PHARMACEUTICAL FORMULATIONS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)

/x/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Fiscal Year Ended July 3, 1999

OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Transition Period from ____ to ____

Commission file number: 0-11274
----------------------------

PHARMACEUTICAL FORMULATIONS, INC.
(Exact name of Registrant as Specified in its Charter)

DELAWARE 22-2367644
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)

460 PLAINFIELD AVENUE, EDISON, NJ 08818
(Address of principal executive offices, including zip code)

(732) 985-7100
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $.08 PAR VALUE, AND COMMON STOCK PURCHASE WARRANTS
(Title of Class)

Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
reporting requirements for the past 90 days. Yes / / No /x/

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /

The aggregate market value of the voting stock held by non-affiliates
(based upon the average of the high and low bid prices) on September 24, 1999
was approximately $2,033,295.

As of September 24, 1999, there were 30,253,320 shares of Common
Stock, par value $.08 per share, outstanding

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be filed with the Securities and
Exchange Commission (the "Commission") with respect to the registrant's Annual
Meeting of Stockholders to be held in 1999 (the "1999 Proxy Statement") are
incorporated by reference into Part III of this Form 10-K.

PART I

ITEM 1. BUSINESS

THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF THAT TERM IN THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995 (SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934). ADDITIONAL WRITTEN OR ORAL FORWARD-LOOKING
STATEMENTS MAY BE MADE BY US FROM TIME TO TIME, IN FILINGS WITH THE SECURITIES
EXCHANGE COMMISSION OR OTHERWISE. STATEMENTS CONTAINED IN THIS REPORT THAT ARE
NOT HISTORICAL FACTS ARE FORWARD-LOOKING STATEMENTS MADE PURSUANT TO THESE SAFE
HARBOR PROVISIONS. FORWARD-LOOKING STATEMENTS MAY INCLUDE PROJECTIONS OF
REVENUE, INCOME OR LOSS AND CAPITAL EXPENDITURES; STATEMENTS REGARDING FUTURE
OPERATIONS, FINANCING NEEDS, COMPLIANCE WITH FINANCIAL COVENANTS IN LOAN
AGREEMENTS, PLANS FOR ACQUISITION OR SALE OF ASSETS OR BUSINESSES AND
CONSOLIDATION OF OPERATIONS OF NEWLY ACQUIRED BUSINESSES, AND PLANS RELATING TO
PRODUCTS OR SERVICES; ASSESSMENTS OF MATERIALITY; AND PREDICTIONS OF FUTURE
EVENTS AND THE EFFECTS OF PENDING AND POSSIBLE LITIGATION, AS WELL AS
ASSUMPTIONS RELATING TO THESE STATEMENTS. IN ADDITION, WHEN WE USE THE WORDS
"ANTICIPATES," "BELIEVES," "ESTIMATES," "EXPECTS," AND "INTENDS," AND "PLANS,"
AND VARIATIONS THEREOF AND SIMILAR EXPRESSIONS, WE INTEND TO IDENTIFY
FORWARD-LOOKING STATEMENTS.

FORWARD-LOOKING STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND
UNCERTAINTIES, SOME OF WHICH CANNOT BE PREDICTED OR QUANTIFIED BASED ON CURRENT
EXPECTATIONS. CONSEQUENTLY, FUTURE EVENTS AND ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE SET FORTH IN, CONTEMPLATED BY, OR UNDERLYING THE FORWARD-
LOOKING STATEMENTS CONTAINED IN THIS REPORT. STATEMENTS IN THIS REPORT,
PARTICULARLY IN "ITEM 1. BUSINESS", "ITEM 3. LEGAL PROCEEDINGS", THE NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS AND "ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," DESCRIBE CERTAIN
FACTORS THAT COULD CONTRIBUTE TO OR CAUSE SUCH DIFFERENCES. OTHER FACTORS THAT
COULD CONTRIBUTE TO OR CAUSE SUCH DIFFERENCES INCLUDE UNANTICIPATED DEVELOPMENTS
IN ANY ONE OR MORE OF THE FOLLOWING AREAS:

o OUR ABILITY, AND THE ABILITY OF CERTAIN OF OUR VENDORS, TO OBTAIN AND
MAINTAIN APPROVALS FROM THE U.S. FOOD AND DRUG ADMINISTRATION FOR NEW
PRODUCTS AND OTHER REGULATORY MATTERS, AND OUR ABILITY TO QUALIFY
ADDITIONAL VENDORS FOR SIGNIFICANT RAW MATERIAL,

o THE RECEPTIVITY OF CONSUMERS TO GENERIC DRUGS,

o THE RATE OF OUR NEW PRODUCT INTRODUCTIONS AND THE RECEPTIVITY OF OUR
CUSTOMERS TO SUCH PRODUCTS,

o COMPETITION, INCLUDING PRESSURES WHICH MAY REQUIRE US TO REDUCE OUR
PRICES,

o THE NUMBER AND NATURE OF CUSTOMERS AND THEIR PRODUCT ORDERS, INCLUDING
MATERIAL CHANGES IN ORDERS FROM OUR MOST SIGNIFICANT CUSTOMERS,

o ABILITY OF OUR VENDORS TO CONTINUE TO SUPPLY OUR NEEDS, ESPECIALLY
WITH RESPECT TO OUR KEY PRODUCTS SUCH AS IBUPROFEN,

o BORROWING COSTS, AND OUR ABILITY TO GENERATE CASH FLOW TO PAY INTEREST
AND SCHEDULED AMORTIZATION PAYMENTS AS WELL AS OUR ABILITY TO
REFINANCE SUCH INDEBTEDNESS OR TO SELL ASSETS WHEN IT COMES DUE,

o RELATIONS WITH OUR CONTROLLING SHAREHOLDER, INCLUDING ITS CONTINUING
WILLINGNESS TO PROVIDE FINANCING AND OTHER RESOURCES,

o PENDING OR NEW LITIGATION,

o THE IMPACT OF YEAR 2000 ISSUES, AND

o THE CONTINUED INVOLVEMENT OF KEY PERSONNEL OR THE ABILITY TO OBTAIN
SUITABLE REPLACEMENT PERSONNEL,

AS WELL AS OTHER RISKS FACTORS WHICH MAY BE DETAILED FROM TIME TO TIME IN OUR
SECURITIES AND EXCHANGE COMMISSION FILINGS.

YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING
STATEMENTS CONTAINED IN THIS REPORT, WHICH IS ACCURATE ONLY AS OF THE DATE OF
THIS REPORT. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULT OF ANY
REVISIONS TO THESE FORWARD-LOOKING STATEMENTS THAT MAY BE MADE TO REFLECT EVENTS
OR CIRCUMSTANCES AFTER THE DATE OF THIS REPORT OR TO REFLECT THE OCCURRENCE OF
UNEXPECTED EVENTS.

INTRODUCTION

Pharmaceutical Formulations, Inc. (PFI), a Delaware corporation, is
the second largest publicly-traded private label manufacturer and distributor of
nonprescription (sometimes called "over-the-counter" or "OTC") solid dose
pharmaceutical products (which are referred to in this report as "generic OTC
products") in the United States. Such products, which are made in tablet, caplet
or capsule form are primarily sold under our customers' store brands or other
private labels, manufactured under contract for national brand pharmaceutical
companies or sold in bulk to others who repackage them for sale to small,
typically independent, retailers and to other manufacturers who do not have
government approval to manufacture certain formulas such as ibuprofen. We also
sell and market a line of antifungal aerosols. To a limited extent, we also sell
generic OTC products under our own brand names, including HEALTH+CROSS(R) anD
HEALth PHARM(R), which sales account for less than 1% of our total revenues.

We believe that the therapeutic benefits of our generic OTC products
are comparable to those of equivalent national brand name products because the
chemical compositions of the active ingredients of the brand name products on
which our products are patterned are identical to those of our products. We are
subject to regulation by the U.S. Food and Drug Administration (FDA). Our
largest customers include Walgreen Company (Walgreen), Costco Wholesale
(Costco), K-Mart (K-Mart) and CVS Corp. (CVS), which in May 1997 merged with
Revco D.S., Inc. (Revco).

CERTAIN RELATIONSHIPS WITH ICC

In September 1991, we entered into an agreement with ICC Industries
Inc. (ICC) pursuant to which ICC was granted a series of options and related
preemptive rights to acquire a total of approximately 66.7% of the outstanding
shares of our common stock. ICC is a major international manufacturer and
marketer of chemical, plastic and pharmaceutical products which had calendar
1998 sales in excess of $1 billion. ICC and its subsidiaries have offices in key
business centers around the world and own numerous manufacturing plants. ICC has
exercised all of its options and certain of the related preemptive rights and
currently owns an aggregate of 19,635,894 shares of common stock, representing
approximately 64.9% of our outstanding common stock. In fiscal 1996, we sold
2,500,000 shares of Series A Cumulative Redeemable Convertible Preferred Stock
to ICC. The preferred stock is currently convertible into common stock at the
option of ICC on three months notice to the Company. Each share of preferred
stock is convertible to such number of shares of common stock as equals the
then-current liquidation preference for such shares of preferred stock
(currently $1.00) divided by the lower of the current market price for the
common stock (as defined) at the conversion date (as defined) or $2.00 per share
(subject to certain antidilution adjustments). (The current market price is
defined as the average of the daily market prices (as defined) for the common
stock for 30 consecutive trading days commencing 45 days prior to the conversion
date, which is the third monthly anniversary date of the date of notice of
conversion). If ICC elected to convert such shares of preferred stock and it is
assumed that the applicable current market price is equal to the average of the
high and low asked priced for the common stock on September 24, 1999 ($.29),
then the 2,500,000 shares of preferred stock would convert into 8,620,689 shares
of common stock. After such conversion, ICC would then own 28,256,583 shares of
common stock, which is 72.7% of the outstanding common stock. If the market
price for the common stock is greater than $.29 per share at the conversion
date ICC would own fewer shares, and if the market price is less than $.29 per
share ICC would own more shares, after any such conversion.

In addition, the Company purchases certain raw materials from ICC and
previously leased equipment from ICC, and its affiliates. See "Certain
Relationships and Related Transactions." Also, on April 1, 1999, ICC provided a
term loan of $3,000,000 and a temporary guarantee of $1,500,000 in advances
under a line of credit and term loan from a lending institution. The term loan
is secured by a subordinated pledge of all the assets of the Company and is
repayable in 12 monthly installments of $75,000 each commencing May 2000 and 12
monthly installments of $100,000 each commencing in May 2001 with a final
payment of $900,000 in May 2002. Interest is payable at 1% over prime. On
October 1, 1999 the guaranteed advance was reduced by $100,000.

PRODUCTS

Currently, we market more than 90 different types of generic OTC
products (including different dosage strengths of the same chemical
composition). These include analgesics (such as ibuprofen, acetaminophen and
naproxen sodium), cough-cold preparations, sinus/allergy products and
gastrointestinal relief products. Sales of ibuprofen accounted for 34%, in
fiscal 1999, 39% in fiscal 1998 and 38% in fiscal 1997 of our total revenues.
New products introduced in fiscal 1999 include ibuprofen capsules.

Generic pharmaceutical products are drugs which are sold under
chemical names rather than brand names and possess chemical compositions (and,
we believe, therapeutic benefits), equivalent to the brand name drugs on which
they are patterned. OTC drugs are drugs which can be obtained without a
physician's prescription. Generic drug products are subject to the same
governmental standards for safety and efficacy (effectiveness) as their brand
name equivalents and are typically sold at prices substantially below the brand
name drug. We manufacture generic OTC products which we believe are chemically
and therapeutically equivalent to such brand name products as Advil(R),
Aleve(R), Anacin(R), Tylenol(R), Bufferin(R), Ecotrin(R), Motrin(R), Advil(R),
Excedrin(R), Sominex(R), Mylanta(R), Sudafed(R), Comtrex(R), Sinutab(R),
Dramamine(R), Actifed(R), Benadryl(R), Allerest(R) and Tagamet(R) HB(TM), among
other products.(1)

In fiscal 1998 we entered into wo cooperative endeavors to expand our
product offerings. In July 1997 we entered into an alliance with A&S
Pharmaceutical Corporation to which A&S's complete range of aspirin products are
now made available to our customers. This enables us to satisfy demand in a
growth segment driven largely by the therapeutic benefits of aspirin-based
products for cardiovascular patients. In November 1997 we erneted into a joint
venture with APG, Inc., through PFI LLC, a limited liability company owned in
equal portions by APG, Inc. and the Company, to develop, manufacture and market
certain healthcare products. APG is the second largest privately-owned contract
packager of aerosol products in the United States. The first product marketed by
this joint venture was a line of anti-fungal aerosols, which were first sold in
July 1998. A second product to be marketed by the joint venture is a line of
cough/cold liquids, which commenced in October 1999.

- ----------
1 Such brand names, and other brand names mentioned in this report, are
registered marks of companies unrelated to PFI, unless otherwise notes.

MANUFACTURING

In order to manufacture generic OTC products, we acquire raw materials
from suppliers located in the United States and abroad, including ICC, an
affiliate of the Company. During the fiscal year ended July 3, 1999, we
purchased from ICC $2,667,000 of raw materials.

