhibits have previously been filed by the Company:

3.1	-	Articles of Incorporation, as amended (1)

3.4	-	By-laws, as amended December 20, 1977 (2)

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

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

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

1444 Santa Anita Avenue, South El Monte, California 91733
(Address of principal executive offices)

(626) 442 - 3141
(Issuer’s telephone number)

N/A
(Former name, former address and former fiscal year, if changed since last report)

			LEE PHARMACEUTICALS
			(Registrant)


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

(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.