Acura Pharmaceuticals/Inc · 10-K · For 12/31/97

Filed On 4/15/98   ·   SEC File 1-10113   ·   Accession Number 950123-98-3851

Annual Report   ·   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Halsey Drug Co., Inc.                                 82    394K 
 2: EX-10.42    Letter Agreement                                       3     16K 
 3: EX-10.43    Employment Agreement Re M. Reicher                    16     48K 
 4: EX-10.44    Employment Agreement Re Peter Clemens                 15     46K 
 5: EX-23.1     Consent of Grant Thornton Llp                          1      5K 
 6: EX-27       Financial Data Schedule                                1      6K 

10-K   ·   Halsey Drug Co., Inc.
Document Table of Contents

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 FORM 10-K

 FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 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 December 31, 1997                   

/ /      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 1-10113

 HALSEY DRUG CO., INC.
(Exact Name of Registrant as Specified in Its Charter)

  New York                                  11-0853640
   (State or Other Jurisdiction             (I.R.S. Employer Identification No.)
of Incorporation or Organization)                                               

  695 North Perryville Road, Crimson Building No. 2, Rockford, Illinois  61107
               (Address of Principal Executive Offices)               (Zip Code)

Registrant's telephone number, including area code       (718) 467-7500         

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

Title of Each Class:                  Name of Each Exchange on Which Registered:
Common Stock, Par Value $0.01         The American Stock Exchange               

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

None

None
(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 
filing requirements for the past 90 days. Yes X No__                            

       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 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. / /                                                

      As of March 16, 1998, the registrant had 13,708,081 shares of Common
Stock, par value $0.01, outstanding. Based on the closing price of the Common   
Stock on March 16, 1998 ($3 1/16), the aggregate market value of the voting     
stock held by non-affiliates of the registrant was approximately $32,933,000.   

 DOCUMENTS INCORPORATED BY REFERENCE
Document                                                  Where Incorporated    
--------                                                  ------------------    
Proxy Statement for the 1998 Annual Meeting               Part III              
of Shareholders                                                                 

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                                  CONTENTS

                                                                · Download Table

                                                                         PAGE 

PART I                                                                        

                                                                              
Item 1.   Business                                                           2

Item 2.   Properties                                                        13

Item 3.   Legal Proceedings                                                 14

Item 4.   Submission of Matters to a Vote of Security Holders               18

PART II                                                                       

Item 5.   Market for Registrant's Common Equity and Related Stockholder       
          Matters                                                           19

Item 6.   Selected Financial Data                                           20

Item 7.   Management's Discussion and Analysis of Financial                   
          Condition and Results of Operations                               22

Item 8.   Financial Statements and Supplementary Data                       28

Item 9    Changes in and Disagreement with Accountants on                     
          Accounting and Financial Disclosure                               28

PART III                                                                      

Item 10.  Directors and Executive Officers of the Registrant                29

Item 11.  Executive Compensation                                            29

Item 12.  Security Ownership of Certain Beneficial Owners and                 
          Management                                                        29

Item 13.  Certain Relationships and Related Transactions                    29

PART IV                                                                       

Item 14.  Exhibits, Financial Statement Schedules and Reports                 
          on Form 8-K                                                       30

          Signatures                                                        35

          Index to Consolidated Financial Statements                        36

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 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Report under the captions Item 7, "Management's      
Discussion and Analysis of Financial Condition and Results of Operations," Item 
1, "Business" and elsewhere in this Report constitute "forward-looking          
statements" within the meaning of the Private Securities Litigation Reform Act  
of 1995 (the "Reform Act"). Such forward-looking statements involve known and   
unknown risks, uncertainties and other factors which may cause the actual       
results, performance or achievements of Halsey Drug Co., Inc. ("Halsey" or the  
"Company"), or industry results, to be materially different from any future     
results, performance, or achievements expressed or implied by such              
forward-looking statements. Such factors include, among others, the following:  
changes in general economic and business conditions; loss of market share       
through competition; introduction of competing services by other companies;     
changes in industry capacity; pressure on prices from competition or from       
purchasers of the Company's products; regulatory changes in the generic         
pharmaceutical manufacturing industry; regulatory obstacles to the introduction 
of new products are important to the Company's growth; availability of qualified
personnel; the loss of any significant customers; and other factors both        
referenced and not referenced in this Report. When used in this Report, the     
words "estimate," "project," "anticipate," "expect," "intend," "believe," and   
similar expressions are intended to identify forward-looking statements.        

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PART I

ITEM 1.  BUSINESS.                                                              

GENERAL                                                                         

  The Company, a New York corporation established in 1935, and its
subsidiaries, are engaged in the manufacture, sale and distribution of generic  
drugs. A generic drug is the chemical and therapeutic equivalent of a brand-name
drug for which patent protection has expired. A generic drug may only be        
manufactured and sold if patents (and any additional government-granted         
exclusivity periods) relating to the brand-name equivalent of the generic drug  
have expired. A generic drug is usually marketed under its generic chemical name
or under a brand name developed by the generic manufacturer. The Company sells  
its generic drug products under its Halsey label and under private-label        
arrangements with drugstore chains and drug wholesalers. While subject to the   
same governmental standards for safety and efficacy as its brand-name           
equivalent, a generic drug is usually sold at a price substantially below that  
of its brand-name equivalent.                                                   

      Halsey's wholly-owned subsidiaries include Houba, Inc. ("Houba"), an
Indiana corporation, Halsey Pharmaceuticals, Inc. ("Halsey Pharmaceuticals"), a 
Delaware corporation, Indiana Fine Chemicals Corporation ("Indiana Chemicals"), 
a Delaware corporation, H.R. Cenci Laboratories, Inc., a California corporation 
(97% owned) ("Cenci Laboratories"), and Cenci Powder Products, Inc. ("Cenci     
Powder"), a Delaware corporation. The Company also has two other subsidiaries,  
Blue Cross Products, Inc., a New York corporation, and The Medi- Gum            
Corporation, a Delaware corporation, each of which is inactive.                 

     The Company manufactures its products at facilities in New York and
Indiana. During 1995, in connection with the sale of its oxycodone with         
acetaminophen tablet business, the Company began manufacturing such product for 
a third party. See "Business-- Dispositions," below. During the last several    
years, the Company has sought to diversify its businesses through strategic     
acquisitions and through the development, manufacture and sale of bulk chemical 
products used by others as raw materials in the manufacture of finished drug    
forms.                                                                          

RECENT EVENTS                                                                   

Regulatory Compliance                                         

During the past several years, the Company's business has been
adversely affected by the discovery of various manufacturing and record keeping 
problems identified with certain products manufactured at its Brooklyn, New York
plant. In October 1991, the U.S. Food and Drug Administration (the "FDA") placed
the Company on the FDA's Application Integrity Policy list and its restrictions 
(collectively, the "AIP"). Under the AIP, the FDA suspended all of the parent   
company's applications for new drug approvals, including Abbreviate New Drug    
Applications ("ANDAs") and Supplements to ANDAs. During the period that         
followed, the U.S. Department of Justice ("DOJ") conducted an investigation into
the manufacturing and record keeping practices at the Company's Brooklyn plant. 
As a consequence, on June 21, 1993, the Company entered into a plea agreement   
(the "Plea Agreement") with the DOJ to resolve the DOJ's investigation. Under   
the terms of the Plea Agreement, the Company agreed to plead guilty to five     
counts of adulteration of a single drug product shipped in interstate commerce  
and related record keeping violations. The Plea Agreement also required the     
Company to pay a fine of $2,500,000 over five years in quarterly installments of
$125,000 commencing in September 1993. As of February 28, 1998, the Company was 
in                                                                              

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default of the payment terms of the Plea Agreement and had made payments        
aggregating $350,000. On March 30, 1998, the Company and the DOJ signed a Letter
Agreement serving to amend the Plea Agreement relating to the terms of the      
Company's satisfaction of the fine assessed under the Plea Agreement. The Letter
Agreement provides, among other things, that the Company will satisfy the       
remaining $2,150,000 of the fine through the payment of $25,000 on a monthly    
basis commencing May 1, 1998, plus interest on the outstanding balance. The     
terms of the Letter Agreement are subject to the approval of the U.S. District  
Court for the District of Maryland. Prior to the execution of the Letter        
Agreement with the DOJ, the entire $2,150,000 balance of the fine payable to the
DOJ under the Plea Agreement had been classified as current. See "Item 3. Legal 
Proceedings" and "Item 7. Management's Discussion and Analysis of Financial     
Condition and Results of Operations - Liquidity and Capital Resources" for a    
more detailed description of the Letter Amendment to the Plea Agreement between 
the DOJ and the Company.                                                        

  On June 29, 1993, the Company entered into a consent decree (the
"Consent Decree") with the U.S. Attorney for the Eastern District of New York on
behalf of the FDA that resulted from the FDA's investigation into the Brooklyn  
plant's compliance with the FDA's Current Good Manufacturing Practices ("CGMP") 
regulations. Under the terms of the Consent Decree, the Company was enjoined    
from shipping any solid dosage drug products (i.e., excluding liquid drug       
formulations) manufactured at the Brooklyn plant until the Company established, 
to the satisfaction of the FDA, that the methods used in, and the facilities and
controls used for, manufacturing, processing, packing, labeling and holding any 
drug, were established, operated, and administered in conformity with the       
Federal Food, Drug, and Cosmetic Act and all CGMP Regulations. As part of       
satisfying these requirements, the Company was required to validate the         
manufacturing processes for each solid dosage drug product prior to             
manufacturing and shipping the drug product.                                    

        On October 23, 1996, the Company withdrew four of its ANDAs, including
its ANDA (the "Capsules ANDA") for acetaminophen/oxycodone capsules (the        
"Capsules"), and halted sales of the affected products. Net sales derived from  
the withdrawn Capsule ANDA were approximately $3 million and $8 million for the 
years ended December 31, 1996 and December 31, 1995, respectively, and accounted
for approximately 24% and 40% of the Company's total net sales during such      
twelve month periods. The Company instituted the withdrawal of the Capsule ANDA 
at the suggestion of the FDA and in anticipation of its release from the AIP. At
the FDA's suggestion, the Company retained outside consultants to perform       
validity assessments of its drug applications. Thereafter, in October 1996, the 
FDA recommended that several applications, including the Capsule ANDA, be       
withdrawn. As a basis for its decision, the FDA cited questionable and          
incomplete data submitted in connection with the applications. The FDA indicated
that the withdrawal of the four ANDAs was necessary for the release of the      
Company from the AIP. The FDA further required submission by the Company of a   
Corrective Action Plan, which was prepared and submitted by the Company and     
accepted by the FDA.                                                            

       On December 19, 1996, the FDA released the Company from the AIP. As a
consequence, for the first time since October 1991, the Company was permitted to
submit ANDAs to the FDA for review. Since its release from the AIP in December  
1996, through the fiscal year ended December 31, 1997, the Company submitted six
ANDAs for review by the FDA, including a new ANDA with respect to the Capsules. 
During the period from the Company's release from the AIP to March 15, 1998, the
Company received the following ANDA approvals, all of which relate to ANDA      
filings made with the FDA subsequent to the Company's release from the AIP:     

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                                                        · Enlarge/Download Table

Product Name                                                                           
(Drug Class)                     Strength     Trade Name         Status                

                                                                                       
Hydrocodone Bitartate                                                                  
and Acetaminophen Tablets        5mg/500mg    Vicodin (1)        FDA approval of ANDA  
(narcotic analgesic)                                             received September 26,
                                                                 1997.                 

Hydrocodone Bitartate                                                                  
and Acetaminophen Tablets        7.5mg/750mg  VicodinES(R)(1)    FDA approval of ANDA  
(narcotic analgesic)                                             received September 26,
                                                                 1997.                 

Hydrocodone Bitartate                                                                  
and Acetaminophen Tablets, CIII  7.5mg/650mg  Lorcet Plus(R)(2)  FDA approval of       
(narcotic analgesic)                                             ANDA received         
                                                                 November 26, 1997.    

Hydrocodone Bitartrate                                                                 
and Acetaminophen Tablets, CIII  10mg/650mg   Lorcet(R)(2)       FDA approval of       
(narcotic analgesic)                                             ANDA received November
                                                                 26, 1997.             

Oxycodone HCI                                                                          
and Acetaminophen Capsules, CII  5mg/50mg     Tylox(R)(3)        FDA approval of       
(narcotic analgesic)                                             ANDA  received January
                                                                 22, 1998.             

-----------------------                                                         
(1)      Registered trademark of Knoll Pharmaceutical Co.                       

(2)      Registered trademark of Forest Laboratories, Inc.                      

(3)      Registered trademark of McNeil Consumer Products Company               

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         As of March 15, 1998, the Company had submitted two ANDAs for review by
the FDA in fiscal 1998 and anticipates the submission of eight additional ANDAs 
during the balance of fiscal 1998. Although the Company has been successful in  
receiving the ANDA approvals described above since its release from the AIP in  
December 1996, there can be no assurance that any of its newly submitted ANDAs, 
or those contemplated to be submitted, will be approved by the FDA. The Company 
will not be permitted to market any new product unless and until the FDA        
approves the ANDA relating to such product. Failure to obtain FDA approval for  
the Company's pending ANDAs, or a significant delay in obtaining such approval, 
would adversely affect the Company's business operations and financial          
condition.                                                                      

Private Offering                                              

On March 10, 1998, the Company completed a private offering of
securities (the "Offering") to Galen Partners, III , L.P., Galen Partners       
International III, L.P., Galen Employee Fund III, L.P., (collectively, "Galen") 
and each of the Purchasers listed on the signature page to a certain Debenture  
and Warrant Purchase Agreement dated March 10, 1998 between the Company and such
Purchasers (inclusive of Galen, collectively the "Galen Investor Group"). The   
securities issued in the Offering consisted of 5% convertible senior secured    
debentures (the "Debentures") and common stock purchase warrants (the           
"Warrants") exercisable for an aggregate of 4,202,020 shares of the Company     
common stock. The net proceeds to the Company from the Offering , after the     
deduction of related Offering expenses, was approximately $19.6 million .       

      Immediately prior to the completion of the Offering, the Company was
attempting to address various actions and proceedings which threatened the      
Company's continuing operations, most of which stemmed from the Company's lack  
of working capital to satisfy outstanding liabilities. In particular, the       
Company's Banks had given notice of a forced sale of certain of their security  
relating to the Company's outstanding bank indebtedness, which would have       
resulted in the loss of Houba's Indiana facility. In addition, the landlord of  
the Company's Brooklyn facility had served the Company with a notice of eviction
and various creditors had obtained judgments against the Company and filed      
restraining notices against its bank accounts. A lack of funding also resulted  
in the Company being unable to purchase meaningful quantities of raw materials  
and left inventories depleted and sales reduced.                                

    The net proceeds of the Offering have, in large part, been used to
satisfy a substantial portion of the Company's liabilities and accounts payable.
Such liabilities include the full satisfaction of the Company's Bank            
indebtedness and related fees, payment to the landlord of the Brooklyn facility 
and satisfaction of outstanding judgments and liens. Such repayments have       
allowed the Company to avoid the threatened foreclosure sale by its Banks of the
Indiana facility securing such indebtedness. Additionally, pursuant to          
agreements reached with other large creditors in anticipation of the completion 
of the Offering, including the Company's landlord and the DOJ, the Company has  
been able to bring these creditors current and will be in compliance with       
installment payment agreements providing favorable terms to the Company.        
Satisfaction of the Company's current obligations to its landlord of the        
Brooklyn facility for accrued and unpaid rent, penalties and expenses has       
allowed the Company to renegotiate its lease and avoid eviction. The Offering   
proceeds will also allow the Company to satisfy its outstanding state and       
Federal payroll tax obligations and meet current payroll tax obligations.       

   After giving effect to the application of the net proceeds of the
Offering, and based on Management's belief as to the Company's ability to defer 
a portion of the Company's remaining notes and accounts payable and certain     
other assumptions, the Company believes that it will have working capital of    
approximately $3                                                                

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million. See "Item 7. Management's Discussion and Analysis of the Financial     
Condition and Results of Operations--Liquidity and Capital Resources."          

      Under the rules of the American Stock Exchange ("AMEX") on which the
Company's shares are listed for trading, the Company was required to obtain the 
approval of its shareholders in order to complete the Offering. In view of the  
Company's financial condition, its need for immediate capital and the delay     
associated with soliciting the approval of its shareholders, the Company        
requested a waiver from the AMEX in order to complete the Offering without the  
necessity of obtaining shareholder approval. In requesting the waiver, the      
Company provided detailed information, including a written submission, to the   
AMEX and met with representatives of the AMEX to discuss the proposed terms of  
the Offering, the experience of new Senior Management, Galen's investment       
history and the urgent need to complete the Offering on or before March 11, 1998
in order to allow for the payment of the liabilities previously described, some 
of which threatened to cease the Company's continuing operations.               

The AMEX granted the Company's request for the waiver from its
shareholder approval requirement in connection with the Offering in order to    
permit its timely completion. As part of this process, the AMEX suspended       
trading in the Company stock commencing Friday, March 6, 1998. Trading on the   
AMEX resumed on Monday, March 16, 1998 following the circulation on March 11,   
1998 of a Press Release to the Company's shareholders of record describing the  
terms of the Offering and its completion on March 10, 1998. Such press release  
was also distributed over the wire services on Friday, March 13, 1998.          

        Reference is made to the Company's Current Report on Form 8-K as filed
with the Securities and Exchange Commission on March 24, 1998 which describes,  
among other things, the Offering and the terms of the Debentures and Warrants   
issued in the Offering. The Form 8-K is incorporated herein by this reference   
and attached as Exhibit 10.41 hereto.                                           

Cessation of California Operations                            

    On March 20, 1998, the Company discontinued the operation of Cenci
Laboratories. Cenci Laboratories had been a manufacturer of drug products in    
liquid and powder preparations. Continuing operating losses and the Company's   
inability to leverage the manufacturing capacity of Cenci Laboratories were     
among factors considered by the Board and Management in its determination to    
cease such operations.                                                          

       On March 26, 1998, the Company signed a Letter of Intent with Zuellig
Botanicals for the sale of substantially all of the non-real property assets of 
Cenci Powder. The Letter of Intent provides that the purchase price for the     
assets will consist of the forgiveness by Zuellig Botanicals of approximately   
$262,000 in indebtedness owed by Cenci Powder to Zuellig Botanicals related to  
the purchase of raw materials. The Letter of Intent provides further that       
Zuellig Botanicals will satisfy the manufacture and delivery requirements of    
Cenci Powder at its located facility in Fresno, California, under an existing   
third party supply contract. Additionally, the Letter Agreement contemplates a  
right of first refusal in favor of an affiliate of Zuellig Botanicals to supply 
the Company's raw material requirements for the production of doxycycline. The  
terms of the Letter Intent are subject to the negotiation and execution of      
definitive purchase agreements, of which there can be no assurance. It is the   
Company's intent to dispose of the real property owned by Cenci Powder in       
Fresno, California in the ordinary course. Continuing operating losses and the  
Company's                                                                       

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inability to leverage the manufacturing capacity of Cenci Powder were among the 
factors considered by the Board and Management in its determination to terminate
the operations of Cenci Powder.                                                 

PRODUCTS AND PRODUCT DEVELOPMENT                                                

Generic Drug Products                                         

     The Company historically has manufactured and sold a broad range of
prescription and over-the-counter drug products. The Company's pharmaceutical   
product list currently includes a total of approximately 27 products, consisting
of 18 dosage forms and strengths of prescription drugs and 9 dosage forms and   
strengths of over-the-counter drugs. Each dosage form and strength of a         
particular drug is considered in the industry to be a separate drug product. The
Company's drug products are sold in various forms, including liquid and powder  
preparations, compressed tablets and two-piece, hard-shelled capsules.          

      Most of the generic drug products manufactured by the Company can be
classified within one of the following categories:                              

1.       Antibiotics,                                         

2.       Narcotic analgesics,                                 

3.       Anti-infective and anti-tubercular drugs,            

4.       Antihistamines and antihistaminic decongestants, or  

5.       Antitussives.                                        

   During fiscal 1997, sales of antitussives and narcotic analgesics
accounted for approximately 90% of total net sales during such year. The Company
anticipates that sales of antitussives and narcotic analgesics will continue to 
represent a significant portion of the Company's revenue.                       

      The Company's development strategy for new drug products has been to
focus on the development of a broad-range of generic form drugs, each of which  
(i) has developed a solid market acceptance with a wide base of customers, (ii) 
can be sold on a profitable basis notwithstanding intense competition from other
drug manufacturers, and (iii) is no longer under patent protection. The Company 
has also diversified its current product line to include some less widely       
prescribed drugs as to which limited competition might be expected. In addition,
the Company will continue to pursue the development of its existing             
pharmaceutical business as well as the development of the chemical products     
business of its Houba subsidiary.                                               

        Development activities for each new generic drug product begin several
years in advance of the patent expiration date of the brand-name drug           
equivalent. This is because the profitability of a new generic drug usually     
depends on the ability of the Company to obtain FDA approval to market that drug
product upon or immediately after the patent expiration date of the equivalent  
brand-name drug. Being among the first to market a new generic drug product is  
vital to the profitability of the product. As other off-patent drug             
manufacturers receive FDA approvals on competing generic products, prices and   
revenues typically decline. Accordingly, the Company's ability to attain        
profitable operations will, in large part, depend on its ability to develop and 
introduce new products, the timing of receipt of FDA approval of such products  
and the number and timing of FDA approvals for competing products.              

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Bulk Chemical Products                                        

 In the last few years, the Company has increased its efforts to
develop, manufacture and market bulk chemical products. The development and sale
of bulk chemicals is generally not subject to the same level of regulation as is
the development and sale of drug products; accordingly, chemicals may be brought
to market substantial sooner than drug products.                                

