___________________________________________________________________________


                          SECURITIES AND EXCHANGE COMMISSION

                               Washington, D.C.  20549

                                     FORM 10-K/A
                                   Amendment No. 2 
                                           
                   Annual Report Pursuant to Section 13 or 15(d) of
                         the Securities Exchange Act of 1934

     For the fiscal year ended December 31, 1995    Commission file No. 1-10113

                                HALSEY DRUG CO., INC.
                (Exact name of registrant as specified in its charter)

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

          1827 Pacific Street, Brooklyn, New York)                  11233
          (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

     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      No  X    
   -----   -----

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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 25 , 1996, the registrant had 8,486,792 shares of Common stock,
par value $0.01, outstanding.  Based on the average of the high and low sales
prices of the common stock on March 25 , 1996  ($6.567),   the aggregate market
value of the voting stock held by non-affiliates of the registrant was
approximately $51,278,270.

                       Documents Incorporated by Reference

  Portions of the Proxy Statement for the Annual Meeting of Stockholders to be
                         held on June 4, 1996 (Part III)

___________________________________________________________________________


                              Page 1  of ____ Pages
                          Exhibit Index is on Page ____






<PAGE>

                                TABLE OF CONTENTS
                                                                 Page
Contents                                                         Number
- ----------                                                       ------
Cover Page                                                            i  

PART I

     Item 1.  Business                                                1 


PART II

     Item 6.  Selected Financial Data                                 30


     Item 7.  Management's Discussion and Analysis of 
              Financial  Condition and Results of Operations          33


     Item 8.  Financial Statements and Supplementary Data             42


PART IV

     Item 14.  Exhibits, Financial Statement Schedules                44

     Signatures                                                       50

          Index to Financial Information                             F-1


     Exhibit Index                                                    51









<PAGE>


                                     PART I


Item 1.  Business.
         --------

Introduction
- ------------

     Halsey Drug Co., Inc., a New York corporation established in 1935
("Halsey"), and its subsidiaries (collectively, the "Company"), 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 Blue Cross Products, Inc., a New
York corporation (currently inactive), Houba, Inc. ("Houba"), an Indiana
corporation, Halsey Pharmaceutical, Inc. ("Halsey Pharmaceutical"), a Delaware
corporation, The Medi-Gum Corporation, a Delaware corporation (currently
inactive), and Indiana Fine Chemicals Corporation ("Indiana Chemicals"), a
Delaware corporation.  Halsey has two additional subsidiaries: H.R. Cenci
Laboratories, Inc. ("Cenci"), a California corporation (51% owned), and Cenci
Powder Products, Inc. ("Cenci Powder"), a Delaware corporation (51% owned).

     The Company manufactures its products at facilities in New York, Indiana
and California.  During 1995, in connection with the sale of its Oxycodone with
Acetaminophen Tablet business, the Company began manufacturing Oxycodone with
Acetaminophen Tablets 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 



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<PAGE>

forms.  The Company's ability to develop and manufacture bulk chemical products
was enhanced by the acquisition in 1990 of 100% of the capital stock of Houba
and the completion by Houba in late 1991 of a new 15,000-square-foot
manufacturing facility.  Houba currently produces and markets raw materials
intended for pharmaceutical and food supplements, as well as solid dosage forms
of generic drug products.  In October and December 1991, the Company acquired
majority interests in Cenci and Cenci Powder, respectively.  These acquisitions
gave the Company a greater presence on the West Coast of the United States, and
added new products.  Cenci and Cenci Powder manufacture liquid and powder
preparations, respectively, of pharmaceutical products in various dosage forms. 
The Company's Indiana Chemicals subsidiary is engaged in the manufacture of the
specialty vitamin Biotin.  Halsey Pharmaceutical is a trading company engaged
exclusively in sales operations.

     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 the Brooklyn, New York plant. 
These problems caused the Company to halt production and sale of a number of
products and to establish a $2,000,000 reserve as of December 31, 1992, and a
reserve of $3,875,000 in 1993 to cover estimated costs associated with inventory
write-offs, recalls of the affected products and estimated additional legal
expenses.  The affected products accounted for approximately 28% of the
Company's total revenues in 1992 and 1993, respectively.  See "Item 7. 

Management's Discussion and Analysis of Financial Condition and Results of
Operations -- General."

     On June 21, 1993, the Company entered into a plea agreement with the United
States Department of Justice (the "DOJ") to resolve the DOJ's investigation into
the manufacturing and recordkeeping practices at the Company's Brooklyn plant. 
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 recordkeeping violations.  The plea agreement also requires
the Company to pay a fine of $2,500,000 over five years in quarterly
installments of $125,000 commencing in September 1993.  Two installments have
been paid to date.  Only additional partial payments have been paid in the
amount of $90,000.  The agreement with the DOJ stipulates that if any payments
are not made in a timely fashion the entire amount of the fine shall become 




                                       2






<PAGE>

due and payable immediately.  Such nonpayment also constitutes a default under
the Company's Credit Agreement with its banks.  As a result, the entire amount
of the settlement has been classified as current.  As of the date of this
Report, no action has been initiated to require payment of the entire
outstanding amount of the fine.

     On June 29, 1993, the Company entered into a consent decree with the U.S.
Attorney for the Eastern District of New York on behalf of the Food & Drug
Administration (the "FDA") that resulted from the FDA's investigation into the
Brooklyn plant's compliance with the FDA's Current Good Manufacturing Practice
("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 to be used for, manufacturing, processing, packing,
labeling and holding any drug, are 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 is required
to validate the manufacturing processes for each solid dosage drug product prior
to manufacturing and shipping the drug product.  The Company, however, was
permitted under the terms of the consent decree to manufacture and ship from the
Brooklyn plant six identified solid dosage drug products ("the "Brooklyn Solid
Dosage Products") at its own risk provided that: (i) at least twice per month,
the Company's independent expert certifies that each batch of drug product upon
validation will have been manufactured in accordance with the CGMP Regulations
and the formulation described in the drug product's approved New Drug
Application ("NDA") or Abbreviated New Drug Application ("ANDA"), until such
time as validation is completed for these products; and (ii) for any batches of
these products that have already been manufactured, such certification will
include a certification by a Company representative with personal knowledge of
the records relating to such drug that such records are accurate and complete
and a certification signed by an independent expert that he has personally
reviewed the records, and that in his professional opinion the foregoing
requirement concerning validation has been met.

     At the beginning of August 1993, the Brooklyn plant resumed shipments of
two drug products (Class II narcotics), Oxycodone with Acetaminophen Capsules
5mg/500mg and 



                                       3






<PAGE>

Oxycodone with Acetaminophen Tablets 5mg/325mg, and thereafter resumed shipments
of a third solid dosage drug product, Acetaminophen, Butalbital and Caffeine
Tablets 325mg, 50mg, 40mg.  During 1995, the Company sold its Oxycodone with
Acetaminophen Tablet business to a company (together with affiliates, 
"Mallinckrodt") under common control with Mallinckrodt Chemical, Inc.
Under a tolling arrangement with Mallinckrodt, the Company will continue to
manufacture such tablets for Mallinckrodt for at least two years. See "Business-
                                                                  ---
- -Dispositions," below.  In September 1993, the Company resumed shipments of two
other solid dosage drug products, Isoniazid 300mg and Tetracycline 250mg and
500mg capsules, from the Brooklyn plant.  After review by the Company of one of
the Brooklyn Solid Dosage Products which the Company was permitted to continue
to manufacture and ship under the terms of the consent decree, Hydrocodone
Bitartrate 5mg and Acetaminophen 500mg Tablets, discrepancies were discovered
with some of the data in the Company's ANDA.  This resulted in a voluntary
recall of this product in November 1993 and the withdrawal of the ANDA.  As a
result of such recall and the transaction with Mallinckrodt the Company
manufactures and ships four solid dosage products from its Brooklyn plant on its
own behalf and manufactures one solid dosage product on behalf of Mallinckrodt.


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 31 products, consisting
of 20 dosage forms and strengths of prescription drugs and 11 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:
       





                                       4






<PAGE>

      1.  Antibiotics,
      2.  Anti-infective and anti-tubercular drugs,
      3.  Neuropharmacological drugs,
      4.  Antihistamines and antihistaminic decongestants, or
      5.  Antitussives.
      
     In October 1991, the FDA suspended review of all of Halsey's (but not
Houba's or Halsey's other subsidiaries) applications for new drug approvals.  It
is unlikely that Halsey will receive any new approvals to market any generic
drugs from the FDA in 1996.  See "Government Regulation" below.  

     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.  As a result of the FDA
consent decree, the Company's strategy at the Brooklyn plant has been to
concentrate on conforming the operations of the plant to the FDA's CGMP
regulations and to satisfy the conditions for the resumption of shipments of the
remaining four Brooklyn Solid Dosage Products described above.  However, during
1996, the Company, through its Houba subsidiary, may continue to apply for ANDA
approvals.  In addition, the Company will continue to pursue the development of
its existing pharmaceutical business as well as the development of Houba's
chemical products business.

     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 so that the Company will be among the first to market the new
generic drug product.  As other off-patent drug manufacturers receive FDA
approvals on competing products, prices and revenues typically decline. 
Accordingly, the 





                                       5






<PAGE>

Company's ability to attain its previous levels of profitability depends on the
Company's ability to develop and introduce new products, the resumption of FDA
review of Halsey's application for new drug approvals at its Brooklyn plant, the
timing of FDA approval of such products and the number and timing of FDA
approvals for competing products.

     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 substantially sooner than drug products. 

     Dispositions

      On March 21, 1995 (the "Closing Date"), the Company sold its abbreviated
new drug application ("Tablets ANDA") for 5 mg Oxycodone HCl/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") to Mallinckrodt.  Mallinckrodt paid the Company
$2 million of the Purchase Price on the Closing Date, having previously paid
$500,000 in July 1994.  The balance (the "Deferred Payment") of the Purchase
Price is payable as follows.  Mallinckrodt will pay $1 million when the Company
receives general clearance from the FDA for unrestricted operations at its
Brooklyn facility and written notice from the FDA that the Company is in
compliance with certain provisions of the consent order dated July 2, 1993. 
Mallinckrodt will pay the Company the $1.9 million balance of the Deferred
Payment when Mallinckrodt receives certain authorizations (the "Mallinckrodt
Authorizations") from the FDA, but in no event later than September 21, 1997.

     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 is evidenced by a promissory note (the "Note") with
interest accruing at a rate of 8% per annum.  The Note, which may be prepaid at
any time, is due and payable on the earlier of the date of the Mallinckrodt
Authorization or September 21, 1997.  Mallinckrodt may offset its Deferred
Payment 



                                       6






<PAGE>

obligations against the amount due on the Note, provided certain conditions are
met.  The Company may also offset the amount due to Mallinckrodt on the Note
against the Deferred Payment obligations when such obligations mature.  However,
the Company has agreed with its banks (See "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operation," below) not to
exercise its right of offset until the Company has repaid in full the amounts
due to its banks.  The Note, which is subordinate to future bank indebtedness of
up to $8,000,000, is secured by substantially all of the Company's and Houba's
assets.