To date, we have obtained the raw materials we need and expect that
such raw materials will continue to be readily available in the future. Our raw
materials are first placed in quarantine so that samples of each lot can be
assayed for purity and potency by a team of our trained chemists and
technicians. Incoming materials are tested to assure that they are free of
objectionable microorganisms and that they meet chemical and physical testing
requirements. Throughout the manufacturing process, samples are taken by quality
assurance inspectors for quality control testing. The raw materials must meet
standards established by the United States Pharmacopoeia, the National Formulary
and the FDA, as well as by us and our customers.

To produce capsules and tablets, we utilize specialized equipment
which compresses tablets and fills powder and granules into hard gelatin
capsules. At this stage, certain tablets are film or sugar coated to achieve an
aesthetically appealing tablet. The customer chooses whether its order of
generic OTC products will be delivered in bulk containers or in packages.
Typically, we assist our customers in developing the size, design and graphics
of the folding carton, label and container for the products. The package can be
automatically placed into shipping containers of the customer's selection.

Since January 1992, we have entered into various subleases of
equipment and leasehold improvements from companies affiliated with ICC, for
which we pay such affiliates fixed monthly fees. In fiscal 1999, we assumed
these subleases and are now making the lease payments directly to a leasing
company, which is not associated with ICC. We no longer lease equipment or other
capital items from ICC.

In response to drug tampering problems affecting the industry
generally, we have instituted certain tamper-evident features in our packaging
operation. A tamper-evident package is one which readily reveals any violation
of the packaging or possible contamination of the product. These include a foil
inner-seal which is electronically sealed after the capping operation and, for
some customers, a neck band or outer safety seal applied to the bottle and cap
as an additional tamper-evident feature. In addition, we manufacture a banded
capsule which contains a gelatin band in the center to deter ease of opening
and/or closing the capsule product. Although we take steps to make our products
tamper-resistant, we believe that no product is "tamper-proof." There can be no
assurance that our products will not be tampered with. Any such tampering, even
if it occurs in the retail outlets, may have a material adverse effect on our
business. See "Insurance."

CUSTOMERS

Our customers consist of over 50 retailers (including major national
and regional drug, supermarket and mass-merchandise chains), wholesalers,
distributors, and brand-name pharmaceutical companies. Sales to our various
categories of customers in fiscal 1999, 1998 and 1997 by percentage of total
sales were as follows:

PERCENTAGE OF SALES
-----------------------

CATEGORY 1999 1998 1997
- -------- ---- ---- ----

Retail drug and supermarket chains and mass 93% 86% 84%
merchandisers
Bulk sales to wholesalers and distributors 5% 8% 10%
Brand-name pharmaceutical companies 2% 6% 6%

All of these sales consisted of products which our customers sell under their
own store brand or other labels.

Sales to customers who represented more than 10% of sales in any one
or more of the years 1999, 1998 and 1997 were as follows:

SALES ($ AND PERCENTAGE OF TOTAL SALES)
--------------------------------------

CUSTOMER 1999 1998 1997
- -------- ---- ---- -----

Walgreens $15,412,000 (17%) $14,422,000 (17%) $10,685,000 (14%)
Costco $12,522,000 (14%) $16,643,000 (20%) $12,343,000 (16%)
Revco * - - $12,930,000 (17%)

*As noted above, in May 1997 Revco merged with CVS; sales to Revco/CVS after the
merger did not exceed 10% of our sales in fiscal 1998 or 1999.

Other retail customers include American Stores, a grocery chain;
AmeriSource, a drug wholesaler; BJ Wholesale Club, a warehouse discounter;
Eckerd, a drug store chain; Family Dollar, a discount chain; Fleming Cos., a
food wholesaler; H.E. Butt, a food chain; Kmart, a mass merchandise chain;
Pathmark Stores, a grocery store chain; Rite Aid, a drug store chain; Super
Value, a food wholesaler; Wakefern/Shoprite, a grocery store co-op; and
Winn-Dixie, a grocery store chain.

The amounts of backlog orders at the end of fiscal 1999 and 1998 were
not significant. International sales are not significant at this time.

SALES AND MARKETING

We have 14 employees in sales and customer service. This staff and
over 20 independent brokers sell our generic OTC pharmaceutical products and our
marketing services to current and potential customers. There currently are four
account teams servicing different geographic areas of the U.S., each headed by a
sales director who works with the marketing group, a customer service
representative and a management information systems specialist. A team is
assigned to each retail customer, to focus on servicing that customer and make
marketing recommendations to help build retail store brand business.

We have six employees in marketing and graphic design area who work
with customers to develop and execute customized marketing programs directed at
selling consumers on the therapeutic benefits of the OTC pharmaceutical store
brands products.

GOVERNMENTAL REGULATION

Pharmaceutical companies are subject to extensive regulation by the
Federal government, primarily by the FDA, under the Federal Food, Drug and
Cosmetic Act, the Controlled Substance Act and other federal statutes and
regulations. These regulations govern or influence the testing, manufacture,
safety, labeling, storage, recordkeeping, approval, pricing, advertising and
promotion of our drug products. Failure to comply with FDA and other
governmental requirements can result in a variety of adverse regulatory actions,
including but not limited to the seizure of company products, demand for a
product recall, total or partial suspension of manufacturing/production, refusal
by FDA to approve new products, and withdrawal of existing product approvals.

The FDA requires all new pharmaceutical products to be proven safe and
effective before they may be commercially distributed in the United States. In
order to prove the safety and efficacy of most new pharmaceutical products,
pharmaceutical companies are often required to conduct extensive preclinical
(animal) and clinical (human) testing. Such testing is extensively regulated by
the FDA.

Most prescription drug products obtain FDA marketing approval via
either the "new drug application" (NDA) process or the "abbreviated new drug
application" (ANDA) process. An NDA is submitted to the FDA in order to prove
that a drug product is safe and effective. NDAs typically contain data developed
from extensive clinical studies. The filing of an NDA with the FDA provides no
assurance that the FDA will approve the applicable drug product for marketing.

Generic drug products are capable of being approved for marketing by
the FDA via the ANDA process. An ANDA is submitted to the FDA in order to
demonstrate that a drug product is "bioequivalent" to a drug product that has
already been approved by the FDA for safety and effectiveness (I.E. an
"innovator" drug product). Unlike an NDA, an ANDA is not required to contain
evidence of safety and effectiveness. Instead, ANDAs for orally administered
dosage forms typically contain "bioavailability" studies to demonstrate
"bio-equivalence." FDA approvals of ANDA's generally take 18 to 24 months to
obtain. As with NDAs, the filing of an ANDA with the FDA provides no assurance
that the FDA will approve the applicable drug product for marketing.

The current regulatory framework that governs generic drug approvals
via the ANDA process was enacted in 1984 and is commonly known as the
"Waxman-Hatch Act." Under the Waxman-Hatch Act, companies are permitted to
conduct studies required for regulatory approval notwithstanding the existence
of patent protection relevant to the substance or product under investigation.
Thus, "bioavailability" studies for a generic drug product may be conducted
regardless of whether the related "innovator" product has patent protection.

A company generally may file an ANDA application with the FDA at any
point in time. There are certain exceptions, however, such as when an
"innovator's" drug product was granted five years of "marketing exclusivity"
under the Waxman-Hatch Act. In such case, the ANDA application may not be filed
with FDA until the five years of "marketing exclusivity" have expired. Such
prohibition on filing does not apply, however, if the period of marketing
exclusivity is three years.

When an ANDA application is filed, the FDA may immediately review the
application regardless of whether the "innovator's" product has patent
protection or is subject to "marketing exclusivity." The FDA's ANDA approval,
however, is conditional and does not become effective until the expiration of
any applicable patent or "marketing exclusivity" periods. After the expiration
of these periods, a generic product that has received conditional ANDA approval
may be marketed immediately.

Some drug products that are intended for over-the-counter marketing
require NDA or ANDA approval. Most OTC drug products, however, may be
commercially distributed without obtaining FDA approval of an NDA or ANDA
application. The FDA established the OTC Drug Review in the early 1970's, which
led to the creation of OTC drug monographs that indicate whether certain drug
ingredients are safe and effective for specific intended uses. Final OTC drug
monographs have the force of law. Products that conform with the requirements of
a final OTC drug monograph do not require NDA or ANDA approval, whereas OTC
products not covered by a monograph must by approved via an NDA or ANDA.

Many OTC drug monographs have not yet been finalized. The FDA
generally permits the marketing of OTC drug products that conform to the
proposed requirements of a non-final monograph. The FDA also permits the
marketing of OTC products that do not conform to a non-final monograph subject
to certain limitations. Normally, such products may be marketed, pending the
effective date of the applicable final OTC drug monograph, if they are
substantially similar to OTC drug products that were marketed OTC in the United
States prior to December 4, 1975.

If the final drug monographs require us to expend substantial sums to
maintain FDA compliance, we could be materially adversely affected. In the past,
our generic OTC products (with the exception of ibuprofen) have not required
approval of NDAs or ANDAs. Certain products which we recently introduced or are
under development, however, require such approvals (see "Products - Products in
Development"). The FDA has approved ANDA's in 200 mg., 300 mg., 400 mg., 600 mg.
and 800 mg. dosage strengths for our ibuprofen product (although, at present, we
sell our ibuprofen products in the 200 mg. strength only). We have also obtained
FDA approval of certain different colors and shapes for our 200 mg. ibuprofen
product. Our naproxen sodium product received ANDA approval in fiscal 1997 and
our cimetidine product received ANDA approval in fiscal 1998. In addition, we
received ANDA approval for an ibuprofen capsule in July 1998.

All drug products, whether prescription or OTC, are required to be
manufactured and processed in compliance with the FDA's "good manufacturing
practices" (GMPs). GMPs are "umbrella" regulations that prescribe, in general
terms, the methods to be used for the manufacture, packing, processing and
storage of drug products to ensure that such products are safe and effective.
Examples of GMP regulatory requirements include record-keeping requirements and
mandatory testing of in-process materials and components. FDA inspectors
determine whether a company is in compliance with GMPs. Failure to comply with
GMPs may render a drug "adulterated" and could subject the company to adverse
regulatory actions.

The FDA regulates many other aspects of pharmaceutical product
development and marketing, including but not limited to product labeling and,
for prescription drug products, product advertising. The Federal Trade
Commission is the primary Federal agency responsible for regulating OTC drug
product advertising.

In addition to Federal regulation, pharmaceutical companies are
subject to state regulatory requirements, which may differ from one state to
another.

We believe that we are currently in compliance with FDA regulations.
However, in anticipation of more stringent and extensive requirements by FDA, we
undertook a major renovation and upgrade of our manufacturing plant. We believe
that these improvements, which were substantially completed in June 1996 at a
cost of approximately $4,500,000, will help to satisfy both present and future
FDA regulations and guidelines as well as facilitate our ability to produce
state-of-the-art products for our customers.

Federal and/or state legislation and regulations concerning various
aspects of the health care industry are under almost constant review and we are
unable to predict, at this time, the likelihood of passage of additional
legislation, nor can we predict the extent to which we may be affected by
legislative and regulatory developments concerning our products and the health
care field generally.

ENVIRONMENTAL MATTERS

The prior owner of our Edison, New Jersey manufacturing facility,
Revco, has conducted a soil and groundwater cleanup of such facility, under the
New Jersey Industrial Site Recovery Act (ISRA), as administered by the New
Jersey Department of Environmental Protection (NJDEP). NJDEP has determined that
the soil remediation was complete and has approved the groundwater remediation
plan, subject to certain conditions. Revco began operating a groundwater
remediation treatment system in 1995. Although CVS (as the successor to Revco)
is primarily responsible for the entire cost of the cleanup, we guaranteed the
cleanup. In addition, we agreed to indemnify the owner of the facility under the
terms of the 1989 sale lease-back. If CVS defaults in its obligations to pay
the cost of the clean-up, and such costs exceed the amount of the bond posted by
Revco, we may be required to make payment for any cleanup. The likelihood of
CVS, being unable to satisfy any claims which may be made against it in
connection with the facility, however, are remote in our opinion. Accordingly,
we believe that we will not have to bear any costs associated with remediation
of the facility and we will not need to make any material capital expenditures
for environmental control facilities.

RESEARCH AND DEVELOPMENT; NEW PRODUCTS AND PRODUCTS IN DEVELOPMENT

We are engaged in a research and development program which seeks to
develop and gain regulatory approval of products which are comparable to
national brand products under the FDA OTC Drug Monograph process or the ANDA
process. We are also engaged in R&D efforts related to certain prescription
(sometimes referred to as ethical) products and are exploring potential
acquisition candidates or joint ventures to facilitate entry into other drug
categories.