Dispositions                                                  

On March 21, 1995 (the "Closing Date"), the Company sold to   
Mallinckrodt its Tablets ANDA for 5 mg Oxycodone HCI/325 mg Acetaminophen       
tablets ("Tablets"), and certain pieces of equipment utilized in connection with
its production activities under the Tablets ANDA, for up to $5.4 million (the   
"Purchase Price"). Mallinckrodt paid the Company $2 million of the Purchase     
Price on the Closing Date, having previously paid $500,000 in July 1994. The    
$2.9 million balance of the Purchase Price (the "Deferred Payment") was payable 
as follows. Mallinckrodt paid $1 million on January 9, 1997, following the      
Company's release from the AIP program. In connection with the transaction,     
Mallinckrodt agreed to defer $1.2 million of the Company's trade debt due to an 
affiliate of Mallinckrodt. The deferred indebtedness was evidenced by a         
promissory note (the "Note") with interest accruing at a rate of 8% per annum.  
On September 21, 1997 Mallinckrodt offset a portion of its remaining Deferred   
Payment obligations against the amount due on the Note. The remaining portion of
the Deferred Payment has been satisfied and the purchase transaction has been   
finalized.                                                                      

        In connection with the sale of the Tablets ANDA, the Company agreed to
manufacture Tablets for Mallinckrodt for a period of three years and            
Mallinckrodt agreed to order a minimum number of Tablets from the Company for   
the two year period following the Closing Date. The Company and Mallinckrodt    
also entered into a non-competition agreement pursuant to which the Company     
agreed not to compete with Mallinckrodt and its affiliates in the United States 
with respect to the Tablets ANDA until March 21, 2000. If, prior to the time it 
is possible for Mallinckrodt to commence production under the Tablets ANDA or   
any new Tablets ANDA at its own facility, the Company ceases or is forced to    
cease or substantially curtail production under the Tablets ANDA, as a          
consequence of (i) any action or communication by the FDA or any other          
regulatory or governmental authority or (ii) any financial or other business    
difficulty, then Mallinckrodt has the right to a full refund of any portion of  
the Deferred Payment already made to the Company. During fiscal 1997,           
approximately $2,024,000 of the Company's revenues (approximately 22%) were     
derived from the toll manufacturing agreement with Mallinckrodt for the Tablets.

        In connection with the sale of the Tablets ANDA, the Company issued to
Mallinckrodt an option exercisable at any time until March 21, 1998 (the "Option
Exercise Date"), to purchase the Capsule ANDA at an exercise price equal to 75% 
of Net Capsule Revenue, subject to downward adjustment in the event of a decline
in pricing levels. Mallinckrodt did not exercise its option to purchase the     
Tablets ANDA prior to the Option Exercise Date.                                 

Acquisitions                                                  

  The Company has engaged Penick Corporation ("Penick") to process
certain of the raw materials utilized in the production of                      
acetaminophen/oxycodone tablets. In order to ensure the continued viability of  
Penick, the Company's Houba subsidiary purchased a 25% equity interest in       
Penick in mid-1993. In addition, in September 1995, Houba purchased an 8.3%     
equity interest in Penick Pharmaceutical, Inc., which owns the other 75% of     
Penick. In May 1996, the Company advanced Penick approximately $250,000 in      

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order to continue the supply of raw materials for the production of             
acetaminophen/oxycodone capsules. In June 1994, both Penick Corporation and     
Penick Pharmaceutical, Inc, filed petitions under Chapter 11 of the United      
States Bankruptcy Code. During the first quarter of 1997, the Company ceased    
purchasing raw materials from Penick in favor of a new raw material supplier.   
See "Raw Materials."                                                            

RESEARCH AND DEVELOPMENT                                                        

         The Company conducts research and development activities at each of its
Brooklyn and Indiana facilities. The Company's research and development         
activities consist primarily of new generic drug product development efforts and
manufacturing process improvements, as well as the development for sale of new  
chemical products. New drug product development activities are primarily        
directed at conducting research studies to develop generic drug formulations,   
reviewing and testing such formulations for therapeutic equivalence to brand    
name products and additional testing in areas such as bioavailability,          
bioequivalence and shelf-life. For fiscal years 1997, 1996 and 1995, total      
research and development expenditures were $979,000, $1,854,000 and $818,000    
respectively. During 1998 the Company intends to concentrate its research and   
development efforts in the areas of pain management and steroids:               

       As of March 15, 1998, the Company maintained a full-time staff of two
and a part-time staff of six in its Research and Development Departments.       

MARKETING AND CUSTOMERS                                                         

       The application of the AIP to the Company's operations until December
1996, combined with the Company's continuing operating losses and lack of       
adequate working capital during fiscal 1997 resulted in the Company's inability 
to maintain sufficient raw materials and finish goods inventories to permit the 
Company to actively solicit customer orders, and when orders were received, to  
fill such orders promptly. Following the completion of the Offering, new        
Management adopted a marketing strategy focused on developing and maintaining   
sufficient raw materials and finish goods inventories so as to permit a targeted
sales effort by the Company to a core customer group, with an emphasis on       
quality, prompt product delivery and excellent customer service. In this regard,
the Company has recently hired Stephanie Heitmeyer to serve as Vice President of
Sales. The Company believes this addition will substantially enhance the        
Company's marketing and sales efforts and complement the Company's existing two 
salaried sales persons. The Company's products are, in large part, be sold by   
such sales persons and, to a lesser extent, through one independent sales       
representative, who is compensated on a commission basis. The Company is also   
considering the addition of one additional independent sales representative.    
Sales of the Company's drugs in dosage form are made primarily to drug          
wholesalers, drugstore chains, distributors and other manufacturers and are not 
concentrated in any specific region.                                            

         During 1997, the Company had net sales to one customer in excess of 10%
of total sales, aggregating 22.3% of total sales, and sales to a second         
customer aggregating 9.8% of total sales. The Company believes that the loss of 
this customer would have a material adverse effect on the Company. During 1996, 
the Company had net sales to one customer in excess of 10% of total sales,      
aggregating 10% of total sales. During 1995, the Company had net sales to two   
customers in excess of 10% of total sales, each aggregating 25% and 11% of      
total sales, respectively.                                                      

 The estimated dollar amount of the backlog of orders for future
delivery as of March 15, 1998 was approximately $800,000 as compared with       
approximately $3,560,000 as of February 28, 1997. Although these orders are     
subject to cancellation, management expects to fill substantially all orders by 
the second quarter of 1998.                                                     

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GOVERNMENT REGULATION                                                           

General                                                       

         All pharmaceutical manufacturers, including the Company, are subject to
extensive regulation by the Federal government, principally by the FDA, and, to 
a lesser extent, by state and local governments. The Company cannot predict the 
extent to which it may be affected by legislative and other regulatory          
developments concerning its products and the healthcare industry generally. The 
Federal Food, Drug, and Cosmetic Act, the Generic Drug Enforcement Act of 1992, 
the Controlled Substance Act and other Federal statutes and regulations govern  
or influence the testing, manufacture, safe labeling, storage, record keeping,  
approval, pricing, advertising, promotion, sale and distribution of             
pharmaceutical products. Noncompliance with applicable requirements can result  
in fines, recall or seizure of products, criminal proceedings, total or partial 
suspension of production, and refusal of the government to enter into supply    
contracts or to approve new drug applications. The FDA also has the authority to
revoke approvals of new drug applications. Recent changes in FDA procedures have
increased the time and expense involved in obtaining ANDA approvals and in      
complying with the FDA's CGMP standards. The ANDA drug development and approval 
process now averages approximately eight months to two years. The approval      
procedures are generally costly and time consuming.                             

         FDA approval is required before any "new drug," whether prescription or
over-the-counter, can be marketed. A "new drug" is one not generally recognized 
by qualified experts as safe and effective for its intended use. Such general   
recognition must be based on published adequate and well controlled clinical    
investigations. Generally, a drug which is the generic equivalent of a          
previously approved prescription drug will be treated as a new drug requiring   
FDA approval. Furthermore, each dosage form of a specific generic drug product  
requires separate approval by the FDA. However, as discussed below, less costly 
and time consuming approval procedures may be used for generic equivalents.     
Among the requirements for drug approval is that the prospective manufacturer's 
methods must conform to the CGMPs. CGMPs apply to the manufacture, receiving,   
holding and shipping of all drugs, whether or not approved by the FDA. CGMPs    
must be followed at all times during which the drug is manufactured. To ensure  
full compliance with standards, some of which are set forth in regulations, the 
Company must continue to expend time, money and effort in the areas of          
production and quality control. Failure to so comply risks delays in approval of
drugs, disqualification from eligibility to sell to the government, and possible
FDA enforcement actions, such as an injunction against shipment of the Company's
products, the seizure of noncomplying drug products, and/or, in serious cases,  
criminal prosecution. The Company's manufacturing facilities are inspected on a 
regular basis by the FDA and by consultants retained by the Company to perform  
self-auditing functions to ensure compliance on an ongoing basis with CGMPs. See
also Item 3. "Legal Proceedings."                                               

         In addition, products marketed outside the United States, but which are
manufactured inside the United States, are subject to certain FDA regulations,  
as well as regulation by the country in which the products are to be sold.      

        In addition to the regulatory approval process, the Company is subject
to regulation under Federal, state and local laws, including requirements       
regarding occupational safety, laboratory practices, environmental protection   
and hazardous substance control, and may be subject to other present and future 
local, state, Federal and foreign regulations, including possible future        
regulations of the pharmaceutical industry.                                     

Drug Approvals                                                

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      There are currently three ways to obtain FDA approval of a new drug.

      1.       New Drug Applications ("NDA"). Unless one of the procedures
       discussed in paragraph 2 or 3 below is available, a
               prospective manufacturer must conduct and submit to the FDA
          complete clinical studies to prove a drug's safety and
       efficacy, in addition to the bioavailability and/or
                bioequivalence studies discussed below, and must also submit
             to the FDA information about manufacturing practices, the
chemical make-up of the drug and labeling.  

     2.       Abbreviated New Drug Applications ("ANDA"). The Drug Price
                  Competition and Patent Term Restoration Act of 1984 (the "1984
          Act") established the ANDA procedure for obtaining FDA
         approval for those drugs that are off-patent or whose
         exclusivity has expired and that are bioequivalent to
               brand-name drugs. An ANDA is similar to an NDA, except that
                  the FDA waives the requirement of conducting complete clinical
           studies of safety and efficacy, although it may require
           expanded clinical bioavailability and/or bioequivalence
               studies. "Bioavailability" means the rate of absorption and
                levels of concentration of a drug in the blood stream needed
           to produce a therapeutic effect. "Bioequivalence" means
                equivalence in bioavailability between two drug products. In
                  general, an ANDA will be approved only upon a showing that the
            generic drug covered by the ANDA is bioequivalent to the
                previously approved version of the drug, i.e., that the rate
              of absorption and the levels of concentration of a generic
               drug in the body are substantially equivalent to those of a
                previously approved equivalent drug. The principal advantage
               of this approval mechanism is that an ANDA applicant is not
                 required to conduct the same preclinical and clinical studies
                 to demonstrate that the product is safe and effective for its
intended use.                               

                 The 1984 Act, in addition to establishing the ANDA procedure,
             created new statutory protections for approved brand-name
                  drugs. In general, under the 1984 Act, approval of an ANDA for
               a generic drug may not be made effective until all relevant
              product and use patents for the equivalent brand name drug
                have expired or have been determined to be invalid. The only
         exceptions are situations in which the ANDA applicant
              challenges the validity or applicability of the patent and
             either the patent holder does not file suit or litigation
                 extends more than 30 months after notice of the challenge was
                 received by the patent holder. Prior to enactment of the 1984
                Act, the FDA gave no consideration to the patent status of a
                  previously approved drug. Additionally, under the 1984 Act, if
                  specific criteria are met, the term of a product or use patent
                  covering a drug may be extended up to five years to compensate
               the patent holder for the reduction of the effective market
              life of that patent due to federal regulatory review. With
                 respect to certain drugs not covered by patents, the 1984 Act
                sets specified time periods of two to ten years during which
                approvals of ANDAs for generic drugs cannot become effective
                 or, under certain circumstances, ANDAs cannot be filed if the
              equivalent brand-name drug was approved after December 31,
1981.                                       

3.       Alternative New Drug Applications. An alternative NDA
               procedure is provided by the 1984 Act whereby the applicant
             may rely on published literature and more limited testing
                  requirements. That alternative seldom provides advantages over
                the ANDA procedure, however, and is accordingly rarely used.

Generic Drug Enforcement Act                                  

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         As a result of hearings and investigations concerning the activities of
the generic drug industry and the FDA's generic drug approval process, Congress 
enacted the Generic Drug Enforcement Act of 1992 (the "Generic Drug Act"). The  
Generic Drug Act confers significant new authority upon the FDA to impose       
debarment and civil penalties for individuals and companies who commit certain  
illegal acts relating to the generic drug approval process.                     

       The Generic Drug Act requires the mandatory debarment of companies or
individuals convicted of a federal felony for conduct relating to the           
development or approval of any ANDA, and gives the FDA discretion to debar      
corporations or individuals for similar conduct resulting in a federal          
misdemeanor or state felony conviction. The FDA may not accept or review during 
the period of debarment (one to ten years in the case of mandatory, or up to    
five years in the case of permissive, debarment of a corporation) any ANDA      
submitted by or with the assistance of the debarred corporation or individual.  
The Generic Drug Act also provides for temporary denial of approval of generic  
drug applications during the investigation of crimes that could lead to         
debarment. In addition, in more limited circumstances, the Generic Drug Act     
provides for suspension of the marketing of drugs under approved generic drug   
applications sponsored by affected companies. The Generic Drug Act also provides
for fines and confers authority on the FDA to withdraw, under certain           
circumstances, approval of a previously granted ANDA if the FDA finds that the  
ANDA was obtained through false or misleading statements. The Company was not   
debarred as a result of the FDA investigation and settlement and the Consent    
Decree with the FDA makes no provision therefor.                                

Healthcare Reform                                             

         Several legislative proposals to address the rising costs of healthcare
have been introduced in Congress and several state legislatures. Many of such   
proposals include various insurance market reforms, the requirement that        
businesses provide health insurance coverage for all their employees,           
significant reductions in the growth of future Medicare and Medicaid            
expenditures, and stringent government cost controls that would directly control
insurance premiums and indirectly affect the fees of hospitals, physicians and  
other healthcare providers. Such proposals could adversely affect the Company's 
business by, among other things, reducing the demand, and the prices paid, for  
pharmaceutical products such as those produced and marketed by the Company.     
Additionally, other developments, such as (i) the adoption of a nationalized    
health insurance system or a single payor system, (ii) changes in needs-based   
medical assistance programs, or (iii) greater prevalence of capitated           
reimbursement of healthcare providers, could adversely affect the demand for the
Company's products.                                                             

COMPETITION                                                                     

        The Company competes in varying degrees with numerous companies in the
health care industry, including other manufacturers of generic drugs (among     
which are divisions of several major pharmaceutical companies) and manufacturers
of brand-name drugs. Many of the Company's competitors have substantially       
greater financial and other resources and are able to expend more money and     
effort than the Company in areas such as marketing and product development.     
Although a company with greater resources will not necessarily receive FDA      
approval for a particular generic drug before its smaller competitors,          
relatively large research and development expenditures enable a company to      
support many FDA applications simultaneously, thereby improving the likelihood  
of being among the first to obtain approval of at least some generic drugs.     

        One of the principal competitive factors in the generic pharmaceutical
market is the ability to introduce generic versions of brand-name drugs promptly
after a patent expires. The Company believes that                               

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it was at a competitive disadvantage until its release from the AIP program and 
the FDA's resumption of review of ANDAs submitted by the Company's Brooklyn     
plant. See "Government Regulation--Generic Drug Enforcement Act" above. Other   
competitive factors in the generic pharmaceutical market are price, quality and 
customer service (including maintenance of sufficient inventories for timely    
deliveries).                                                                    

RAW MATERIALS                                                                   

The raw materials essential to the Company's business are bulk
pharmaceutical chemicals purchased from numerous sources. Raw materials are     
generally available from several sources. The Federal drug application process  
requires specification of raw material suppliers. If raw materials from a       
supplier specified in a drug application were to become unavailable on          
commercially acceptable terms, FDA supplemental approval of a new supplier would
be required. During 1997, the Company purchased approximately $1,187,000 of its 
raw materials (constituting 24.7% of its aggregate purchases of raw materials)  
from Mallinckrodt. Although the Company is now able to submit Supplements to the
FDA in order to allow the Company to purchase raw materials from alternate      
sources, there can be no assurance that if the Company were unable to continue  
to purchase raw materials from this supplier, that the Company would be         
successful in receiving FDA approval to such Supplement or that it would not    
face difficulties in obtaining raw materials on commercially acceptable terms.  
Failure to receive FDA approval for, and to locate, an acceptable alternative   
source of raw materials would have a material adverse effect on the Company.    

      The United States Drug Enforcement Administration (the "DEA") limits
the quantity of the Company's inventories of certain raw materials used in the  
production of controlled substances based on historical sales data. In view of  
the Company's recently depressed sales volume, these DEA limitations could      
increase the likelihood of raw material shortages and of manufacturing delays in
the event the Company experiences increased sales volume or is required to find 
new suppliers of these raw materials.                                           

EMPLOYEES                                                                       

   As of March 15, 1998, the Company had approximately 142 full-time
employees. Approximately 30 are administrative and professional personnel and   
the balance are in production and shipping. Among the professional personnel, 2 
are engaged in research and product development. Approximately 65 employees at  
the Company's Brooklyn plant are represented by a local collective bargaining   
unit. The collective bargaining agreement between the Company and the union was 
extended on March 5, 1998 (retroactive to July 2, 1997) and expires June 30,    
2000. Management believes that its relations with its employees and the union   
are satisfactory.                                                               

ITEM 2. PROPERTIES                                                              

        Halsey leases, as sole tenant, a total of approximately 112,300 square
feet, in three buildings on Pacific Street and Dean Street in Brooklyn, New     
York. Each of these leases is between Halsey and unaffiliated lessors. The      
approximate aggregate minimum rental commitments under these operating leases   
are as follows: $928,000 for the year 1996, $975,000 for the year 1997 and      
$1,029,000 for the year 1998. As part of the completion of the Offering, the    
Company settled a pending proceeding with its landlord for the Brooklyn facility
to, among other things, satisfy rent arrearages, penalties and other charges and
to delete certain prior amendments to the Lease Agreements requiring more       
frequent rental payments and the imposition of substantial penalties. These     
leases expire on December 31, 2005. The buildings leased by Halsey in Brooklyn  
house its research and development and manufacturing facilities.                

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       Halsey leases approximately 4,700 square feet of office space located
at 695 North Perryville Road, Building No. 2, Rockford, Illinois. The lease is  
between the Company and an unaffiliated lessor. The lease has a term of two     
years expiring March 30, 2000 and calls for annual rental, including            
maintenance and common area expense, of approximately $50,000 per year. The     
Company is in the process of making necessary leasehold improvements and        
additions of computer and office furniture and equipment in order to operate    
the Company's principal executive offices from this location, including its     
sales, administration and finance operations.                                   

  Houba owns approximately 45,000 square feet of building space on
approximately 30 acres of land in Culver, Indiana, which includes a 15,000      
square foot manufacturing facility. This manufacturing facility houses separate 
plants for the production of Doxycycline raw materials, Doxycycline capsules and
tablets and Biotin raw materials. In 1996, in conjunction with a settlement with
two former employees, the Company acquired real property, improved by a         
residential property, in Culver, Indiana adjacent to the manufacturing facility.
The Company became the lessor of the residential property upon closing of the   
acquisition.                                                                    

      Cenci Laboratories and Cenci Powder together own approximately 6,700
square feet of manufacturing and distribution building space located on         
approximately one-half acre in Fresno, California. In addition, Cenci           
Laboratories and Cenci Powder lease approximately 18,000 square feet of space in
a building located in Fresno, California used for manufacturing and corporate   
offices. This lease is currently on a month-to-month basis and is anticipated to
be terminated on or about May 31, 1998 as part of the cessation of the Cenci    
Laboratories and Cenci Powder operations. See "Item 1. Business - Recent Events 
- Cessation of California Operations." During the years ended December 31, 1997,
1996 and 1995, Cenci and Cenci Powders paid an aggregate of $90,000, $90,000 and
$86,000 respectively, to a former officer of Cenci Laboratories and Cenci Powder
in respect of this lease.                                                       

      The Company also leases office space in Westwood, New Jersey for its
marketing and sales departments on a year-to-year basis. It is anticipated that 
this lease will be terminated on April 30, 1998 as part of the relocation of the
Company's corporate headquarters to Rockford, Illinois.                         