     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.  Mallinckrodt may terminate the
manufacturing agreement after two years.  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 with respect to the Tablets
ANDA in the United States 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, and 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 cancel payment of any yet unpaid
portion of the Deferred Payment ($1.9 million) and shall further have the right
to a full refund of any portion of the Deferred Payment already made to the
Company.


     During the fiscal years ended December 31, 1994, 1993 and 1992, the Company
derived net revenues from Tablets of approximately $6,600,000, $5,600,000 and
$4,200,000, respectively.  Management anticipated that Tablet sales would
decline during 1995 as a result of increasing competition.  Management's
determination that an integrated supplier such as Mallinckrodt would be better
suited to increasingly competitive market conditions than the Company was an
important factor in the decision to proceed with the sale of the Tablets ANDA.

     In connection with the sale of the Tablets ANDA, the Company issued to
Mallinckrodt an option exercisable at any time until March 21, 1998, to purchase
the ANDA for acetaminophen/oxycodone capsules at an exercise price (the 

                                       7






<PAGE>

"Option Price") equal to 75% of Net Capsule Revenue, subject to downward
adjustment in the event of a decline in pricing levels.  Net Capsule Revenue is
defined to mean all revenue (net of rebates, adjustments, discounts, allowances,
expenses incurred in product recalls and similar items) derived from sales of
acetaminophen/oxycodone capsules during the twelve month period immediately
prior to the date the option is exercised. The Option Price is payable as
follows: $200,000 on the later of (i) exercise and (ii) the date when
Mallinckrodt or an affiliate qualifies as the new source for certain raw
materials, with the remainder of the Option Price due when Mallinckrodt obtains
certain authorizations from the FDA or such earlier date as the parties agree. 
Upon exercise, if any,  Mallinckrodt will purchase from the Company equipment
used to manufacture the capsules for the greater of $250,000 or the appraised
value of the equipment.  At such time the Company and Mallinckrodt will enter
into agreements pursuant to which the Company will (a) manufacture
acetaminophen/oxycodone capsules for Mallinckrodt for a period of time and (b)
be prohibited from competing with Mallinckrodt and its affiliates with respect
to the production of capsules.

     Acquisitions

     The Company has engaged Penick Corporation ("Penick") to process certain of
the raw materials utilized in the production of acetaminophen/oxycodone
capsules.  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 Corporation. In June
1994 both Penick Corporation and Penick Pharmaceutical, Inc, filed petitions
under Chapter 11 of the United States Bankruptcy Code.  If Penick were to cease
operations, there can be no assurance that the Company would be able to enter
into a relationship with another entity licensed by the FDA to process such raw
materials on commercially acceptable terms.


                                       8






<PAGE>

Other Transactions
- ------------------

     Agreements with Zatpack, Inc. 

     On March 30, 1995, the Company signed an agreement (the "Zatpack
Agreement") with Zatpack, Inc. ("Zatpack"), an affiliate of Zuellig Group N.A.,
Inc. ("Zuellig").  The Zatpack Agreement provides for the purchase of 500,000
shares of common stock of Halsey (the "Shares") by Zatpack, a British Virgin
Islands Company, in consideration of $1,000,000.  The $1,000,000 purchase price
was comprised of a combination of cancellation of indebtedness (primarily
incurred by subsidiaries of Halsey for the purchase of raw materials previously
delivered and in the process of being delivered from affiliates of Zuellig),
purchase of inventory,  and surrender of shares of Indiana Chemicals.  Zatpack
has the right to have the Shares registered under the Securities Act of 1933, as
amended (the "Securities Act").  As a result of the transaction, the Company now
owns 100% of Indiana Chemicals.  

     Pursuant to the Zatpack Agreement, the Company issued a convertible
promissory note (the "Zatpack Note"), dated as of December 1, 1994, to Zatpack
as consideration for cancellation of additional indebtedness.  This indebtedness
resulted from trade payables and advances to the Company by Zuellig and certain
of its subsidiaries. The Zatpack Note is in the original principal amount of
$1,292,242, with interest accruing at a rate of 8%, compounded annually.  The
Zatpack Note was initially convertible into common stock (the "Conversion
Shares") of the Company at a price of $2.50 per share (the "Conversion Price"),
subject to adjustment.  Since issuance the conversion price has been reduced to
$2.41, as a result of the triggering of anti-dilution clauses.  The Zatpack Note
is subordinate to all bank and institutional indebtedness of the Company, and
may be prepaid by the Company, in whole but not in part, upon 30 days notice to
the holders thereof without penalty.  The holders of the Zatpack Note have the
right to have the Conversion Shares registered under the Securities Act.

     In connection with the transactions contemplated by the Zatpack Agreement,
a subsidiary of Zuellig agreed to supply a subsidiary of the Company with
Methacycline HCl for a three year period.   






                                       9






<PAGE>

     Sale of Stock to Ranbaxy

     On October 27, 1994, the Company signed a Letter of Intent ("LOI") with
Ranbaxy Pharmaceuticals, Inc. ("RPI"), a wholly owned United States subsidiary
of Ranbaxy Laboratories Ltd. of New Delhi, India.  The Company received $1
million from RPI in payment for 500,000 shares of common stock in accordance
with the terms of the LOI.  The LOI provided for completion of due diligence by
RPI within a period of 30 days, after which the parties would negotiate and
finalize a definitive agreement.  After execution of a definitive agreement, RPI
was to have purchased an additional 5,000,000 newly issued shares of common
stock for $10 million.  On November 29, 1994, the Company announced that RPI had
decided not to proceed with its second purchase of the Company's common stock. 
In August 1995, the Company repurchased the RPI Shares from RPI for an aggregate
purchase price of $1,100,000, which funds were derived from the proceeds of a
private offering of the Company's securities.  See "Item 7.  Management's
Discussion and Analysis of Financial Condition and Results of Operations."  









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<PAGE>

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, recordkeeping,
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 two to five years.  The approval procedures
are generally costly and time consuming.  

     FDA approval is required before any "new drug," 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 approvals 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


                                       11






<PAGE>

drug is manufactured.  To ensure full compliance with the 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 action such as an
injunction against shipment of the Company's products or the seizure of
noncomplying drug products, and/or, in serious cases, criminal prosecution.  See
also "Government Regulation -- FDA Investigations" below and "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.

     The Company also is governed by federal, state and local laws of general
applicability, such as those regulating working conditions.  In addition, the
Company is subject, as are manufacturers generally, to various federal, state
and local environmental protection laws and regulations, including those
governing the discharge of materials into the environment.  Compliance with
these laws is not expected to have any material effect upon the Company's
capital expenditures, earnings or competitive position.

     Drug Approvals

     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 




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<PAGE>

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 patentholder 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 




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<PAGE>

testing requirements.  That alternative seldom provides advantages over the ANDA
procedure, however, and is accordingly rarely used.

     Generic Drug Enforcement Act

     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 "Act").  The 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 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 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 Act provides for suspension of the marketing of drugs
under approved generic drug applications sponsored by affected companies.  The
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
has not been debarred as a result of the FDA investigation and settlement and
the consent decree with the FDA makes no provision therefor.  The Company does
not know when the FDA will resume review of the Company's new drug applications,
but such review can begin after the FDA finds that the Company is in compliance
with CGMP regulations.  To date, the FDA has not made such a finding.  See "Item
3. Legal Proceedings -- Government Consent Decrees."








                                       14






<PAGE>

     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.  

     FDA Investigations

     In April and May of 1990, the FDA conducted a pre-approval inspection of
the Company's Brooklyn plant, certain pending ANDAs relating to one drug product
(in four dosages) and the Company's compliance with the CGMPs.  The FDA issued
Inspectional Observations concerning, and made further investigation of, the
Company's recordkeeping practices and the accuracy of certain research and
development stage batch records maintained by the Company for one drug product. 
As a result, the Company voluntarily withdrew the pending ANDAs relating to this
product, and shortly thereafter for one other product, which have never been
marketed by the Company.  At that time, the FDA also inspected ten then
currently marketed drug products (23 dosages) and issued no Inspectional
Observations with respect to such products.

     In late 1991, the Company was notified that the FDA had undertaken a
validity assessment, pursuant to which the FDA suspended review of all of
Halsey's new drug applications, including four pending ANDAs.  At the FDA's
suggestion, the Company voluntarily undertook an internal audit and retained an
outside consultant to review pending and various filed and approved ANDAs, the
results of which were provided to the FDA.  Based on this initial review, the
Company 


                                       15






<PAGE>

voluntarily withdrew in 1991 three ANDAs for the drug fenoprofen calcium.

Product Recalls 
- ---------------

     In March 1993, the Company stopped production and sale of five products
previously manufactured at the Company's Brooklyn plant as a result of various
problems identified with these products, which related primarily to the addition
of unapproved inactive ingredients, processing deviations and recordkeeping
discrepancies.  The disclosures regarding the affected products, Quinidine
Gluconate, Propylthiouracil, Acetaminophen with Codeine, Propoxyphene Napsalate
with Acetaminophen and Metronidazole, resulted from investigations by the
Company, the FDA and DOJ into the Company's existing and pending ANDA drug
approvals and recordkeeping practices.

     In response to these problems, the Board of Directors adopted and informed
the FDA that the Board would enact a series of measures designed to address the
specific problems identified with the affected products and to avoid the
recurrence of similar problems.  The Company notified the FDA that the Company
had indefinitely suspended the manufacture and sale of the affected products,
and that it had initiated a recall of those products from distributors and
retail sellers.  In addition, the Company agreed to withdraw its ANDAs for
Propoxyphene Napsalate with Acetaminophen.  A number of personnel and related
changes at the Brooklyn plant were instituted as part of the plan proposed to
the FDA directed at the Company's oversight of regulatory affairs.  The plan
proposed to the FDA called for, among other things, the hiring of new
supervisors in the production department at the Brooklyn plant, including a new
head of production.  The Company also extended its internal audit of the
Company's products at the Brooklyn plant to determine if any other problems
existed and to determine the causes of the identified problems.  The Company
retained an additional qualified outside consultant to assist the Company's then
current outside consultant.

     In June 1993, the Company entered into a plea agreement with the DOJ and a
consent decree with the U.S. Attorney for the Eastern District of New York on
behalf of the FDA with respect to the DOJ and FDA investigations of the Company.
As a direct result of the consent decree, and a subsequent product recall, the
Company is limited to manufacturing and shipping five identified solid dosage
drug products from its 



                                       16






<PAGE>

Brooklyn plant (the consent decree does not affect the Company's ability to
manufacture and ship liquid dosage drug products or affect the Company's
operations in its Indiana or California facilities), one of which is being
manufactured on behalf of Mallinckrodt.  The Company has charged an aggregate of
approximately $5,935,000 to operations with respect to the plea agreement and
the consent decree.  This amount was comprised of inventory write-offs, product
recalls and fines.  See "Item 3.  Legal Proceedings -- Government Consent
Decrees" and "Item 7.  Management's Discussion and Analysis of Financial
Condition and Results of Operations."