We maintain a staff of five employees in our product development
department, as well as other support staff to assist our customers. Our research
and development activities are primarily related to the determination of the
formula and specifications of the products desired by customers, as well as the
potency, dosage, flavor, quality, efficacy, color, hardness, form (I.E. tablet,
caplet or capsule) and packaging of such products, as well as costs related to
new products in development including costs associated with regulatory
approvals. Our research and development expenditures were $667,000 in fiscal
1999, $904,000 in fiscal 1998 and $867,000 in fiscal 1997. The rate of R&D
expenditures fluctuates significantly from year to year depending primarily on
what branded products are coming off patent in the near future and whether or
not such products are appropriate for development by us. Expenditures in one
year are not necessarily indicative of expenditures in future years. We expect
to spend in fiscal 2000 between $800,000 and $1,300,000 on research and
development activities consistent with our goal of continually increasing and
improving our product line.

In October 1993, we entered into an agreement with Farmacon, Inc.
(Farmacon), the owner of certain proprietary information and technology relating
to sucralfate tablets used for the treatment of ulcers, pursuant to which we
agreed to develop sucralfate tablets with Farmacon. The contract grants us
certain exclusive manufacturing, marketing and distribution rights with respect
to such product in both the ethical and OTC markets. The agreement (which
expires ten years after approval by the FDA of distribution of the product
subject to certain rights to extend the agreement) provides that the cost of all
clinical studies and the cost of obtaining regulatory approval will be borne by
Farmacon, while the costs of raw materials and components used to produce
clinical batches and to produce the product after regulatory approval will be
borne by us. We agreed, however, to contribute $600,000 (all of which has been
contributed through fiscal 1998) to the development and approval process based
on certain benchmarks as defined in the agreement. The parties further agreed
that any "product profit" (as defined in the agreement) will be distributed 75%
to Farmacon and 25% to us. An ANDA for the product was filed with the FDA in
October 1996.

In connection with ICC, we have developed the OTC version of a
cimetidine based H2 antagonist, for the relief from heartburn, acid indigestion
and sour stomach. An ANDA for this product was approved by the
FDA in June 1998 and we began selling the OTC version of cimetidine immediately
upon approval.

PATENTS AND TRADEMARKS

ALLERFED(R), LEG EASE(R), HEALTH+CROSS(R) AND HEALTH PHARM(R) are
federally registered trademarks owned by us. To the extent that our packaging
and labeling of generic OTC products may be considered similar to the brand name
products to which they are comparable, and to the extent that a court may
determine that such similarity may constitute confusion over the source of the
product, we may be subject to legal actions under state and Federal statutes and
case law to enjoin the use of the packaging and for damages.

INSURANCE

We may be subject to product liability claims by persons damaged by
the use of our products. We maintain product liability insurance for our generic
OTC products covering up to $10,000,000 in liability. Although there have been
no material product liability claims made against us to date, there can be no
assurance that such coverage will adequately cover any claims which may be made
or that such insurance will not significantly increase in cost or become
unavailable in the future. The inability to maintain necessary product liability
insurance would significantly restrict our ability to sell any products and
could result in a cessation of our business.

COMPETITION

We compete not only with numerous manufacturers of generic OTC
products, but also with brand name drug manufacturers, most of which are well
known to the public. In addition, our products compete with a wide range of
products, including well-known name brand products, almost all of which are
manufactured or distributed by major pharmaceutical companies. Some of our
competitors, including all of the manufacturers and distributors of brand name
drugs, have greater financial and other resources than we have, and are
therefore able to expend more effort than we do in areas such as product
development and marketing. The crucial competitive factors are price, product
quality, customer service and marketing. Although we believe that our present
equipment and facilities render our operations competitive as to price and
quality, many competitors may have far greater resources than we have, which may
enable them to perform high quality services at lower prices than the services
performed by the Company. Additionally, some of our customers may acquire the
same equipment and technology used by ourselves and perform for themselves the
services which we now perform for them.

EMPLOYEES

As of September 15, 1999, we employed approximately 450 full-time
employees. Of such employees, approximately 340 are engaged in manufacturing
activities and approximately 260 are covered by a collective bargaining
agreement between the Company and Local 522 affiliated with the International
Brotherhood of Teamsters of New Jersey (Local 522), which expires in October
2001. Additionally, five of our employees are represented by Local 68 of the
International Union of Operating Engineers, affiliated with the AFL-CIO. We had
20 persons employed in sales and marketing, 35 administrative and operational
employees and 51 laboratory technicians and scientists. We believe that our
relations with our employees are satisfactory.

EXECUTIVE OFFICERS

The executive officers of the Company as of September 15, 1999 are set
forth below:

NAME POSITIONS

Charles E. LaRosa President; Chief Executive Officer; Director

Clifford H. Straub, Jr. Senior Vice President-Chief Administrative
Officer; Chief Financial Officer

Ward Barney Vice President, Operations

Brian W. Barbee Vice President, Scientific Affairs

Anthony Cantaffa Vice President, New Business Development

George Chin Vice President, Sales

Alexander M. Schobel Vice President, Research & Development

The business experience of the Company's executive officers is set
forth below;

CHARLES E. LAROSA, age 57, has been a director of the Company and
President and Chief Executive Officer since December 1995. For the five years
prior to joining the Company he was President of American Home Food Products, a
subsidiary of American Home Products Corporation.

CLIFFORD H. STRAUB, JR., age 55, has been Senior Vice President-Chief
Administrative Officer and Chief Financial Officer since March 1999. Prior to
joining the Company, Mr. Straub was a consultant and from 1996 to 1998 was Vice
President and Chief Financial Officer of Prins Recycling and from 1998 to 1995
was Vice President and Chief Financial Officer of West Pharmaceutical Services
Inc. (formerly Paco Pharmaceutical Services, Inc.). Mr. Straub is a Certified
Public Accountant.

WARD BARNEY, age 48, has been the Company's Vice President, Operations
since June 1999. Prior to joining the Company, he was Vice President, Operations
of Schein Pharmaceuticals Inc. from 1997 to 1999 and Senior Vice President from
1994 to 1997 and has been in operations and engineering in the pharmaceutical
industry for over 20 years.

BRIAN W. BARBEE, age 49, has been Vice President of Scientific Affairs
since 1995. He was Vice President, Quality Assurance/Quality Control and
Regulatory, between 1993 and 1995. He joined the Company in 1978 and became
Director of Quality Assurance in 1982 and Director of Regulatory Affairs in
1988.

ANTHONY CANTAFFA, age 56, has been the Company's Vice President, New
Business Development since September 1997. Mr. Cantaffa also acted as Vice
President-Operations from December 1998 to June 1999. He was Vice President,
Mergers and Acquisitions from August 1995 until September 1997, Chief Financial
Officer from 1998 until 1990 and from 1991 to 1995; and Chief Operating Officer
from 1988 until 1995.

GEORGE CHIN, age 46, has been Vice President, Sales since 1991. Mr.
Chin was Field Sales Manager from 1989 until 1991. Prior to joining the Company,
he was National Account Manager of Perrigo Company, a store brand health and
beauty aids manufacturer, from 1986 to 1989 and District Supervisor of Beecham
Products.

ALEXANDER M. SCHOBEL, age 43, joined the Company in November 1997 and
has been Vice President of Research and Development since March 1999. Mr.
Schobel was Director of Research and Development for the Consumer Products
Division of Warner-Lambert Company where he spent 13 years.

ITEM 2. PROPERTIES

We lease approximately 214,000 square feet of office, manufacturing
and warehousing space in Edison, New Jersey, under a lease which expires in 2004
with two five-year renewal options. The monthly rental is currently $151,847 per
month and will increase on each 30th month after February 1997 by a cost of
living increase. The rental during each of the renewal options, if any, will be
the higher of the "fair rental value" (as that term is defined in the lease) of
the premises at the commencement of each renewal option or the rent in effect at
the end of the lease. In addition, we are obligated to pay all utilities, real
estate taxes, assessments, repairs, improvements, maintenance costs and expenses
in connection with the premises, comply with certain environmental obligations
and maintain certain minimum insurance protection.

In March 1995, we entered into a ten-year lease for a 91,200 square
foot building located adjacent to our present manufacturing facility. We have
two additional five-year renewal options. Rent payments are $26,600 per month
for the first five years and $28,500 per month for the balance of the initial
ten-year term. In addition, we are obligated to pay all utilities, real estate
taxes, assessments, repairs, improvements, maintenance costs and expenses in
connection with the premises, comply with certain environmental obligations and
maintain certain minimum insurance protection.

We believe that both of these facilities provide the potential for
increased expansion of manufacturing capacity, if necessary.

ITEM 3. LEGAL PROCEEDINGS

CLAIMS RELATED TO MAX TESLER. In July 1997, we received an arbitration
demand from the estate of Dr. Max Tesler, the former President of PFI who died
in December 1996. For alleged breaches of employment and other agreements
between the Company and Dr. Tesler, the Dr. Tesler's estate is seeking an award
of not less than $5,500,000 in compensatory damages, $10,000,000 in punitive
damages and such number of shares of common stock as would equal 10% of the
total number of shares outstanding (approximately 4,000,000 shares, which had a
value as of the alleged "change of control" date of approximately $3.5 million.
For claimed tortuous conduct, the Dr. Tesler's estate is seeking $20,000,000 for
intentional infliction of emotional distress and $10,000,000 for PRIMA FACIE
tort. The estate is also seeking attorney's fees and it sought a revised warrant
agreement pursuant to claimed antidilution provisions. The claimed breaches of
contract include failure to pay (a) salary through December 1998, (b) change of
control payments on the assumption that there was a change of control, as
defined, at the 1996 annual meeting and (c) death benefits. The claims for death
benefits and a revised warrant, however, were subsequently released by Dr.
Tesler's estate. Dr. Tesler's estate subsequently increased its claim for shares
from four million shares (10% of the outstanding stock) to approximately
15,594,000 shares (including shares for claimed interest through September 30,
1999) (which would be approximately 34% of the post-issuance outstanding shares)
due to reductions in the value of such shares from the time when the estate
alleges they should have been issued.

With respect to the claim for continuing salary, we have advised Dr.
Tesler's estate of counterclaims which we have, which exceed the amount of such
payments. We maintain that as a result of the termination of Dr. Tesler's
employment in December 1995, we ceased to have any liability under the
change-of-control provisions of the various agreements with Dr. Tesler, as well
as having other defenses to such claims.

The children and a former spouse of Dr. Tesler also raised certain
claims arising out of the death of Dr. Tesler. They sought $1.46 million in
death benefits allegedly due under an employment agreement and $550,000 in
benefits allegedly due under a group life insurance policy. They also sought
punitive damages, interest and attorneys fees in connection with the failure to
pay benefits. The matter was settled in December 1998 for $1,178,000 including
legal fees and other costs related to the settlement.

In December 1995, the Company accrued the continuing salary due to Dr.
Tesler for the period through December 1998. The Company has not made provision
for any of the other amounts claimed or accrued any amounts due from Dr.
Tesler's estate. As noted above, we believe that the claims by Dr. Tesler's
estate are without merit and that it has valid offsetting claims. We intend to
vigorously defend against the arbitration claim and to prosecute our claims
against Dr. Tesler's estate.

ROSENBLUM V. PFI. In 1991, an action was instituted in the Superior
Court of New Jersey, County of Middlesex, against us by Marvin Rosenblum,
seeking $3,500,000 in damages and other relief for claimed breach of an alleged
employment agreement. We interposed counterclaims for fraud and related claims
and claimed damages in the amount of $5,000,000. The case was dismissed with
prejudice in April 1998. The plaintiff filed an appeal seeking to have the case
reinstated and such appeal was denied in 1999.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS

Our common stock is registered under Section 12(g) of the Securities Exchange
Act of 1934 and is traded on the over-the-counter market (OTC Bulletin Boardsm,
Pink Sheetstm symbol: PHFR). Trading to date has been limited and there can be
no assurance that an active trading market will ever develop for the common
stock. As of September 24, 1999, there were 1,464 holders of record of the
common. The following table sets forth the range of high and low closing bid
quotations for the common stock as reported by National Quotation Bureau. These
quotations represent prices between dealers, without adjustments for retail
mark-ups, mark-downs or other fees or commissions, and may not represent actual
transactions.

HIGH BID LOW BID
-------- ---------

Year Ended June 30, 1998
First Quarter ................................ $ .78 $ .56
Second Quarter ............................... .80 .53
Third Quarter ................................ .81 .56
Fourth Quarter ............................... .75 .50

Year Ended July 3, 1999
First Quarter ................................ .72 .51
Second Quarter ............................... .52 .35
Third Quarter ................................ .39 .23
Fourth Quarter ............................... .36 .20

Year Ending July 1, 2000
First Quarter (through September
24, 1999) .................................. $ .35 $ .21

The high bid and low asked price of the common stock on September 24,
1999, as reported by the National Quotation Bureau, were $.27 and $.31,
respectively.

We have never paid any dividends on our common stock. We anticipate
that for the foreseeable future any earnings will be retained for use in our
business or for other corporate purposes, and we do not anticipate that cash
dividends will be paid. Furthermore, the agreement with our institutional lender
prohibits the payment of dividends without the lender's consent. Also, any
dividends must first be paid on preferred stock to the extent in arrears prior
to payments of any common stock dividend.