ITEM 3. LEGAL PROCEEDINGS.                                                      

GOVERNMENT CONSENT DECREES                                                      

      On June 21, 1993, the Company entered into a Plea Agreement with the
DOJ to resolve the DOJ's investigation into the manufacturing and record keeping
practices of the Company's Brooklyn plant. Under the terms of the Plea          
Agreement, the Company agreed to plead guilty to five counts of adulteration of 
drug products shipped in interstate commerce. Each count involved product       
adulteration and record keeping deficiencies relating to a single drug product, 
Quinidine Gluconate (324mg tablets), manufactured at the Brooklyn plant. The    
Plea Agreement also required the Company to pay a fine of $2,500,000 over five  
years in quarterly installments of $125,000, commencing on or about September   
15, 1993. The Company's plea was entered and the terms of the Plea Agreement    
were approved by the United States District Court for the District of Maryland  
on July 16, 1993. As of February 28, 1998, the Company was in default of the    
payment terms of the Plea Agreement and had made payments aggregating $350,000. 
On March 30, 1998, the Company and the DOJ signed a Letter Agreement serving to 
amend the Plea Agreement relating to the terms of the Company's satisfaction of 
the fine assessed under the Plea Agreement. Specifically, the Letter Agreement  
provides that the Company will satisfy the remaining $2,150,000 of the fine     
through the payment of $25,000 on a monthly basis commencing May 1, 1998, plus  
interest on such outstanding balance (at the                                    

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rate calculated pursuant to 28 U.S.C. Section 1961)(currently 5.319%). Such     
payment schedule will result in the full satisfaction of the DOJ fine in        
December, 2005. The Letter Agreement also provides certain restrictions on the  
payment of salary or compensation to any individual in excess of $150,000       
without the written consent of the United States District Court for the District
of Maryland, subject to certain exceptions. In addition, the Letter Agreement   
requires the prepayment of the outstanding fine to the extent of 25% of the     
Company's after tax profit and 25% of the net proceeds received by the Company  
on any sale of a capital asset for a sum in excess of $10,000. The terms of the 
Letter Agreement are subject to the approval of the U.S. District Court for the 
District of Maryland.                                                           

      See "Item 1. Business - Recent Events" for information regarding the
release of the Company from the FDA's AIP program and resumption by the FDA of  
review of ANDAs filed by the Company.                                           

OTHER GOVERNMENTAL PROCEEDINGS                                                  

       By letter dated October 23, 1995, the Company was notified by the New
York State Education Department (the "Department") that the Professional Conduct
Officer of the Office of Professional Discipline had determined that there was  
sufficient evidence of professional misconduct on the Company's part to warrant 
a disciplinary proceeding under New York law. Upon contacting the Deputy        
Director of the Office of Professional Discipline, counsel for the Company was  
advised that the alleged misconduct related to the same activities that were the
subject of the DOJ investigation. The Company submitted a written response to   
the Department on November 16, 1995. The Company and the Department entered into
a consent order effective July 18, 1997, concluding any disciplinary            
proceedings. The consent order requires that the Company pay $175,000 in fines  
over a period of five years. The consent order also provides that the Company's 
registration as a manufacturer of drugs in New York State is revoked, but such  
revocation is stayed and the Company has been placed on probation for a maximum 
period of five years. The Company has the right to apply for removal from       
probation two years after the effective date of the consent order.              

         Immediately prior to the completion of the Offering, the Company was in
default under the consent order with the Department for failure to satisfy two  
of the monthly installments of the fine as provided in the consent order. Prior 
to the completion of the Offering, the Company advised the Department as to the 
existence of the default and that such deficiencies would be corrected upon the 
completion of the Offering. The Company has satisfied these outstanding amounts 
and is now current under the consent order with the Department. Based on        
discussions between representatives of the Department and the Company's outside 
counsel handling this matter, the Company has been advised that the revocation  
of the Company's registration as a manufacturer of drugs in the State of New    
York will remain stayed and that the Company continues to have the right to     
apply for removal from probation after two years from the effective date of the 
consent order.                                                                  

    On November 9, 1995, the Company received two Notices of Charge of
Discrimination from the United States Equal Employment Opportunity Commission   
relating to two claimed violations of Title VII of the Civil Rights Act of 1964.
The first charge of employment discrimination was filed on October 31, 1995 by a
female employee of the Company and alleges sexual discrimination and harassment.
A second separate charge of discrimination was also filed on October 31, 1995,  
by another female employee alleging sexual harassment against the same          
individual named in the first charge of discrimination. On November 20, 1995,   
the EEOC terminated its process with respect to the charges and issued Notices  
of Right to Sue to the claimants. In February 1996, two lawsuits were filed in  
the Eastern District of New York captioned Golovatskaya v. Halsey Drug Co., 96  
CIV 0662 and Petrakova v. Halsey Drug Co., 96 CIV 0660 in connection with the   
above charges. The lawsuits sought unspecified damages. These actions were      
settled                                                                         

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by the Company on September 26, 1997 and an aggregate payment of $12,400 made on
March 27, 1998 (approximately $5,200, in the case of Golovatskaya and           
approximately $7,200, in the case of Petrakova).                                

CENCI PROCEEDING                                                                

        The Company was named as a defendant in a lawsuit in the United States
District Court for the Eastern District of California entitled Cenci v. Halsey  
Drug Co. The claims in this lawsuit relate to a 1991 Stock Purchase Agreement   
pursuant to which the Company purchased 51% of the stock of Cenci Labs and Cenci
Powder.                                                                         

         The plaintiff, both individually and as a shareholder of Cenci Labs and
Cenci Powder, had sued the Company, one of the current officers and two former  
officers of the Company. The complaint alleged that the Company had breached a  
number of representations made during the course of the negotiations leading to 
the stock purchase, including the representation that the Company would provide 
financial assistance to both Cenci Labs and Cenci Powder. The complaint also    
alleged misrepresentations relating to the scope of FDA's investigation of the  
Company.                                                                        

The Complaint, which included several causes of action, sought
unspecified compensatory damages, as well as punitive damages, rescission,      
specific performance, reformation and a declaration as to what amount, if any,  
was owed to plaintiff. The counterclaims of the Company sought unspecified      
compensatory and punitive damages.                                              

  On March 10, 1997, a Settlement Agreement and Mutual Release was
executed by all parties to the lawsuit, terminating the action. The terms of the
Settlement provide for repayment of certain outstanding loan, made by the       
plaintiff to Cenci Labs and Cenci Powders, as well as payment of settlement     
funds, aggregating $600,000, to be paid in equal monthly installments, without  
interest, from March 1997 to June 1998 and the delivery to the plaintiff of     
25,000 shares of unregistered common stock of the Company. The Settlement       
Agreement further provided for the balance of capital stock of Cenci Labs and   
Cenci Powder to be conveyed to the Company, making Cenci Powder and Cenci Labs  
100% and 97% owned subsidiaries, respectively, of the Company. Following with   
the completion of the Offering, the Company satisfied its outstanding monetary  
obligations to the plaintiff under the Cenci litigation in connection with the  
execution of an Acknowledgment of Partial Satisfaction of Judgment by the       
plaintiff. The Company, however, is obligated to remove the restrictions on the 
25,000 shares of the Company's common stock previously tendered to the          
plaintiff.                                                                      

OTHER PENDING LEGAL PROCEEDINGS                                                 

    The Company was named as a defendant in an action captioned Allied
Welfare Fund, Vacation Fringe Benefit Fund and Union Mutual Fund v. Halsey Drug 
Co., 96 Civ 3655, brought in the United States District Court for the Eastern   
District of New York. The Complaint sought sums allegedly owed to three of the  
Company's labor union funds under the Company's collective bargaining agreement,
in the amount of approximately $265,000. A settlement agreement was reached     
between the parties and executed July 31, 1997 requiring the Company to remain  
current on its obligations under its collective bargaining agreement and to pay 
portions of the alleged arrearages in installments. Prior to the completion of  
the Offering, the Company was in default under the settlement agreement. On     
March 19, 1998, the Company satisfied its obligations under the settlement      
agreement pursuant to the payment of $309,151 to the Union                      

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   On March 4, 1992, an action was commenced against the Company and
numerous other pharmaceutical manufacturers in the Pennsylvania Court of Common 
Pleas, Philadelphia Division, captioned Ciavarelli and Ciavarelli v. Abbott     
Laboratories, Inc., et al. The Complaint contains seven causes of action,       
including negligence, strict liability and breach of warranty, among others, in 
connection with the alleged exposure of Ms. Ciavarelli to diethylstilbestrol    
("DES"). The plaintiff was unable to determine which of the defendants produced 
the DES used by Ms. Ciavarelli. The Complaint seeks in excess of $25,000 in     
compensatory and punitive damages. This matter has been referred to the         
Company's insurance carrier for defense, which has been assumed. Twenty         
additional actions commenced during 1992 and 1993 are still pending against the 
Company along with numerous other pharmaceutical manufacturers in the           
Pennsylvania Court of Common Pleas, Philadelphia Division. Each of these actions
alleges injury in connection with exposure to DES and each seeks in excess of   
$25,000 in compensatory and punitive damages. In each suit, the plaintiff was   
unable to determine which of the defendants produced the DES that was used.     
Numerous similar actions have already been settled and dismissed with nominal   
contribution payments made by the Company.                                      

         Two DES claims referred to the Company's insurance carriers are pending
in jurisdictions other than Pennsylvania.                                       

  Each of the foregoing matters has been referred to the Company's
insurance carrier for defense. The Company does not believe any of such actions 
will have a material impact on the Company's financial condition.               

        The Company has been named a defendant in an action captioned "Raymore
v. Halsey Drug Co., Inc. and Benito Amado" commenced in March, 1997 in the      
Eastern District of New York, 97 CIV 3116. The complaint alleges sexual         
misconduct and harassment against a named individual defendant and seeks        
$1,000,000 in compensatory and punitive damages. This action is currently in    
discovery. Various settlement offers have been exchanged, ranging between       
$30,000 and $75,000. The Company does not believe that the ultimate outcome of  
this proceeding will have a material adverse effect on the Company's financial  
condition.                                                                      

      The Company has been named as a defendant in four additional actions
which have been referred to the Company's insurance carrier and have been       
accepted for defense. The first action, Alonzo v. Halsey Drug Co., Inc. and     
K-Mart Corp., No. 64DOT-95111-CT-2736 (Indiana Superior Court, Porter County),  
was commenced on November 7, 1995 and involves a claim for unspecified damages  
relating to the alleged ingestion of "Doxycycline 100." The second action, Files
v. Halsey Drug Co., Index No. 198787/93 (New York Supreme Court, Suffolk        
County), commenced on September 16, 1993, seeks $10,000,000 in damages for      
wrongful death allegedly caused by the ingestion of Isoniazid. The action is    
currently in discovery. The third and fourth actions, entitled Hunt v. Halsey   
Drug Co., Inc., and McCray v. Halsey Drug Co., Inc. (New York State Supreme     
Court, Kings County), were commenced on October 21, 1993 and seek the recovery  
of $8,000,000 for alleged personal injuries suffered by two Well Fargo security 
guards who responded to an alarm and were shot, resulting in the death of one   
and the injury to the other. The Company has impleaded the former security      
service used by the Company as a third-party defendant. These actions are       
currently in discovery. At this early stage of the proceedings, the Company is  
unable to predict with any degree of certainty the likely outcome of these      
claims and whether they will have a material adverse effect on the Company's    
financial condition.                                                            

       In addition to the matter described above, prior to the completion of
the Offering, the Company was a defendant in actions brought by various parties,
including Merill New York Co., relating to printing                             

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services and expenses of approximately $164,000, Valley City Disposal, relating 
to waste disposal services in the amount of approximately $105,000, Xerox Corp.,
relating to expenses under office machine contracts of approximately $58,000,   
and Atlantic Properties Company, relating to outstanding rent, expenses and     
penalties of approximately $400,000. As part of the completion of the Offering, 
the Company was able to negotiate discounts on the amounts paid to such         
creditors and has satisfied the outstanding liabilities and settle these        
matters. See also "Item 2 - Properties."                                        

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.                   

    No matters were submitted to a vote of security holders during the
fourth quarter of 1997.                                                         

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 PART II

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

Market and Market Prices of Common Stock                      

     The Company's Common Stock is listed on the American Stock Exchange
(the "Exchange") under the symbol "HDG." Set forth below for the periods        
indicated are the high and low sales prices for the Common Stock as reported on 
the Exchange.                                                                   

                                                                · Download Table

Period                         High      Low 
                                             
1998 FISCAL YEAR                             
      First Quarter (through                 
     March 15, 1997)           3 5/8    1 1/4
1997 FISCAL YEAR                             
     First Quarter               6      4 3/8
     Second Quarter            5 1/8   2 9/16
     Third Quarter            4 13/16  2 5/16
     Fourth quarter           4 13/16  1 5/16
1996 FISCAL YEAR                             
     First Quarter             7 3/4      3  
     Second Quarter            7 1/4      4  
     Third Quarter             5 7/8      4  
     Fourth Quarter            6 3/8      4  

Holders                                                       

         There were 873 holders of record of the Company's common stock on March
15, 1998. This number, however, does not reflect the ultimate number of         
beneficial holders of the Company's common stock.                               

Dividend Policy                                               

       The payment of cash dividends from current earnings is subject to the
discretion of the Board of Directors and is dependent upon many factors,        
including the Company's earnings, its capital needs and its general financial   
condition. The terms of the Company's 5% convertible senior secured debentures  
prohibit the Company from paying cash dividends. The Company does not intend to 
pay any cash dividends in the foreseeable future.                               

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Private Offerings                                             

         As described under the caption "Business - Recent Events," on March 10,
1998, the Company completed a private offering of 5% convertible senior secured 
debentures in the principal amount of $20.8 million and warrants exercisable for
4,202,020 shares of the Company's common stock. The securities were offered     
solely to and purchased solely by accredited investors as defined under Rule 501
of Regulation D promulgated under the Securities Act. The Company relied on     
Section 4(2) of the Securities Act and Regulation D promulgated thereunder.     
Reference is made to the Company's Form 8-K as filed with the Securities and    
Exchange Commission on March 24, 1998 for a detailed description of the Offering
and the terms of the debentures and warrants. The Form 8-K is incorporated      
herein by this reference and is attached to this Report as Exhibit 10.41.       

ITEM 6.  SELECTED FINANCIAL DATA.                                               

     The selected consolidated financial data presented on the following
pages for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 are      
derived from the Company's audited Consolidated Financial Statements. The       
Consolidated Financial Statements as of December 31, 1997 and December 31, 1996,
and for each of the years in the three year period ended December 31, 1997, and 
the report thereon, are included elsewhere herein. The selected financial       
information as of and for the years ended December 31, 1994 and 1993 are derived
from the audited Consolidated Financial Statements of the Company not presented 
herein.                                                                         

   The information set forth below is qualified by reference to, and
should be read in conjunction with, the Consolidated Financial Statements and   
related notes thereto included elsewhere in this Report and "Management's       
Discussion and Analysis of Financial Condition and Results of Operations," (Item
7).                                                                             

                                                                · Download Table

                                        Years ended December 31,                
                        1997      1996            1995           1994     1993  
                       -------  --------        --------        -------  -------
                                  (in thousands, except per share data)         
OPERATING DATA:                                                                 
                                                                                
 Net sales             $ 9,088  $ 12,379        $ 20,225        $24,182  $36,024
Costs and expenses                                                              
     Cost of sales      15,407    16,826          18,097         21,584   28,848
     Research and                                                               
       development         979     1,854             818            502    2,140
     Selling, general                                                           
       and                                                                      
     administrative        630     7,486           6,098          7,128    8,976

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                                                        · Enlarge/Download Table

                                                          Years ended December 31,                              
                              1997              1996               1995               1994          1993        
                          ------------       -----------        -----------        -----------   -----------    
                                         (in thousands, except per share data)                                  
                                                                                                                
OPERATING DATA:                                                                                                 

Provision for                                                                                                   
  regulatory                                                                                                    
settlement                        --                --                 --                 --           5,935    
Interest expense                 1,144             1,708              1,307                735           631    
Loss(Gain) on sale of                                                                                           
 assets                            264            (1,000)            (2,288)              --            --      
Provision for                                                                                                   
  stockholders'                                                                                                 
   litigation settlement          --                --                 --                 --           3,000    

Income (loss) before                                                                                            
provision for income                                                                                            
taxes, minority interest                                                                                        
and cumulative effect                                                                                           
of accounting change                                                                                            
                               (15,014)          (14,495)            (3,807)            (5,767)      (13,326)(1)

Provision (benefit) for                                                                                         
income  taxes                     --                --                  296               --          (2,540)   

Minority interest in net                                                                                        
loss (benefit) of                                                                                               
subsidiaries                      --                --                 --                 --             150    

Cumulative effect of                                                                                            
accounting change                 --                --                 --                 --            (267)   
                          ------------       -----------        -----------        -----------   -----------    

Net income (loss)         $    (15,014)      $   (14,495)       ($    4,103)       $    (5,767)  $   (10,903)   
                          ============       ===========        ===========        ===========   ===========    
Net income (loss) per                                                                                           
shares                    $      (1.12)      $     (1.49)       $      (.52)       $      (.80)  $     (1.57)   
                          ============       ===========        ===========        ===========   ===========    
Weighted average                                                                                                
common and common                                                                                               
shares equivalents                                                                                              
outstanding               $ 13,434,215         9,724,106          7,886,101          7,173,908     6,954,713    
                          ============       ===========        ===========        ===========   ===========    

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                                                        · Enlarge/Download Table

                                                          December 31,                         
BALANCE SHEET DATA:               1997       1996            1995            1994       1993   
                                --------   --------        --------        --------   -------- 
                                             (In thousands, except per share data)             
                                                                                               
Working capital (deficiency)    ($24,705)  $(12,201)       $ (7,393)       $ (4,451)  $ (2,801)
Total assets                       7,667     11,982          18,862          19,276     24,674 
Total liabilities                 27,523     19,063          20,402          19,924     20,755 
Retained earnings (accumulated   (44,498)   (29,484)        (14,989)        (10,886)    (5,118)
deficit)                                                                                       
Stockholders' equity (deficit)   (19,856)    (7,081)         (1,540)           (468)     2,919 

(1)      After giving effect to charges to operations aggregating $5,935,000    
         arising from, among other things, the Company's consent decree and plea
      agreement with the DOJ and a $3,000,000 provision in connection with
the settlement of shareholder and derivative litigations.     

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

Certain statements set forth under this caption constitute    
"forward-looking statements" within the meaning of the Reform Act. See "Special 
Note Regarding Forward-Looking Statements " on page 1 of this Report for        
additional factors relating to such Statements.                                 

General                                                                         

         On December 19, 1996, the Company was released from the FDA Application
Integrity Program (the "AIP"), allowing the Company to submit ANDA applications 
for FDA review for new products, as well as Supplements, for the first time     
since October 1991. At or about the time of such release, the Company submitted 
five new ANDAs to the FDA for it review. In addition, the Company had previously
submitted a new ANDA with respect to the Capsules. As described under Item 1.   
Business - Recent Events, the Company received FDA approval for five ANDAs since
its release from the AIP in December 1996, has three ANDA applications pending  
and anticipates the submission of eight additional ANDAs during the balance of  
1998. No assurance can be given, however, that pending ANDAs will be approved or
that the Company will be successful in submitting its planned ANDAs or in       
receiving FDA approval for those already filed or to be filed.                  

Sales for the year ended December 31, 1997 were approximately 
$9,088,000 as compared to sales of approximately $12,379,000 for 1996. The net  
loss for the year ended December 31, 1997 was $15,014,000, or $1.12 per share,  
as compared with the net loss of $14,495,000 or $1.49 per share for 1996.       

 The reduction in sales for the year ended December 31, 1997 was
primarily attributable to the lack of sufficient working capital necessary to   
purchase raw materials. Without adequate inventory, the Company was unable to   
satisfy customer orders in a timely fashion.                                    

        Depreciation and amortization was approximately $1,294,000 in 1997, as
compared to $1,906,000 in 1996.                                                 

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   On March 10, 1998, the Company completed a private offering of 5%
convertible senior secured debentures in the principal amount of $20.8 million  
and common stock purchase warrants exercisable for an aggregate of 4,202,020    
shares of the Company's common stock (the "Offering"). The net proceeds to the  
Company from the Offering was approximately $19.6 million. In addition to       
providing the Company with approximately $3 million in working capital, the net 
proceeds from the Offering have permitted the Company to, among other things,   
retire its existing bank indebtedness in the amount of approximately $3 million,
provide the funds necessary to satisfy its outstanding Federal and state payroll
tax liabilities, satisfy accrued and unpaid rent at its Brooklyn facility,      
satisfy a significant portion of the Company's other current liabilities and    
accounts payable, as well as permit the purchase of raw materials in order to   
produce finished goods for shipment and to develop a finished goods inventory.  
See "Liquidity and Capital Resources" and "Item 1. Business - Recent            
Developments."                                                                  

Results of Operations                                                           

     The following chart reflects expenses, earnings, income, losses and
profits expressed as a percentage of net sales for the years 1997, 1996 and     
1995.                                                                           

                                                        · Enlarge/Download Table

                                         Percentage of Net Sales         Percentage Change     
                                                                           Year-to-Year        
                                                                        Increase (Decrease)    
                                         Year ended December               Years ended         
                                                                           December 31,        
                                 1997           1996         1995    1996 to 1997  1995 to 1996
                                 ----           ----         ----    ------------  ------------
                                                                                               
Net sales                        100%          100.0%        100.0%     (26.6)       (38.8)    
Cost of Goods                    169.5         135.9          89.5       (8.47)       (7.0)    
Gross Profit                     (69.5)        (35.9)         10.5       42.1       (309.0)    
Research & Development            10.8          15.0           4.0      (47.2)       126.7     
Selling, general and                                                                           
    administrative expense        69.4          60.5          30.0      (15.7)        22.8     
(Loss) earnings from                                                                           
operations                      (149.7)       (111.4)        (23.7)      (1.3)       187.9     
Interest expense                  12.6          13.9           6.5      (33.0)        30.6     
Other (income) expenses           2.9           (8.2)        (11.3)    (126.4)       (56.3)    

(Loss) earnings before income                                                                  
taxes, minority interest        (165.2)       (117.1)        (18.9)       3.6        280.7     

(Benefit) provision for income                                                                 
taxes                           --            --               1.5     --             (100)    
                                                             -----                             

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                                                        · Enlarge/Download Table

                                Percentage of Net Sales                    Percentage Change          
                                                                            Year-to-Year              
                                                                         Increase (Decrease)          
                                 Year ended December                         Years ended              
                                                                             December 31,             
                           1997            1996          1995      1996 to 1997          1995 to 1996 
                           ----            ----          ----      -------------          ------------

                                                                                                      
(Loss) earnings before                                                                                
   minority interest       (165.2)         (117.1)        (20.4)           3.6               253.3    
Minority interest in net                                                                              
    earnings (loss) of                                                                                
subsidiaries                  -                -             -              -                  -      

Net (loss) earnings       (165.2%)         (117.1)%       (20.4)%         3.6%              253.3%    
                                           ========       =======         ====              ======    

Net Sales                                                                       

         Net sales of $9,088,000 represents a decrease of $3,291,000 as compared
to net sales for the year ended December 31, 1996. The Decrease in 1997 is      
primarily attributable to a lack of sufficient working capital necessary to     
purchase raw materials. Without adequate inventory, the Company was unable to   
satisfy customer orders in a timely fashion. The Company's net sales for the    
year ended December 31, 1996 of $12,379,000 represents a decrease by $7,846,000 
as compared to net sales for the year ended December 31, 1995. In 1995, the     
Company's net sales decreased by $3,957,000 as compared to 1994. The decrease in
1996 is primarily attributable to the removal from the marketplace of four      
products and the withdrawal of four ANDA's by the Company, pursuant to a        
requirement by the FDA, as a pre-condition to release of the Company from the   
AIP. The decrease in 1995 was primarily attributable to the sale of the Tablets 
ANDA to Mallinckrodt.                                                           

Cost of Goods Sold                                                              

  For 1997 and 1996, cost of goods sold decreased by approximately
$2,782,000 and $1,272,000, respectively, as compared to 1995. These decreases   
are attributable to the reduction in shipments of products. For 1995, cost of   
goods sold decreased by approximately $3,487,000 as compared to 1994. The       
decrease for 1995 is primarily attributable to the reduction in shipments of    
tablet products due to the sale by the Company of the Tablets ANDA combined with
significant reductions in manufacturing costs of personnel and other expenses.  
The Company's gross margin as a percentage of sales for the fiscal years ended  
December 31,1997, 1996 and 1995 was (69.5%), (35.9%) and 10.54%, respectively.  
Sales reductions, withdrawal of the ANDA of the Capsule product, unabsorbed     
manufacturing costs and inventory write-off had a direct impact upon gross      
margin during 1996.                                                             

Research & Development expenses                                                 

     For 1997, research and development expenses amounted to $978,000 as
compared to $1,854,000 in 1996. This decrease was a result of reductions in     
personnel necessitated by the Company's liquidity crisis.                       