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 1995, 1994 and 1993, total
research and development expenditures were $818,000, $491,000 and $2,140,000,
respectively.  During 1996 the Company intends to concentrate its research and
development efforts in the following areas:

     1.   Reintroduction of products suspended as a result of the consent decree
     which require prior FDA validation;

     2.   Reintroduction of products which will require changes in formulation
     and submission for prior approval from the FDA;

     3.   Reintroduction of the products withdrawn in 1993 and resubmission of
     the related ANDAs to the FDA; and

     4.   Development of new products.

     There can be no assurance that the FDA will grant the requisite approvals
for any such product introductions.



                                       17






<PAGE>

     The Company  currently maintains a full-time staff of eight in its Research
and Development Departments.

Marketing and Customers
- -----------------------

     A key element of the Company's marketing strategy is to maintain sufficient
raw material and finished good inventories to enable the Company to fill
customer orders promptly.  This strategy requires a substantial amount of
working capital to maintain inventories at a level sufficient to meet
anticipated demand.

     The Company sells its products primarily through three salaried employees
and to a lesser extent through two independent sales representatives, each of
whom are compensated on a commission basis.  Sales of 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 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. During
1994, the Company had net sales to three customers in excess of 10% of total
sales, each aggregating 12% of total sales.  During 1993, the Company had net
sales to two customers in excess of 10% of total sales, each aggregating 12% of
total sales.   Balances due from these customers were approximately 25% and 7%
of total accounts receivable at December 31, 1995 and 1994, respectively.  The
Company believes that the loss of either of these customers could have a
material adverse effect on the Company.

     The estimated dollar amount of the backlog of orders for future delivery as
of March 28, 1996 was approximately $1,070,000 as compared with approximately
$5,000,000 as of March 31, 1995.  Although these orders are subject to
cancellation, management expects to fill substantially all orders as of March 
28, 1996 during the second quarter of 1996.

                                       18






<PAGE>

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 it will be at a competitive
disadvantage until the FDA resumes 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).


                                       19






<PAGE>

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.  During 1995, the Company purchased
approximately $2,741,000 of its raw materials (constituting 38.4% of its
aggregate purchases of raw materials) from Mallinckrodt, and as of December 31,
1995 more than 29.7% of the Company's trade payables was owed to this supplier. 
If the Company became unable to continue to purchase raw materials from this
supplier, there can be no assurance that the Company will not face difficulties
in obtaining raw materials on commercially acceptable terms, which could have a
material adverse effect on the Company.  See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."  The federal drug application process requires specification
of raw materials suppliers.  If raw materials from a supplier specified in a
drug application were to become unavailable on commercially acceptable credit
terms, FDA supplemental approval of any new supplier would be required.  In view
of the FDA consent decree and the suspension of review of the Company's ANDAs by
the FDA, the Company would be unable to obtain FDA supplemental approval at the
Brooklyn plant for a new supplier except in very limited circumstances. 

     The 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.  These limitations could
increase the likelihood of raw material shortages and of manufacturing delays in
the event the Company was required to find new suppliers of these raw materials.

     In 1994, one of the Company's suppliers filed a Chapter 11 petition under
the United States Bankruptcy Code.  Penick continues to supply the Company but
there can be no assurance they will continue to do so.  See "-Products and
Product Developments-Acquisitions."

                                       20






<PAGE>

 
Employees
- ---------

     As of December 31, 1995, the Company had approximately 247 full-time
employees.  Approximately 120 are administrative and professional personnel and
the balance are in production and shipping.  Among the professional personnel,
eight are engaged in product development.  Approximately 90 employees at the
Company's Brooklyn plant are represented by a local collective bargaining unit
whose agreement with the Company expires on July 1, 1997.  Management believes
that its relations with its employees and unions are satisfactory.
  






                                       21






<PAGE>


 
                                    PART II


Item 6.  Selected Financial Data.
         ------------------------

     The following selected consolidated financial data of the Company and its
subsidiaries has been derived from the financial statements of the Company.  The
selected financial data should be read in conjunction with, and is qualified in
its entirety by reference to, the financial statements of the Company and the
notes thereto included elsewhere in this report.  See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations."






                                       22






<PAGE>

Summary of Statement of Earnings
- --------------------------------

<TABLE><CAPTION>

                                                       Years ended December 31, 
                                                       ------------------------

                         1995(1)       1994            1993            1992          1991
                         ----          ----            ----            ----          ----
<S>                  <C>           <C>             <C>             <C>            <C>
 Net sales            $20,225,000    $24,182,000      $36,024,000   $49,868,000   $37,462,000

 Earnings (Loss)     ($3,807,000)   ($5,767,000)   ($13,326,000)(2) $2,019,0002(3) $3,104,000

 Net Earnings        ($4,103,000)   ($5,767,000)    ($10,903,000)      $928,000    $1,727,000
 Earnings (Loss)           ($.52)        ($0.80)          ($1.57)         $ .13         $ .26

- --------------------
</TABLE>


1  The financial statements for the year ended December 31, 1995 has been 
restated with respect to the gain recognized on the sale of assets.  See 
Management's Discussion and Analysis of Financial Condition and Results of 
operations - and Note I of Notes to Consolidated Financial Statements.

2  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.

3  Earnings before income taxes and minority interest, net earnings and earnings
per share were adversely affected by the establishment of a reserve in the 
amount of $2,000,000 to cover estimated inventory write-offs, product recalls 
and additional legal expenses.



                                       23






<PAGE>

     Summary of Balance Sheets
     -------------------------


<TABLE>
<CAPTION>
                      1995          1994             1993             1992          1991
                      ----          ----             ----             ----          ----
                                                
<S>               <C>           <C>             <C>             <C>            <C>         
Working           (7,393,000)   ($ 4,451,000)   ($ 2,801,000)   $  3,461,000   $  2,350,000

Total Assets      18,862,000      19,276,000      24,674,000      33,385,000     26,561,000

Long-term          2,595,000       5,492,000       4,513,000          87,000        250,000
Stockholders'      1,540,000        (648,000)      3,919,000      14,038,000     11,117,000
</TABLE>








                                       24






<PAGE>


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

General
- -------

     Sales for the year ended December 31, 1995 are approximately $20,000,000 as
compared to sales of approximately $24,000,000 for 1994.  The net loss for the
year ended December 31, 1995 was $4,103,000 or $.52 per share, compared with the
net loss of $5,700,000 or $.80 per share for 1994.

     For the year ended December 31, 1995, the reduction in sales was primarily
attributable to the reduction in shipments of tablet products due to the sale at
the end of the first quarter by the Company of the Tablets ANDA to Mallinckrodt
which is partially offset by manufacturing revenue that the Company is receiving
as part of its agreement with Mallinckrodt.  In addition, the decrease is
attributable to price reductions effected during the year in order to meet
increased competition in the market. Depreciation and amortization was
approximately $1,956,000 in 1995 as compared to $2,350,000 for 1994. 

     For the year ended December 31, 1994, the reduction in sales was primarily
attributable to the FDA consent decree of June 29, 1993, which resulted in lower
sales from July 1993 to December 31, 1994.  The net credits issued for recalled
products in excess of previous estimated reserves for returns was approximately
$740,000.  Cost of Goods Sold includes inventory write-offs in excess of
estimated reserves for inventory of recalled products (approximately $440,000). 
Depreciation and amortization was approximately $2,350,000 in 1994 as compared
to $2,104,000 for 1993.  The year ended December 31, 1994 had no benefit
available for carryback to prior years as a result of the prior year 1993
carryback utilizing the available tax benefit of $2,500,000.

     On June 21, 1993, the Company entered into a plea agreement with the DOJ
pursuant to which the Company agreed to plead guilty to five counts of
adulteration of a single drug product and related record keeping violations. 
The Company also agreed to pay a fine in the amount of $2,500,000, payable in
quarterly installments of $125,000 over five years commencing on September 15,
1993.

     On June 29, 1993, the Company entered into a consent decree with the U. S.
Attorney for the Eastern District of New York on behalf of the FDA as a result
of the FDA's 








                                       25






<PAGE>

investigation into the manufacturing and record keeping practices at the
Company's Brooklyn plant.

     See "Item 3. Legal Proceedings.  Government Consent Decrees" for additional
information regarding the plea agreements with the DOJ and the consent decree on
behalf of the FDA.

     During 1994, the Company completed the validation of the five solid dosage
products required by the FDA consent decree in 1994.  The Company also completed
validation of certain liquid products at the Brooklyn plant.  The Company is
currently in the process of completing validity assessment studies and preparing
validation protocols for products with plans to re-introduce the products in the
near future.  

Outlook
- -------

     During 1996, the Company intends to focus its research and development
program primarily on the reintroduction of certain previously discontinued
products as well as the development of new generic pharmaceuticals.  See "Item
1. Business - Research and Development."  Moreover, as a result of the consent
decree, the Company is conforming the operations of its Brooklyn plant to the
FDA's CGMP regulations and to satisfy the conditions for the resumption of
shipments of the five products permitted under the consent decree.  For the
fiscal years ended December 31, 1995, 1994 and 1993, these five solid dosage
products accounted for approximately $12,400,000, $15,275,000 and $17,729,000 of
sales or 61%, 63% and 49.2% of the total sales for the Company, respectively.

     For the fiscal year ended December 31, 1993, Hydrocodone Bitartrate and
Acetaminophen Tablets ("HBA") (shipments of which have not been resumed as a
result of the validation process) accounted for approximately $2,922,000 or 8.1%
of the total sales of the Company.  There were no shipments of this product
after June 29, 1993.  The Company wrote off inventory of HBA of approximately
$1,000,000 during 1993.  There can be no assurance, however, that the Company
will be able to achieve similar levels of sales of these products in future
periods, or that the Company's current product mix will enable the Company to
return to profitability.  As a result of the substantial reduction in the number
of products manufactured at the Brooklyn plant, however, and as part of the
Company's continuing efforts to reduce operating costs at the Brooklyn plant,
the Company has achieved substantial workforce reductions, which management
estimates will result in annual savings of approximately $4,500,000.  As a
result of the foregoing, the historical results of operations reflected in the
condensed consolidated financial statements may not be indicative of future
operating results.






                                       26






<PAGE>

     As a result of problems identified at Cenci, new management conducted an
internal review of its operations.  This review led Cenci to discover
irregularities which prompted it to cease all manufacturing operations and to
replace certain key personnel.  Cenci has had ongoing discussions with officials
of the FDA.  Cenci has cooperated with requests from the U.S. Department of
Justice/U.S. Attorney for the District of Maryland ("USDOJ"/"USADM") in its
investigation into the practices of certain of Cenci's former employees while
they were acting on behalf of Cenci.  In addition, several current employees
have appeared before the grand jury and or spoken with representatives of the
USDOJ/USADM.   In October 1995 the former regulatory affairs director for Cenci
pleaded guilty to making false statements to the FDA.  In December 1995 this
individual was sentenced.  At this time, the Company is unable to predict what
other consequences, if any, will result from the USDOJ/USADM's investigation.



Results of Operations

        The following chart reflects expenses, earnings, income, losses and
profits expressed as a percentage of net sales for the years 1995, 1994 and
1993.