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data presented below for the
five-years ending July 3, 1999 and June 30, 1998, 1997, 1996 and 1995 are
derived from the consolidated financial statements of the Company which
financial statements have been audited by BDO Seidman, LLP, independent public
accountants, whose report the three years ended July 3, 1999 appears in this
report. During 1999 the Company changed its fiscal year from June 30 to a 52
week period ended on the last Saturday closest to June 30. The selected
consolidated financial data should be read in conjunction with the consolidated
financial statements and notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
report.

Year Ended Years Ended
July 3, June 30,
1999 1998 1997 1996 1995
------------- ----------------------------------------
(in thousands, except per share amounts)

STATEMENT OF OPERATIONS DATA;

Gross sales $ 89,821 $ 85,179 $ 75,013 $ 57,572 $ 62,427
Net sales 82,174 80,829 71,117 54,327 59,107
Net income (loss) (6,565) 1,867 1,332 (3,465) 2,046
Net income (loss) per share
of common stock:
Basic (.22) .06 .04 (.12) .07
Diluted (.22) .05 .04 (.12) .06
Weighted average common
shares and dilutive securities
outstanding(1):
Basic 30,253 30,199 29,559 29,312 30,023
Diluted 30,253 36,710 36,242 29,312 32,520

BALANCE SHEET DATA:
Current assets $ 38,003 $ 36,658 $ 29,939 $ 21,823 $ 24,759
Current liabilities 29,219 25,952 18,550 13,895 12,587
Working capital 8,784 10,706 11,389 7,928 12,172
Total assets 59,653 59,864 48,734 39,661 40,456
Long-term debt and
capital lease obligations 33,548 30,536 28,734 25,752 26,938
Stockholders' equity (deficit) (3,510) 3,055 1,077 (411) 454

1 See Note 2 of Notes to Consolidated Financial Statements as to the
calculation of weighted average common and dilutive securities outstanding.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FINANCIAL CONDITION AT JULY 3, 1999

At July 3, 1999, the Company had working capital of $8,784,000 as
compared to $10,706,000 in the prior year. Working capital at July 3, 1999
included $16,600,000 of account receivable as compared to $14,861,000 in the
prior year. The accounts receivable increase of $1,739,000 was a result of
higher sales, especially sales which occurred in the last month of the fiscal
year. Working capital in 1999 also included $17,916,000 of inventory as compared
to $20,096,000 in the prior year. The inventory decrease of $2,180,000 was a
result of improved inventory management during the later part of fiscal 1999.
Additionally, working capital was increased by a decrease in accounts payable of
$151,000 from $20,951,000 in 1998 to $20,800,000 in 1999.

The Company used $4,913,000 in cash from operations in fiscal 1999
that was provided by an increase in borrowings.

On August 7, 1998, the Company modified its line of credit and
equipment term loan with its financial institution. The maximum amount of the
line of credit and term loan is $25,000,000. At July 3, 1999, borrowings were
$21,076,000. Borrowings under the modified agreement, which expires August 7,
2001, bear interest at the prime rate less 3/4%. Such borrowing rate was
increased by 2% effective April 1, 1999. In addition on April 1, 1999 the line
was further increased up to $1,500,000 over eligible receivables and
inventories, as defined, up to the contractual limit. Such increase was
guaranteed by ICC. As of July 3, 1999, the Company was in violation of certain
financial loan covenants, which were subsequently waived. Future financial
covenants have been modified. In addition, the Company has convertible
subordinated debentures and capitalized lease obligations, which together with
the line of credit borrowings have a substantial impact on the working capital
requirements in terms of principal and interest payments.

The Company has outstanding 2,500,000 shares of Series A cumulative
redeemable convertible preferred stock sold to ICC. Dividends from the date of
issue (April 8, 1996) through June 30, 1999 totaling $650,000 have accumulated
and are in arrears. There is no obligation or intention to pay dividends
currently on the preferred stock. Dividends will continue to accrue at the rate
of $200,000 per year until declared and paid. On April 1, 1999 the Company
entered into a loan agreement with ICC for $3,000,000 with interest at 1% above
the prime rate.

The Company has a deferred tax asset of $4,420,000, before the
valuation allowance at July 3, 1999, which consists of future tax benefits of
net operating loss carry forwards and various other temporary differences. The
Company has forecasted profitable operations for at least the next few years.
The benefits of net operating loss carry forwards and other temporary
differences that will take more than a few years to realize can not be
reasonably determined at this time. Accordingly, a valuation allowance of
$664,000 was recorded at July 3, 1999 to provide for this uncertainty. The
realization of this asset in future periods will improve the liquidity of the
Company.

The Company continues to take steps aimed at increasing sales and
reducing costs to improve operating results and increase profitability. The
Company intends to spend an estimated $1,500,000 to $2,000,000 of capital
improvements in the fiscal year ending July 1, 2000 to increase manufacturing
capacity and reduce costs. The Company anticipates that these capital
expenditures will be funded through equipment lease financing and working
capital. While the Company has in the past had no difficulty in obtaining such
financing or meeting working capital needs, there can be no assurance the
Company will obtain the equipment lease financing or meet working capital needs
in the future.

The Company believes that cash flow from operations, together with
revolving credit and equipment and term loan financing, will be sufficient to
fund the Company's currently anticipated working capital, capital spending and
debt service requirements until the maturity of the facility in August 2001, but
there can be no assurance in this regard. The Company expects that its working
capital needs will require it to obtain new revolving credit facilities at the
time that the credit and equipment term facility matures, whether by extending,
renewing, replacing or otherwise refinancing the facility. No assurance can be
given that any such extension, renewal, replacement or refinancing can be
successfully accomplished.

RESULTS OF OPERATIONS FOR FISCAL 1999 COMPARED TO FISCAL 1998

Gross sales for the fiscal year ended July 3, 1999 were $89,821,000 as
compared to $85,179,000 in the prior fiscal year. The increase in sales of
$4,642,000 or 5.4% was mainly due to an increase in the private label sector of
the business. The private label sales were $83,222,000 as compared to
$73,254,000 in the prior year. This increase of $9,968,000 or 13.6 % is a result
of the addition of new customers, the introduction of new products, and growth
with existing customers. This increase offset the pressure on shipment levels
created by the Company's conversion to a new computer system. The bulk/contract
manufacturing sector had sales of $6,599,000 as compared to $11,925,000 in the
prior year. The decrease was due to lost business in the
bulk/contract-manufacturing sector which had not been replaced in the current
fiscal year. Sales to two customers, Walgreen Company and Costco Wholesale, were
$27,934,000 or 31.1% of sales as compared to $31,065,000 or 36.5% of sales in
the comparable period in the prior fiscal year.

Net sales for the fiscal year ended July 3, 1999 were $82,174,000 as
compared to $80,829,000 in the prior year. The increase was due to higher gross
sales which was partially offset by an increase in discounts and allowances net
of an increase in gross sales.

Cost of sales as a percentage of net sales was 86.4% for the fiscal
year ended July 3, 1999 as compared to 76.6% in the prior fiscal year. The
increase was partly due to the change in sales mix as mentioned above whereby
more of the Company's business is in the private label (store brand) sector,
which has a higher cost of sales percentage than the bulk/contract manufacturing
business. To improve operating efficiencies and insure year 2000 compliance, the
Company, during fiscal 1999, installed and implemented a new integrated computer
system. This major system conversion caused serious disruptions in inventory
control, shipping, production and planning resulting in reduced sales and
increased cost of sales. Cost of sales was also affected by the increased cost
of packaging due to new equipment installed in fiscal 1998 which caused
production inefficiencies and higher waste due to the beginning trials of the
equipment during the current year. The Company estimates that such costs
incurred relating to the computer system conversion and other related
disruptions which occurred during fiscal 1999 to be approximately $7,000,000.

Selling, general and administrative expenses were $14,547,000 or 17.7%
of net sales for the fiscal year ended July 3, 1999 as compared to $12,296,000
or 15.2% of net sales for the prior fiscal year. The increase of $2,251,000 was
mainly a result of increased sales, legal, distribution and hiring expenses. The
increased distribution costs are related to shipping problems impacted by the
new computer system. The increased hiring costs are due to the Company's
commitment to having qualified people at all levels of the organization.

Research and development costs were $675,000 for the fiscal year ended
July 3, 1999 as compared to $904,000 for the prior fiscal year.

Interest expense was $4,675,000 for the fiscal year ended July 3, 1999
as compared to $3,982,000 in the prior fiscal year. As a result of the
implementation of the new computer system the Company experienced delays in
billings and collections which caused a substantial increase in accounts
receivable which required increased borrowing and additional interest expense.
The increase in interest expense is primarily a result of increases in capital
lease obligations and borrowings under the revolving credit agreement to support
the additional capital expenditures and working capital requirements of
increased receivables partially offset by reduced interest rates to March 31,
1999 on the new revolving credit agreement.

The Company settled claims relating to the children and a former
spouse of Dr. Tesler, the former President of the Company who died in December
1996. Accordingly, the Company has recorded a lawsuit settlement expense of
$1,179,000 for the fiscal year ended July 3, 1999.

Net loss for the fiscal year ended July 3, 1999 was $6,565,000 or $.22
per share as compared to net income of $1,867,000, or $.06 per share in the
prior fiscal year.

The Company continues to take steps aimed at increasing profitability.
These steps include: (a) seeking new customers and products to increase sales
volume, (b) continuing efforts to reduce material costs and (c) other
cost-saving measures. There can be no assurance that such actions will be
successful in returning the Company to profitability.

RESULTS OF OPERATIONS FOR FISCAL 1998 COMPARED TO FISCAL 1997

Gross sales for the fiscal year ended June 30, 1998 were $85,179,000
compared to $75,013,000 in the prior fiscal year. This increase of $10,166,000
or 14% was the result of increased sales to existing customers and new customers
obtained by the Company. In addition, the increased sales were the result of new
products introduced by the Company such as Cimetidine, which was introduced late
in the fourth quarter of fiscal 1998.

Sales discounts and allowances were $4,350,000 or 5.1% of sales as
compared to $3,896,000 or 5.2% of sales in the prior fiscal year.

Two customers each represent over 10% of the Company's sales for the
fiscal year ended June 30, 1998. These two customers are Walgreens and Costco.
Sales to these two customers aggregated $31,065,000 (36%) as compared to
$23,028,000 (31%) in the prior fiscal year.

Cost of sales as a percentage of net sales was 76.6% of net sales as
compared to 75.9% in the prior fiscal year. The increase in cost of sales as a
percentage of net sales was due to the sales mix whereby a greater percentage of
sales are in the private label (store brand) component of the business verses
the bulk contract component, which component traditionally has a lower cost of
sales percentage. In addition, in fiscal 1998 the Company launched new products
utilizing new equipment which had higher waste and lower production efficiencies
due to the beginning trials of the equipment. It is anticipated that such waste
levels will be reduced and production efficiencies will increase as production
of the new product utilizing such equipment is increased.

Selling, general and administrative expenses were $12,296,000 in
fiscal 1998 as compared to $10,325,000 in the prior fiscal year. The increase of
$1,971,000 was mainly a result of increased marketing, sales and distribution
costs to continually expand the Company's customer and product base.

Research and development costs were $904,000 in the fiscal year ended
June 30, 1998, compared to $867,000 in the prior fiscal year. The increase of
$37,000 represented increased expenditures on research and development to
develop new products.

Interest and other expenses were $3,903,000 in the fiscal year ended
June 30, 1998 as compared to $3,754,000 in the prior fiscal year. The increase
of $149,000 was mainly a result of increased borrowing to support higher
accounts receivable and inventory requirements for the increased sales.

Income tax benefit in fiscal 1998 was a $39,000 compared to a $882,000
expense in fiscal 1997. The decrease in the income tax was a result of a change
in the deferred income tax asset of $741,000 which represented tax benefits
realized in fiscal year 1998 and the recognition of tax benefits available for
future years.

Net income was $1,867,000 or $.06 basic earnings per share in the
fiscal year ended June 30, 1998, as compared to $1,332,000 or $.04 basic
earnings per share in the prior year period.

EFFECTS OF INFLATION

We do not believe that inflation had a material effect on our
operations for the fiscal years ended July 3, 1999 and June 30, 1998 and 1997.

YEAR 2000 COMPLIANCE

We are in the process of analyzing and addressing what is known as the
year 2000 (or "Y2K") issue. This issue has arisen because many existing computer
programs use only two dates to identify a year in the data field. These programs
were designed and developed without considering the impact of the upcoming
change in the century. The failure of such applications or systems to properly
recognize the dates beginning in the year 2000 could result in miscalculations
or systems failures. For instance, in connection with our business it is
necessary for the computers to calculate and place on product packaging the
expiration dates of our products, which currently run to years past 2000. We
have at all times been able to address such problems, under prior and current
computer systems. In fiscal 1999 we purchased and installed a completely new
computer system, and installed all new software on the system. While such system
and software were purchased to satisfy our needs caused by our expanded
business, and would accordingly have been done whether or not there was a Y2K
issue, such purchase also obviated the need to analyze the previous system and
software for Y2K compliance and to fix any problems which such analysis
disclosed. We believe that all of the newly-installed hardware and software is
Y2K compliant and that the transfer of data from the previous system did not
entail the transfer of non-complaint software or other Y2K deficiencies. We
have a management information system (MIS) director who has assessed our
compliance situation and we accordingly believe that all of our internal
computer systems (both hardware and software) and embedded technology (to the
extent that it is date sensitive) are currently Y2K compliant. We have not
retained any outside services to conduct independent verification of our
compliance status and do not intend to hire any such service.