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For 1996, research & developments expenses amounted to $1,854,000 as compared to
$818,000 in 1995. This increase is attributable to the Company's effort to      
actively introduce new products, and to reintroduce products previously         
discontinued.                                                                   

Selling, General and Administrative Expenses                                    

       Selling, general and administrative expenses as a percentage of sales
for the fiscal years 1997, 1996 and 1995 were 69.4%, 60.5%, and 30.0%,          
respectively. These expenses decreased by approximately $1,178,000 or 15.7%in   
fiscal year 1997 as compared to 1996. The decrease was attributable to cost     
saving measures effected by management during the 1996 year. These expenses     
increased by approximately $1,388,000, or 22.8%, in fiscal year 1996, as        
compared to 1995. This increase is attributable to additional legal expenses and
litigation settlements during the year, as well as consulting expenses for FDA  
related matters.                                                                

Interest Expense                                                                

         Interest expense for 1997 decreased by $564,000 as compared to 1996 due
primarily to the conversion in the latter part of 1996 of $7,740,000 of         
convertible debentures bearing interest at 10% into common stock. Interest      
expense for 1996 increased by $401,000 as compared to 1995 as a result of a     
higher level of borrowings due to the issuance of convertible subordinated      
debentures, as well as fees payable to the Company's banks (see "Liquidity and  
Capital Resources" below). Interest expense for 1995 increased by $572,000 as   
compared to 1994 due to the issuance of the convertible subordinated debentures.

Provision for Income Taxes                                                      

    The Company had no tax (benefit) provision for 1997, 1996 and 1995
since the available loss carryback to prior years was completely utilized by the
net operating loss for 1993 carryback to the prior three years.                 

Net Loss                                                                        

 For 1997 and 1996 the Company had net losses of $15,014,000 and
$14,495,000, respectively, as compared to a net loss of $4,103,000 for 1995.    
These net losses are attributable to the reduction in sales not offset by a     
comparable reduction in cost of goods sold, increased legal expenses, litigation
settlements during the year and, in 1997, expenses incurred in discontinuing    
certain manufacturing operations.                                               

Liquidity and Capital Resources                                                 

    At December 31, 1997, the Company had cash and cash equivalents of
$26,000 as compared to $118,000 at December 31, 1996. The Company had a working 
capital deficit at December 31, 1997 of $24,705,000.                            

         On March 10, 1998, the Company completed the Offering to Galen Partners
III, L.P., Galen Partners International III, L.P., Galen Employee Fund III, L.P.
(collectively, "Galen") and each of the Purchasers (along with Galen,           
collectively the "Galen Investor Group") listed on the signature page to a      
certain Debenture and Warrant Purchase Agreement dated March 10, 1998 (the      
"Purchase Agreement"). The net proceeds to the Company from the Offering, after 
deduction of related Offering expenses, were approximately $19.6 million. The   
securities issued in the Offering consisted of 5% convertible senior            

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secured debentures (the "Debentures") and common stock purchase warrants (the   
"Warrants") exercisable for an aggregate of 4,202,020 shares of the Company's   
common stock. See "Item 1. Business - Recent Events" for a discussion of the    
Debentures and Warrants. Reference is also made to the Company's Form 8-K as    
filed with the Securities and Exchange Commission on March 24, 1998 for a more  
detailed description of the Debentures and Warrants, which is hereby            
incorporated by this reference and is attached as Exhibit 10.41 to this Report. 

    The Offering net proceeds of approximately $19.6 million have been
allocated to satisfy a substantial portion of the Company's current liabilities 
and accounts payable. Such liabilities include the full satisfaction of the     
Company's Bank indebtedness and related fees of approximately $3 million,       
payment to the landlord at the Company's Brooklyn facility, and satisfaction of 
judgments and liens. Such repayments have allowed the Company to avoid a        
threatened foreclosure sale by its former Banks of Houba' s Indiana facility,   
which secured the bank indebtedness.                                            

        In addition, pursuant to agreements reached with other large creditors
in anticipation of completing the Offering, including the Company's landlord and
the DOJ, the Company has been able to bring these creditors current and in      
compliance with installment payment agreements providing favorable terms to the 
Company. The Offering proceeds will allow the Company to satisfy its outstanding
state and Federal payroll tax obligations and meet current payroll tax          
obligations. The Offering proceeds also will allow the Company to satisfy a     
substantial portion of its extensive arrear accounts payable and to secure      
discounts relating to such payments. Finally, the significant reduction of the  
Company's current liabilities combined with the working capital derived from the
Offering proceeds, have resulted in the Company's independent certified public  
accountants issuing a report on the Company's financial statements for the year 
ended December 31, 1997 which does not contain an explanatory paragraph as to   
the Company's ability to continue as a going concern, which going concern       
qualification was included in such reports for fiscal 1996 and 1995.            

Prior to the completion of the Offering, the Company was in   
negotiations with the DOJ to restructure the payment of the $2,500,000 fine that
had been levied under the Plea Agreement in order to address the Company's      
failure to satisfy the $125,000 quarterly installments provided for under the   
Plea Agreement. On March 30, 1998, the Company and the DOJ signed a Letter      
Agreement serving to amend the Plea Agreement relating to the terms of the      
Company's satisfaction of the fine assessed under the Plea Agreement.           
Specifically, the Letter Agreement provides that the Company will satisfy the   
remaining $2,150,000 of the fine through the payment of $25,000 on a monthly    
basis commencing May 1, 1998, plus interest on such outstanding balance (at the 
rate calculated pursuant to 28 U.S.C. Section 1961)(currently 5.319%). Such     
payment schedule would result in the full satisfaction of the DOJ fine in       
December, 2005. The Letter Agreement also provides certain restrictions on the  
payment of salary or compensation to any individual in excess of $50,000 without
the written consent of the United States District Court for the District of     
Maryland, subject to certain exceptions. In addition, the Letter Agreement      
requires the prepayment of the outstanding fine to the extent of 25% of the     
Company's after tax profit and 25% of the net proceeds received by the Company  
on any sale of a capital asset for a sum in excess of $10,000. The terms of the 
Letter Agreement are subject to the approval of the U.S. District Court for the 
District of Maryland.                                                           

         During the period from May 1997 through July 1997, the Company borrowed
approximately $3 million from Mylan Laboratories, Inc. pursuant to five         
unsecured, demand promissory notes. The advances made by Mylan Laboratories,    
Inc. were part of a proposed investment by Mylan Laboratories, Inc. in the      
Company, including the proposed purchase of the Company's Houba Indiana facility
as well as a partial tender offer for the Company's common stock. The Company   
used the proceeds of these borrowings for working capital. The $3 million       
indebtedness relating to such advances remains outstanding and the              

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Company anticipates negotiating with representatives of Mylan Laboratories, Inc.
in an attempt to structure repayment terms acceptable to the Company. While the 
Company believes that repayment terms acceptable to each of the Company and     
Mylan Laboratories, Inc. will be agreed upon, no assurance can be made that the 
Company will be successful in restructuring this indebtedness on terms favorable
to the Company. Failure to extend the term over which this indebtedness will be 
repaid or to permit satisfaction of all or a portion of the indebtedness through
delivery of product produced by the Company, may have an adverse effect on the  
Company's operations and financial condition.                                   

        During the period from late 1996 through early March 1998, the Company
borrowed an aggregate of approximately $1,100,000 from certain of the holders of
the Company's convertible subordinated debentures and common stock. These       
borrowings, evidenced by promissory notes, are due and payable as to principal  
on demand. Interest on these notes, at the rate of 10% per annum, is payable on 
a quarterly basis. The Company utilized the proceeds of these borrowings for    
working capital. Upon the completion of the Offering, the Company satisfied     
$800,000 of such indebtedness from the net proceeds of the Offering. The        
remaining $300,000 of such indebtedness has, by agreement with the holder of    
such note, been extended for a term of one year.                                

  During fiscal 1997 and up to the completion of the Offering, the
Company had insufficient capital resources to meet both its current and         
long-term obligations. As a result of inadequate working capital, a decline in  
shipments of solid dosage products from the Company's Brooklyn plant following  
the entry of the Consent Decree, and the lack of available borrowings under the 
Company's then existing credit facility, the Company's liquidity position had   
been materially adversely affected since June 30, 1993 and the Company's capital
resources had been severely limited. During this period, the Company actively   
sought to reduce its operating costs at the Brooklyn plant, including reductions
in personnel. Significant liabilities, however, and the absence of adequate     
working capital, impaired the Company's ability to purchase and process raw     
materials for sale as finished goods and to satisfy current liabilities and meet
operating expenses.                                                             

         The net proceeds from the Offering has permitted the Company to satisfy
a significant portion of its current liabilities and accounts payable. In       
addition, based on Management's belief as to the Company's ability to defer a   
portion of the Company's remaining notes and accounts payable and certain other 
assumptions, including the restructuring of the indebtedness to Mylan           
Laboratories, Inc., the Company believes that it has approximately 3 million in 
cash available for working capital derived from the net proceeds of the         
Offering. The Company estimates that such working capital will permit the       
Company to purchase needed raw materials and fund near term operating losses    
for approximately three to six months. In order to supplement such working      
capital, the Company is in the process of negotiating with a banking            
institution to secure a $5 million line of credit. In addition, in accordance   
with the terms of the Debenture and Warrant Purchase Agreement pursuant to      
which the Offering was completed, the Company has granted the Galen Investor    
Group an option to invest an additional $5 million in the Company at any time   
within eighteen months from the date of the closing of the Offering in exchange 
for Debentures and Warrants having terms identical to those issued in the       
Offering (the "Galen Option"). Galen has expressed an indication of interest to 
exercise the Galen Option in the event the Company is in need of additional     
capital. No assurance can be given, however, that the Company will be           
successful in securing the $5 million line of credit or that the Galen Option   
will be exercised. In the event the Company is successful in securing the line  
of credit or in the event the Galen Option is exercised, the Company believes   
that it will have sufficient working capital to fund operations for at least    
the next twelve months.                                                         

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Capital Expenditures                                                            

    The Company's capital expenditures during 1997, 1996 and 1995 were
$49,000, $208,000, and $536,000, respectively. The decrease in capital          
expenditures in 1997 as compared to prior years is attributable to the Company's
cash conservation measures implemented in 1995.                                 

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.                           

See Index to Financial Statements after signature page.       

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

Not Applicable.                                               

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.                    

       The information required by Item 10 will be included in the Company's
Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be filed
within 120 days after the close of the Company's fiscal year ended December 31, 
1997, and is hereby incorporated herein by reference to such Proxy Statement.   

ITEM 11. EXECUTIVE COMPENSATION.                                                

       The information required by Item 11 will be included in the Company's
Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be filed
within 120 days after the close of the Company's fiscal year ended December 31, 
1997, and is hereby incorporated herein by reference to such Proxy Statement.   

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

       The information required by Item 12 will be included in the Company's
Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be filed
within 120 days after the close of the Company's fiscal year ended December 31, 
1997, and is hereby incorporated herein by reference to such Proxy Statement.   

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.                       

       The information required by Item 13 will be included in the Company's
Proxy Statement for the 1998 Annual Meeting of Shareholders, which will be filed
within 120 days after the close of the Company's fiscal year ended December 31, 
1997, and is hereby incorporated herein by reference to such Proxy Statement.   

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 PART IV

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

    (a)      Financial Statements - See Index to Financial Statements.

(b)      Reports on Form 8-K                                  

None.                                       

(c)      Exhibits                                             

Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

3.1      Certificate of Incorporation and amendments (incorporated by reference 
    to Exhibit 3.1 to Amendment No. 2 to the Registrant's Registration
Statement on Form S-18, File No. 2471-NY).                    

3.2      Restated Bylaws (incorporated by reference to Exhibit 3.1 to the       
       Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1993).                                                    

10.1     Credit Agreement, dated as of December 22, 1992, among the Registrant  
  and The Chase Manhattan Bank, N.A. (incorporated by reference to
     Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the
year ended December 3 1, 1992 (the "1992 Form 10-K")).        

10.2     Amendment Two, dated as of January 12, 1994, to Credit Agreement among 
         the Registrant and The Chase Manhattan Bank, N.A. , together with forms
     of Stock Warrant and Registration Rights Agreement (incorporated by
      reference to Exhibit 10.1. to the Registrant's Annual Report on Form
    10-K for the year ended December 31, 1993 (the "1993 Form 10-K")).

10.3     Amendment Three, dated as of May 31, 1994, to Credit Agreement among   
    the Registrant and The Chase Manhattan Bank, N.A. (incorporated by
        reference to Exhibit 6(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1994).                   

10.4     Amendment Four, dated as of July 1994, to Credit Agreement among the   
Registrant and The Chase Manhattan Bank, N.A. (incorporated by
        reference to Exhibit 6(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994)).                   

10.5     Amendment Five, dated as of March 21, 1995, to Credit Agreement among  
    the Registrant and The Chase Manhattan Bank, N.A. (incorporated by
      reference to Exhibit 10.7 to the Registrant's Current Report on Form
8-K dated March 21, 1995 (the "March 8-K")).                  

10.5(l)  Form of Warrants issued to The Bank of New York, The Chase Manhattan   
       Bank, N.A. and the Israel Discount Bank (incorporated by reference to
        Exhibit 10.5(i) to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995 (the "1995 Form 10-K")).         

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.5(2)  Letter Agreement, dated July 10, 1995, among Halsey Drug Co.,Inc., The 
      Chase Manhattan Bank, N.A., The Bank of New York and Israel Discount
    Bank of New York (incorporated by reference to Exhibit 6(a) to the
       Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1995 (the "June 10-Q")).                                  

10.5(3)  Letter Agreement, dated November 16, 1995, among Halsey Drug Co.,Inc., 
 The Chase Manhattan Bank, N.A., The Bank of New York and Israel
 Discount Bank of New York (incorporated by reference to Exhibit
10.25(iv) to the 1995 10-K).                                  

10.5(4)  Amendment 6, dated as of August 6, 1996, to Credit Agreement among     
       Halsey Drug Co.,Inc., The Chase Manhattan Bank, N.A., The Bank of New
         York and Israel Discount Bank of New York (incorporated by reference to
         Exhibit 10.1 to Amendment No. 1 to the Registrant's Quarterly Report on
       Form 10-Q for the quarter ended June 30, 1996 (the "June 1996 10-Q)).

10.5(5)  Letter Agreement, dated March 25, 1997 among Halsey Drug Co., Inc., The
       Chase Manhattan Bank, as successor in interest to The Chase Manhattan
       Bank (National Association), The Bank of New York and Israel Discount
Bank.                                                         

10.6     Agreement Regarding Release of Security Interests dated as of March 21,
        1995 by and among the Company, Mallinckrodt Chemical Acquisition, Inc.
         and The Chase Manhattan Bank, N.A.(incorporated by reference to Exhibit
10.9 of the March 8-K).                                       

10.7     Consulting Agreement dated as of September, 1993 between the Registrant
        and Joseph F. Limongelli (incorporated by reference to Exhibit 10.6 to
the 1993 Form 10-K).                                          

10.8     Employment Agreement, dated as of January 1, 1993, between the         
     Registrant and Rosendo Ferran (incorporated by reference to Exhibit
10.2 to the 1992 Form 10-K).                                  

10.10(1) Halsey Drug Co., Inc. 1984 Stock Option Plan, as amended (incorporated 
by reference to Exhibit 10.3 to the 1992 Form 10-K).          

10.10(2) Halsey Drug Co., Inc. 1995 Stock Option and Restricted Stock Purchase  
    Plan (incorporated by reference to Exhibit 4.1 to the Registrant's
Registration Statement on Form S-8, File No. 33- 98396).      

10.10(3) Halsey Drug Co., Inc. Non-Employee Director Stock Option Plan.         

10.11    Leases, effective February 13, 1989 and January 1, 1990, respectively, 
among the Registrant and Milton J. Ackerman, Sue Ackerman, Lee
    Hinderstein, Thelma Hinderstein and Marilyn Weiss (incorporated by
        reference to Exhibits 10.6 and 10.7, respectively, to the Registrant's
   Annual Report on Form 10-K for the year ended December 31, 1989).

10.12    Lease, effective as of April 15, 1988, among the Registrant and Milton 
    J. Ackerman, Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and
        Marilyn Weiss, and Rider thereto (incorporated by reference to Exhibit
         10.12 to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1987).                                           

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.12(l) Lease, as of October 31, 1994, among Registrant and Milton J. Ackerman,
      Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and Marilyn Weiss,
   together with Modification, Consolidation and Extension Agreement
     (incorporated by reference to Exhibit 10. 12(i) to the Registrant's
   Annual Report on Form 10-K for the year ended December 31, 1995).

10.13    Asset Purchase Agreement dated as of March 21, 1995 among Mallinckrodt 
    Chemical Acquisition, Inc. ("Acquisition"), Mallinckrodt Chemical,
     Inc., as guarantor and the Registrant (incorporated by reference to
Exhibit 10.1 to the March 8-K).                               

10.14    Toll Manufacturing Agreement for APAP/Oxycodone Tablets dated as of    
        March 21, 1995 between Acquisition and the Registrant (incorporated by
reference to Exhibit 10.2 to the March 8-K).                  

10.15    Capsule ANDA Option Agreement dated as of March 21, 1995 between       
      Acquisition and the Registrant (incorporated by reference to Exhibit
10.3 to the March 8-K).                                       

10.16    Tablet ANDA Noncompetition Agreement dated as of March 21, 1995 between
      the Registrant and Acquisition (incorporated by reference to Exhibit
10.4 to the March 8-K).                                       

10.17    Subordinated Non-Negotiable Promissory Term Note in the amount of      
        $1,200,00 dated March 21, 1995 issued by the Registrant to Acquisition
(incorporated by reference to Exhibit 10.5 to the March 8-K). 

10.18    Term Note Security Agreement dated as of March 21, 1995 among the      
    Company, Houba, Inc. and Acquisition (incorporated by reference to
Exhibit 10.6 to the March 8-K).                               

10.19    Amendment dated March 21, 1995 to Subordination Agreement dated as of  
 July 21, 1994 between Mallinckrodt Chemical, Inc., Mallinckrodt
      Chemical Acquisition, Inc., the Registrant, The Chase Manhattan Bank
       (National Association), Israel Discount Bank of New York, The Bank of
New York, and The Chase Manhattan Bank (National Association) 
(incorporated by reference to Exhibit 10.8 to the March 8-K). 

10.20    Agreement dated as of March 30, 1995 between the Registrant and        
        Zatpack, Inc. (incorporated by reference to Exhibit 10.10 to the March
8-K).                                                         

10.21    Waiver and Termination Agreement dated as of March 30, 1995 between    
  Zuellig Group, W.A., Inc. and Indiana Fine Chemicals Corporation
(incorporated by reference to Exhibit 10.11 to the March 8-K).

10.22    Convertible Subordinated Note of the Registrant dated December 1, 1994 
        issued to Zatpack, Inc. (incorporated by reference to Exhibit 10.12 to
the March 8-K).                                               

10.23    Agreement dated as of March 30, 1995 among the Registrant, Indiana Fine
Chemicals Corporation, Zuellig Group, N.A., Inc., Houba Inc., 
         Zetapharm, Inc. and Zuellig Botanicals, Inc. (incorporated by reference
to Exhibit 10.13 to the March 8-K).                           

10.24    Supply Agreement dated as of March 30, 1995 between Houba, Inc. and    
    ZetaPharm, Inc. (incorporated by reference to Exhibit 10.14 to the
March 8-K).                                                   

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.25    Form of 10% Convertible Subordinated Debenture (incorporated by        
reference to Exhibit 6(a) to the June 10-Q).                  

10.26    Form of Redeemable Common Stock Purchase Warrant (incorporated by      
reference to Exhibit 6(a) to the June 10-Q).                  

10.27    Form of 10% Convertible Subordinated Debenture (incorporated by        
         reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K
dated December 4, 1995 (the "December 8- K")).                

10.28    Form of Redeemable Common Stock Purchase Warrant (incorporated by      
reference to Exhibit 4.2 to the December 8-K).                

10.29    Form of 10% Convertible Subordinated Debenture (incorporated by        
reference to Exhibit 99 to the June 1996 10-Q).               

10.30    Form of Redeemable Common Stock Purchase Warrant (incorporated by      
     reference to Exhibit 4.1 to Amendment No. 1 to the June 1996 10-Q).

10.31    Form of 5% Convertible Senior Secured Debenture (incorporated by       
         reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K
dated March 24, 1998 (the "March 1998 8- K")).                