<TABLE><CAPTION>
                                                                      Percentage Change
                                                                      Year-to-Year
                               Percentage of Net Sales                Increase(Decrease)
                               ------------------------             -----------------------
                                Year ended December                 Years ended December 31
                               ------------------------             -----------------------
                                                                       1994         1993
                                                                        to           to
                                  1995     1994           1993         1995         1994
                                  ----     ----           ----         ----         ----
<S>                             <C>        <C>            <C>          <C>          <C>
Net sales                            100%  100.0%          100.0%        (16.4)     (32.9%)
Cost of Goods                        87.9   88.4             80.1        (16.8)      (25.2)
                                     ----  -----             ----        ------      ------
Gross Profit                         12.1   11.6             19.9        (12.8)      (60.8)

Research & Development                4.0    2.0              5.9          66.6      (77.1)
Selling, general and
administrative expenses              28.7   28.6             24.4        (16.0)      (18.9)
Cost of temporary closeing
of facility                           3.0    1.8
Provision for regulatory
settlement                            ---   ----             16.5          ----     (100.0)
(Loss) Earnings from
operations                         (23.7)  (20.8)          (26.9)         (4.8)      (48.1)
Provision for stockholders
litigation settlement                                         8.3                   (100.0)
                                     ----   ----                           ----     
Gain on the sale of assets           11.3                                 100.0
                                            ----             ----                    ------
Interest expense                      6.5    3.0              1.8          77.8        16.5
                                      ---    ---              ---                      ----
</TABLE>



                                       27






<PAGE>


<TABLE>
<S>                             <C>        <C>            <C>          <C>          <C>
(Loss) earnings before
income taxes, minority
interest and cumulative
effect of accounting change
                                   (18.9)  (23.8)          (37.0)        (66.9)      (56.7)
(Benefit) provision for
income taxes                          1.5   ----            (7.0)         100.0       100.0
                                      ---   ----            -----
(Loss) earnings before
minority interest and
cumulative effect of
accounting change
                                   (20.4)  (23.8)          (29.9)        (61.8)      (46.5)
Minority interest in net
earnings (loss) of                                             .4                   (100.0)
subsidiaries                      ------    ------                       ------     
                                  -------   ------             --        ------     -------
Loss (earnings) before
cumulative effect of
accounting change                  (20.4)  (23.8)          (29.5)        (61.8)      (45.8)
Cumulative effect of                                         (.7)                   (100.0)
accounting change                    ----   ----                         ------     
                                            ----             ----                   -------
Net (loss) earnings                (20.4)  (23.8%)        (30.2%)        (61.8)     (47.1%)
                                   ======   =====          =====         ======      =====
</TABLE>




                                       28






<PAGE>

Net Sales
- ---------

     The Company's net sales for the fiscal year ended December 31, 1995 of
$20,225,000 represents a decrease by $3,957,000 as compared to net sales for the
fiscal year ended December 31, 1994. The decrease in 1995 is primarily
attributable to the sale of the Tablets ANDA to Mallinckrodt. Also, in 1995 the
decrease in sales is attributable to price reductions implemented in order to
meet increased market competion. In 1994, the Company's net sales decreased by
$11,842,000 as compared to 1993. The decrease in 1994 is primarily attributable
to the discontinuance of certain solid dosage products as a result of the June
1993 consent decree on behalf of the FDA.  In addition, the Company decided to
suspend shipments of liquid products of Cenci for the last six months of 1994
and in 1995. This suspension of shipments contributed to the decline in net
sales during 1994.  Also impacting 1994 sales are credits issued for recalled
products which exceeded the estimated reserves established at December 31, 1993
by approximately $740,000.

Cost of Goods Sold
- ------------------

     For 1995, cost of goods sold decreased by approximately $3,598,000 as
compared to 1994, and in 1994 by approximately $7,476,000 as compared to 1993. 
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.
However, these reductions were partially offset by increased raw material costs
during the year. The decrease for 1994 is primarily attributable to the
reduction in units produced and the suspension of shipments of certain solid
dosage products.  In addition, in 1994, the suspension of shipments of certain
liquid products of Cenci as a result of the Company's review of operations at
this location and at the Brooklyn plant, resulted in the write-off of inventory
for recalled products in excess of the reserve in the amount of approximately
$440,000.  Management effected certain cost saving measures such as reducing
personnel and other expenditures during 1995. The Company's gross margin as a
percentage of sales for the fiscal years ended December 31, 1995, 1994 and 1993
was 12.1%, 11.6% and 20.0%, respectively. 

Selling, General and Administrative Expenses
- --------------------------------------------

     Selling, general and administrative expenses as a percentage of sales for
the fiscal years 1995, 1994 and 1993 were 28.7%, 28.6% and 24.4%, respectively. 
These expenses decreased by approximately $1,118,000 or 16.0% in fiscal year
1995 as compared to 1994.  The decrease in both years was attributable to cost
saving measures effected by management during each year, coupled with a decrease
in net sales. 







                                       29






<PAGE>

Cost of Temporary Closing of Facility
- -------------------------------------

     As a a result of irregularities identified in the manufacuring operations
of H.R. Cenci Laboratories, Inc.(Labs), the Company, in July 1994, ceased all
sales activities at Labs.  Upon completion of its review and modifications at
the facility, the Company reopened Labs in January 1996.  In connection with
this temporary closure, the company recorded costs of $ 615,000 and $ 427,000
for the years ended December 31, 1995 and 1994, respectively.  These costs
consist of inventory writeoffs, utilities, security and rent.

Provision for Stockholders Litigation
- -------------------------------------

     In June 1994, the Company and the plaintiffs in certain class actions and
shareholder derivative lawsuits agreed to settle the litigations.  In June 1994,
the Company agreed to a settlement of these lawsuits.  In November 1994, both
the Federal and State Courts approved the terms of the settlement, under which
the Company agreed to pay $1,000,000 in cash and, at the Company's option,
either (i) to issue shares of common stock having an aggregate market value, as
of the date of distribution, of $3,000,000, or (ii) to pay $3,000,000 in cash,
or (iii) to distribute any combination of shares or cash having a combined value
as of the date of distribution of $3,000,000. The initial payment of $1,000,000
was paid by the Company's insurers.  In November 1995 the Company paid the
remainder of the settlement fund by the issuance of 824,742 shares of common
stock at a per share price of $3.6375, or an aggregate value of $3,000,000.
The Company had previously recorded an estimated provision of $3,000,000 in the
fourth quarter of 1993 as the estimated cost to settle the above shareholder
actions.

Interest Expense
- ----------------

     Interest expense for 1995 increased by $572,000 as compared to 1994 as a
result of fees payable to the Company's banks, an increase in the level of
borrowings due to the issuance of convertible subordinated debentures and an
increase in the interest rate after the second quarter of 1994 (see "Liquidity
and Capital Resources" below).  Interest expense for 1994 increased by $104,000
as compared to 1993 as a result of an increase in the prime rate in 1994 and an
increase in the margin rate in mid-1993 applicable to the Company's borrowings. 



(Benefit) Provision for Income Taxes
- ------------------------------------

     The Company had no tax (benefit) provision for 1995 and 1994 since the
available loss carryback to prior years was utilized by the net operating loss
for 1993 carryback to the prior three years.  In 1993 the Company's effective
tax benefit rate was approximately 19.2% as compared to an effective income tax
rate of 55.8% in 





                                       30






<PAGE>

fiscal year 1992.  The benefit rate in 1993 arose as a result of a net operating
loss carryback to the preceding three years and is attributable to the lack of
tax benefit of subsidiary losses combined with the nondeductibility of the DOJ
settlement.

Net Loss
- --------

        For 1995, the Company had a net  loss of $4,103,000 as compared to a net
loss of $5,767,000 for 1994.  The decrease in net loss is attributable to the
gain on the sale of assets of $2,288,000 net of the tax provision of $296,000,
or $1,992,000.  The net loss for 1994 of $5,767,000 represents a decrease in the
amount of loss of $5,136,000 as compared to the net loss for 1993 of
$10,903,000.  The loss in 1994 is primarily attributable to the suspension of
shipments of certain solid dosage products as part of the aforementioned consent
decree in June 1993 combined with the suspension of shipments of liquid products
at the subsidiary for the second half of the year. 



Liquidity and Capital Resources
- -------------------------------

     At December 31, 1994, the Company had cash and cash equivalents of $353,000
as compared to $28,000 at December 31, 1993.  The Company had a working capital
deficiencey at December 31, 1995 of $7,393,000.

     The Company consummated a private offering (the "July Private Offering") of
408 units ("Units") of securities on July 18, 1995 for an aggregate purchase
price of $4,080,000.  Each Unit consisted of (i) a convertible subordinated
debenture ("July Debentures") in the principal amount of $10,000 issued at par
and (ii) 750 redeemable common stock purchase warrants ("July Redeemable
Warrants").  

     The July Debentures will become due and payable as to principal five years
from the date of issuance.  Interest, at the rate of 10% per annum, is payable
on a quarterly basis.  The July Debentures are convertible at any time after
issuance into Underlying Shares at a conversion price (the "Conversion Price")
of $2.00 per share, subject to adjustment.

     Each July Redeemable Warrant entitles the holder to purchase one Underlying
Share for $2.00 during the five year period commencing on the date of issuance. 
The July Redeemable Warrants are redeemable by the Company at a price of $.01
per Warrant at any time commencing one year after issuance, upon not less than
30 days prior written notice, if the last sale price of the Common Stock on the
Exchange following such one year anniversary equals or exceeds $2.00 per share
(the "Threshold") for the 20 consecutive trading days ending on the third day
prior to the notice of redemption to holders.






                                       31






<PAGE>

     The Company consummated a private offering (the "November Private Offering"
and, collectively with the July Private Offering, the "Private Offerings") of
336 Units on November 29, 1995 for an aggregate purchase price of $3,660,000. 
Each Unit consisted of (i) a convertible subordinated debentures ("November
Debentures") in the principal amount of $10,000 issued at par and (ii) 600
redeemable common stock purchase warrants ("November Redeemable Warrants").  

     The November Debentures will become due and payable as to principal five
years from the date of issuance.  Interest, at the rate of 10% per annum, is
payable on a quarterly basis.  The November Debentures are convertible at any
time after issuance into Underlying Shares at a Conversion Price of $2.50 per
share, subject to adjustment.

     Each November Redeemable Warrant entitles the holder to purchase one
Underlying Share for $2.50 during the five year period commencing on the date of
issuance.  The November Redeemable Warrants are redeemable by the Company at a
price of $.01 per Warrant at any time commencing one year after issuance, upon
not less than 30 days prior written notice, if the last sale price of the Common
Stock on the Exchange following such one year anniversary equals or exceeds
$2.50 for the 20 consecutive trading days ending on the third day prior to the
notice of redemption to holders.

     Holders of the November Debentures and any shares into which such
Debentures are converted, while the November Debentures remain outstanding, have
a right of first refusal to participate in any offering of securities by the
Company, with certain exceptions, to the extent the gross proceeds from such
offering, or series of offerings, in any twelve month period exceed $200,000.

     The net proceeds of the Private Offerings were approximately $7,013,000. 
The Company utilized $1,100,000 of such proceeds to repurchase 500,000 shares of
Common Stock (the "RPI Shares") from a former stockholder of the Company.  The
Company used an additional $945,000 of such net proceeds to repay a portion of
its bank debt.  The Company intends to utilize the balance of the net proceeds
of the Private Offerings for the following purposes: for working capital; for
the purchase of equipment; for research and development expenses; and for the
registration of the Underlying Shares under the Securities Act.