We are currently contacting our key customers and vendors to ascertain
their Y2K compliance to the extent that their problems could affect us. We
expect to have completed that process by November 1, 1999. At this time we
cannot make any predictions as to the degree of compliance by such vendors and
customers or the consequence of any noncompliance. We have not devised any
back-up plans should any such customers' or vendors' Y2K problems affect us.
After completion of our review of queries sent to such customers and vendors, we
will assess the need for any contingency plans.

No information technology projects have been deferred due to Y2K
efforts. We are not in a position to determine what would be its most reasonably
likely worst case Y2K scenario or any plan for handling such scenario. The
expenses incurred to-date to achieve year 2000 compliance have not had a
material impact on our results of operations or financial condition. Based on
our current status of internal Y2K compliance and other preliminary information,
we do not anticipate that any expenses yet to be incurred to achieve year 2000
compliance will have any material impact on our results of operations or
financial condition during the next two fiscal years. This prediction, however,
may change if its later ascertained that one or more key customers or vendors
may have Y2K compliance problems which could adversely affect us.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED JULY 3, 1999 FOR
PHARMACEUTICAL FORMULATIONS, INC. AND SUBSIDIARIES

Report of Independent Certified Public Accountants F-1

Consolidated Financial Statements

Balance Sheets at July 3, 1999 and June 30, 1998 F-2

Statements of Operations for the Years
Ended July 3, 1999 and June 30, 1998 and 1997 F-3

Statements of Changes in Stockholders'
Equity (Deficiency) for the Years Ended
July 3, 1999 and June 30, 1999 and 1998 F-4

Statements of Cash Flows for the Years
Ended July 3, 1999 and June 30, 1999 and 1998 F-5

Notes to Consolidated Financial Statements F-6

FINANCIAL STATEMENT SCHEDULE

Report of Independent Certified Public Accountants
on Financial Statement Schedule F-23

Schedule II - Valuation and Qualifying Accounts F-24

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

That portion of the Company's definitive 1999 Proxy Statement
appearing under the caption "ELECTION OF DIRECTORS," is hereby incorporated by
reference. The information regarding the executive officers of the Company is
contained under "Executive Officers" under Item 1 to this Report.

ITEM 11. EXECUTIVE COMPENSATION.

That portion of the Company's definitive 1999 Proxy Statement
appearing under the caption "EXECUTIVE COMPENSATION" is hereby incorporated by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

That portion of the Company's definitive 1999 Proxy Statement
appearing under the caption "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT" is hereby incorporated by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

That portion of the Company's definitive 1999 Proxy Statement
appearing under the caption "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" is
hereby incorporated by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K

(a)(1) and (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE:
See Item 8, "Financial Statements and Supplementary Data".

(a) (3) and (c) EXHIBITS: Exhibits are numbered in accordance with
Item 601 of Regulation S-K.

(3) ARTICLES OF INCORPORATION AND BY-LAWS:

3.1 Articles of Incorporation, as amended (3)

3.2 By-laws, as amended (3)

(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING
INDENTURES:

4.1 Indenture (1)

4.2 New Indenture (2)

(10) MATERIAL CONTRACTS:

10.1 Employment Agreement with Max A. Tesler dated February 1, 1984,
as extended and amended (4)*

10.2(A) Employment Agreement with Charles E. LaRosa dated April 4,
1997 (9)*

10.2(B) Amendment, dated February 20, 1998, to Employment Agreement
with Charles E. LaRosa (11)*

10.3(A) Loan and Security Agreement dated August 4, 1989 between
Fidelcor Business Credit Corporation (subsequently assumed by The CIT
Group/Credit Finance, Inc. and the Registrant (formerly known as PharmaControl
Corp.) (5)

10.3(B) Letter Agreement dated August 7, 1998 between The CIT
Group/Credit Finance, Inc. ("CIT") and the Registrant amending the Loan and
Security Agreement between the Registrant and Fidelcor Business Credit
Corporation as assumed by The CIT Group/Credit Finance, Inc (the "CIT Loan
Agreement")(12)

10.3(C) Letter Agreement dated April 1, 1999 between CIT and the
Registrant amending the CIT Loan Agreement

10.3(D) Letter Agreement dated April 1, 1999 between CIT and ICC
Industries Inc. ("ICC") amending the Intercreditor Agreement between ICC and CIT
dated March 25, 1992, as attached

10.3(E) Letter Agreement dated April 1, 1999 between CIT and the
Registrant amending Warrant Certificates dated April 1, 1992 for the purchase of
100,000 shares and March 30, 1993 for the purchase of 10,000 shares of common
stock of the Registrant extending the expiration dates to March 31, 2004

10.3(F) Limited Guaranty dated April 1, 1999 by ICC in favor of CIT
with respect to the CIT Loan Agreement

10.3(G) Letter Agreement dated April 26, 1999 between CIT and the
Registrant amending the CIT Loan Agreement

10.3(H) Letter Agreement dated June 2, 1999 between CIT and the
Registrant amending the CIT Loan Agreement

10.4 Agreement dated September 6, 1991 among the Registrant (formerly
known as PharmaControl Corp.), Private Formulations, Inc. and ICC Industries
Inc. (6)

10.5 Agreement dated September 24, 1992 among the Registrant (formerly
known as PharmaControl Corp.), Private Formulations, Inc. and ICC Industries
Inc. (7)

10.6 Agreement dated March 29, 1993 among the Registrant (formerly
known as PharmaControl Corp.), Private Formulations, Inc. and ICC Industries
Inc. (8)

10.7 Agreement dated May 8, 1992, among the Registrant (formerly known
as PharmaControl Corp.), Private Formulations, Inc. and ICC Industries Inc. (7)

10.8 Agreement dated May 28, 1992, among the Registrant (formerly
known as PharmaControl Corp.), Private Formulations, Inc. and ICC Industries
Inc. (7)

10.9 Agreement dated May 24, 1993, among the Registrant (formerly
known as PharmaControl Corp.), Private Formulations, Inc. and ICC Industries
Inc. (8)

10.10 Agreement dated September 26, 1997 between the Registrant and
ICC Chemical Corporation regarding Cimetidine (10)

10.11 Form of Warrant Agreement dated October 1, 1992 between the
Registrant (formerly known as PharmaControl Corp.) and Max A. Tesler, Anthony
Cantaffa, George Chin and Sandra J. Brown)(7)*

10.12(A) 1994 Stock Option Plan, as amended September 1999 (11)*

10.12(B) Form of option agreement under 1994 Stock Option Plan (11)*

10.13 Term Loan and Security Agreement dated as of April 1, 1999
between ICC and the Registrant

10.14 Stock Purchase Agreement between the Company and ICC Industries
Inc. dated April 8, 1996 regarding the purchase of 2,500,000 shares of Series A
Cumulative Redeemable Convertible Preferred Stock (13)

(11) STATEMENT RE COMPUTATION OF PER SHARE EARNINGS: not applicable

(12) STATEMENT RE COMPUTATION OF RATIOS: not applicable

(13) ANNUAL REPORT TO SECURITY HOLDERS, FORM 10-Q OR QUARTERLY REPORT TO
SECURITY HOLDERS: not applicable

(16) LETTER RE CHANGE IN CERTIFYING ACCOUNTANT: not applicable

(18) LETTER RE CHANGE IN ACCOUNTING PRINCIPLES: not applicable

(21) SUBSIDIARIES OF THE REGISTRANT: none other than such subsidiaries
which, considered in the aggregate, would not constitute a significant
subsidiary as of the end of the year covered by this report

(22) PUBLISHED REPORT REGARDING MATTERS SUBMITTED TO VOTE OF SECURITY
HOLDERS: not applicable

(23) CONSENT OF EXPERTS AND COUNSEL: consent of the Independent Public
Accountants

(24) POWER OF ATTORNEY: not applicable

(27) FINANCIAL DATA SCHEDULE: attached

(28) INFORMATION FROM REPORTS FURNISHED TO STATE INSURANCE REGULATORY
AUTHORITIES: not applicable

(29) ADDITIONAL EXHIBITS: not applicable

---------------------
* Management contracts or compensatory plans

(1) Incorporated herein by reference to the Registrant's Form S-1, File No.
33-13291

(2) Incorporated herein by reference to the Registrant's Form S-4, File No.
33-44033

(3) Filed with the Annual Report on Form 10-K for the year ended June 30,
1983 and incorporated by reference herein, except for (a) Amendment to
Certificate of Incorporation filed with the Delaware Secretary of State on April
13, 1984 which was filed with the Registration Statement on Form S-1 (File No.
2-88752), (b) Amendment to Certificate of Incorporation filed with the Delaware
Secretary of State on February 3, 1987 which was filed with Post-Effective
Amendment No. 3 to Registration Statement on Form S-1 (File No. 33-6731), (c)
Amendment to Certificate of Incorporation filed with the Delaware Secretary of
State on November 16, 1991, which was filed with the Annual Report on Form 10-K
for the year ended June 30, 1991, (d) Amendment to Certificate of Incorporation
filed with the Delaware Secretary of State on January 26, 1994 which was filed
with the Quarterly Report on Form 10-Q for the period ended March 31, 1994, (e)
Amendment to the Company's By-Laws filed with the Registrant's Quarterly Report
on Form 10-Q for the period ended March 31, 1994, and (f) Certificate of
Designations, Preferences and Rights of Series A Cumulative Preferred Stock
filed with the Registrant's Current Report on Form 8-K for an event occurring on
April 4, 1996, each of which is incorporated by reference herein.

(4) Filed with the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1993 and incorporated herein by reference.

(5) Filed with the Registrant's Current Report on Form 8-K dated August 2,
1989; amended as set forth in Exhibit 10.14 and incorporated herein.

(6) Filed with the Registrant's Current Report on Form 8-K dated September
6, 1991 and incorporated herein.

(7) Filed with the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1992 and incorporated herein by reference.

(8) Filed with the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1994 and incorporated herein by reference.

(9) Filed with the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1996 and incorporated herein by reference.

(10) Filed with the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1996 and incorporated herein by reference.

(11) Filed with the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1997 and incorporated herein by reference.

(12) Filed with the Registrant's Annual Report on Form 10-K for the year
ended June 30, 1998 and incorporated herein by reference.

(13) Incorporated by reference to the Registrant's Current Report on Form 8-K
for an event occurring on April 4, 1996

(b) REPORTS ON FORM 8-K - The Registrant filed the following reports
on Form 8-K during and since the last quarter of the fiscal year ended July 3,
1999:

DATE OF REPORT ITEM NUMBER (SUMMARY)
- -------------- ---------------------
May 18, 1999 5 and 7 (regarding planned restatement of quarterly results)
June 15, 1999 5 (regarding delay in payment of interest on debentures)
July 14, 1999 5 (regarding payment of interest on debentures)

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

PHARMACEUTICAL FORMULATIONS, INC.

By: /s/ CHARLES E. LAROSA
Charles E. LaRosa
President, Chief Executive Officer and a Director

Dated: October 29, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated:

NAME TITLE DATE
---- ----- ----

/S/CHARLES E. LAROSA President; Chief Executive October 29, 1999
- -------------------------- Officer and a Director
Charles E. LaRosa (Principal Executive
Officer)

/S/CLIFFORD STRAUB Senior Vice President, Chief October 29, 1999
- -------------------------- Administrative Officer; and
Clifford Straub Chief Financial Officer
(Principal Financial Officer)

/S/JOHN L. ORAM Chairman of the Board October 29, 1999
- --------------------------
John L. Oram

/S/RAY W. CHEESMAN Director October 29, 1999
- --------------------------
Ray W. Cheesman

PHARMACEUTICAL FORMULATIONS, INC.
AND SUBSIDIARIES

Contents

INDEPENDENT AUDITORS' REPORT F-1

CONSOLIDATED FINANCIAL STATEMENTS:
Balance sheets F-2
Statements of operations F-3
Statements of changes in stockholders' equity F-4
(deficiency)
Statements of cash flows F-5
Notes to consolidated financial statements F-6 - F-22

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON F-23
FINANCIAL STATEMENT SCHEDULE

SUPPLEMENTAL SCHEDULE:
Schedule II - Valuation and Qualifying Accounts F-24

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None

INDEPENDENT AUDITORS' REPORT

To the Stockholders and Board of Directors
Pharmaceutical Formulations, Inc.

We have audited the accompanying consolidated balance sheets of Pharmaceutical
Formulations, Inc. and subsidiaries as of July 3, 1999 and June 30, 1998, and
the related consolidated statements of operations, changes in stockholders'
equity (deficiency) and cash flows for each of the three years in the period
ended July 3, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Pharmaceutical Formulations, Inc. and subsidiaries as of July 3, 1999 and June
30, 1998, and the results of their operations and their cash flows for each of
the three years in the period ended July 3, 1999 in conformity with generally
accepted accounting principles.