10.32    Form of Common Stock Purchase Warrant (incorporated by reference to    
Exhibit 4.2 to the March 1998 8-K).                           

10.33    Debenture and Warrant Purchase Agreement dated March 10, 1998, by and  
         among the Registrant, Galen Partners III, L.P. and the other Purchasers
    listed on the Signature Page thereto (incorporated by reference to
Exhibit 10.1 to the March 1998 8-K).                          

10.34    Form of General Security Agreement of Halsey Drug Co., Inc. dated March
       10, 1998 (incorporated by reference to Exhibit 10.2 to the March 1998
8-K).                                                         

10.35    Form of Agreement of Guaranty of Subsidiaries of Halsey Drug Co., Inc. 
        dated March 10, 1998 (incorporated by reference to Exhibit 10.3 to the
March 1998 8-K).                                              

10.36    Form of Guarantor General Security Agreement dated March 10, 1998      
    (incorporated by reference to Exhibit 10.4 to the March 1998 8-K).

10.37    Stock Pledge Agreement dated March 10, 1998 by and between the         
    Registrant and Galen Partners III, L.P., as agent (incorporated by
reference to Exhibit 10.5 to the March 1998 8-K).             

10.38    Form of Irrevocable Proxy Agreement (incorporated by reference to      
Exhibit 10.6 to the March 1998 8-K).                          

10.39    Agency Letter Agreement dated March 10, 1998 by and among the          
     Purchasers a party to the Debenture and Warrant Purchase Agreement,
        dated March 10, 1998 (incorporated by reference to Exhibit 10.7 to the
March 1998 8-K).                                              

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.40    Press Release of Registrant dated March 13, 1998 (incorporated by      
reference to Exhibit 99.1 to the March 1998 8-K).             

10.41    Current Report on Form 8-K as filed by the Registrant with the         
Securities and Exchange Commission on March 24, 1998.         

*10.42   Letter Agreement between the Registrant and the U. S. Department of    
        Justice dated March 27, 1998 relating to the restructuring of the fine
      assessed by the Department of Justice under the Plea Agreement dated
June 21, 1993.                                                

*10.43   Employment Agreement dated as of March 10, 1998 between the Registrant 
and Michael K. Reicher                                        

*10.44   Employment Agreement dated as of March 10, 1998 between the Registrant 
      and Peter Clemens 21 Subsidiaries of the Registrant (incorporated by
reference to Exhibit 22 to the 1993 Form 10-K).               

*23.1    Consent of Grant Thornton LLP, independent certified public            
accountants.                                                  

*27      Financial Data Schedule, which is submitted electronically to the      
        Securities and Exchange Commission for informational purposes only and
not filed.                                                    

-----------------                                                               
*  Filed herewith.                                                              

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange  
Act of 1934, the registrant has duly caused this report to be signed on its     
behalf by the undersigned, thereunto duly authorized.                           

       HALSEY DRUG CO., INC.

          By   /s/ Michael Reicher
                                  --------------------------------------
                                  Michael Reicher, President and
                                      Chief Executive Officer (Principal
                        Executive Officer)

      Date: April 13, 1998

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

                                                                · Download Table
                                                                          
/s/ William G. Skelly   Chairman and Director               April 13, 1998
----------------------                                                    
William G. Skelly                                                         

/s/ Michael Reicher     President, Chief Executive Officer  April 13, 1998
--------------------                                                      
Michael Reicher         and Director (Principal Executive                 
                             Officer)                                     

/s/ Peter Clemens       Vice President and Chief Financial  April 13, 1998
---------------------                                                     
Peter Clemens           Officer (Principal Financial and                  
                        Accounting Officer)                               

---------------------   Director                            April __, 1998
Alan J. Smith                                                             

/s/ Bruce F. Wesson                                                       
---------------------   Director                            April 13, 1998
Bruce F. Wesson                                                           

/s/ William Sumner      Director                            April 13, 1998
---------------------                                                     
William Sumner                                                            

/s/ Srini Conjeevaram   Director                            April 13, 1998
---------------------                                                     
Srini Conjeevaram                                                         

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 INDEX TO FINANCIAL STATEMENTS

                                                                · Download Table

                                                                  Page       
                                                                  ----       
                                                                             
Report of Independent Certified Public Accountants                F-2        

Consolidated Balance Sheets                                       F-3        

Consolidated Statements of Operations                             F-5        

Consolidated Statement of Stockholders' Equity                    F-6        

Consolidated Statements of Cash Flows                             F-9        

Notes to Consolidated Financial Statements                        F-11 - F-40

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 REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS

Board of Directors                                                              
HALSEY DRUG CO., INC.                                                   

We have audited the accompanying consolidated balance sheets of Halsey Drug Co.,
Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related         
consolidated statements of operations, stockholders' equity and cash flows for  
each of the three years in the period ended December 31, 1997. 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 audit 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 financial statements referred to above present fairly, in   
all material respects, the consolidated financial position of Halsey Drug Co.,  
Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated    
results of their operations and their consolidated cash flows for each of the   
three years in the period ended December 31, 1997, in conformity with generally 
accepted accounting principles.                                                 

GRANT THORNTON LLP                                                              

New York, New York                                                              
April 14, 1998                                                                  

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Halsey Drug Co., Inc. and Subsidiaries

 CONSOLIDATED BALANCE SHEETS

December 31,
(in thousands)

                                                                · Download Table

                                                      1997     1996 
                                                      ----     ---- 
                                                                    
CURRENT ASSETS                                                      
    Cash                                            $    26  $   118
    Accounts receivable - trade, net of allowances                  
       for doubtful accounts of $542 and $424                       
       in 1997 and 1996, respectively                    62      226
    Other receivable                                           1,000
    Inventories                                       2,456    3,758
    Prepaid insurance and other current assets          274      252
                                                    -------  -------
         Total current assets                         2,818    5,354

         PROPERTY, PLANT AND EQUIPMENT, NET           4,630    6,222

         OTHER ASSETS                                   219      406
                                                    -------  -------

                                                    $ 7,667  $11,982
                                                    =======  =======

The accompanying notes are an integral part of these statements.                

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 CONSOLIDATED BALANCE SHEETS (CONTINUED)

December 31,
(in thousands)

                                                                · Download Table

                                                          1997        1996    
                                                          ----        ----    
                                                                              
CURRENT LIABILITIES                                                           
    Bank overdraft                                      $    159    $    286  
    Due to banks                                           2,476       3,195  
    Notes payable                                          4,825       1,625  
    Convertible subordinated debentures                    2,244       2,173  
    Department of Justice settlement                         200       2,168  
    Accounts payable                                       6,086       4,533  
    Accrued expenses                                       7,644       3,575  
    Deferred gain                                          1,900              
                                                        --------    --------  
         Total current liabilities                        25,534      17,555  

         LONG-TERM DEBT                                                1,508  

         DEPARTMENT OF JUSTICE SETTLEMENT                  1,990              

         COMMITMENTS AND CONTINGENCIES                                        

         STOCKHOLDERS' EQUITY (DEFICIT)                                       
    Common stock - $.01 par value; authorized,                                
       20,000,000 shares; issued and outstanding,                             
       14,029,718 shares and 13,175,708 shares                                
       in 1997 and 1996, respectively                        140         131  
    Additional paid-in capital                            25,489      23,316  
    Accumulated deficit                                  (44,497)    (29,484) 
                                                        --------    --------  
                                                         (18,868)     (6,037) 
    Less treasury stock - at cost ( 439,603 shares and                        
    474,603 shares in 1997 and 1996, respectively)          (989)     (1,044) 
                                                        --------    --------  
                                                          (19,857)     (7,081)
                                                        --------    --------  

                                                        $  7,667    $ 11,982  
                                                        ========    ========  

The accompanying notes are an integral part of these statements.        

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Halsey Drug Co., Inc. and Subsidiaries

 CONSOLIDATED STATEMENTS OF OPERATIONS

 Year ended December 31,
 (in thousands, except per share data)

                                                        · Enlarge/Download Table

                                                          1997       1996        1995  
                                                          ----       ----        ----  
                                                                                       
Net sales                                               $  9,088   $ 12,379   $ 20,225 
Cost of goods sold                                        15,406     16,826     18,097 
                                                        --------   --------   -------- 

         Gross profit                                     (6,318)    (4,447)     2,128 

         Research and development                            979      1,854        818 
         Selling, general and administrative expenses      6,308      7,486      6,098 
                                                        --------   --------   -------- 

         Loss from operations                            (13,605)   (13,787)    (4,788)

         Interest expense                                 (1,144)    (1,708)    (1,307)
         Other income (expense)                             (264)     1,000      2,288 
                                                        --------   --------   -------- 

         Loss before income taxes                        (15,013)   (14,495)    (3,807)

         Provision for income taxes                                                296 
                                                        --------   --------   -------- 

         NET LOSS                                       $(15,013)  $(14,495)  $ (4,103)
                                                        ========   ========   ======== 

         Basic loss per common share                    $  (1.12)  $  (1.49)  $   (.52)
                                                        ========   ========   ======== 

         Weighted average number of outstanding shares    13,434      9,724      7,886 
                                                        ========   ========   ======== 

The accompanying notes are an integral part of these statements.                

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CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

Years ended December 31, 1997, 1996 and 1995
(in thousands)

                                                        · Enlarge/Download Table

                                         Common stock,                                Treasury stock,             
                                        $.01 par value    Additional                      at cost                 
                                       -----------------    paid-in   Accumulated   ------------------            
                                       Shares     Amount    capital     deficit     Shares      Amount      Total 
                                       ------     ------    -------     -------     ------      ------      ----- 
                                                                                                                  
Balance at January 1,1995              7,610       $76     $10,162     $(10,886)                          $  (648)

Issuance of common stock                 500         5         791                                            796 
Issuance of common stock in                                                                                       
   connection with litigation                                                                                     
   settlement                            825         8       2,992                                          3,000 
Repurchase of common stock                                                         (500,000)   $ (1,100)   (1,100)
Issuance of warrants with convertible                                                                             
   subordinated debentures                                     416                                            416 
Exercise of stock options                 39         1          98                                             99 
Net loss for the year ended                                                                                       
   December 31, 1996                                        (4,103)                                        (4,103)
                                       -----       ---     -------     --------    --------    --------   ------- 
Balance at December 31, 1995                                                                                      
   (carried forward)                   8,974        90      14,459      (14,989)   (500,000)     (1,100)   (1,540)

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CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (CONTINUED)

Years ended December 31, 1997, 1996 and 1995
(in thousands)

                                                        · Enlarge/Download Table

                                        Common stock,                              Treasury stock,               
                                       $.01 par value   Additional                     at cost                   
                                       ---------------    paid-in   Accumulated   ------------------             
                                       Shares   Amount    capital     deficit     Shares      Amount       Total 
                                       ------   ------    -------     -------     ------      ------       ----- 
                                                                                                                 
Balance at December 31, 1995                                                                                     
    (brought forward)                   8,974    $ 90    $ 14,459    $(14,989)   (500,000)   $ (1,100)  $ (1,540)

Issuance of common stock                                                                                         
    conversion of debentures            3,504      35       6,724                                          6,759 
Issuance of shares as settlement           60                 262                  25,397          56        318 
Issuance of warrants with convertible                                                                            
    subordinated debentures                                   355                                            355 
Exercise of warrants of convertible                                                                              
    debentures                            589       6       1,363                                          1,369 
Stock options exercised                    49                 153                                            153 
Net loss for the year ended                                                                                      
    December 31, 1996                                                 (14,495)                           (14,495)
                                       ------    ----    --------    --------     -------    --------   -------- 
Balance at December 31, 1996                                                                                     
    (carried forward)                  13,176     131      23,316     (29,484)   (474,603)     (1,044)    (7,081)

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CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (CONTINUED)

Years ended December 31, 1997, 1996 and 1995
(in thousands)

                                                        · Enlarge/Download Table

                                          Common stock,                                 Treasury stock,               
                                         $.01 par value     Additional                      at cost                   
                                       ------------------    paid-in    Accumulated   -------------------             
                                       Shares      Amount    capital      deficit     Shares       Amount      Total  
                                       ------      ------    -------      -------     ------       ------      -----  
                                                                                                                      
Balance at December 31, 1996                                                                                          
   (brought forward)                   13,176     $    131   $ 23,316    $(29,484)   (474,603)    $ (1,044)  $ (7,081)

Issuance of common stock -                                                                                            
   conversion of debentures               643            7      1,529                                           1,536 
Issuance of shares as payment of                                                                                      
   interest                                69            1        224                                             225 
Sale of treasury stock                     25                      45                  35,000           55        100 
Exercise of warrants of convertible                                                                                   
   debentures                              22                      72                                              72 
Stock options exercised                    95            1        303                                             304 
Net loss for the year ended                                                                                           
   December 31, 1997                                                      (15,013)                            (15,013)
                                     --------     --------   --------    --------    --------     --------   -------- 
   Balance at December 31, 1997        14,030     $    140   $ 25,489    $(44,497)    439,603     $   (989)  $(19,857)
                                     ========     ========   ========    ========    ========     ========   ======== 

The accompanying notes are an integral part of this statement.                  

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Halsey Drug Co., Inc. and Subsidiaries

 CONSOLIDATED STATEMENTS OF CASH FLOWS

 Year ended December 31,
(in thousands)

                                                        · Enlarge/Download Table

                                                           1997       1996        1995  
                                                           ----       ----        ----  
                                                                                        
Cash flows from operating activities                                                    
    Net loss                                             $(15,013)  $(14,495)  $ (4,103)
                                                         --------   --------   -------- 
    Adjustments to reconcile net loss to net                                            
      cash used in operating activities                                                 
         Depreciation and amortization                      1,733      1,906      1,956 
         Provision for losses on accounts receivable          118        144            
         Provision for loss on investment                                500            
         Gain on sale of assets                                38     (1,000)    (2,288)
         Deferred income taxes                                                      296 
         Changes in assets and liabilities                                              
             Accounts receivable                               45      1,319        637 
             Inventories                                    1,302      3,958       (881)
             Prepaid insurance and other current assets       165        (96)      (160)
             Accounts payable                               1,851      1,029     (2,031)
             Accrued expenses                               4,553      2,913        121 
                                                         --------   --------   -------- 
         Total adjustments                                  9,805     10,673     (2,350)
                                                         --------   --------   -------- 
         Net cash used in operating activities             (5,208)    (3,822)    (6,453)
                                                         --------   --------   -------- 
Cash flows from investing activities                                                    
    Capital expenditures                                      (85)      (390)      (536)
    Decrease (increase) in other assets                                             116 
    Net proceeds from sale of assets                                              1,889 
    Collection of notes receivable                         1,000                        
                                                         --------   --------   -------- 
         Net cash (used in) provided by investing                                       
           activities                                         915       (390)     1,469 
                                                         --------   --------   -------- 

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Halsey Drug Co., Inc. and Subsidiaries

 CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

 Year ended December 31,
(in thousands)

                                                                · Download Table

                                                      1997      1996      1995  
                                                      ----      ----      ----  
                                                                                
Cash flows from financing activities                                            
    Increase (decrease) in notes payable            $ 3,881   $    25   $(1,192)
    Proceeds from issuance of common stock                        318       796 
    Reissuance of treasury stock                         70                     
    Payments to Department of Justice                                       (90)
    Bank overdraft                                     (127)       73        (5)
    Repurchase of common stock                                           (1,100)
    Payments to minority stockholders                            (206)     (212)
    Proceeds from issuance of convertible                                       
      subordinated debentures                         4,600     2,500     7,740 
    Proceeds from exercise of stock options             305       153        99 
    Proceeds from exercise of warrants                   72     1,369           
    Increase in other assets                                     (255)     (727)
                                                    -------   -------   ------- 
         Net cash provided by financing activities    4,201     3,977     5,309 
                                                    -------   -------   ------- 
         NET (DECREASE) INCREASE IN CASH                                        
             AND CASH EQUIVALENTS                       (92)     (235)      325 

Cash and cash equivalents at beginning of year          118       353        28 
                                                    -------   -------   ------- 

Cash and cash equivalents at end of year            $    26   $   118   $   353 
                                                    =======   =======   ======= 

Supplemental disclosures of noncash activities:                                 

Year ended December 31, 1997                                          
----------------------------                                          
The Company issued 642,407 shares of common stock to Zatpack, Inc. as 
payment for an outstanding note payable in the amount of $1,536,000.  

     The Company reissued 25,000 shares of treasury stock as payment for $30,000
in consulting fees and the receipt of $70,000 in cash.                

     The Company issued 25,000 shares of common stock as payment for $225,452 in
accrued interest.                                                     

The Company recorded the satisfaction of $1,400,000 of subordinated   
promissory notes, related accrued interest of $200,000 and accounts   
payable of $300,000 due to Mallinckrodt, in lieu of Mallinckrodt      
paying $1,900,000 owed to the Company as described in Note E.         

Years ended December 31, 1996 and 1995                                
--------------------------------------                                
The issuance of 3,504,000 shares of the Company's common stock upon   
conversion of $6,759,000 of convertible subordinated debentures is    
included in common stock and additional paid-in capital.              

The valuation of the warrants issued in 1996 and 1995, of $355,000 and
$416,000, respectively, with convertible subordinated debentures is   
included in additional paid-in capital.                               

The issuance in 1996 and 1995 of 59,550 and 824,742 shares of the     
    Company's common stock is valued at $318,000 and $3,000,000, respectively,
in connection with litigation settlements.                            

The accompanying notes are an integral part of these statements.                

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Halsey Drug Co., Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1997, 1996 and 1995

NOTE A - SUMMARY OF ACCOUNTING POLICIES                                         

The Company, a New York-based corporation established in 1935, and its
subsidiaries, are engaged in the manufacture, sale and distribution of
     generic drugs. The Company sells its generic drug products under its Halsey
    label and under private-label arrangements with drug store chains and drug
wholesalers throughout the United States.                             

  A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements 
follows.                                                              

1.  Principles of Consolidation and Basis of Presentation             

       The consolidated financial statements include 100% of the accounts of
         the Company and its wholly-owned subsidiaries, Blue Cross Products Co.,
   Inc., Houba, Inc., Halsey Pharmaceuticals, Inc., and Indiana Fine
Chemicals Corporation, The Medi-Gum Corporation, H.R. Cenci   
      Laboratories, Inc. (97% owned) and Cenci Powder Products, Inc. (100%
      owned). The Medi-Gum Corporation and Halsey Pharmaceuticals have not
commenced operations. All material intercompany accounts and  
transactions have been eliminated.                            

2.  Liquidity Matters                                                 

       As of December 31, 1997, the Company has a working capital deficiency
of approximately $24,705,000, has an accumulated deficit of   
    approximately $44,496,000 and has incurred a loss of approximately
  $15,013,000 for the year then ended. The Company was also not in
 compliance with its financial covenants pursuant to its banking
 agreement and its convertible subordinated debenture agreement.

On March 10, 1998, the Company completed a private offering of
       securities consisting of 5% convertible senior secured debentures and
common stock purchase warrants exercisable for an aggregate of
       4,202,020 shares of the Company's common stock. The net cash proceeds
       to the Company from the offering, after the deduction of related cash
offering expenses, was approximately $19.6 million.           

    The net proceeds of the offering have, in large part, been used to
     satisfy a substantial portion of the Company's past due liabilities
      and accounts payable. Such liabilities include the full satisfaction
     of the Company's bank indebtedness and related fees, payment to the
landlord of the Brooklyn                                      

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE A (CONTINUED)                                                              

    facility and satisfaction of outstanding judgments and liens. Such
         repayments have allowed the Company to avoid the threatened foreclosure
       sale by its banks of the Indiana facility securing such indebtedness.
     Additionally, the satisfaction of the bank indebtedness resulted in
         curing the Company's default with its subordinated debenture agreement.
       Further, pursuant to agreements reached with other large creditors in
         anticipation of the completion of the offering, including the Company's
      landlord and the Department of Justice ("DOJ"), the Company has been
      able to bring these creditors current and will be in compliance with
 installment payment agreements providing favorable terms to the
   Company. Satisfaction of the Company's current obligations to its
landlord of the Brooklyn facility for accrued and unpaid rent,
   penalties and expenses has allowed the Company to renegotiate its
     lease and avoid eviction. The offering proceeds will also allow the
  Company to satisfy its outstanding state and Federal payroll tax
obligations and meet current payroll tax obligations.         

   After giving effect to the application of the net proceeds of the
        offering, and based on management's belief as to the Company's ability
        to defer a portion of remaining notes and accounts payable and certain
     other assumptions, the Company believes it will have  approximately
   $3,000,000 of cash available for working capital. The Company has
      submitted Abbreviated New Drug Applications ("ANDA") for approval by
     the Food and Drug Administration ("FDA") (Note M) and believes that
 approval of such  ANDA, which remains uncertain, will result in
 generating increased revenues. The Company is also currently in
      discussions with a financial institution to secure a $5,000,000 line
of credit to supplement its working capital position and could
       potentially secure an additional $5,000,000 of working capital in the
   event that an investor exercises an option to purchase additional
      securities pursuant to the private placement agreement. No assurance
can be given, however, that such financing will be secured on 
    acceptable terms, if at all, or that the investor's option will be
exercised.                                                    

3.  Inventories                                                       

Inventories are stated at the lower of cost or market; cost is
determined using the first-in, first-out method.              

4.  Property, Plant and Equipment                                     

   Property, plant and equipment are stated at cost less accumulated
  depreciation and amortization. Depreciation and amortization are
provided for in amounts sufficient to relate the cost of      

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE A (CONTINUED)                                                              

      depreciable assets to operations over their estimated service lives,
   principally on a straight-line basis. The estimated lives used in
determining depreciation and amortization are:                

                                                                · Download Table

                                                                       
Buildings                                                      25 years
Machinery and equipment                                    5 - 10 years
Leasehold improvements                                     5 - 10 years

       Leasehold improvements are amortized over the lives of the respective
        leases or the service lives of the improvements, whichever is shorter.