     As a result of the decline in shipments of solid dosage products from the
Company's Brooklyn plant following the entry of the consent decree, and as a
result of the lack of available borrowings under the Company's credit agreement,
the Company's liquidity position has been materially adversely affected since
June 30, 1993 and the Company's capital resources have been severely limited. 
The Company has actively sought to reduce its operating costs at the Brooklyn
plant, where it has made 








                                       32






<PAGE>

significant reductions in personnel at the Brooklyn plant.  In addition, the
Company's liquidity position has been affected during the second half of 1994 by
the discontinuance of shipments of liquid products from its Cenci subsidiary as
a result of review completed by the Company of this liquid operation.  In an
effort to reduce the loss from lower revenues at this subsidiary, the Company
has reduced its operating costs at Cenci through significant reductions of
personnel and other expenses.

     Under the terms of the plea agreement with the DOJ, the Company has agreed
to pay a $2,500,000 fine, payable in quarterly installments of $125,000 over
five years.  Two installments have been paid to date.  Only additional partial
payments have been paid in the amount of $90,000.  The agreement with the DOJ
stipulates if any payments are not made in a timely fashion, the entire amount
of the fine shall become due and payable immediately.  As a result, the entire
amount of the settlement has been classified as current as of December 31, 1994.
As of the current date, no action has been initiated to require immediate
payment of the entire amount; however, the Company has recently made several
partial payments.

     In March 1995, the Company and its banks restructured the Company's amended
credit agreement to include an extension of the  due date to August 31, 1995,
modification of the financial covenants, reduction of the exercise prices of all
warrants granted to the banks in excess of $2.375 per share to $2.375 per share
and extension of the expiration date of the warrants to December 1999.  As
consideration for these modifications, the banks received $1,500,000 of the
proceeds received from the transaction with Mallinckrodt.  Funds have been
applied to reduce outstanding principal by approximately $1,113,000 to
approximately $3,777,000, to pay accrued interest (approximately $154,000) and
fees (approximately $233,000).  In addition, if the outstanding borrowings were
not repaid by August 31, 1995, the Company has been required to pay an
additional 3%($ 102,000) of the then outstanding principal due to the banks.
Such amount has been accrued.

     In July 1995, the Company and its banks (the "Banks") amended the credit
agreement as a result of the consummation of the July Private Offering.  As
consideration for waiving any breach or default under the Credit Agreement as a
result of the July Private Offering, the Banks received $500,000 of the proceeds
as payment for interest, fees and principal and an extension of the warrant
exercise period to July 17, 2000. The Banks now hold warrants to purchase
636,000 shares of the Company's common stock at prices ranging from $2.13 to $
2.275, with an average weighted exercise price of $2.26. 



     Although the credit agreement with the Banks expired in March 1996, the
Company and the Banks are currently negotiating on an extension of the
agreement.





                                       33






<PAGE>

     On March 21, 1995, the Company sold its Tablets ANDA for 5mg Oxycodone
HCl/325mg Acetaminophen tablets and certain pieces of equipment utilized in
connection with the production activities under the Tablets ANDA for up to $5.4
million to Mallinckrodt.  Mallinckrodt paid the Company $2 million of the
purchase price on the closing date, having previously paid $500,000 in July
1994.  The balance of the purchase price is payable as follows: Mallinckrodt
will pay $1 million when the Company receives general clearance from the FDA for
unrestricted operations at it facility in Brooklyn, New York and written notice
from the FDA that it is in compliance with certain provisions of the consent
order dated July 9, 1993.  Mallinckrodt will pay the Company $1.9 million
balance of the Deferred Payment when Mallinckrodt receives certain
authorizations from the FDA, but in no event later than September 21, 1997.  See
"Item 1.  Business. Dispositions" for additional information regarding this
transaction.

     On March 30, 1995, the Company signed the Zatpack Agreement with Zatpack
which provides for the purchase of 500,000 shares of common stock of the Company
by Zatpack in consideration of $1,000,000.  See "Item 1. Business.  Other
Transactions - Agreements with Zatpack, Inc." for additional information
regarding the Zatpack Agreement.

     As previously indicated, the Company has continued to actively pursue
financing.  At the current time, the Company is discussing with several parties
obtaining financing which will replace the Company's banks and provide
additional working capital.  There can be no assurance that the Company will be
able to obtain any such financing on commercially acceptable terms.

Capital Expenditures 
- --------------------

     The Company's capital expenditures during 1995, 1994 and 1993 were
$536,000, $216,000 and $1,688,000, respectively. The decrease in capital
expenditures in 1995 as compared to prior years is attributable to the Company's
cash conservation measures implemented in 1994.


Item 8. Financial Statements and Supplementary Data.
        -------------------------------------------

        See Index to Financial Statements after signature page.







                                       34






<PAGE>

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

A.   Financial Statements - See Index to Financial Statements. 

B.   Financial Statement Schedules

     Not Applicable.

C.   Reports on Form 8-K

     Report on Form 8-K dated December 4, 1995 - Item 5 -  Other Events.

D.   Exhibits

        Exhibit
        Number
        ------

          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.
                    33-2471-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 31, 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
                    10.1.1 to the Registrant's Annual Report on Form 10-K for
                    the year ended December 31, 1993 (the "1993 Form 10-K")).





                                       35



<PAGE>
          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(i)   -----Form of Warrants issued to The Bank of New York, The
                    Chase Manhattan Bank, N.A. and the Israel Discount Bank.

          10.5(ii)  -----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")).

          10.6      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 







                                       36


<PAGE>
                    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).

          10.9      Employment Agreement, dated as of July 1, 1994, between the
                    Registrant and Leonard H. Weiss (incorporated by reference
                    to Exhibit 10.9 to the 1994 Form 10-K).

          10.10(i)  -----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(ii) -----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).

          10.11     -----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(i)  -----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 






                                       37



<PAGE>
                    Agreement.

          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     -----Tablets 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 





                                       38



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

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

          10.25(iii)-----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").

          10.25(iv) -----Form of Redeemable Common Stock Purchase 





                                       39


<PAGE>
                    Warrant (incorporated by reference to Exhibit 4.2 to the
                    December 8-K).

          10.25(v)  -----Letter Agreement dated November 16, 1995 between the
                    Company,The Bank of New York, The Chase Manhattan Bank, N.A.
                    and the Israel Discount Bank.

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

          24        Consent of Grant Thornton LLP, independent certified public
                    accountants.

          *27       Financial Data Schedule


________________
*    Filed herewith






                                       40






<PAGE>


    SIGNATURES
    ----------

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

Date:  October 3, 1996             By:  /s/ Rosendo Ferran
                                        ------------------
                                   Rosendo Ferran
                                   President

Date:  October 3, 1996             By:  /s/ Robert J. Mallage
                                        ---------------------
                                   Robert J. Mallage
                                   Corporate Controller

 










                                       41






<PAGE>


                          INDEX TO FINANCIAL STATEMENTS


                                                                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-7

  Notes to Consolidated Financial Statements                    F-9






                                       F-1






<PAGE>

                         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, 1995 and 1994, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1995. 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, 1995 and 1994, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles.

As more fully discussed in Note A, the accompanying financial statements have
been prepared assuming that the Company will continue as a going concern. The
Company has incurred a loss of approximately $4,103,000 during the year ended
December 31, 1995 and as of that date has a deficiency in working capital of
approximately $7,393,000. In addition, the Company's current banking agreement
expires on March 31, 1996 and the Company is currently not in compliance with
the financial covenants of its banking agreement and its convertible
subordinated debentures agreements. These matters raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these conditions are described in Note A. The financial statements do
not include any adjustments that may result from the outcome of this
uncertainty.

As discussed in Note I, the financial statements for the year ended December 31,
1995 as previously reported have been restated in regards to the gain recognized
on the sale of assets.

GRANT THORNTON LLP

New York, New York
March 29, 1996 (except for Note I as to which the date
is September 25, 1996)




                                       F-2






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

                           CONSOLIDATED BALANCE SHEETS

                                  December 31,
                                 (in thousands)



                                                   1995          1994 
                                                  ------        ------
  CURRENT ASSETS                                        
    Cash                                       $     353    $       28
    Accounts receivable - trade, net of                 
    allowances for doubtful accounts
      of $280 and $755 in 1995 and 
      1994, respectively                           1,689         2,326
    Inventories                                    7,716         6,835
    Prepaid insurance and other current        
    assets                                           656           496
    Deferred income taxes                                          296
                                             -----------    ----------
       Total current assets                       10,414         9,981
                                                        
                                                        
                                                        
  PROPERTY, PLANT AND EQUIPMENT, NET               7,394         8,561
                                                        

  OTHER ASSETS                                     1,054           734
                                                 -------     ---------
                                                 $18,862       $19,276
                                               =========     =========


The accompanying notes are an integral part of these statements.



                                       F-3






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

                     CONSOLIDATED BALANCE SHEETS (continued)

                                  December 31,
                                 (in thousands)


                                                     1995          1994
                                                   ------        ------
    CURRENT LIABILITIES                                    
    Bank overdraft                             $      213    $      218
    Due to banks                                    3,395         4,850
    Current maturities of long-term debt              200
    Convertible subordinated debentures             7,347
    Department of Justice settlement                2,000         2,013
    Accounts payable                                2,546         4,414
    Accrued expenses                                1,867         1,823
    Advances from minority stockholders               206           418
    Income taxes payable                               33           196
    Deferred income                                                 500
                                             ------------    ----------
       Total current liabilities                   17,807        14,432
                                                         
  LONG-TERM DEBT                                    2,595         2,492
                                                         
                                                         
  LITIGATION SETTLEMENT                                           3,000
                                                         
  COMMITMENTS AND CONTINGENCIES                          
                                                         
  STOCKHOLDERS' EQUITY (DEFICIT)                         
    Common stock - $.01 par value;                       
    authorized, 20,000,000
      shares; issued and outstanding,                    
      8,973,459 shares and
      7,609,537 shares in 1995 and 1994,               90            76
      respectively 
    Additional paid-in capital                     14,459        10,162
    Accumulated deficit                           (14,989)      (10,886)
                                             ------------    ----------
                                                      440          (648)
  Less treasury stock - at cost (500,000           (1,100)   
  shares in 1995)                            ------------    ----------
                                                         
                                                   (1,540)         (648)
                                             -------------   ----------
                                                         
                                                 $ 18,862     $  19,276
                                               ==========    ==========


The accompanying notes are an integral part of these statements.