/s/ BDO Seidman, LLP
BDO Seidman, LLP

Woodbridge, New Jersey
September 22, 1999

Pharmaceutical Formulations, Inc.
and Subsidiaries

CONSOLIDATED BALANCE SHEETS

July 3, 1999 June 30, 1998
- ----------------------------------------------------------------------------------------------------------
Assets
CURRENT ASSETS:

Cash $ 122,000 $ 608,000
Accounts receivable, net of allowance for doubtful accounts of $255,000 16,600,000 14,861,000
and $ 238,000
Inventories 17,916,000 20,096,000
Prepaid expenses and other current assets 1,268,000 793,000
Income taxes recoverable 947,000
Deferred tax asset 1,150,000 300,000
- ---------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 38,003,000 36,658,000
PROPERTY, PLANT AND EQUIPMENT, NET 18,636,000 21,441,000
OTHER ASSETS:
Deferred tax asset 2,606,000 1,231,000
Other assets 408,000 534,000
- --------------------------------------------------------------------------------------------------------
$ 59,653,000 $ 59,864,000
========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Current portion of long-term debt $ 2,135,000 $ 482,000
Current portion of capital lease obligations 2,879,000 2,898,000
Accounts payable 20,800,000 20,951,000
Income taxes payable 210,000 227,000
Accrued expenses 3,195,000 1,394,000
- ---------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 29,219,000 25,952,000
- ---------------------------------------------------------------------------------------------------------
LONG-TERM DEBT, LESS CURRENT MATURITIES 26,934,000 22,983,000
- ---------------------------------------------------------------------------------------------------------
LONG-TERM CAPITAL LEASE OBLIGATIONS, LESS CURRENT MATURITIES 6,614,000 7,553,000
- ---------------------------------------------------------------------------------------------------------
DEFERRED GAIN ON SALE/LEASEBACK 396,000 321,000
- ---------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY (DEFICIENCY):
Preferred stock - par value $1.00 per share; 10,000,000 shares
authorized; 2,500,000 shares issued and outstanding 2,500,000 2,500,000
Common stock, par value $.08 per share; authorized; 40,000,000,
30,253,320 shares issued and outstanding; 2,421,000 2,421,000
Capital in excess of par value 37,493,000 37,493,000
Accumulated deficit (45,924,000) (39,359,000)
- ---------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIENCY) (3,510,000) 3,055,000
- ---------------------------------------------------------------------------------------------------------
$ 59,653,000 $ 59,864,000
=========================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

Pharmaceutical Formulations, Inc.
and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED JULY 3, 1999 JUNE 30, 1998 JUNE 30, 1997
- ------------------------------------------------------------------------------------------------

GROSS SALES $ 89,821,000 $ 85,179,000 $ 75,013,000
LESS: SALES DISCOUNTS AND ALLOWANCES 7,647,000 4,350,000 3,896,000
- ------------------------------------------------------------------------------------------------
NET SALES 82,174,000 80,829,000 71,117,000
- ------------------------------------------------------------------------------------------------
COST AND EXPENSES:
Cost of goods sold 70,970,000 61,898,000 53,957,000
Selling, general and administrative 14,547,000 12,296,000 10,325,000
Research and development 667,000 904,000 867,000
- ------------------------------------------------------------------------------------------------
86,184,000 75,098,000 65,149,000
- ------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS (4,010,000) 5,731,000 5,968,000
- ------------------------------------------------------------------------------------------------
OTHER EXPENSES (INCOME):
Interest expense 4,675,000 3,982,000 3,865,000
Lawsuit settlement 1,179,000
Other, net (128,000) (79,000) (111,000)
- ------------------------------------------------------------------------------------------------
5,726,000 3,903,000 3,754,000
- ------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT) (9,736,000) 1,828,000 2,214,000
INCOME TAXES (BENEFIT) (3,171,000) (39,000) 882,000
- ------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (6,565,000) 1,867,000 1,332,000
PREFERRED STOCK DIVIDEND REQUIREMENT 200,000 200,000 200,000
- ------------------------------------------------------------------------------------------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON
SHAREHOLDERS $ (6,765,000) $ 1,667,000 $ 1,132,000
================================================================================================
NET INCOME (LOSS) PER SHARE:
Basic $ (0.22) $ 0.06 $ 0.04
Diluted (0.22) 0.05 0.04
================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

Pharmaceutical Formulations, Inc.
and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)

Years ended July 3, 1999, June 30, 1998 and 1997
- -----------------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK COMMON STOCK CAPITAL IN ACCUMULATED
EXCESS OF DEFICIT
PAR VALUE
------------------------- -------------------------
SHARES AMOUNT AT SHARES AMOUNT AT
ISSUED PAR VALUE ISSUED PAR VALUE
- -----------------------------------------------------------------------------------------------------------------------------------

BALANCE, JUNE 30, 1996 2,500,000 $ 2,500,000 29,508,814 $ 2,361,000 $ 37,286,000 $(42,558,000)
SHARES ISSUED IN CONNECTION WITH
EXERCISE BY ICC OF PREEMPTIVE RIGHTS -- -- 221,536 18,000 38,000 --
SHARES ISSUED IN CONNECTION WITH
SETTLEMENT OF LITIGATION -- -- 50,000 4,000 46,000 --
SHARES ISSUED IN CONNECTION WITH
EXERCISE OF COMMON STOCK WARRANTS -- -- 100,000 8,000 42,000 --
NET INCOME -- -- -- -- -- 1,332,000
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 1997 2,500,000 2,500,000 29,880,350 2,391,000 37,412,000 (41,226,000)
SHARES ISSUED IN CONNECTION WITH -- -- 300,000 24,000 51,000 --
EXERCISE OF COMMON STOCK OPTIONS
SHARES ISSUED TO EMPLOYEES -- -- 72,970 6,000 30,000 --
NET INCOME -- -- -- -- -- 1,867,000
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 1998 2,500,000 2,500,000 30,253,320 2,421,000 37,493,000 (39,359,000)
NET LOSS -- -- -- -- -- (6,565,000)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, JULY 3, 1999 2,500,000 $ 2,500,000 30,253,320 $ 2,421,000 $ 37,493,000 $(45,924,000)
===================================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Pharmaceutical Formulations, Inc.
and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED JULY 3, 1999 JUNE 30, 1998 JUNE 30, 1997
- -----------------------------------------------------------------------------------------------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(6,565,000) $ 1,867,000 $ 1,332,000
Adjustments to reconcile net income (loss) to net cash
provided by (used in ) operating activities:
Depreciation and amortization 2,895,000 2,509,000 2,271,000
Amortization of bond discount and deferred
financing costs 255,000 162,000 141,000
Amortization of deferred gain on sale of building (95,000) (52,000) (52,000)
Shares issued to key employees 17,000
Shares issued in settlement of litigation 50,000
Shares issued to officer and outside directors 19,000
Deferred income taxes (2,224,000) (741,000) 360,000
Changes in current assets and liabilities:
Increase in accounts receivable (1,739,000) (5,944,000) (406,000)
(Increase) decrease in inventories 2,180,000 (2,388,000) (7,988,000)
(Increase) decrease in other current assets (476,000) 134,000 (180,000)
(Increase) decrease in income tax receivable (947,000) 1,161,000
Increase in deferred gain on sale / leaseback 170,000
Increase in accounts payable, accrued expenses and
income taxes payable 1,633,000 6,426,000 4,543,000
- -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN ) OPERATING (4,913,000) 2,009,000 1,232,000
ACTIVITIES
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment, net (90,000) (2,993,000) (2,007,000)
Decrease (increase) in other assets 126,000 (304,000) 41,000
- -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING 36,000 (3,297,000) (1,966,000)
ACTIVITIES
- -----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under the line of credit 2,342,000 3,361,000 4,399,000
Borrowings (repayments) of long-term debt 3,007,000 (520,000) (934,000)
Principal repayments of capital leases (2,958,000) (3,107,000) (2,034,000)
Refinancing of capital leases 2,000,000
Issuance of common stock 75,000 106,000
- -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING 4,391,000 (191,000) 1,537,000
ACTIVITIES
----------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH (486,000) (1,479,000) 803,000
CASH AND EQUIVALENTS, BEGINNING OF YEAR 608,000 2,087,000 1,284,000
- -----------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS, END OF YEAR $ 122,000 $ 608,000 $ 2,087,000
===========================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

PHARACEUTICAL FORMULATIONS INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF THE Pharmaceutical Formulations, Inc. (the "Company") is
BUSINESS AND primarily engaged in the manufacture and distribution
RELATED PARTIES of over-the-counter solid dosage pharmaceutical
products in tablet, caplet and capsule form, which are
sold under customers' private labels. The Company also
supplies bulk products to secondary distributors and
re-packers as well as smaller competitors who do not
have sophisticated research and development
departments. The Company also engages in contract
manufacturing of selected branded products for well
known major pharmaceutical companies. The Company also
is engaged in the testing and research and development
of new drug and health care products.

In September 1991, the Company entered into an option
agreement with ICC Industries, Inc. ("ICC"), which, as
amended at various dates (the "Option Agreement"),
provided for options and related preemptive rights to
acquire a total of 66.67% of the number of shares of
the Company's common stock outstanding after exercise
of all options. ICC has exercised all of its options
and certain preemptive rights and miscellaneous options
pursuant to the Option Agreement. The number of shares
issued to ICC through July 3, 1999 was 19,857,430 at
option prices ranging from $.1036 to $.75 per share.

In the event of any future issuance of shares of common
stock of the Company pursuant to the exercise of
existing options, warrants, conversion rights and other
rights as they existed at September 24, 1992
("Outstanding Rights"), issuance of common stock in
settlement of the Company's outstanding debts as of
September 24, 1992, or issuance of shares of stock to
key management, ICC shall be entitled to acquire
additional shares to maintain the ownership percentage
it holds immediately before such shares of common stock
are issued (the "Limited Preemptive Rights"). ICC's
exercise price for the shares is the lesser of $.25
($.50 in the case of certain key management shares) or
the exercise price or conversion price of the
Outstanding Rights as the case may be. ICC exercised
221,536 shares under preemptive rights in 1997 (no
preemptive rights were exercised in 1998 and 1999) at a
price of $.25 per share.

ICC, a major international manufacturer and marketer of
chemical, plastic and pharmaceutical products, with
calendar year 1998 sales in excess of $1 billion, has
offices in key business centers around the world and
owns numerous manufacturing plants. In addition, ICC
supplies certain inventory and has in the past provided
equipment financing to the Company (in 1998, these
leases were assigned to the Company). In addition to
making advances to the Company, ICC also provided a
term loan for $3,000,000 and a temporary guarantee on
$1,500,000 in advances under a revolving loan from a
lending institution on April 1, 1999. ICC has also
indicated its intention to pursue joint venture
arrangements or other forms of business transactions
between the Company and foreign pharmaceutical
companies seeking to market, distribute and sell
products in the United States.

In connection with the ICC Option Agreement, several
key employees were granted, and have the right in the
future to receive, shares of the Company's common
stock.

The Company issued 10,768 shares of common stock to
these employees in 1998. The following transactions
with ICC, are reflected in the consolidated financial
statements as of or for the years ended July 3, 1999,
June 30, 1998 and 1997:

JULY 3, 1999 JUNE 30, 1998 JUNE 30, 1997
- ----------------------------------------------------------------------------------------------------

Inventory purchases $2,667,000 $2,707,000 $1,226,000
Services and finance fees 277,000 276,000 428,000
Accounts payable 2,639,000 3,254,000 786,000
Equipment lease obligations - - 3,268,000
Note payable 3,000,000 - -
Other receivables - - 213,000
=====================================================================================================

2. SUMMARY OF PRINCIPLES OF CONSOLIDATION
SIGNIFICANT
ACCOUNTING
POLICIES

The accompanying consolidated financial statements
include the accounts of the Company and its
wholly-owned subsidiaries. All references to the
"Company" include its wholly-owned subsidiaries. All
significant inter-company accounts and transactions
have been eliminated.

CHANGE IN FISCAL YEAR

Effective in the fourth quarter of fiscal 1999 the
Company changed its fiscal year-end from June 30 to the
52 or 53-week period which ends on the Saturday closest
to June 30. Accordingly, in future years quarterly
periods will generally be comprised of 13 weeks and end
on Saturday. The impact of the change between June 30,
1999 and July 3, 1999 was not significant.

CASH EQUIVALENTS

Cash equivalents consist of short-term, highly liquid
investments, which are readily convertible into cash at
cost.

INVENTORIES

Inventories are stated at the lower of cost or market
with cost determined on a first-in, first out (FIFO)
basis.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost.
Depreciation and amortization is provided on the
straight-line method over the estimated useful lives of
the assets (five to fifteen years).

REVENUE RECOGNITION

Sales of products are recorded when products are
shipped to customers. Provisions for customer volume
discounts, estimated sales returns and allowances, are
accrued at the time revenues are recorded.