5.  Income Taxes                                                      

    The Company accounts for income taxes utilizing an asset liability
       method for financial accounting and reporting for income taxes. Under
       this method, deferred tax assets and liabilities are determined based
        on differences between financial reporting and tax bases of assets and
        liabilities and are measured using the enacted tax rates and laws that
 will be in effect when the differences are expected to reverse.

6.  Statements of Cash Flows                                          

         For purposes of the statements of cash flows, the Company considers all
       highly liquid debt instruments purchased with an original maturity of
         three months or less to be cash equivalents. The Company paid no income
   taxes for the years ended December 31, 1997 and 1996 and $201,000
       during the year ended 1995. In addition, the Company paid interest of
       approximately $1,113,000, $1,173,000, $786,000, respectively, for the
years ended December 31, 1997, 1996 and 1995.                 

7.  Use of Estimates in Consolidated Financial Statements             

   In preparing consolidated financial statements in conformity with
      generally accepted accounting principles, management makes estimates
and assumptions that affect the reported amounts of assets and
        liabilities and disclosure of contingent assets and liabilities at the
        date of the consolidated financial statements, as well as the reported
      amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.                    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE A (CONTINUED)                                                              

8.  Research and Development Costs                                    

   All research and development costs, including payments related to
 licensing agreements on products under development and research
consulting agreements are expensed when incurred.             

9.  Impairment of Long-Lived Assets                                   

         The Company adopted Statement of Financial Accounting Standards No. 121
       ("SFAS No. 121"), "Accounting for the Impairment of Long-Lived Assets
     and for Long-Lived Assets to Be Disposed Of," during the year ended
      December 31, 1996. The statement requires that the Company recognize
and measure impairment losses of long-lived assets and certain
         identifiable intangibles and value long-lived assets to be disposed of.

The Company reviews long-lived assets and certain identifiable
      intangibles held and used for possible impairment whenever events or
        changes in circumstances indicate that the carrying amount of an asset
may not be recoverable (Note I).                              

10.  Stock-Based Compensation                                           

In 1996, the Company adopted Statement of Financial Accounting
 Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
       Compensation," and continues to apply APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations in
      accounting for its plans and does not recognize compensation expense
        for its stock-based compensation plans other than for restricted stock
(Note K).                                                     

11.  New Pronouncements                                                 

Earnings (Loss) Per Share                                     

In 1997, the Company adopted Statement of Financial Accounting
 Standards No. 128 ("SFAS No. 128"), "Earnings Per Share," which
       requires public companies to present basic earnings per share and, if
      applicable, diluted earnings per share. All comparative periods have
been restated in accordance with SFAS No. 128.                

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE A (CONTINUED)                                                              

       The computation of basic loss per share of common stock is based upon
     the weighted average number of common shares outstanding during the
    period, plus (in periods in which they have a dilutive effect) the
      effect of common shares contingently issuable upon exercise of stock
         options and warrants. Diluted earnings per share is considered equal to
         basic earnings per share for all years presented as the effect of other
potentially dilutive securities would be antidilutive.        

Reporting Comprehensive Income                                

        In June 1997, the Financial Accounting Standards Board ("FASB") issued
       Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"),
        "Reporting Comprehensive Income," which is effective for the Company's
      year ending December 31, 1998. The statement addresses the reporting
         and displaying of comprehensive income and its components. Earnings per
      share will only be reported for net income and not for comprehensive
income and its components. Adoption of SFAS No. 130 related to
        disclosure within the financial statements and is not expected to have
a material effect on the Company's financial statements.      

Segment Information                                           

      In June 1997, the FASB also issued Statement of Financial Accounting
      Standards No. 131 ("SFAS No. 131"), "Disclosure About Segments of an
 Enterprise and Related Information," which is effective for the
        Company's year ending December 31, 1998. The statement changes the way
         public companies report information about segments of their business in
         their financial statements and requires them to report selected segment
  information in their quarterly reports. Adoption of SFAS No. 131
  relates to disclosure within the financial statements and is not
expected to have a material effect on the Company's financial 
statements.                                                   

12.  Reclassifications                                                  

Certain reclassifications have been made to the 1996 and 1995 
presentations to conform to the 1997 presentation.            

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE B - FAIR VALUE OF FINANCIAL INSTRUMENTS                                    

       Long-term and Short-term Debt and Convertible Subordinated Debentures

   The fair value of the Company's long-term and short-term debt and
        convertible subordinated debentures is estimated based upon the quoted
      market prices for the same or similar issues or on the current rates
   offered to the Company for debt of the same remaining maturities.

       The carrying amount and fair value of the above financial instruments
are as follows:                                               

                                                        · Enlarge/Download Table

                                                       December 31,                                      
                          -------------------------------------------------------------------------------
                                      1997                                         1996                  
                          -------------------------------                --------------------------------
                          CARRYING             Fair value                Carrying              Fair value
                          AMOUNT                 amount                  amount                    amount
                          ------                 ------                  ------                    ------
                                                         (in thousands)                                  
                                                                                                         
Long-term and short-term                                                                                 
    debt                  $7,301                 $7,301                  $6,328                  $6,328  
Convertible subordinated                                                                                 
    debentures             2,244                  2,244                   2,173                   2,173  

NOTE C - INVENTORIES                                                            

Inventories consist of the following:                                 

                                                                · Download Table

                                                        December 31,          
                                               -------------------------------
                                                1997                     1996 
                                               -------                  ------
                                                       (in thousands)         
                                                                              
Finished goods                                 $   789                  $2,121
Work-in-process                                    263                   1,018
Raw materials                                    1,404                     619
                                               -------                  ------

                                               $2,456                   $3,758
                                               ======                   ======

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE D - PROPERTY, PLANT AND EQUIPMENT                                          

Property, plant and equipment are summarized as follows:      

                                                                · Download Table

                                                         December 31,         
                                                 ---------------------------- 
                                                 1997                    1996 
                                                 ----                    ---- 
                                                        (in thousands)        
                                                                              
Machinery and equipment                         $11,478                $11,641
Leasehold improvements                            5,967                  5,973
Building                                            997                    998
Land                                                265                    265
                                                -------                -------

                                                 18,707                 18,877
Less accumulated depreciation and amortization   14,077                 12,655
                                                -------                -------

                                                $ 4,630                $ 6,222
                                                =======                =======

      Depreciation expense for the years ended December 31, 1997, 1996 and
1995 was approximately $1,640,000, $1,562,000 and $1,576,000, 
respectively.                                                 

NOTE E - DEBT                                                                   

Due to Banks                                                  

At December 31, 1997 and 1996, the Company had $2,476,000 and 
        $3,195,000 outstanding, respectively, under a line of credit agreement
        with three participating banks for which the average borrowing rate on
  these outstanding amounts for the years then ended was 11.9% and
    10.43%, respectively. Borrowings under the line were available for
working capital purposes based upon a percentage of the parent
        company's eligible accounts receivable and were collateralized by such
accounts receivable. The agreement contained certain financial
        covenants, for which the Company was not in compliance at December 31,
    1997. During March 1998, the Company completely satisfied its bank
        indebtedness and terminated the line of credit agreement with the bank
(see Note Q).                                                 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE E (CONTINUED)                                                              

Long-term Debt                                                        

Borrowings under long-term debt are as follows:                       

                                                                · Download Table

                                                        December 31,          
                                               -----------------------------  
                                               1997                     1996  
                                               ----                     ----  
                                                      (in thousands)          
                                                                              
Convertible subordinated promissory note (a)                          $ 1,508 
Subordinated promissory notes (b)                                       1,400 
Notes payable (c)                             $ 4,825                     225 
                                              -------                 ------- 

                                                4,825                   3,133 

Less current maturities of long-term debt      (4,825)                 (1,625)
                                              -------                 ------- 

                                              $  --                   $ 1,508 
                                              =======                 ======= 

(a)  Convertible Subordinated Promissory Note                           

   Pursuant to the Zatpack, Inc. ("Zatpack") agreement (Note N), the
 Company issued a convertible subordinated promissory note dated
      December 1, 1994, to Zatpack, for the cancellation of trade payables
       and advances by Zuellig Group N.A., Inc. ("Zuellig") to the Company's
       subsidiaries, in the amount of $1,292,000, bearing interest at 8% per
   annum, compounded annually, due December 1, 1997. The outstanding
         principal, plus all accrued and unpaid interest, $1,508,000 at December
         31, 1996, was convertible, at the option of Zatpack, into the Company's
       common stock at the rate of one share of common stock for every $2.50
        of principal and interest being converted (the $2.50 is subject to the
     antidilution provisions of the promissory note). In March 1997, the
 principal amount, with related accrued interest of $243,110 was
         converted into 642,407 shares of Common Stock at an adjusted conversion
price of $2.39 per share, thereby cancelling the indebtedness.

(b)  Subordinated Promissory Notes                                      

        On March 21, 1995 (see Note I), the Company satisfied certain accounts
   payable by issuing a subordinated promissory note to Mallinckrodt
     Chemical Acquisition, Inc. ("Mallinckrodt") for $1,200,000, bearing
      interest at 8% per annum, with interest and principal payable at the
earlier                                                       

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE E (CONTINUED)                                                              

        of: (i) receipt by Mallinckrodt of all necessary authorizations from
 the FDA or (ii) March 21, 1998. The note is collateralized by
         substantially all of the assets of the Company and is subordinated to
     future bank indebtedness of up to $8,000,000. The $1,200,000 note
         represents the deferral of payment by the Company of a portion of its
       trade accounts payable due to an affiliate of Mallinckrodt. On July
          14, 1995, the Company borrowed from and issued a $200,000 subordinated
      promissory note to Mallinckrodt, bearing interest at 8% per annum,
        with principal and interest payable June 30, 1996. The principal and
      interest is payable, at the option of Mallinckrodt, in the form of
  cash or a credit to the Company's accounts receivable due from
         Mallinckrodt on June 30, 1996. On September 21, 1997, pursuant to the
         agreement with Mallinckrodt, the Company recorded the satisfaction of
      the $1,200,000 note, the subordinated promissory note of $200,000,
         related accrued interest of $200,000 and accounts payable of $300,000
    due to Mallinckrodt in lieu of Mallinckrodt paying the remaining
     balance of $1,900,000 owed to the Company as described in Note I.

(c)  Notes Payable                                                    

          During 1997, the Company borrowed from and issued to several debenture
       holders and shareholders, unsecured, demand promissory notes in the
          amount of $1,125,000, bearing interest at 12% per annum, with interest
payable quarterly.                                          

        In addition, during the second quarter of 1997, the Company received
        funds, in the amount of $3,000,000, from a proposed purchaser of the
        Company's Indiana facility. These funds were tendered during the due
          diligence period, as an unsecured advance against anticipated payment,
       for the proposed purchase transaction. The purchase transaction was
not consummated and the advance was converted into five non 
        collateralized promissory notes with maturity dates from May 1, 1998
through June 18, 1998.                                      

    During the fourth quarter of 1997, the Company received, from an
         investor of a proposed joint venture, funds in the amount of $500,000
        represented by a demand promissory note, bearing interest at 10% per
      annum, secured by the property of Houba. In addition, as part of a
    proposed financing agreement, the Company received $200,000 as a
      promissory note bearing interest at 8% per annum during the fourth
quarter of 1997.                                            

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE F - CONVERTIBLE SUBORDINATED DEBENTURES AND STOCK WARRANTS                 

    In connection with certain 1995 amendments to the line of credit agreement
described in Note E, the Company issued stock warrants to the bank,   
   expiring July 17, 2000, to purchase up to 699,696 shares of the Company's
    common stock at exercise prices ranging from $1.98 to $2.07 per share. The
    fair value of the warrants, $200,000, as determined by the Company's Board
 of Directors, was recorded by the Company in 1994 as additional paid-in
   capital and a discount to bank debt which was fully amortized through the
maturity date, August 31, 1995.                                       

   On July 18, 1995, the Company issued 408 units, at $10,000 per unit, in a
   private placement of its securities ("July Private Placement"). Each unit
     consists of: (i) a 10% convertible subordinated debenture due July 18, 2000
in the principal amount of $10,000, interest payable quarterly, and   
     convertible into shares of the Company's common stock at a conversion price
of $2.00 per share, subject to antidilution provisions, and (ii) 750  
redeemable common stock purchase warrants ("warrants"). Each warrant  
entitles the holder to purchase one share of common stock for $2.00,  
     subject to adjustment during the five-year period commencing July 18, 1995.
    The warrants were redeemable by the Company at a price of $.01 per warrant
   at any time commencing July 18, 1996, provided that at July 18, 1996, the
     fair market value of the Company's common stock equals or exceeds $2.00 per
    share for the 20 consecutive trading days ending on the third day prior to
     the notice of redemption to the holders of the warrant. The debentures were
converted into 2,040,000 shares of common stock in August 1996.       

     On November 29, 1995, the Company issued 366 units, at $10,000 per unit, in
    a private placement of its securities ("November Private Placement"). Each
    unit consists of (i) a 10% convertible subordinated debenture due November
  29, 2000 in the principal amount of $10,000, interest payable quarterly,
   and convertible into shares of the common stock, at a conversion price of
    $2.50 per share, subject to dilution, and (ii) 600 redeemable common stock
purchase warrants. The terms and conditions of the warrants issued in 
    connection with the November Private Placement are similar to those issued
in the July Private Placement, except that the exercise price of the  
warrant pursuant to the November Private Placement is $2.50 per share.
  These debentures were converted into 1,464,000 shares of common stock in
December 1996.                                                        

The Company received net proceeds from the July and November Private  
    Placements of $7,013,000, net of issuance costs of $727,000, and allocated
   the market value of the warrants, as determined by the Company's Board of
 Directors, $416,000, to additional paid-in capital with a corresponding

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE F (CONTINUED)                                                              

     adjustment to debt discount. The net proceeds from such issuances have been
used for the following purposes: repurchase of 500,000 shares of the  
   Company's common stock, registration of the underlying shares pursuant to
     the Private Placements, the purchase of equipment, research and development
     costs and for working capital. In addition, the Company was required to use
 $950,000 of the net proceeds to repay a portion of its outstanding bank
debt during 1995.                                                     

    On August 6, 1996, the Company issued 250 units, at $10,000 per unit, in a
     private placement of its securities ("August Private Placement"). Each unit
 consists of: (i) a 10% convertible subordinated debenture due August 6,
  2001 in the principal amount of $10,000, interest payable quarterly, and
     convertible into shares of the Company's common stock at a conversion price
 of $3.25 per share, subject to dilution, and (ii) 750 redeemable common
   stock purchase warrants ("warrants"). Each warrant entitles the holder to
    purchase one share of common stock for $3.25, subject to adjustment during
    the five-year period commencing August 6, 1996. Pursuant to the agreement,
   the Company was required to establish an escrow account to repay interest
     in the outstanding convertible debenture, which was fully paid during 1997.
The Company received net proceeds from this private offering of       
    approximately $2,160,000. The Company was required to use $391,000 of said
net proceeds to repay a portion of its bank debt, accrued interest and
legal fees. The Company used the balance of the net proceeds of the   
    Offering for: working capital; registration of the underlying shares under
     the Securities Act; purchase of equipment; and for research and development
expenses.                                                             

NOTE G - ACCRUED EXPENSES                                                       

Accrued expenses are summarized as follows:                           

                                                                · Download Table

                                                       December 31,       
                                                       ------------       
                                               1997                   1996
                                               ----                   ----
                                                      (in thousands)      
                                                                          
Payroll taxes payable (Note H)               $3,290                 $1,554
Interest                                      1,018                    539
Professional fees                               537                    227
Accrued pension and welfare                     501                    185
Medicaid rebates payable                        481                    169
Accrued payroll                                 420                    441
Accrued rent                                    412                    227
Other                                           985                    233
                                             ------                 ------

                                             $7,644                 $3,575
                                              =====                  =====

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE G (CONTINUED)                                                              

At December 31, 1997 payroll taxes payable included $2,900,000 of     
   delinquent payroll taxes due to the Internal Revenue Service and New York
State (Note Q).                                                       

The payroll taxes payable at December 31, 1997 include approximately  
 $2,400,000 and $499,000 of delinquent payroll taxes due to the Internal
Revenue Service and the State of New York, respectively, all of which 
   liability was incurred in 1997 and 1996. The Company has accrued interest
and penalties of $364,000 and $205,000 on these Federal and State     
   liabilities, respectively. The Company expects that the Federal liability
   will be partially offset by income tax refund claims which were filed. To
date, the IRS has not taken action with respect to these refund claims
  pending the completion of an IRS audit for the year 1993. This audit was
 recently completed by the IRS auditor with no changes proposed. However
     completion is pending review within the IRS; therefore, the Company has not
recorded tax refund claims.                                           

NOTE H - INCOME TAXES                                                           

The actual income tax expense varies from the Federal statutory rate  
applied to consolidated operations as follows:                                  

                                                        · Enlarge/Download Table

                                                         YEAR ENDED DECEMBER 31,                              
                                                         -----------------------                              
                                       1997                          1996                      1995           
                                       ----                          ----                      ----           

                                AMOUNT          %             AMOUNT          %        AMOUNT            %    
                                ------          -             ------          -        ------            -    
                                                               (IN THOUSANDS)                                 

                                                                                                              
Federal statutory rate         $(5,105)      (34.0)%        $(4,928)       (34.0)%     $(749)        (34.0)%  
Loss for which no tax benefit                                                                                 
   was provided                  4,924        32.8            4,233         29.1         280          12.7    
Losses of subsidiaries with                                                                                   
   no tax benefit                                               424          3.0         240          10.9    
Amortization of Warrants            24          .2               32           .2                              
Goodwill amortization               12          .1               73           .5          77           3.5    
Department of Justice                                                                                         
   settlement                                                    57           .4                              
Other                              145          .9              109           .8         152           6.9    
                               -------        ----          -------         ----      ------          ----    

Actual tax expense             $    -            -    %     $     -            -   %  $   -              -   %
                               ======         ====          =======         ====      ======          ====    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE H (CONTINUED)                                                              

    The Company has net operating loss carryforwards aggregating approximately
$28,890,000, expiring during the years 2009 through 2012. In addition,
 certain of the Company's subsidiaries filed separate Federal income tax
   returns in prior years and have separate net operating loss carryforwards
     aggregating approximately $5,297,000 expiring during the years 1998 through
2012.                                                                 

    The tax loss carryforwards of the Company and its subsidiaries are subject
   to limitation by Section 382 of the Internal Revenue Code with respect to
the amount utilizable each year. This limitation reduces the Company's
 ability to utilize net operating loss carryforwards included above each
    year. The amount of the limitation has not been quantified by the Company.

     The components of the Company's deferred tax assets (liabilities), pursuant
to SFAS No. 109, are summarized as follows:                           

                                                                · Download Table

                                                          December 31,      
                                                          ------------      
                                                     1997            1996   
                                                     ----            ----   
                                                       (in thousands)       
                                                                            
Deferred tax assets                                                         
   Net operating loss carryforwards                $ 15,115        $ 12,824 
   Allowance for doubtful accounts                      304             178 
   Research and development tax credit                  202             212 
   Reserve for inventory                                886             605 
   Litigation settlement                                195             284 
   Rent                                                 172              96 
   Reserve for Medicaid                                 209                 
   Capital loss carryforwards                           210             210 
   Reserve for property, plant and equipment            111                 
   Other                                                 44              97 
                                                   --------        -------- 
   Gross deferred tax assets                         17,448          14,506 
                                                   --------        -------- 
Deferred tax liabilities                                                    
   Depreciation                                        (828)           (663)
   Installment sale gain                               (798)         (1,218)
   Other                                                (42)           (165)
                                                   --------        -------- 
                                                     (1,668)         (2,046)
                                                   --------        -------- 
      Net deferred tax assets before                                        
         valuation allowance                         15,780          12,460 
 Valuation allowance                                (15,780)        (12,460)
                                                   --------        -------- 
        Net deferred tax assets                    $   --          $     -- 
                                                   ========        ======== 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE H (CONTINUED)                                                              

     SFAS No. 109 requires a valuation allowance against deferred tax assets if,
    based on the weight of available evidence, it is more likely than not that
   some or all of the deferred tax assets may not be realized. The valuation
 allowance at December 31, 1996 primarily pertains to uncertainties with
respect to future utilization of net operating loss carryforwards.    

NOTE I - OTHER INCOME (EXPENSE)                                                 

Cessation of California Operations                                    

During 1997, management decided to shut down its California operations
  which comprised two of its subsidiaries, Cenci Powder Products, Inc. and
     Cenci Laboratories, Inc. The Company had not incurred any significant costs
to exit these operations other than minimal vacation compensation and 
salary paid to a former plant employee to manage the exit process.    

     At December 31, 1997, the net assets of Cenci Laboratories, Inc., consisted
primarily of building, equipment and land with a net carrying value of
$528,000 and inventory with a total net carrying value of $93,000.    
Accordingly, during 1997 the Company recorded a charge of $264,000 to 
reduce the fixed assets to their estimated net realizable value, and a
  $93,000 charge to write off the remaining inventory. For the years ended
December 31, 1997, 1996 and 1995, these subsidiaries, in aggregate,   
   accounted for revenues of approximately $400,000, $290,000, and $446,000,
respectively.                                                         

During March 1998, the Company signed a letter of intent to sell      
     substantially all of the non-real property assets of Cenci Powder Products,
Inc., consisting primarily of $90,000 in inventory, to a              
purchaser/creditor, in exchange for the forgiveness of approximately  
$260,000 of the Company's indebtedness.                               