                                       F-4






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

                      CONSOLIDATED STATEMENTS OF OPERATIONS

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



                                           1995        1994         1993
                                        -------   ---------    ---------
  Net sales                             $20,225     $24,182     $ 36,024
  Cost of goods sold                     17,774      21,372       28,848
                                        -------   ---------    ---------
                                                           
       Gross profit                       2,451       2,810        7,176
                                                           
  Research and development                  818         491        2,140
  Selling, general and                    5,806       6,924        8,796
  administrative expenses
  Temporary closing costs of                615         427
  facility 
  Provision for regulatory                        
  settlement                                                       5,935
                                        -------   ---------    ---------

       Loss from operations              (4,788)     (5,032)      (9,695)
                                                           
  Interest expense                        1,307         735          631
  Gain on sale of assets                 (2,288)                        
                                        -------   ---------    ---------
  Provision for stockholders'                     
 litigation settlement                                             3,000
                                        -------   ---------    ---------
                                                           
       Loss before income taxes,                           
         minority interest and                             
         cumulative 
         effect of accounting change     (3,807)     (5,767)     (13,326)

                                                                        
  Provision (benefit) for income            296   
  taxes                                                           (2,540)
                                        -------   ---------    ---------
                                                           
       Loss before minority interest                       
       and 
         cumulative effect of            (4,103)     (5,767)     (10,786)
         accounting change
                                        -------   ---------    ---------
                                                                        
  Minority interest in net loss of                
  subsidiaries                                                       150

       Loss before cumulative effect                       
         of accounting change            (4,103)     (5,767)     (10,636)
                                        -------   ---------    ---------
                                                                        
  Cumulative effect of accounting                 
  change                                                           (267)

                                                           
       NET LOSS                        $ (4,103)   $ (5,767)    $(10,903)
                                        =======     =======      =======

  Loss per common share 
    Loss before cumulative effect of
     accounting change                  $(.52)      $(.80)       $(1.53)
    Cumulative effect of accounting                                (.04)
    change                              -------   ---------    ---------

       Net loss                         $(.52)      $(.80)       $(1.57)
                                         ====        ====         =====
                                                                        
   Average number of outstanding      
     shares                           7,886,101   7,173,908    6,954,713
                                      =========   =========    =========  

The accompanying notes are an integral part of these statements.






                                       F-5






<PAGE>


                                      Halsey Drug Co., Inc. and Subsidiaries

                                  CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

                                   Years ended December 31, 1995, 1994 and 1993
                                                  (in thousands)


<TABLE><CAPTION>

                                                                                   
                                              Common stock,                          Retained          Treasury stock,
                                             $.01 par value          Additional      earnings             at cost
                                        ------------------------       paid-in     (accumulated    ----------------------
                                          Shares          Amount       capital       deficit)       Shares         Amount    Total
                                        --------          ------    -------------- --------------  ------------   -------  --------
<S>                                    <C>                 <C>       <C>           <C>             <C>            <C>      <C>
Balance at January 1, 1992             6,795,217           $68       $  8,186      $   5,784                               $ 14,038

Exercise of stock options                314,320             3            781                                                   784
Net loss                                                                             (10,903)                               (10,903)
                                      ----------          ----     -----------       -------                                 -------
  

Balance at December 31, 1993           7,109,537            71          8,967         (5,119)                                 3,919

Issuance of common stock                 500,000             5            995                                                 1,000
Issuance of warrants to banks                                             200                                                   200
Net loss                                                                              (5,767)                                (5,767)
                                      ----------          ----     -----------      --------                                --------

Balance at December 31, 1994           7,609,537            76         10,162        (10,886)                                  (648)

Issuance of common stock                 500,000             5            791                                                   796
Issuance of common stock in
connection
  with litigation settlement             824,742             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                 39,180             1             98                                                    99
Net loss                                                                              (4,103)                                (4,103)
                                      ----------          ----     -----------      --------    -------------   ---------   --------


Balance at December 31, 1995           8,973,459           $90        $14,459       $(14,989)      500,000        $(1,100)  $(1,540)
                                       =========            ==         ======        =======       =======         ======    =======
</TABLE>



The accompanying notes are an integral part of this statement.




                                       F-6




<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                             Year ended December 31,
                                 (in thousands)



                                         1995         1994         1993  
                                         ----         ----         ----  

  Cash flows from operating                                
  activities
    Net loss                           $(4,103)     $(5,767)   $(10,903)
                                        ------       ------     -------
    Adjustments to reconcile net                           
    loss to net 
     cash (used in) provided by                            
     operating activities
       Depreciation and amortization     1,956        2,350       2,104
       Provision for losses on                          271         365
       accounts receivable
       Gain on sale of assets           (2,288)         (92)
       Accrued Department of Justice        77          100
       interest
       Deferred income taxes               296                     (667)
       Minority interest in net loss                               (150)
       of subsidiaries
       Settlement of product recall                                (985)
       Department of Justice                                      2,060
       settlement 
       Provision for stockholders'                                3,000
       litigation settlement 
       Changes in assets and                               
       liabilities 
         Accounts receivable               637            2       4,374
         Inventories                      (881)       2,389       4,085
         Income taxes receivable                        660        (660)
         Prepaid insurance and other      (160)         134         (25)
         current assets
         Accounts payable               (1,868)        (912)     (1,126)
         Accrued expenses                   44          528         859
         Income taxes payable             (163)         (83)     (1,157)
                                        ------         ----      ------ 



                                                           
       Total adjustments                (2,350)       5,347      12,077
                                        ------         ----      ------   

       Net cash (used in) provided                                     
       by operating activities          (6,453)        (420)      1,174
                                        ------         ----      ------ 
                                                           
  Cash flows from investing                                
       activities
    Capital expenditures                  (536)        (216)     (1,688)
    Decrease in other assets               116         (169)        (75)
    Net proceeds from sale of assets     1,889          125
    Deferred income                                     500    
                                        ------         ----      ------ 
       Net cash provided by (used
       in) investing activities          1,469          240      (1,763)
                                        ------         ----      ------ 









                                       F-7






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

                CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

                             Year ended December 31,
                                 (in thousands)






                                         1995         1994         1993  
                                         ----         ----         ----  
 
  Cash flows from financing                                
  activities
    (Decrease) increase in notes        $(1,192)   $   (489) $        28
    payable 
    Proceeds from issuance of common        796       1,000
    stock 
    Payments to Department of               (90)        (86)         (61)
    Justice 
    Bank overdraft                           (5)       (224)        (486)
    Repurchase of common stock           (1,100)           
    Payments to minority                   (212)        (25)
    stockholders
    Proceeds from issuance of                              
    converted subordination
     debentures                           7,740            
    Proceeds from exercise of stock          99                      784
 
    options
    Increase in other assets               (727)           
                                        -------    --------     --------
                                                           
       Net cash provided by
       financing activities               5,309         176          450
                                        -------    --------     --------
       NET INCREASE (DECREASE) IN                          
       CASH AND CASH EQUIVALENTS            325          (4)        (139)

  Cash and cash equivalents at
  beginning of year                          28          32          171
                                        -------    --------     --------

  Cash and cash equivalents at end     $    353   $      28  $        32
    of year                             =======    ========   ==========
                                                           
                                                           


Supplemental disclosures of noncash activities:

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

2.   The issuance in 1995 of 824,742 shares of the Company's common stock is
   valued at $3,000,000 in connection with the litigation settlement.

3.   The valuation of the warrants issued in 1994 , $200,000, to its banks, is
   included in additional paid-in capital.






The accompanying notes are an integral part of these statements.

                                       F-8






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                        December 31, 1995, 1994 and 1993



NOTE A - SUMMARY OF ACCOUNTING POLICIES

   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 (see Note N), its 80%-owned subsidiary, The Medi-Gum
     Corporation, its 51%-owned subsidiaries, H.R. Cenci Laboratories, Inc. and
     Cenci Powder Products, Inc.  The Medi-Gum Corporation and Halsey
     Pharmaceuticals have not commenced operations.  All material intercompany
     accounts and transactions have been eliminated. 

     As of December 31, 1995, the Company has a working capital deficiency of
     approximately $7,393,000, has an accumulated deficit of approximately
     $14,989,000, has incurred a loss of approximately $4,103,000 during the
     year ended December 31, 1995, and is not in compliance with its financial
     covenants pursuant to its banking agreement and its convertible
     subordinated debenture agreements.  In addition the Company's credit
     agreement with its banks expires March 31, 1996.  These factors and the
     Food and Drug Administration ("FDA") and other matters as discussed in Note
     M, raise substantial doubt about the Company's ability to continue as a
     going concern.  The financial statements do not include any adjustments
     relative to the recoverability and classification of recorded asset amounts
     or amounts and classification of liabilities that might be necessary should
     the Company be unable to continue in existence.  Management's plans with
     respect to those conditions include seeking alternative sources of
     financing.  In this regard, the Company (a) is reviewing several
     unsolicited expressions of interest from prospective joint venture partners
     and investors, (b) plans to refinance or extend the maturity date of the
     Company's bank debt, and (c) has sold the rights to one of its products to
     a major vendor and has received a commitment for future production of such
     product (Note I).  There can be no assurance that management can obtain
     alternative sources of financing.

   2. Inventories

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

                                      F-9






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE A (continued)

   3.     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 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:

              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.

   4.     Income Taxes

     The Company adopted Statement of Financial Accounting Standards No. 109,
     "Accounting for Income Taxes" ("SFAS No. 109"), as of January 1, 1993.  The
     standards for SFAS No. 109 require that the Company utilize an asset and
     liability approach for financial accounting and reporting for income taxes.
     The primary objectives of accounting for income taxes under SFAS No. 109
     are to (a) recognize the amount of tax payable for the current year and (b)
     recognize the amount of deferred tax liability or asset based on
     management's assessment of the tax consequences of events that have been
     reflected in the Company's financial statements or tax returns.  The
     cumulative effect of this change was to increase the 1993 net loss by
     $267,000.

   5.     Loss Per Share

     The computation of 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.
     Fully diluted earnings per share is considered equal to primary earnings
     per share for all years presented as the effect of other potentially
     dilutive securities would be antidilutive. 



                                      F-10






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE A (continued)

   6.     Statement 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 income taxes for
     the years ended December 31, 1995, 1994 and 1993 of 
     $201,000, $39,000 and $199,000, respectively, and interest of $786,000,
     $504,000 and $406,000, respectively.  

   7.     Costs in Excess of Net Assets Acquired

     The Company amortizes its costs in excess of net assets acquired on a
     straight-line basis over a five-year period.  Amounts paid in excess of net
     assets acquired of $1,127,000, net of accumulated amortization of $932,000
     and $707,000 in 1995 and 1994, respectively, are included in other assets
     in the accompanying consolidated financial statements.  On an ongoing
     basis, management reviews the valuation and amortization of goodwill to
     determine possible impairment by comparing the carrying value to the
     undiscounted cash flows of the related assets.

   8.     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.

   9.     Reclassifications

     Certain reclassifications have been made to the 1994 and 1993 presentation
     to conform to the 1995 presentation.








                                      F-11






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE A (continued)

  10.     Accounting Pronouncements Not Yet Adopted

     Adoption of 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," is required for fiscal years beginning
     after December 15, 1995.  The standards for SFAS No. 121 require 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 primary objectives under SFAS No. 121 are to:  (a) recognize an
     impairment loss of an asset whenever events or changes in circumstances
     indicate that its carrying amount may not be recoverable and (b) if
     planning to dispose of long-lived assets or certain identifiable
     intangibles, such assets have been reflected in the Company's consolidated
     balance sheet at the net asset value less cost to sell.  At December 31,
     1995, the Company has not adopted SFAS No. 121.  The impact of adopting
     SFAS No. 121 on the Company's financial statements has not yet been
     determined.  