EARNINGS PER SHARE

Effective December 15, 1997, the Company accounts for
earnings per share under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share", which requires a dual
presentation of basic and diluted earnings per share.
Basic earnings per share excludes dilution and is
computed by dividing income available to common
stockholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per
share is computed assuming the conversion of
convertible preferred stock and the exercise or
conversion of common equivalent shares, if dilutive,
consisting of unissued shares under options and
warrants. As required, SFAS 128 was retroactively
applied to the prior periods presented. There was no
impact to the prior period amounts.

CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the
Company to credit risk consist principally of trade
receivables. The Company extends credit to a
substantial number of its customers and performs
ongoing credit evaluations of those customers'
financial condition while, generally, requiring no
collateral. Customers that have not been extended
credit by the Company are on a cash on delivery basis
only. At July 3, 1999, approximately 50% of the
accounts receivable balance was represented by five
customers. At June 30, 1998, approximately 54% of the
accounts receivable balance was represented by five
customers.

INCOME TAXES

The Company accounts for income taxes in accordance
with Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes," which requires the
recognition of deferred tax liabilities and assets at
currently enacted tax rates for the expected future tax
consequences of events that have been included in the
financial statements or tax returns.

USE OF ESTIMATES

The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates and assumptions that
affect the reported amounts of assets and liabilities
and disclosure 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.

LONG-LIVED ASSETS

Effective July 1, 1996, the Company adopted SFAS No.
121, "Accounting for the Impairment of Long-Lived
Assets and Long-Lived Assets Being Disposed Of," which
provides guidance on how and when impairment losses are
recognized on long-lived assets based on non-discounted
cash flows. This statement did not have a material
impact on the financial position or results of
operations of the Company. No impairment losses have
occurred through July 3, 1999.

STOCK BASED COMPENSATION

Effective July 1, 1996, the Company adopted SFAS No.
123, "Accounting for Stock-Based Compensation." The
Company chose to apply APB Opinion 25 and related
interpretations in accounting for its stock options. As
a result, this statement did not have an effect on the
financial position or results of operations of the
Company.

NEW ACCOUNTING PRONOUNCEMENTS

In June 1998, SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), was
issued. SFAS 133 standardizes accounting and reporting
for derivative instruments and for hedging activities.
This statement is effective in the year 2001. The
Company does not have derivative instruments,
therefore, this pronouncement should not have any
impact to the Company's financial reporting.

FAIR VALUE AND FINANCIAL INSTRUMENTS

Financial instruments of the Company include long-term
debt. Based upon the current borrowing rates available
to the Company, estimated fair values of the revolving
credit and term loans (see Note 6) approximate their
recorded carrying amounts. It was not deemed practical
to determine the estimated fair value of the remaining
debt. The carrying amounts for cash, accounts
receivable, accounts payable and accrued expenses are
reasonable estimates of their fair value due to the
short maturity of these items.

COLLECTIVE BARGAINING AGREEMENT

Substantially all of the Company's non-management
employees are covered by a collective bargaining
agreement which expires in October 2001.

SALE/LEASEBACK TRANSACTIONS

The Company periodically enters into sale/leaseback
transactions in connection with obtaining machinery and
equipment. Gains recorded on such transactions, when
appropriate, are deferred and amortized over the
applicable lease terms.

3. COSTS RELATED TO In order to upgrade services to customers, improving
COMPUTER SYSTEM operating efficiencies and insure year 2000
CONVERSION compliance, the Company, during fiscal 1999, installed
and implemented a new integrated computer system. This
major system conversion caused major disruptions in
inventory control, shipping, production and planning
resulting in reduced sales and increased cost of sales.
In addition, the Company experienced delays in billings
and collections which required an increase in borrowing
levels resulting in additional interest expense. The
Company was not able to identify all of the additional
costs related to the conversion to the new computer
system.

4. INVENTORIES Inventories consist of the following:

JULY 3, 1999 JUNE 30, 1998
------------------------------------------------------
Raw materials $ 6,253,000 $ 6,589,000
Work in process 862,000 717,000
Finished goods 10,801,000 12,790,000
------------------------------------------------------
$17,916,000 $20,096,000
======================================================

5. PROPERTY, PLANT Property, plant equipment consist of the following:
AND EQUIPMENT

JULY 3, 1999 JUNE 30, 1998
------------------------------------------------------
Land and building $ 8,348,000 $8,348,000
Leasehold improvements 6,692,000 5,175,000
Machinery and equipment 21,783,000 21,875,000
Other 1,476,000 3,126,000
------------------------------------------------------
38,299,000 38,524,000
Less: Accumulated
depreciation 19,663,000 17,083,000
and amortization
------------------------------------------------------
$ 18,636,000 $21,441,000
======================================================

The net book value of property, plant and equipment
under capital leases was $10,635,000 and $11,817,000 at
July 3, 1999 and June 30, 1998, respectively.

6. LONG-TERM DEBT Long-term debt and capital lease obligations consist
AND CAPITAL LEASE of the following:
OBLIGATIONS

JULY 3, 1999 June 30, 1998
--------------------------------------------------------------------------------------------------------
Long-Term Capital Long-Term Capital
Debt Leases Debt Leases
--------------------------------------------------------------------------------------------------------

Revolving/term loans (a) $21,076,000 $ - $18,500,000 $ -
Term loan due ICC (b) 3,000,000 - -
Convertible subordinated
debentures, $1,000 face value
(less unamortized discount
of $1,374,000 and
$1,629,000 (c) 3,722,000 - 3,567,000 -
Convertible subordinated
debentures, $570,000 face
value (d) 711,000 - 758,000 -
New Jersey Economic Develop-
ment Authority Loan (e) 560,000 - 640,000 -
Building sale/leaseback (f) 4,731,000 5,343,000
Capital equipment lease
obligations (g) 4,762,000 5,108,000
--------------------------------------------------------------------------------------------------------
29,069,000 9,493,000 23,465,000 10,451,000
Less Current portion: 2,135,000 2,879,000 482,000 2,898,000
--------------------------------------------------------------------------------------------------------
$26,934,000 $6,614,000 $22,983,000 $7,553,000
========================================================================================================

a) On August 7, 1998, the Company modified its line of credit and
equipment term loan with its lending institution. The maximum
available funds under this modification are $25,000,000. Advances
under the revolving loans are limited to the sum of eligible
accounts receivable and up to $12,500,000 of eligible inventory,
as defined. In addition, on April 1, 1999, the line was further
amended to provide up to a $1,500,000 advance beyond contractual
ratios described above, which is guaranteed by ICC. Such advances
are to be repaid during the current fiscal year. The term loan
was refinanced in 1998 to a total of $1,200,000 and is payable in
36 monthly installments of $30,000, with the then outstanding
balance due on August 7, 2001. The revolving loan is also due on
that date. The term loan and the revolving loan are secured by
substantially all of the assets of the Company. Interest, payable
monthly, at the prime rate, minus3/4% was increased by 2%
effective April 1, 1999 resulting from the modification of
certain contractual ratios.

The loan agreement as modified contains certain loan covenants,
which, among other things, prohibits the Company from making
dividend payments, limit the Company's annual capital
expenditures and require the Company to maintain financial
ratios.

At July 3, 1999, the Company was in violation of certain of its
financial covenants. The aforementioned covenant violations have
been waived by the lending institution. Management and the
lending institution have modified the covenants in the credit
agreement such that further compliance will be more likely.

b) On April 1, 1999, the Company entered into a term loan and
security agreement with ICC for $3,000,000 with interest payable
monthly at 1% above the prime rate. The loan is secured by a
security interest in all the assets of the Company behind other
secured indebtedness. Principle payments are to commence in May
2000 at $75,000 per month and are increased to $100,000 in May
2001 with a final payment of $900,000 in May 2002.

c) At July 3, 1999, the Company has 5,196 units outstanding
consisting of a $1,000 principal amount convertible subordinate
debenture due June 15, 2002 (the "8% Debentures") with interest
payable semi-annually. The holders of the 8% Debentures may
convert them at any time into common stock of the Company at a
conversion price of $48 per share. The 8% Debentures are
redeemable at the option of the Company under certain
circumstances at par, plus an applicable premium, as defined.

d) On July 3, 1999, the Company has 1,753 units outstanding
consisting of $325 principal amount 8 1/4% convertible debentures
due June 15, 2002 (which includes $570,000 face value and
interest through maturity of $141,000). Interest is payable
annually on June 30. The holders of the 8 1/4% debentures may
convert them at any time into shares of common stock at a
conversion price of $.55 per share. The Company has no right to
redeem the 8 1/4% Debentures.

e) The loan, which is secured by certain equipment, bears interest
at 6D% and is due as follows: $80,000 at June 1, 2000 and 2001;
and $400,000 at June 1, 2002. A provision in the loan agreement
allows the lender to declare the loan immediately due and payable
if there has been an event of default in any of the Company's
other debt agreements.

f) In August 1989, PFI entered into a sale and leaseback of its land
and building in Edison, New Jersey. The term of the lease is 15
years, plus two five-year renewal options. Monthly base rent is
$107,000 for the first 30 months increased by the change in the
Consumer Price Index on the thirty-first month after commencement
and on each thirtieth month thereafter. On February 1, 1997, the
monthly base rent increased to $139,000. The Company is obligated
to pay all utilities, real estate taxes, assessments and repair
and maintenance costs in connection with the premises. The land
and building has been recorded as a capital lease and the gain on
the sale and leaseback of approximately $750,000 has been
deferred and is being amortized over the term of the lease. The
lease has been capitalized at the net present value of the future
minimum rental payments ($8,348,000), assuming a 13 1/4% interest
rate factor, and is being amortized over the term of the lease.

g) The Company leases various equipment under capital lease
agreements. The terms of the leases vary from three to five years
with monthly rentals of approximately $332,000.

The Company's debt and obligations under capital leases mature
in fiscal years as follows:

Capital Lease Long-Term
Obligations Debt
--------------------------------------------------------------------------

2000 $ 3,769,000 $ 2,135,000
2001 2,795,000 1,055,000
2002 1,903,000 25,879,000
2003 1,762,000
2004 1,523,000
Thereafter 107,000
-------------------------------------------------------------------------
Total Payments 11,859,000 $29,069,000
=============
Less: Amount representing interest (2,366,000)
--------------------------------------------------
Present value of net minimum lease $9,493,000
payments
==================================================

7. Commitments and COMMITMENTS
Contingencies.

In fiscal 1996, the Company entered into a long-term
lease for a building adjacent to the Company's
manufacturing facility. The lease term is ten years
with two five-year renewal options. The lease is
classified as an operating lease. The rent payments are
$319,200 per annum for the first five years and
$342,000 per annum for the balance of the initial term.

CONTINGENCIES

In July 1997, the Company received an arbitration
demand from the estate of Dr. Max Tesler, the former
President of the Company who died in December 1996. For
alleged breaches of employment and other agreements
between the Company and Dr. Tesler, the Estate is
seeking an award of $5,500,000 in compensatory damages,
$10,000,000 in punitive damages and such number of
shares of common stock of the Company as would equal
10% of the total number of shares outstanding. For
claimed tortuous conduct, the Estate is seeking
$20,000,000 for intentional infliction of emotional
distress and $10,000,000 for PRIMA FACIE TORT. The
Estate is also seeking attorney's fees and a revised
warrant agreement pursuant to claimed antidilution
provisions.

The claimed breaches of contract include failure to pay
(a) salary through December 1998, (b) change of control
payments on the assumption that there was a change of
control, as defined, at the 1996 annual meeting and (c)
death benefits. The claim for death benefits, however,
was subsequently released by the Estate.

With respect to the claim for continuing salary, the
Company has advised the Estate of counterclaims which
the Company has, which, exceed the amount of such
payments. The Company maintains that as a result of the
termination of Dr. Tesler's employment in December
1995, the Company ceased to have any liability under
the change-of-control provisions of the various
agreements with Dr. Tesler, as well as having other
defenses to such claims. It is also the position of the
Company that certain provisions of the warrants issued
to Dr. Tesler were not as agreed and authorized. The
warrants expired October 1, 1998.

The children and a former spouse of Dr. Tesler have
also raised certain claims arising out of the death of
Dr. Tesler. The Company settled their claims in
December 1998. Accordingly, the Company has recorded a
lawsuit expense of $1,179,000 which includes legal and
other costs related to the settlement. Payments to date
were advanced by ICC on behalf of the Company.

In December 1995, the Company accrued the continuing
salary due to Dr. Tesler for the period through
December 1998. It has not made provision for any of the
other amounts claimed, nor has it accrued any amounts
due from the Estate. As noted above, the Company
believes that the claims are without merit and that the
Company has valid offsetting claims. The Company
intends to vigorously defend against the arbitration
claim and to prosecute its claims against the Estate.

In 1991, an action was instituted in the Superior Court
of New Jersey, County of Middlesex, against the Company
by Marvin Rosenblum, seeking $3,500,000 in damages and
other relief for claimed breach of an alleged
employment agreement. The Company interposed
counterclaims for fraud and related claims and claimed
damages in the amount of $5,500,000. The case was
dismissed with prejudice in April 1998. The plaintiff
filed an appeal seeking to have the case reinstated and
such appeal was denied.

Management believes the final outcome of the above
proceedings will not have a material effect upon the
Company's financial position, liquidity or operating
results.