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE I (CONTINUED)                                                              

Sale of Assets                                                

       (a)      On March 21, 1995, the Company sold its Abbreviated New Drug
                  Application ("ANDA") for 5mg Oxycodone HCL/325mg Acetaminophen
         Tablets ("Tablets") and certain equipment used in the
       production of the Tablets for up to $5.4 million to
                  Mallinckrodt. The Company received $500,000 of the proceeds in
           July 1994, which was recorded as deferred income on the
                Company's 1994 consolidated balance sheet. Mallinckrodt also
         paid the Company $2,000,000 on March 21, 1995 and the
               remainder was to be payable as follows: (i) $1,000,000 upon
            the Company receiving general clearance from the FDA for
                unrestricted operations at its Brooklyn facility and written
             notice from the FDA that it is in compliance with certain
                 provisions of the consent degree dated June 29, 1993 and (ii)
           $1,900,000 at the earlier of (a) Mallinckrodt receiving
              certain authorizations from the FDA or (b) March 21, 1998.
                 Mallinckrodt also agreed to defer $1,200,000 of the Company's
            trade debt due to an affiliate of Mallinckrodt (Note E).
         Pursuant to the release of the Company from the FDA's
          Application Integrity Policy list and its Restrictions
                  (collectively, the "AIP") by the FDA on December 19, 1996, the
              Company recorded a gain of $1,000,000. On January 9, 1997,
                 Mallinckrodt tendered this amount to the Bank Group. Pursuant
                to the agreement of September 21, 1997, the Company recorded
               $1,900,000 as a deferred gain which was recognized on March
21, 1998.                                   

           In connection with the agreement, the Company agreed to
              manufacture Tablets for Mallinckrodt for a period of three
              years and Mallinckrodt agreed to order a minimum number of
                 Tablets from the Company for two years ending March 21, 1997.
              The Company and Mallinckrodt entered into a noncompetition
                 agreement pursuant to which the Company agreed not to compete
            with Mallinckrodt and its affiliates with respect to the
Tablets until March 21, 2000.               

                In addition, the Company issued to Mallinckrodt an option to
                purchase the ANDA for acetaminophen/oxycodone capsules at an
                 exercise price equal to 3/4 of annual net capsule revenue, as
                defined. As of March 21, 1998, Mallincrodkt did not exercise
the option, which had lapsed at that time.  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE J - PENSION EXPENSE                                                        

The Company maintains the following two pension plans:                  

1.  Management Pension Plan                                           

The Company had maintained a defined benefit plan covering    
       substantially all nonunion employees which was terminated in November
        1996. Subsequently, all Plan assets were converted to cash and held in
   a money market fund (to continue the Trust) from which all vested
      participant interests will be paid. Based on information provided by
       the Company's actuary, the total liability of the Plan as of the plan
       year ended November 30, 1997 was $398,281. The actuary has determined
      that this amount is sufficient to pay the vested interests of all of
        the participants who were in the Plan as of November 30, 1996, and for
      any participants who had terminated with previously vested interests
 that had not yet been paid. Included in the Plan's assets as of
      November 30, 1997, were receivables from the Company and the Insurer
        for $54,631 and $57,468, respectively, which were subsequently paid in
         March 1998. No additional contributions were required to be paid to the
Trust for the period ended November 30, 1997.                 

        Pending certain approvals by the Pension Benefit Guarantee Corporation
        ("PBGC"), relating to plan termination, the plan Trustees will be able
   to make the distributions to the vested participants. The actuary
anticipates these distributions during 1998. Prior to such    
       distributions, any earnings realized on the Plan assets will be added
      to the vested participant's account proportionately. When all assets
      are distributed from the Trust, the Trust will terminate and a final
filing will be made with the Internal Revenue Service.        

       Historically, the Company's funding policy for the management pension
plan (the "Plan"), had been to contribute amounts equal to its
       liability as determined under the Employee Retirement Income Security
       Act of 1974 ("ERISA"). Under this funding policy, contributions would
  be sufficient to maintain plan assets in excess of the projected
         benefit obligation. As of December 31, 1996, the Company has not funded
      its 1995 ERISA obligation of approximately $92,000 and the remaining
 balance of its 1993 and 1992 ERISA obligations of approximately
         $191,000. As a result of Company contributions during 1997, earnings on
  plan assets and terminations during 1997, the Company's previous
outstanding obligations mentioned above had been satisfied.   

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE J (CONTINUED)                                                              

         Net pension cost for the Company-sponsored pension plan consists of the
following:                                                                      

                                                                · Download Table

                                            December 31,         
                                            ------------         
                                    1997         1996       1995 
                                    ----         ----       ---- 
                                            (in thousands)       

                                                                 
Normal service cost                 $           $ 24        $ 49 
Interest cost                         31          32          25 
Actual return on plan assets         (23)        (23)        (19)
Net amortization and deferral         (8)         (8)         (9)
                                    ----        ----        ---- 

     Net pension cost               $--         $ 25        $ 46 
                                    ====        ====        ==== 

   The reconciliation of the funded status of the plan to the amount
reported in the Company's balance sheet is as follows:        

                                                                · Download Table

                                                         Year ended December 31,
                                                         -----------------------
                                                            1997         1996   
                                                            ----         ----   
                                                             (in thousands)     
                                                                                
Actuarial present value of benefit obligations                                  
    at November 30, 1996 and 1995                                               
       Estimated present value of vested benefits          $ 398        $ 440   
       Estimated present value of nonvested benefits                       52   
                                                           -----        -----   

       Accumulated benefit obligation                        398          492   
       Value of future pay increases                                       12   
                                                           -----        -----   

       Projected benefit obligation                          398          504   

Estimated market value of plan assets                                           
   at November 30, 1997 and 1996                             398          569   
                                                           -----        -----   

        Excess (deficiency) of plan assets                                      
           over projected benefit obligation                               65   

Unrecognized net (gain) loss                                 (15)         (72)  
Unrecognized net asset at December 1,                                           
    1987 being amortized over 24 years                        (8)          (8)  
                                                           -----        -----   

                                                             (23)       $ (15)  
                                                           =====        =====   

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE J (CONTINUED)                                                              

      The assumptions used as of November 30, 1997 and 1996 in determining
pension expense and funded status shown above were as follows:

                                                                · Download Table

                                            1997            1996
                                            ----            ----
                                                                
Discount rate                               7.00%          7.00%
Rate of salary progression                     0%          4.00 
Long-term rate of return on assets          7.00           7.00 

2.  Employees' Pension Plan                                           

       The Company contributed approximately $407,000, $492,000 and $450,000
      in 1997, 1996 and 1995 respectively, to a multiemployer pension plan
         for employees covered by collective bargaining agreements. This plan is
     not administered by the Company and contributions are determined in
       accordance with provisions of negotiated labor contracts. Information
     with respect to the Company's proportionate share of the excess, if
    any, of the actuarially computed value of vested benefits over the
         total of the pension plan's net assets is not available from the plan's
administrator.                                                

   The Multiemployer Pension Plan Amendments Act of 1980 (the "Act")
       significantly increased the pension responsibilities of participating
      employers. Under the provision of the Act, if the plans terminate or
      the Company withdraws, the Company could be subject to a "withdrawal
liability."                                                   

NOTE K - STOCK OPTION PLAN                                                      

     In September 1995, the stockholders of the Company approved the adoption of
     a stock option and restricted stock purchase plan (the "1995 Option Plan").
    The 1995 Option Plan replaces its existing stock option plan which expired
in January 1994. The 1995 Option Plan provides for the granting of (i)
 nonqualified options to purchase the Company's common stock at not less
    than the fair market value on the date of the option grant, (ii) incentive
stock options to purchase the Company's                               

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE K (CONTINUED)                                                              

common stock at not less than the fair market value on the date of the
   option grant and (iii) rights to purchase the Company's common stock on a
"Restricted Stock" basis, as defined, at not less than the fair market
  value on the date the right is granted. The total number of shares which
  may be sold pursuant to options and rights granted under the 1995 Option
Plan is 1,000,000. No option can be granted under the 1995 Option Plan
 after May 2005 and no option can be outstanding for more than ten years
after its grant.                                                      

   In October 1996, the Board of Directors of Company adopted a non-employee
    director stock option plan which provides for the granting of nonqualified
stock options not to exceed 100,000 shares in total and at an exercise
     price per share equal to the fair market value of a share or the respective
   grant dates. No option can be granted under the plan or after October 16,
 2006 and no option can be outstanding for more than ten years after its
grant. No options have been granted under this plan to date.          

     The Company has adopted the disclosure provisions of Statement of Financial
    Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
    Compensation." It applies APB Opinion No. 25, "Accounting for Stock Issued
    to Employees," and related interpretations in accounting for its plans and
  does not recognize compensation expense for its stock-based compensation
plans other than for restricted stock. If the Company had elected to  
    recognize compensation expense based upon the fair value at the grant date
    for awards under these plans consistent with the methodology prescribed by
SFAS No. 123, the Company's net income and earnings per share would be
reduced to the pro forma amounts indicated below:                     

                                                                · Download Table

                              Year ended December 31,              
                              -----------------------              
                   1997                 1996                 1995  
                   ----                 ----                 ----  
                       (thousands, except per share amounts)       
                                                                   
Net loss                                                           
    As reported  $15,013             $(14,495)             $(4,103)
    Pro forma     15,328              (14,180)              (4,459)
Loss per share                                                     
    As reported   $(1.12)              $(1.49)               $(.52)
    Pro forma      (1.14)               (1.46)                (.56)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE K (CONTINUED)                                                              

 These pro forma amounts may not be representative of future disclosures
because they do not take into effect pro forma compensation expenses  
 related to grants made before 1995. The fair value of these options was
     estimated at the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions for the years ended   
     December 31, 1997, 1996 and 1995, respectively: expected volatility of 82%,
    82% and 71%; risk-free interest rates of 6.6%, 6.6% and 5.8%; and expected
lives of 4 years, 4.6 years and 8.8 years. At the date of grant, all  
exercise prices equaled the market value of the stock.                

The Black-Scholes option valuation model was developed for use in     
estimating the fair value of traded options which have no vesting     
restrictions and are fully transferable. In addition, option valuation
 models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock 
   options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can  
  materially affect the fair market estimate, in management's opinion, the
     existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.                             

Transactions involving stock options are summarized as follows:       

                                                                · Download Table

                                                                   Weighted
                                                      Stock        average 
                                                      options      exercise
                                                    outstanding     price  
                                                    -----------     -----  

                                                                           

Balance at January 1, 1995                            222,150         3.98 

Granted                                               471,600         3.16 
Exercised                                             (39,180)        2.50 
Cancelled                                             (54,070)        3.36 
                                                     --------              
Balance at December 31, 1995 (carried forward)        600,500         3.49 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE K (CONTINUED)                                                              

                                                                · Download Table

                                                             Weighted
                                                  Stock       average
                                                  options    exercise
                                                outstanding    price 
                                                -----------    ----- 
                                                                     
Balance at December 31, 1995 (brought forward)     600,500    $3.49  

Granted                                            126,000     4.77  
Exercised                                          (49,159)    3.12  
Cancelled                                          (21,334)    4.39  
                                                 ---------           

Balance at December 31, 1996                       656,007     3.53  

Exercised                                          (89,300)    3.22  
Cancelled                                          (84,968)    5.16  
                                                 ---------           

Balance at December 31, 1997                       481,739     3.60  
                                                  ========           

     The following table summarizes information concerning currently outstanding
and exercisable stock options:                                                  

                                                        · Enlarge/Download Table

                                   Options outstanding                     Options exercisable    
                 -----------------------------------------------    ------------------------------
                                        Weighted                                                  
                    Number               average        Weighted        Number           Weighted 
                 outstanding at         remaining        average    exercisable at        average 
   Ranges of     December 31,          contractual      exercise     December 31,        exercise 
exercise prices      1997                 life            price          1997              price  
---------------  -------------         -----------     -----------  --------------      --------  
                                                                                                  
 $1.90 -  $4.00    363,572                7.69             $3.13       363,572            $3.13   
  4.01 -   5.00     95,667                8.53              4.79        14,667             4.34   
  5.01 -   6.25     22,500                4.37              6.17        19,500             6.15   
                   -------                                             -------                    
                   481,739                                             397,739                    
                   =======                                             =======                    

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE L - COMMITMENTS                                                            

The Company occupies plant and office facilities under noncancellable 
     operating leases which expired in December 1995. The Company entered into a
     new operating lease for the plant and office facilities covering the period
from January 1, 1996 to December 31, 2005. These new operating leases 
provide for scheduled base rent increases over the term of the lease, 
however, the total amount of the base rent payments will be charged to
   operations using the straight-line method over the term of the lease. The
    leases provide for payment of real estate taxes based upon a percentage of
   the annual increase. The Company's subsidiaries, H.R. Cenci Laboratories,
    Inc. and Cenci Powder Products, Inc., lease plant and office facilities on
a month-to-month basis from a former officer of the subsidiaries. Rent
     expense relating to these leases amounted to approximately $90,000, $90,000
    and $86,000 in 1997, 1996 and 1995, respectively. In addition, the Company
     rents certain equipment under operating leases, generally for terms of four
   years. Total rent expense for the years ended December 31, 1997, 1996 and
 1995 was approximately $1,243,000, $884,000 and $659,000, respectively.

     The approximate minimum rental commitments under these operating leases are
as follows:                                                                     

                                                                · Download Table

Twelve months ending December 31,                            (in thousands)
                                                                           
    1998                                                         $   975   
    1999                                                           1,023   
    2000                                                           1,075   
    2001                                                           1,128   
    2002                                                           1,186   
    2003 and thereafter                                            3,921   
                                                                   -----   

       Total minimum payments required                            $9,308   
                                                                  ======   

NOTE M - CONTINGENCIES                                                          

    The Company currently is a defendant in several lawsuits involving product
   liability and other claims. The Company's insurance carriers have assumed
the defense for all product liability and other actions involving the 
  Company. None of the lawsuits is brought as a class action. The ultimate
outcome of these lawsuits cannot be determined at this time, and      
accordingly, no adjustment has been made to the consolidated financial
statements.                                                           

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE M (CONTINUED)                                                              

   On October 23, 1996, the Company withdrew four of its ANDAs including its
    ANDA for acetaminophen/oxycodone capsules (the "Capsule ANDA"), and halted
     sales of the affected products. Net sales pursuant to the withdrawn Capsule
ANDA were approximately $3 million and $8 million for the years ended 
   December 31, 1996 and 1995, respectively, and accounted for approximately
24% and 50% of the Company's total net sales during such twelve-month 
periods (Note P). There were no related sales during 1997. The Company
    instituted the withdrawal at the suggestion of the FDA and in anticipation
  of its release from the FDA's AIP. The FDA had placed the Company on the
     AIP, in October 1991, in connection with its investigation of the Company's
    operations which culminated in the 1993 consent decree. Under the AIP, the
FDA suspended all of the parent company's (i.e., Halsey Drug Co.'s)   
 applications for new drug approvals, including ANDAs and supplements to
     ANDAs. At the FDA's suggestion, the Company retained outside consultants to
perform validity assessments of its drug applications. Thereafter, in 
    October 1996, the FDA recommended that several applications, including the
Capsule ANDA, be withdrawn. As a basis of its decision, the FDA cited 
questionable and incomplete data submitted in connection with the     
applications. The FDA indicated that withdrawal of the four ANDAs was 
necessary for the release of the Company from the AIP. The FDA further
   required submission by the Company of a Corrective Action Plan. Said Plan
  was prepared and submitted by the Company and accepted by the FDA during
1997.                                                                 

On December 19, 1996, the FDA released the Company from the AIP. As a 
consequence, for the first time since October 1991, the Company was   
     permitted to submit ANDAs to the FDA for review. Since its release from the
    AIP in December 1996, through the fiscal year ended December 31, 1997, the
 Company submitted six ANDAs for review by the FDA, including a new ANDA
    with respect to the Capsules. During the period from the Company's release
   from the AIP to March 15, 1998, the Company received five ANDA approvals,
 all of which relate to ANDA filings made with the FDA subsequent to the
Company's release from the AIP.                                       

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE M (CONTINUED)                                                              

  As of March 15, 1998, the Company had submitted two additional ANDAs for
  review by the FDA in fiscal 1998 and anticipates the submission of eight
  additional ANDAs during the balance of fiscal 1998. Although the Company
   has been successful in receiving the ANDA approvals described above since
   its release from the AIP in December 1996, there can be no assurance that
  any of its newly submitted ANDAs, or those contemplated to be submitted,
  will be approved by the FDA. The Company will not be permitted to market
     any new product unless and until the FDA approves the ANDA relating to such
     product. Failure to obtain FDA approval for the Company's pending ANDAs, or
    a significant delay in obtaining such approval, would adversely affect the
Company's business operations and financial condition.                

     On June 21, 1993, the Company entered into a Plea Agreement with the DOJ to
   resolve the DOJ's investigation into the manufacturing and record keeping
practices of the Company's Brooklyn plant. Under the terms of the Plea
Agreement, the Company agreed to plead guilty to five counts of       
  adulteration of drug products shipped in interstate commerce. Each count
    involved product adulteration, and record keeping deficiencies relating to
     a single drug product, Quinidine Gluconate (324mg tablets), manufactured at
   the Brooklyn plant. The Plea Agreement also required the Company to pay a
   fine of $2,500,000 over five years in quarterly installments of $125,000,
   commencing on or about September 15, 1993. The Company's plea was entered
and the terms of the Plea Agreement were approved by the United States
District Court for the District of Maryland on July 13, 1993. As of   
   February 28, 1998, the Company was in default of the payment terms of the
 Plea Agreement and had made payments aggregating $350,000. On March 27,
    1998, the Company and the DOJ signed the Letter Agreement serving to amend
   the Plea Agreement relating to the terms of the Company's satisfaction of
the fine assessed under the Plea Agreement. Specifically, the Letter  
   Agreement provides that the Company will satisfy the remaining $2,150,000
  of the fine through the payment of $25,000 on a monthly basis commencing
May 1, 1998, plus interest on such outstanding balance (at the rate   
calculated pursuant to 28 U.S.C Section 1961)(currently 5.319%). Such 
  payment schedule will result in the full satisfaction of the DOJ fine in
    December, 2005. The Letter Agreement also provides certain restrictions on
the payment of salary or compensation to any individual in excess of  
  $150,000 without the written consent of the United States District Court
   for the District of Maryland, subject to certain exceptions. In addition,
    the Letter Agreement requires the repayment of the outstanding fine to the
  extent of 25% of the Company's after tax profit or the remaining balance
   owed and 25% of the net proceeds received by the Company on any sale of a
    capital asset for a sum in excess of $10,000. If, at any time, the Company
    does not make the payments required under the Letter Agreement in a timely
fashion, the United States will be free to declare that the fine is   
     delinquent and/or in default, and exercise all legal process to immediately
 collect the full amount of the fine, interest and applicable penalties.

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December 31, 1997, 1996 and 1995

NOTE M (CONTINUED)                                                              

    In connection with several shareholder lawsuits, the Company agreed to pay
    to the plaintiffs $1,000,000 in cash, which has been paid by the Company's
insurance carrier in full. In November 1995, the Company satisfied the
 remainder of its settlement obligation by issuing 824,742 shares of its
common stock valued at $3,000,000 or $3.6375 per share.               

On January 29, 1997, the Securities and Exchange Commission ("SEC")   
    simultaneously instituted and settled an administrative proceeding against
     the Company, pursuant to the Company's Offer of Settlement, dated September
 13, 1996, as modified by letters dated October 11, 1996 and January 10,
1997. The Order made the following findings, among others, which the  
  Company neither admitted nor denied. The Company's December 31, 1990 and
   December 31, 1991 Annual Reports on Form 10-K stated that the Company had
    to follow current Good Manufacturing Practices ("CGMP") regulations at all
  times during which an FDA-approved drug was manufactured by the Company.
   These annual reports further stated that the Company had to "expend time,
   money and effort in the areas of production and quality control to ensure
  full technical compliance." These annual reports failed to disclose that
  the Company was not manufacturing drugs in accordance with CGMP, but was
   using unapproved formulas and procedures, and the Company's employees, at
  former management's direction, were concealing product adulteration from
the FDA. These annual reports also failed to disclose that, since the 
  Company was not manufacturing generic drugs in accordance with CGMP, FDA
  approval for any or all of the Company's new products could be adversely
 affected. Based on the foregoing, the Commission found that the Company
  committed violations of Sections 10(b) and 13(a) of the Exchange Act and
 Rules 10b-5, 12b-20 and 13a-1 thereunder, by filing with the Commission
    Annual Reports on Form 10-K for the years ended December 31, 1990 and 1991
     that omitted to state material facts necessary to make the statements made,
in the light of the circumstances under which they were made, not     
   misleading. The Order also requires the Company to "cease and desist from
   committing or causing any violation and any future violation" of Sections
10-(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20 and 13a-1
thereunder.                                                           

In 1995, the SEC filed a complaint requiring the Company to cease and 
desist from violating Section 17(a) of the Securities Act and Sections
10(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and
  13a-13 thereunder. The complaint alleged that the Company's December 31,
    1990 and December 31, 1991 Annual Reports on Form 10-K and March 31, 1991,
June 30, 1991, September 30, 1991, March 31, 1992, June 30, 1992 and  
September 30, 1992 quarterly reports on                               

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE M (CONTINUED)                                                              

    Form 10-Q were materially false and misleading. The SEC complaint conforms
     in large part to a settlement proposal previously submitted by the Company.
The Company, without admitting the allegations, entered into a Consent
Decree not to violate the law in the future.                          