     Adoption of Statement of Financial Accounting Standards No. 123  ("SFAS No.
     123"), "Accounting for Stock-Based Compensation," is required for fiscal
     years beginning after December 15, 1995 and allows for a choice of the
     method of accounting used for stock-based compensation.  Entities may use
     the "intrinsic value" method currently based on APB No. 25 or the new "fair
     value" method contained in SFAS No. 123.  The Company intends to implement
     SFAS No. 123 in fiscal 1996 by continuing to account for stock-based
     compensation under APB No. 25.  As required by SFAS No. 123, the pro forma
     effects on net income and earnings per share will be determined as if the
     fair value-based method had been applied and disclosed in the notes to the
     consolidated financial statements.


NOTE B - FAIR VALUE OF FINANCIAL INSTRUMENTS

   Statement of Financial Accounting Standards No. 107 ("SFAS No. 107"), "Fair
   Value of Financial Instruments," requires disclosure of the estimated fair
   value of an entity's financial instrument assets and liabilities.  For the
   Company, financial instruments consist principally of cash and cash
   equivalents, subordinated promissory notes and long-term debt.



                                      F-12






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE B (continued)

   The following methods and assumptions are used to estimate the fair value of
   each class of financial instrument for which it is practicable to estimate
   that value:

   1.     Cash and Cash Equivalents

     The carrying amount reasonably approximates fair value because of the short
     maturity of those instruments.


   2.     Long-term Debt and Convertible Subordinated Debentures

     The fair value of the Company's long-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:

                                            December 31,             
                           -----------------------------------------
                                  1995                   1994       
                          -------------------   ---------------------
                          Carrying  Fair value  Carrying   Fair value
                          amount     amount      amount      amount
                          ------     ------      ------      ------
                                        (in thousands)

                                                       
     Cash and cash       $   353     $   353   $     28    $     28
     equivalents
     Long-term debt        6,190       6,190      7,342       7,342
     Convertible 
      subordinated 
      debentures           7,347       7,347  








                                      F-13






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE C - INVENTORIES

   Inventories consist of the following:
   
                                                      December 31,    
                                                     ----------------
                                                    1995         1994  
                                                    ----         ----  
                                                     (in thousands)

      Finished goods                               $2,491       $1,990
      Work-in-process                               1,398        1,301
      Raw materials                                 3,827        3,544
                                                    -----        -----

                                                   $7,716       $6,835
                                                    =====        =====


NOTE D - PROPERTY, PLANT AND EQUIPMENT

   Property, plant and equipment are summarized as follows:

                                                      December 31,    
                                                     ----------------
                                                    1995         1994  
                                                    ----         ----  
                                                     (in thousands)

      Machinery and equipment                     $11,247      $10,989
      Leasehold improvements                        5,756        5,656
      Building                                      1,203        1,203
      Land                                            265          265
                                                  -------      -------

                                                   18,471       18,113
      Less accumulated depreciation and
        amortization                               11,077        9,552
                                                  -------      -------

                                                 $  7,394     $  8,561
                                                  =======      =======

   Depreciation expense for the years ended December 31, 1995, 1994 and 1993 was
   approximately $1,576,000, $1,930,000 and $1,880,000, respectively.








                                      F-14






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE E - DEBT

   a. Line of Credit

     In December 1992, the Company entered into a credit agreement providing for
     borrowings of up to $7,000,000 at the prime rate plus an initial margin of
     1/2%, originally maturing in December 1994.  Upon certain conditions, as
     defined in the agreement, the margin rate increases by 2%.  Borrowings
     under the line were available for working capital purposes based upon a
     percentage of the parent company's eligible accounts receivable and are
     collateralized by such accounts receivable.  The agreement contains certain
     financial covenants, including minimum interest coverage and working
     capital ratios, tangible net worth, limitations on capital expenditures,
     and maximum debt-to-equity ratios.  As of December 31, 1995, the Company
     was not in compliance with the above covenants.

     In 1994, the Company and its banks amended the credit agreement to include
     the stock of certain subsidiaries, the accounts receivable of Houba, Inc.,
     and the parent company's inventory and equipment as additional collateral,
     to increase the initial margin rate to 2% (10.5% at December 31, 1995), to
     restrict certain payments made by the Company, to require payment to be
     made by the Company to the banks of any income tax refunds received by the
     Company, to extend the maturity date to August 31, 1995, and to agree in
     principal to modify the financial covenants at a later date.  In addition,
     if the outstanding borrowings were not repaid by August 30, 1995, the
     Company was required to pay $102,000, which represented 3% of the then
     outstanding principal due to the banks.  Such amount was accrued in 1995
     and fully paid in 1996.

     As consideration for the above amendments and the Company's continued
     borrowings in excess of the borrowing formula, the Company has issued to
     the banks stock warrants, expiring December 31, 1999, to purchase up to
     635,663 shares of the Company's common stock at exercise prices ranging
     from $2.25 to $2.375 per share (subject to the antidilution provisions of
     the credit agreement, as amended).  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.






                                      F-15






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE E (continued)

     In addition, the Company and its banks amended the credit agreement as a
     result of the Company having consummated private offerings of its
     securities on July 18, 1995 and November 29, 1995.  As consideration for
     waiving any breach or default under the credit agreement as a result of
     these private offerings, the bank group received $950,000 of the proceeds
     as payment for interest, fees and principal and an extension of the warrant
     exercise period to July 17, 2000.  In addition, the exercise prices of all
     warrants for 635,653 shares of the Company's common stock have been
     adjusted for antidilution to prices ranging from $2.13 to $2.275. 

  b. 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, $1,395,000 at December 31, 1995, can be converted, 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).
     The note is subordinated to the bank debt.

  c. 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 of:  (i)
     receipt by Mallinckrodt of all necessary authorizations from the FDA or
     (ii) September 21, 1997.  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.







                                      F-16






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE E (continued)

     Borrowings under long-term debt are as follows: 

                                                     December 31,    
                                                    ----------------
                                                   1995         1994  
                                                   ----         ----  
                                                    (in thousands)

         Convertible subordinated promissory
         note                                     $1,395       $1,292
                                                        
         Subordinated promissory notes             1,400        1,200
                                                   -----        -----

                                                   2,795        2,492
                                                        
         Less; current maturities of long-term
           debt                                     (200)         -  
                                                  ------     --------
                                                  $2,595       $2,492
                                                   =====        =====
                                                        

NOTE F - CONVERTIBLE SUBORDINATED DEBENTURES

   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 dilution, 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 are 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.

   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







                                      F-17






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE F (continued)

   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.

   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
   adjustment to debt discount.  The net proceeds from such issuances have been
   or will be 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 bank debt.  At
   December 31, 1995 the Company was in default of its convertible subordinated
   debentures agreements as a result of its default with its banking agreement,
   and accordingly, the convertible subordinated debentures are currently due.

NOTE G - ACCRUED EXPENSES 

   Accrued expenses are summarized as follows:

                                                      December 31,    
                                                     ----------------
                                                    1995         1994  
                                                    ----         ----  
                                                     (in thousands)

         Payroll related                          $   850       $1,039
         Professional fees                            120           74
         Interest                                     337          251
         Other                                        560          459
                                                   ------    ---------
                                                         
                                                   $1,867       $1,823
                                                    =====        =====
                                                         








                                      F-18






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE H - INCOME TAXES

   The benefit for income taxes for the year ended December 31, 1993 is composed
   of the following (in thousands):

      Current - Federal                                      $(1,606)
      Deferred - Federal, state and local                       (934)
                                                             -------

                                                             $(2,540)
                                                              ======

   Deferred income tax (benefits) provisions, resulting from differences between
   accounting for financial statement purposes and tax purposes, were as follows
   for the year ended December 31, 1993 (in thousands):

      Depreciation                                         $      50
      Provision for stockholders' litigation settlement       (1,260)
      Pension expense                                           (116)
      Provision for product recall                               417
      Provision for doubtful accounts                           (172)
      Inventory reserve                                         (168)
                                                             --------

           Deferred benefit before net operating 
             loss carrybacks                                  (1,249)

      Limitation of net operating loss carrybacks                315
                                                             -------

                                                            $   (934)
                                                             =======

                                      F-19






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE H (continued)

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


<TABLE>
<CAPTION>
                                                 Year ended December 31,   
                                                --------------------------
                               1995               1994              1993 
                         -------------      -------------      --------------
                         Amount     %        Amount     %       Amount     % 
                         ------    ---       ------    ---      ------    ---
                                          (in thousands)
     <S>                 <C>       <C>       <C>       <C>      <C>       <C>
     Federal statutory $(1,295)   (34.0)%   $(1,961)   (34.0)   $(4,497) (34.0)%
     rate                                                                 
     Change in             296    7.8                                     
     valuation                                                            
     allowance                                                            
     Loss of which no                                                     
     tax benefit                                                          
       was provided        280    7.4         1,223   21.2                
     Losses of                                                            
     subsidiaries with                                                    
       no tax benefit      240    6.3           479    8.3        472      3.5
     Goodwill               77    2.0            77    1.3         77       .7
     amortization                                                         
     Department of                                                        
     Justice                                                              
       settlement                                                 850      6.4
     Gain on sale of                                                      
     assets               546    14.3                                     
     Other                152     6.9           182    3.2        558      4.2
                          ---     ---           ---    ---        ---      ---
                                                                          
     Actual (benefit)                                                     
       tax expense   $   296      7.8%     $    -      -    $  (2,540)   (19.2)%
                     =======     ====      ========= =====     ======    ===== 
</TABLE>


     The Company has net operating loss carryforwards aggregating approximately
     $6,613,000, expiring during the years 2009 through 2010. In addition,
     certain of the Company's subsidiaries file separate Federal income tax
     returns and have separate net operating loss carryforwards aggregating
     approximately $4,783,000, expiring during the years 1998 through 2010.

     The Company's tax loss carryforwards could be limited by Section 382 of the
     Internal Revenue Code with respect to the amount utilizable each year. This
     limitation would reduce the Company's ability to utilize net operating loss
     carryforwards included above. The amount of the limitation has not been
     quantified by the Company.







                                      F-20






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

                        December 31, 1995, 1994 and 1993



NOTE H (continued)

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

                                                      December 31,    
                                                     ----------------
                                                    1995         1994  
                                                    ----         ----  
                                                     (in thousands)

      Deferred tax assets                                
        Net operating loss carryforwards         $  4,792     $  3,543
        Allowance for doubtful accounts               117          318
        Research and development tax credit           212
        Reserve for inventory                          65           92
        Litigation settlement                                    1,260
        Other                                          36           44
                                                ---------    ---------
                                                                      
                                                             ---------
           Gross deferred tax assets                5,222        5,257
                                                    -----    ---------
                                                         
      Deferred tax liabilities                           
        Depreciation                                 (771)        (517)
        Other                                        (165)         (17)
                                                  --------   ---------
                                                         
                                                     (936)        (534)
                                                 ---------   ---------
                                                         
           Net deferred tax assets before                
             valuation allowance                    4,286        4,723
                                                                      
                                                             ---------
      Valuation allowance                          (4,286)      (4,427)
                                                   -------   ---------
                                                         
           Net deferred tax assets            $    -          $    296
                                               ==========      =======
                                                         
   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, 1995 primarily pertains to uncertainties with
   respect to future utilization of net operating loss carryforwards.