The Company is a party to various other legal
proceedings arising in the normal conduct of business.
Management believes that the final outcome of these
proceedings will not have a material adverse effect
upon the Company's financial position or results of
operations.

8. Income Taxes Income taxes (benefit) consist of the following
federal taxes:

1999 1998 1997
----------------------------------------------------------------------------------

Current $ (947,000) $ 702,000 $522,000
Deferred (2,224,000) (741,000) 360,000
----------------------------------------------------------------------------------
Total income taxes (benefit) $ (3,171,000) $ (39,000) $882,000
==================================================================================

The Company's income taxes (benefit) differ from the
amount of income tax determined by applying the
applicable statutory U.S. Federal income tax rate to
pretax income as a result of the following:

1999 1998 1997
----------------------------------------------------------------------------------------------

Statutory U.S. tax (benefit) $(3,310,000) $ 622,000 $753,000
Increase (decrease) resulting from: 110,000 133,000
State income taxes
Expiration of state net operating 42,000
loss carry forwards
Net change in valuation account 364,000 (1,054,000) 30,000
Other (225,000) 241,000 (34,000)
-----------------------------------------------------------------------------------------------
Effective income taxes (benefit) $(3,171,000) $ (39,000) $882,000
-----------------------------------------------------------------------------------------------

The Company utilized tax loss carry forwards of
approximately $165,000 and $1,150,000 for U.S. regular
tax purposes during the fiscal years ended June 30,
1998 and 1997, respectively.

As of July 3, 1999, the Company had available net
operating losses of approximately $7,589,000 for U.S.
regular tax purposes, which expire through 2019. The
utilization of losses that were generated prior to
September 1991, which approximates $1,485,000 is
limited to approximately $166,000 per year for U.S.
regular tax purposes due to the change in ownership
resulting from the ICC investment. State income tax net
operating loss carry forwards of approximately
$18,977,000, which expire through 2007, are available
to the Company.

Deferred tax assets are comprised of the following
temporary differences:

July 3,1999 June 30, 1998
-----------------------------------------------------------------------------------------------

Tax benefit of state income tax net operating $1,139,000 $ 675,000
loss carry forwards
Tax benefit of federal income tax net operating 2,580,000 505,000
loss carry forwards
Depreciation 61,000 (41,000)
Deferred gain on sale/leaseback of building 135,000 109,000
Basis difference 8 1/4% debentures as a result of 48,000 64,000
restructuring
Capitalized inventory costs 111,000 120,000
Deferred compensation 155,000 155,000
Allowance for doubtful accounts 87,000 81,000
Alternative minimum tax carry forward 104,000 163,000
-----------------------------------------------------------------------------------------------
Gross deferred tax asset 4,420,000 1,831,000
Valuation allowance (664,000) (300,000)
-----------------------------------------------------------------------------------------------
Net deferred tax asset $3,756,000 $1,531,000
===============================================================================================

The Company anticipates profitable operations for at
least the next few years and, therefore, has recorded a
net deferred tax asset of $3,756,000 at July 3, 1999.
The benefits of net operating loss carry forwards and
other temporary differences that are estimated to take
more than a few years to realize cannot be reasonably
determined at this time due to the Company's
inconsistent operating results in the past.
Accordingly, a valuation allowance of $664,000 was
recorded at July 3, 1999 to provide for this
uncertainty.

9. Common Stock, The Company has granted options to employees,
Options and directors and others under various stock option plans,
Warrants lending arrangements, and under the ICC Option
Agreement.

The following is a summary of stock options and
warrants issued, exercised, forfeited or canceled for
the period July 1, 1996 through July 3, 1999 (not
including ICC preemptive rights or additional shares
issuable to management in connection with ICC
preemptive rights):

Shares Weighted-
Average
----------------------------------------------------------------------------------------

Outstanding - June 30, 1996 1,736,800 $.64
Issued 501,750 $.84
Exercised (100,000) $.50
Forfeited (399,850) $.96
----------------------------------------------------------------------------------------
Outstanding - June 30, 1997 1,738,700 $.62
Issued 349,000 $.85
Exercised (300,000) $.25
Forfeited (40,700) $.85
----------------------------------------------------------------------------------------
Outstanding - June 30, 1998 1,747,000 $.77
Issued 346,000 $.39
Forfeited (849,700) $.65
----------------------------------------------------------------------------------------
Outstanding - July 3, 1999 1,243,300 $.72
========================================================================================
Exercisable - July 3, 1999 987,300 $.80
========================================================================================

The following table summarizes information about stock
options outstanding at July 3, 1999:

Options Outstanding Options Exercisable

----------------------------------------------------------------------------------------------------
Range of Number Weighted Weighted Number Weighted
Exercised Outstanding Average Average Exercisable Average
Prices at July 3, Remaining Exercise at July 3, Exercise
1999 Life (Years) Price 1999 Price
--------------------------------------------------------------------------------------------------------

$0.85 227,800 1.2 $0.85 227,800 $0.85
0.84 186,500 3.4 0.84 186,500 0.84
0.80 272,000 3.4 0.80 272,000 0.80
0.41 115,000 4.4 0.41
0.25 to 0.56 141,000 4.8 0.38
0.56 to 0.89 116,000 2.0 0.61 116,000 0.61
0.75 110,000 4.8 0.75 110,000 0.75
0.91 75,000 0.6 0.91 75,000 0.91
--------------------------------------------------------------------------------------------------------
1,243,300 987,300
========================================================================================================

The weighted average fair market value of options
granted during the fiscal years 1999, 1998 and 1997
were $.17, $.54, and $.36, respectively.

As of July 3, 1999, substantially all outstanding stock
options expire at various dates through fiscal year
2003. These options were granted at prices which were
at or above quoted market value on the dates granted.

The Company has adopted the disclosures only provisions
of SFAS No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has
been recognized for the stock options granted. Had
compensation cost been determined based on the fair
value at the date of grant consistent with provisions
of SFAS No. 123, the Company's financial statements
would have included the following:

JULY 3, 1999 June 30, 1998 June 30, 1997
------------------------------------------------------------------------------------------------------

Net income (loss) - as $(6,565,000) $1,867,000 $1,332,000
reported
Net income (loss) - pro forma $(6,562,000) $1,772,000 $1,282,000
======================================================================================================

The application of SFAS No. 123 had no effect on the
Company's net income (loss) per share-basic and diluted
during the years presented herein.

The fair market value of each option grant is estimated
on the date of grant using the Black-Scholes
option-pricing model with the following weighted
average assumptions used for grants: expected
volatility of 46%, 47% and 35% for 1999, 1998 and 1997,
respectively, risk-free interest rate of 4.4%, 5.9% and
6.06% for 1999, 1998 and 1997, respectively, expected
lives of 5 years and no dividend yield for all three
years ended 1999.

10. Preferred Stock On April 8, 1996, the Company sold 2,500,000 shares of
Series A Preferred Stock to ICC for an aggregate of
$2,500,000. The preferred stock is redeemable at the
option of PFI and is currently convertible into common
stock of the Company by ICC at the lower of market
price of the common stock or $2.00 per share. The
preferred stock accrues dividends at the rate of $.08
per share, payable semi-annually and is cumulative and
non-participating. Dividends in arrears totaled
$650,000 at July 3, 1999.

11. Major Customers For the years ended July 3, 1999, June 30, 1998 and
and Products 1997, 17%, 17% and 14% respectively, of consolidated
net sales were derived from Walgreen Company. Costco
Wholesale accounted for 14%, 20%, and 16% of
consolidated net sales for 1999, 1998 and 1997,
respectively. Sales to Revco accounted for 17% of
consolidated net sales for the year ended June 30,
1997.

For the years 1999, 1998 and 1997, sales of ibuprofen
represented 32%, 39% and 38% of consolidated net sales,
respectively.

12. Earnings Per The following data shows the amounts used in computing
Share earnings (loss) per share and the effect on income
(loss) and the weighted average number of shares of
dilutive potential common stock:

1999 1998 1997
----------------------------------------------------------------------------------------------

Net income (loss) $(6,565,000) $1,867,000 $1,332,000
Less: Preferred dividends 200,000 200,000 200,000
----------------------------------------------------------------------------------------------
Net income available (loss) (6,765,000) 1,667,000 1,132,000
attributable to common
shareholders used in basic
earnings per share
Convertible preferred stock 200,000 200,000 200,000
dividends
----------------------------------------------------------------------------------------------
Income available (loss) $(6,565,000) $1,867,000 $1,332,000
attributable to common
shareholders after
assumed conversions of
dilutive securities
----------------------------------------------------------------------------------------------
Weighted average number 30,253,000 30,199,000 29,559,000
of common shares used in
basic earnings per share
Effect of dilutive securities:
Stock options/warrants 400,000 688,000
Convertible preferred stock 3,788,000 3,472,000
Convertible bonds 2,323,000 2,523,000
==============================================================================================
Weighted average number 30,253,000 36,710,000 36,242,000
of common shares and
dilutive securities
==============================================================================================

Notes to Consolidated Financial Statements

In 1999, options, warrants, preferred stock and
convertible debentures amounting to 10,014,000 shares
of common stock were not included in computing diluted
earnings because the effect was antidilutive options.
In 1998 and 1997 options and warrants for 1,137,000 and
829,000, shares of common stock respectively, were not
included in computing diluted earnings per share
because their effects were antidulutive.

13. Supplemental Cash Supplemental disclosures of cash flow information:
Flow Information

1999 1998 1997
------------------------------------------------------------------------------------------------------

Cash paid during the year:
Interest $4,195,000 $3,820,000 $3,724,000
Income taxes 150,000 330,000 300,000
======================================================================================================

SUPPLEMENTAL NON-CASH INVESTING AND FINANCING
INFORMATION:

Capital lease obligations of $0, $1,801,000 and
$1,537,000 were incurred when the Company entered into
various leases in 1999, 1998 and 1997, respectively.

14. Quarterly The Company recorded certain adjustments, primarily
Financial Data related to inventory, sales and accounts receivable
(Unaudited) allowances, which were required to properly reflect
financial results previously reported in its 1st and
2nd quarters filed on Form 10-Q for fiscal 1999. The
Company plans to restate these Form 10-Q filings in the
near future to reflect these adjustments. The adjusted
net loss amounts, by quarter, are reflected below:

Fiscal 1999 quarter Net loss, as Adjustments Net loss, as
originally adjusted
reported
----------------------------------------------------------------------------------------

First $ (85,000) $(2,503,000) $(2,588,000)
Second (1,414,000) (1,330,000) (2,744,000)
========================================================================================

In addition, the Company did not file the third quarter
Form 10-Q. The net loss reported for the third quarter
ended March 31, 1999 when filed will be approximately
$1,348,000.

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE

The audits referred to in our report dated September 22, 1999 relating to the
consolidated financial statements of Pharmaceutical Formulations, Inc. and
subsidiaries, which is contained in Item 8 of this Form 10-K, included the
audits of the financial statement schedule listed in the accompanying index.
This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based upon our audits.

In our opinion, such financial statements schedule presents fairly, in all
material respects, the information set forth therein.

/s/ BDO Seidman, LLP
BDO Seidman, LLP

Woodbridge, New Jersey

September 22, 1999

PHARMACEUTICAL FORMULATIONS, INC.
and Subsidiaries

Schedule II - Valuation and Qualifying Accounts

Allowance for doubtful Balance at Additions Charge to Deductions Balance at
accounts beginning of charged to other write-offs end of period
period costs & accounts uncollectible
expenses accounts
- ------------------------------------------------------------------------------------------------------------------------------

Year ended July 3, 1999 $238,000 $125,000 $ - $108,000 $255,000
- ------------------------------------------------------------------------------------------------------------------------------
Year ended June 30, 1998 $301,000 $ 60,000 $ - $123,000 $238,000
- ------------------------------------------------------------------------------------------------------------------------------
Year ended June 30, 1997 $300,000 $ 1,000 $ - $ - $301,000
- ------------------------------------------------------------------------------------------------------------------------------

EXHIBIT INDEX

10.3(C) Letter Agreement dated April 1, 1999 between CIT and the Registrant
amending the CIT Loan Agreement

10.3(D) Letter Agreement dated April 1, 1999 between CIT and ICC Industries
Inc. ("ICC") amending the Intercreditor Agreement between ICC and CIT
dated March 25, 1992, as attached

10.3(E) Letter Agreement dated April 1, 1999 between CIT and the Registrant
amending Warrant Certificates dated April 1, 1992 for the purchase of
100,000 shares and March 30, 1993 for the purchase of 10,000 shares of
common stock of the Registrant extending the expiration dates to March
31, 2004

10.3(F) Limited Guaranty dated April 1, 1999 by ICC in favor of CIT with
respect to the CIT Loan Agreement

10.3(G) Letter Agreement dated April 26, 1999 between CIT and the Registrant
amending the CIT Loan Agreement

10.3(H) Letter Agreement dated June 2, 1999 between CIT and the Registrant
amending the CIT Loan Agreement

10.13 Term Loan and Security Agreement dated as of April 1, 1999 between ICC
and the Registrant

23 Consent of the Independent Public Accountants

27 Financial Data Schedule