    By letter dated October 23, 1995, the Company was notified by the New York
     State Education Department (the "Department") that the Professional Conduct
    Officer of the Office of Professional Discipline had determined that there
     was sufficient evidence of professional misconduct on the Company's part to
     warrant a disciplinary proceeding pursuant to New York law. Upon contacting
   the Deputy Director of the Office of Professional Discipline, counsel for
 the Company was advised that the alleged misconduct related to the same
   activities that were the subject of the DOJ investigation, indictment and
  plea. The Company submitted a written response on November 16, 1995. The
Company and the Department have agreed to the entry of a Consent Order
   concluding any disciplinary proceedings. The Company will pay $175,000 in
fines over five years. In addition, the Company's registration as a   
    manufacturer of drugs in New York State is revoked, but such revocation is
   stayed and the Company has been placed on probation for a maximum of five
    years. The Company has the right to apply for removal from probation after
two years.                                                            

A lawsuit was filed by the minority shareholders of H.R. Cenci        
    Laboratories, Inc. and Cenci Powder Products, Inc. against the Company and
several of the officers of the Company. The lawsuit alleged that the  
Company has breached several representations made during the course of
    negotiations leading to the Company's purchase of 51% of the stock of H.R.
Cenci Laboratories, Inc. This action sought unspecified compensatory  
 damages, as well as punitive damages, rescission, specific performance,
reformation and a declaration as to what amount, if any, was owed to  
plaintiff. The Company filed a Counterclaim, seeking unspecified      
compensatory and punitive damages. On March 10, 1997, a Settlement    
  Agreement and Mutual Release was executed by all parties to the lawsuit,
   terminating the action. The terms of the Settlement provide for repayment
     of certain outstanding loans, made by the plaintiff to Cenci Labs and Cenci
Powders, as well as payment of settlement funds. These payments total 
   $600,000, payable in equal monthly installments from March, 1997 to June,
  1998. The Settlement Agreement further provided for the balance of Cenci
   Labs and Cenci Powder stock to be turned over to the Company. Twenty-five
   thousand shares of unregistered Common Stock of the Company was issued to
    the plaintiff. (Following the completion of the private offering (Note A),
     the Company satisfied its outstanding monetary obligations to the plaintiff
under the Cenci litigation in connection with the execution of an     
Acknowledgement of Partial Satisfaction of Judgment by the plaintiff.)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE M (CONTINUED)                                                              

    The Company was named as a defendant in an action captioned Allied Welfare
 Fund, Vacation Fringe Benefit Fund and Union Mutual Fund v. Halsey Drug
Co., 96 Civ 3655, brought in the United States District Court for the 
  Eastern District of New York. The complaint seeks sums allegedly owed to
 three of the Company's labor union funds under the Company's collective
     bargaining agreement, in the amount of approximately $265,000. A settlement
agreement was reached between the parties and executed July 31, 1997  
requiring the Company to remain current on its obligations under its  
collective bargaining agreement and to pay portions of the alleged    
  arrearages in installments. Prior to the completion of the Offering, the
   Company was in default under the settlement agreement. On March 19, 1998,
the Company satisfied its obligations under the settlement agreement  
pursuant to the payment of $309,151 to the Unions.                    

NOTE N - SALE OF COMMON STOCK                                                   

     On March 30, 1995, the Company entered into an agreement with Zatpack which
    provides for the purchase of 500,000 shares of common stock of the Company
   by Zatpack, with registration rights, in consideration of $1,000,000. The
$1,000,000 consideration consists of the cancellation of indebtedness 
   (incurred by the Company's subsidiaries for the purchase of raw materials
    delivered from affiliates of Zuellig) and shares of Indiana Fine Chemicals
     Corporation. As a result of the above transaction, the Company owns 100% of
Indiana Fine Chemical Corporation (prior to the above transaction, the
   Company owned 70% of Indiana Fine Chemical Corporation). In addition, the
    Company issued a convertible promissory note to Zatpack, dated December 1,
   1994 (Note E). Zatpack has acquired the above assets from Zuellig and its
subsidiaries.                                                         

     On October 27, 1994, the Company sold 500,000 shares of its common stock in
    exchange for $1,000,000 from Ranbaxy Pharmaceuticals, Inc. ("Ranbaxy"). In
   connection with these shares, Ranbaxy had the right to have its shares of
    the Company's common stock registered under the Securities Act of 1933. In
July 1995, the Company repurchased the 500,000 shares from Ranbaxy for
$1,100,000.                                                           

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE O - SIGNIFICANT CUSTOMERS AND SUPPLIERS                                    

The Company sells its products to a large number of customers who are 
   primarily drug distributors, drugstore chains and wholesalers and are not
  concentrated in any specific region. The Company performs ongoing credit
 evaluations of its customers and generally does not require collateral.
     During 1997, the Company had net sales to two customers in excess of 10% of
     total sales, aggregating 32.1% of total sales. During 1996, the Company had
    net sales to one customer aggregating 10% of total sales. During 1995, the
 Company had net sales to two customers aggregating 25% and 11% of total
sales, respectively.                                                  

NOTE P - FOURTH QUARTER ADJUSTMENTS                                             

During the fourth quarter of 1997, the Company recorded a provision to
write down approximately $1,300,000 of inventory to its net realizable
value.                                                                

Additionally, during the fourth quarter of 1997, the Company accrued  
approximately $650,000 in connection with penalties and/or interest on
  delinquent rent and payroll taxes. Subsequent to year-end, these amounts
    were substantially paid or incorporated into a repayment schedule with the
related creditor.                                                     

NOTE Q - SUBSEQUENT EVENTS                                                      

Private Placement                                                     

    As described in Note A, effective March 10, 1998 the Company consummated a
private offering of securities, simultaneously with a Debenture and   
Warrant Purchase agreement with multiple investors, in exchange for an
 aggregate purchase price of $20,800,000. Net proceeds of this financing
     approximating $19,700,000, along with related non-cash issuance costs, will
be recorded during the first quarter of 1998. The securities consisted
of 5% convertible senior secured debentures and common stock purchase 
  warrants exercisable for 4,202,020 shares of the Company's common stock.
The debentures mature on March 15, 2003 with interest payable on a    
   quarterly basis. Also, in accordance with certain "as converted" terms of
the purchase agreement, one investor, will likely obtain voting rights
 enabling it to control approximately 50% of the Company's common stock.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE Q (CONTINUED)                                                              

    With respect to the 4,202,020 warrants, 2,101,010 warrants were granted to
 purchase common shares with a par value of $.01 at an exercise price of
$1.50 with the remaining 2,101,010 warrants being granted to purchase 
common shares with a par value of $.01 at an exercise price of $2.375.
  Additionally, the debentures may be converted at any time after issuance
into common shares at a price of $1.50 per share or in accordance     
with other terms of the purchase agreement.                           

The net proceeds from this offering have been allocated to satisfy a  
substantial portion of the Company's current liabilities and accounts 
payable (approximately $7,333,000) which include: (i) the complete    
satisfaction of the Company's bank debt and related fees approximating
$3,000,000 and (ii) an obligation to a landlord and satisfaction of   
related judgments and liens. Further, pursuant to repayment agreements
reached with other large creditors in anticipation of the completed   
 offering creditors (including the Department of Justice as described in
  Note M ), the Company has been able to bring these creditors current and
    potentially comply with terms for future repayment. Such terms include (i)
payment to Internal Revenue Service of approximately $2,000,000 for   
  delinquent Federal payroll taxes and interest in April 1998 (ii) payment
  to New York State of $375,000 for delinquent payroll taxes in March 1998
 and (iii) an installment payment program with the Department of Justice
which provides for, among other things, the payment of penalties and  
    interest totaling $2,150,000 to be made in monthly installments of $25,000
commencing in May 1998 through December 2005.                         

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1997, 1996 and 1995

NOTE Q (CONTINUED)                                                              

Employment Contracts                                                  

    During March 1998, the Company entered into employment contracts with each
  of two new officers/employees of the Company which cover a five-year and
 three-year period, respectively. The contracts provide for, among other
  things: (i) annual salaries of $170,000 and $140,000 to be paid over the
 five-year and three-year periods, respectively and (ii) an aggregate of
   1,300,000 options to purchase the Company's stock at an exercise price of
   $2.38 per common share that vest evenly over a three to five year service
period and expire in ten years.                                       

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 Index to Exhibits

Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

3.1      Certificate of Incorporation and amendments (incorporated by reference 
    to Exhibit 3.1 to Amendment No. 2 to the Registrant's Registration
Statement on Form S-18, File No. 2471-NY).                    

3.2      Restated Bylaws (incorporated by reference to Exhibit 3.1 to the       
       Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1993).                                                    

10.1     Credit Agreement, dated as of December 22, 1992, among the Registrant  
  and The Chase Manhattan Bank, N.A. (incorporated by reference to
     Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the
year ended December 3 1, 1992 (the "1992 Form 10-K")).        

10.2     Amendment Two, dated as of January 12, 1994, to Credit Agreement among 
         the Registrant and The Chase Manhattan Bank, N.A. , together with forms
     of Stock Warrant and Registration Rights Agreement (incorporated by
      reference to Exhibit 10.1. to the Registrant's Annual Report on Form
    10-K for the year ended December 31, 1993 (the "1993 Form 10-K")).

10.3     Amendment Three, dated as of May 31, 1994, to Credit Agreement among   
    the Registrant and The Chase Manhattan Bank, N.A. (incorporated by
        reference to Exhibit 6(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1994).                   

10.4     Amendment Four, dated as of July 1994, to Credit Agreement among the   
Registrant and The Chase Manhattan Bank, N.A. (incorporated by
        reference to Exhibit 6(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994)).                   

10.5     Amendment Five, dated as of March 21, 1995, to Credit Agreement among  
    the Registrant and The Chase Manhattan Bank, N.A. (incorporated by
      reference to Exhibit 10.7 to the Registrant's Current Report on Form
8-K dated March 21, 1995 (the "March 8-K")).                  

10.5(1)  Form of Warrants issued to The Bank of New York, The Chase Manhattan   
       Bank, N.A. and the Israel Discount Bank (incorporated by reference to
        Exhibit 10.5(i) to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995 (the "1995 Form 10-K")).         

10.5(2)  Letter Agreement, dated July 10, 1995, among Halsey Drug Co.,Inc., The 
      Chase Manhattan Bank, N.A., The Bank of New York and Israel Discount
    Bank of New York (incorporated by reference to Exhibit 6(a) to the
       Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1995 (the "June 10-Q")).                                  

10.5(3)  Letter Agreement, dated November 16, 1995, among Halsey Drug Co.,Inc., 
 The Chase Manhattan Bank, N.A., The Bank of New York and Israel
 Discount Bank of New York (incorporated by reference to Exhibit
10.25(iv) to the 1995 10-K).                                  

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.5(4)  Amendment 6, dated as of August 6, 1996, to Credit Agreement among     
       Halsey Drug Co.,Inc., The Chase Manhattan Bank, N.A., The Bank of New
         York and Israel Discount Bank of New York (incorporated by reference to
         Exhibit 10.1 to Amendment No. 1 to the Registrant's Quarterly Report on
       Form 10-Q for the quarter ended June 30, 1996 (the "June 1996 10-Q)).

10.5(5)  Letter Agreement, dated March 25, 1997 among Halsey Drug Co., Inc., The
       Chase Manhattan Bank, as successor in interest to The Chase Manhattan
       Bank (National Association), The Bank of New York and Israel Discount
Bank.                                                         

10.6     Agreement Regarding Release of Security Interests dated as of March 21,
        1995 by and among the Company, Mallinckrodt Chemical Acquisition, Inc.
         and The Chase Manhattan Bank, N.A.(incorporated by reference to Exhibit
10.9 of the March 8-K).                                       

10.7     Consulting Agreement dated as of September, 1993 between the Registrant
        and Joseph F. Limongelli (incorporated by reference to Exhibit 10.6 to
the 1993 Form 10-K).                                          

10.8     Employment Agreement, dated as of January 1, 1993, between the         
     Registrant and Rosendo Ferran (incorporated by reference to Exhibit
10.2 to the 1992 Form 10-K).                                  

10.10(1) Halsey Drug Co., Inc. 1984 Stock Option Plan, as amended (incorporated 
by reference to Exhibit 10.3 to the 1992 Form 10-K).          

10.10(2) Halsey Drug Co., Inc. 1995 Stock Option and Restricted Stock Purchase  
    Plan (incorporated by reference to Exhibit 4.1 to the Registrant's
Registration Statement on Form S-8, File No. 33-98396).       

10.10(3) Halsey Drug Co., Inc. Non-Employee Director Stock Option Plan.         

10.11    Leases, effective February 13, 1989 and January 1, 1990, respectively, 
among the Registrant and Milton J. Ackerman, Sue Ackerman, Lee
    Hinderstein, Thelma Hinderstein and Marilyn Weiss (incorporated by
        reference to Exhibits 10.6 and 10.7, respectively, to the Registrant's
   Annual Report on Form 10-K for the year ended December 31, 1989).

10.12    Lease, effective as of April 15, 1988, among the Registrant and Milton 
    J. Ackerman, Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and
        Marilyn Weiss, and Rider thereto (incorporated by reference to Exhibit
         10.12 to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1987).                                           

10.12(l) Lease, as of October 31, 1994, among Registrant and Milton J. Ackerman,
      Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and Marilyn Weiss,
   together with Modification, Consolidation and Extension Agreement
     (incorporated by reference to Exhibit 10. 12(i) to the Registrant's
   Annual Report on Form 10-K for the year ended December 31, 1995).

10.13    Asset Purchase Agreement dated as of March 21, 1995 among Mallinckrodt 
    Chemical Acquisition, Inc. ("Acquisition"), Mallinckrodt Chemical,
     Inc., as guarantor and the Registrant (incorporated by reference to
Exhibit 10.1 to the March 8-K).                               

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.14    Toll Manufacturing Agreement for APAP/Oxycodone Tablets dated as of    
        March 21, 1995 between Acquisition and the Registrant (incorporated by
reference to Exhibit 10.2 to the March 8-K).                  

10.15    Capsule ANDA Option Agreement dated as of March 21, 1995 between       
      Acquisition and the Registrant (incorporated by reference to Exhibit
10.3 to the March 8-K).                                       

10.16    Tablet ANDA Noncompetition Agreement dated as of March 21, 1995 between
      the Registrant and Acquisition (incorporated by reference to Exhibit
10.4 to the March 8-K).                                       

10.17    Subordinated Non-Negotiable Promissory Term Note in the amount of      
        $1,200,00 dated March 21, 1995 issued by the Registrant to Acquisition
(incorporated by reference to Exhibit 10.5 to the March 8-K). 

10.18    Term Note Security Agreement dated as of March 21, 1995 among the      
    Company, Houba, Inc. and Acquisition (incorporated by reference to
Exhibit 10.6 to the March 8-K).                               

10.19    Amendment dated March 21, 1995 to Subordination Agreement dated as of  
 July 21, 1994 between Mallinckrodt Chemical, Inc., Mallinckrodt
      Chemical Acquisition, Inc., the Registrant, The Chase Manhattan Bank
       (National Association), Israel Discount Bank of New York, The Bank of
New York, and The Chase Manhattan Bank (National Association) 
(incorporated by reference to Exhibit 10.8 to the March 8-K). 

10.20    Agreement dated as of March 30, 1995 between the Registrant and        
        Zatpack, Inc. (incorporated by reference to Exhibit 10.10 to the March
8-K).                                                         

10.21    Waiver and Termination Agreement dated as of March 30, 1995 between    
  Zuellig Group, W.A., Inc. and Indiana Fine Chemicals Corporation
(incorporated by reference to Exhibit 10.11 to the March 8-K).

10.22    Convertible Subordinated Note of the Registrant dated December 1, 1994 
        issued to Zatpack, Inc. (incorporated by reference to Exhibit 10.12 to
the March 8-K).                                               

10.23    Agreement dated as of March 30, 1995 among the Registrant, Indiana Fine
Chemicals Corporation, Zuellig Group, N.A., Inc., Houba Inc., 
         ZetaPharm, Inc. and Zuellig Botanicals, Inc. (incorporated by reference
to Exhibit 10.13 to the March 8-K).                           

10.24    Supply Agreement dated as of March 30, 1995 between Houba, Inc. and    
    ZetaPharm, Inc. (incorporated by reference to Exhibit 10.14 to the
March 8-K).                                                   

10.25    Form of 10% Convertible Subordinated Debenture (incorporated by        
reference to Exhibit 6(a) to the June 10-Q).                  

10.26    Form of Redeemable Common Stock Purchase Warrant (incorporated by      
reference to Exhibit 6(a) to the June 10-Q).                  

10.27    Form of 10% Convertible Subordinated Debenture (incorporated by        
         reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K
dated December 4, 1995 (the "December 8- K")).                

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               

10.28    Form of Redeemable Common Stock Purchase Warrant (incorporated by      
reference to Exhibit 4.2 to the December 8-K).                

10.29    Form of 10% Convertible Subordinated Debenture (incorporated by        
reference to Exhibit 99 to the June 1996 10-Q).               

10.30    Form of Redeemable Common Stock Purchase Warrant (incorporated by      
     reference to Exhibit 4.1 to Amendment No. 1 to the June 1996 10-Q).

10.31    Form of 5% Convertible Senior Secured Debenture (incorporated by       
         reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K
dated March 24, 1998 (the "March 1998 8- K")).                

10.32    Form of Common Stock Purchase Warrant (incorporated by reference to    
Exhibit 4.2 to the March 1998 8-K).                           

10.33    Debenture and Warrant Purchase Agreement dated March 10, 1998, by and  
         among the Registrant, Galen Partners III, L.P. and the other Purchasers
    listed on the Signature Page thereto (incorporated by reference to
Exhibit 10.1 to the March 1998 8-K).                          

10.34    Form of General Security Agreement of Halsey Drug Co., Inc. dated March
       10, 1998 (incorporated by reference to Exhibit 10.2 to the March 1998
8-K).                                                         

10.35    Form of Agreement of Guaranty of Subsidiaries of Halsey Drug Co., Inc. 
        dated March 10, 1998 (incorporated by reference to Exhibit 10.3 to the
March 1998 8-K).                                              

10.36    Form of Guarantor General Security Agreement dated March 10, 1998      
    (incorporated by reference to Exhibit 10.4 to the March 1998 8-K).

10.37    Stock Pledge Agreement dated March 10, 1998 by and between the         
    Registrant and Galen Partners III, L.P., as agent (incorporated by
reference to Exhibit 10.5 to the March 1998 8-K).             

10.38    Form of Irrevocable Proxy Agreement (incorporated by reference to      
Exhibit 10.6 to the March 1998 8-K).                          

10.39    Agency Letter Agreement dated March 10, 1998 by and among the          
     Purchasers a party to the Debenture and Warrant Purchase Agreement,
        dated March 10, 1998 (incorporated by reference to Exhibit 10.7 to the
March 1998 8-K).                                              

10.40    Press Release of Registrant dated March 13, 1998 (incorporated by      
reference to Exhibit 99.1 to the March 1998 8-K).             

10.41    Current Report on Form 8-K as filed by the Registrant with the         
Securities and Exchange Commission on March 24, 1998.         

*10.42   Letter Agreement between the Registrant and the U. S. Department of    
        Justice dated March 27, 1998 relating to the restructuring of the fine
      assessed by the Department of Justice under the Plea Agreement dated
June 21, 1993.                                                

40

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Exhibit                                                                         
Number   Document                                                               
------   --------                                                               
*10.43   Employment Agreement dated as of March 10, 1998 between the Registrant 
and Michael K. Reicher                                        

*10.44   Employment Agreement dated as of March 10, 1998 between the Registrant 
and Peter Clemens                                             

21       Subsidiaries of the Registrant (incorporated by reference to Exhibit 22
to the 1993 Form 10-K).                                       

*23.1    Consent of Grant Thornton LLP, independent certified public            
accountants.                                                  

*27      Financial Data Schedule, which is submitted electronically to the      
        Securities and Exchange Commission for informational purposes only and
not filed.                                                    

-----------------                                                               
*  Filed herewith.                                                              

41

Dates Referenced Herein   and   Documents Incorporated By Reference

				Referenced-On Page
This 10-K Filing		Date		First		Last			Other Filings
		3/4/92		19
		3/31/92		72
		6/30/92		72
		9/30/92		72
		12/22/92		32		78
		1/1/93		33		79
		6/21/93		4		81
		6/29/93		5		62
		6/30/93		29		78
		7/13/93		71
		7/16/93		16
		9/15/93		16		71
		9/16/93		19
		10/21/93		19
		12/31/93		22		78
		1/12/94		32		78
		3/31/94		32		78
		5/31/94		32		78
		6/30/94		32		78
		7/21/94		34		80
		10/27/94		74
		10/31/94		34		79
		12/1/94		34		80
		12/31/94		22
		3/21/95		10		80
		3/30/95		34		80
		6/30/95		33		78			10-Q/A
		7/10/95		33		78
		7/14/95		56
		7/18/95		57
		8/31/95		57
		10/23/95		17		73
		10/31/95		17
		11/7/95		19
		11/9/95		17
		11/16/95		17		78
		11/20/95		17
		11/29/95		57
		11/30/95		64
		12/4/95		35		80
		12/31/95		5		79			10-K/A
		1/1/96		69
		6/30/96		33		79			10-Q, 10-Q/A
		7/18/96		57
		8/6/96		33		79			8-K
		9/13/96		72
		10/11/96		72
		10/23/96		5		70
		11/30/96		63		65
		12/19/96		5		70
		12/31/96		5		77			10-K, 10-K/A, NT 10-K
		1/9/97		10		62
		1/10/97		72
		1/29/97		72
		2/28/97		11
		3/10/97		18		73
		3/15/97		21
		3/21/97		62
		3/25/97		33		79
		7/2/97		15
		7/18/97		17
		7/31/97		18		74
		9/21/97		10		62
		9/26/97		6		18
		11/26/97		6
		11/30/97		63		65
		12/1/97		55
For The Period Ended		12/31/97		1		77			10-K/A, NT 10-K
		1/22/98		6
		2/28/98		4		71
		3/5/98		15
		3/6/98		8
		3/10/98		7		82			3, 8-K
		3/11/98		8
		3/13/98		8		81			3
		3/15/98		5		71
		3/16/98		1		8
		3/19/98		18		74			3
		3/20/98		8
		3/21/98		10		62
		3/24/98		8		81			8-K, SC 13G
		3/26/98		8					3
		3/27/98		18		81
		3/30/98		5		28
		4/13/98		37
		4/14/98		39
Filed On / Filed As Of		4/15/98
		4/30/98		16					10-K/A, 4
		5/1/98		5		71
		5/31/98		16
		6/18/98		56
		12/31/98		52					10-K, 10-K/A
		3/21/0		10		62
		3/30/0		16					NT 10-K
		6/30/0		15					10-Q
		7/17/0		57
		7/18/0		57
		11/29/0		57
		8/6/1		58
		3/15/3		75
		12/31/5		15		69
		10/16/6		66
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