                                      F-21






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                        December 31, 1995, 1994 and 1993

NOTE I - 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 has been 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 will 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 (such $1,000,000 will be recorded by
     the Company when general clearance is obtained from the FDA) and (ii)
     $1,900,000 at the earlier of (a) Mallinckrodt receiving certain
     authorizations from the FDA or (b) September 21, 1997 ("Deferred
     Payments").  Mallinckrodt also agreed to defer $1,200,000 of the Company's
     trade debt due to an affiliate of Mallinckrodt (Note E). 

          In connection with the agreement, the Company agreed to manufacture
     Tablets for Mallinckrodt for a period of three years  through March 31,
     1998 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 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, and 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 cancel
     payment of any yet unpaid portion of the Deferred Payment ($1.9 million)
     and shall further have the right to a full refund of any portion of the
     Deferred Payment already made to the Company.





     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.  Upon exercise of the
     option, the Company and Mallinckrodt would enter into agreements pursuant
     to which the Company would (i) manufacture acetaminophen/oxycodone
     capsules for Mallinckrodt for a period of time and (ii) be prohibited from
     competing with Mallinckrodt and its affiliates with respect to the
     production of such capsules.

     In connection with the filing of a Registration Statement with the 
     Securities and Exchange Commission, the Company has revised the gain 
     recorded on the sale of assets to Mallinckrodt and will not recognize the 
     Deferred Payment until the earlier of (a) Mallinckrodt receiving certain 
     authorizations from the FDA or (b) March 31, 1998.  The effect of the 
     adjustments on the accompanying financial statements is as follows (In 
     thousands, except per share amounts):



As of December 31, 1995:

                                                    As
                                                Previously

                                                 Reported   As Restated
                                                 --------   -----------

  Net loss                                        $(2,203)      $(4,103)
  Net loss per common share                          (.28)         (.52)
  Long Term Receivable                              1,900            --


                                      F-22






<PAGE>

  Accumulated deficit                             (13,089)      (14,989)



                                      F-23






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE J - PENSION EXPENSE



  The Company maintains the following two pension plans:



   1.     Management Pension Plan



     The Company maintains a defined benefit pension plan covering substantially
     all nonunion employees.



     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, 1995, the Company has not funded its 1994 ERISA obligation of
     approximately $116,000 and the remaining balance of its 1993 and 1992 ERISA
     obligations of approximately $191,000.  Failure to timely fund these
     obligations may result in the termination of the Plan and/or other monetary
     penalties.  During 1993, the Company (i) amended the Plan to reduce
     employee benefits, (ii) terminated certain employees sooner than expected,
     and (iii) reduced the discount rate used to determine the projected benefit
     obligations, all of which did not have a material effect on the Company's
     1993 consolidated results of operations.  



     Planned Company contributions over the next several years are expected to
     improve the funded status of the plan.  The plan's assets are diversified
     in stocks, bonds, mutual funds and short-term and other investments.



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



                                               December 31,          
                                       1995         1994         1993  
                                       ----         ----         ----  
                                              (in thousands)

         Normal service cost           $ 49         $ 50         $ 45
         Interest cost                   25           27           38
         Actual return on plan          (19)         (18)         (36)
         assets
         Net amortization and            (9)         (10)         (10)
                                       ----    ---------    ---------
         deferral

            Net pension cost           $ 46         $ 49         $ 37
                                        ===          ===          ===


                                      F-24






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE J (continued)



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



                                                   
                                                 Year ended December 31,
                                                 -----------------------

                                                    1995         1994 
                                                    ----         ---- 
                                                     (in thousands)
                                                          
         Actuarial present value of benefit               
         obligations
           at November 30, 1995 and 1994                  
            Estimated present value of vested         $405        $307
            benefits 
            Estimated present value of                    
            nonvested 
              benefits                                  44          36
                                                      ----   ---------
                                                                      
                                                             ---------
            Accumulated benefit obligation             449         343
            Value of future pay increases               22          17
                                                      ----   ---------
                                                                      
                                                             ---------
            Projected benefit obligation               471         360
                                                          
         Estimated market value of plan assets            
          at November 30, 1995 and 1994                456         402
                                                       ---   ---------
                                                          
             (Deficiency) excess of plan assets           

               over projected benefit                  (15)         42
               obligation 
                                                          
         Unrecognized net gain                          33          23
         Unrecognized net asset at December 1,            
           1987 being amortized over 24 years           (9)         (9)
                                                      ----   ---------
                                                          
         Prepaid pension cost                       $    9       $  56
                                                     =====        ====
                                                          


                                      F-25






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE J (continued)



     The assumptions used as of November 30, 1995 and 1994 in determining
     pension expense and funded status shown above were as follows:



                                                  1995          1994  
                                                  ------        ------
                                                        
         Discount rate                             7.00%         7.00%
         Rate of salary progression                4.00          4.00
         Long-term rate of return on assets        7.00          7.00
                                            
   2.  Employees' Pension Plan



     The Company contributed approximately $450,000, $462,000 and $515,000 in
     1995, 1994 and 1993, 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 

                                      F-26






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE K (continued)



   the date of the option grant, (ii) incentive stock options to purchase the
   Company's 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.  



   A summary of activity of all options is as follows:



                                                December 31,          
                                       -------------------------------

                                       1995         1994         1993  
                                       ----         ----         ----  

      Outstanding at beginning of     222,150      413,881      794,857
      year 
      Granted                         471,600       10,000       66,000
      Cancelled                       (54,070)    (201,731)    (132,656)
      Exercised                       (39,180)                 (314,320)
                                      --------    ---------    ---------

      Outstanding at end of year      600,500      222,150      413,881
                                      ========    =========    =========

      Shares exercisable              183,900      144,742      239,610
                                      ========    =========    =========
      Option prices per share 
        Granted                    $1.94 - $3.19  $2.00        $4.00-$6.25
        Cancelled                    2.50 - 6.25   2.01 - 6.25  2.14- 6.25
        Exercised                    2.50                       2.01- 5.50
        Exercisable                  2.50 - 6.25   2.50 - 6.25  2.01- 6.25


NOTE L - COMMITMENTS



   The Company occupies plant and office facilities under noncancellable
   operating leases which expired in December 1995.  On October 31, 1994, 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, 51% H.R.
   Cenci

                                      F-27






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE L (continued)



   Laboratories, Inc. and Cenci Powder Products, Inc., lease plant and office
   facilities on a month-to-month basis from an officer of the subsidiaries. 
   Rent expense relating to these leases amounted to approximately $86,000,
   $99,000 and $91,000 in 1995, 1994 and 1993, 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, 1995,
   1994 and 1993 was approximately $659,000, $582,000 and $502,000,
   respectively.



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



              Twelve months ending December 31,
                                              (in thousands)
                1996                            $     884
                1997                                  928
                1998                                  975
                1999                                1,023
                2000                                1,075
                2001 and thereafter                 6,234
                                                  -------
                 Total minimum payments
                 required                         $11,119
                                                   ======

   On January 1, 1993, the Company entered into an employment agreement with an
   officer having an initial term of five years.  On July 1, 1994, the Company
   entered into an employment agreement with another officer having an initial
   term of three years.  These employment agreements contain change in control
   provisions that would entitle each officer to receive certain severance
   benefits if there is a change in control in the Company, as defined, and a
   termination of employment.  The maximum contingent liability as of December
   31, 1995 under these agreements are approximately $1,027,000.



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.




                                      F-28






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE M (continued)



   In April and May of 1990, the FDA conducted a pre-approval inspection of the
   Company's facilities, certain pending approval applications and its
   manufacturing procedures.  The FDA issued "Inspectional Observations" and
   made further investigations of the Company's recordkeeping practices and the
   accuracy of certain records maintained by the Company 

   during the research and development stage for a single drug entity not being
   marketed by the Company.  On July 29, 1991, the Company received a Federal
   grand jury subpoena for documents relating to approved and unapproved ANDAs
   for various products and other documents relating to the Company's
   operations.

   The Company received a letter dated October 25, 1991 from the FDA advising
   that the FDA, under its fraud policy, had undertaken a validity assessment
   with respect to the Company's ANDAs, including four pending ANDAs and various
   ANDA supplements, pursuant to which all reviews are suspended.  The Company
   voluntarily undertook an internal audit and retained an outside consultant to
   review pending and various filed and approved ANDAs.  As part of that
   process, the Company withdrew its ANDAs for the drug product, fenoprofen
   calcium.

   On June 29, 1993, the Company entered into a 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.  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 Company's
   facilities until the Company established, to the satisfaction of the FDA,
   that the methods used in, and the facilities and controls to be used for,
   manufacturing, processing, packing, labeling and holding any drug are
   established, operated and administered in conformity with the Federal Food,
   Drug and Cosmetic Act and the FDA's Current Good Manufacturing Practice
   regulations.  As part of satisfying the foregoing requirements, the Company
   is required to validate the manufacturing processes for each solid dosage
   drug product prior to manufacturing and shipping the drug product, except
   that the Company is permitted under the terms of the consent decree to
   manufacture and ship from its facilities six identified drug products at its
   own risk provided that:  (i) at least twice per month, the Company's
   independent expert certifies that each batch of drug product upon validation
   will have been manufactured in accordance with the FDA Regulations and the
   formulation described in the drug products approved NDA ("New Drug
   Application") or ANDA, until such time as validation is completed for these
   products; and (ii) for any batches of these products that have already been
   manufactured, such certification will include certification by a company
   representative with personal

                                         






                                      F-29






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993




NOTE M (continued)


   knowledge of the records relating to such drug that they are accurate and
   complete and a certification signed by an independent expert that he has
   personally reviewed the records provided and that in his professional
   opinion, the foregoing requirement concerning validation has been met.  The
   Company commenced shipments of five of the six solid dosage products under
   the foregoing certification 

   process.  After review by the Company and its consultants of one of the
   Company's six core products, a hydrocone bitartrate 5mg and acetaminophen
   500mg tablet, discrepancies were discovered with some of the data in the
   Company's ANDA.  This resulted in a voluntary recall of this product and the
   withdrawal of the ANDA.  For the fiscal years ended December 31, 1995, 1994
   and 1993, the remaining five products accounted for approximately 61%, 63%
   and 49% of the total sales of the Company, respectively. 

   During 1992, the Company understood that the Department of Justice ("DOJ")
   was continuing to conduct an ongoing criminal investigation into the
   Company's ANDAs, and related manufacturing and recordkeeping practices.  In
   March of 1993, the Company received a second Federal grand jury subpoena for
   documents relating to two specific products and any other products
   manufactured by the Company for which improper records may have been kept. 
   As a result of the government's investigation, the Company discovered certain
   product adulterations and recordkeeping problems with five products
   manufactured at the Company's Brooklyn plant.  As a result of the above, for
   certain products, the Company indefinitely ceased production, initiated a
   product recall and recorded a charge to operations of approximately
   $5,935,000 for the year ended December 31, 1993, consisting of inventory
   write-offs ($2,925,000), a recall of products sold ($950,000) and the DOJ
   settlement of $2,060,000, as discussed below.  Included in 1993 net sales are
   sales of discontinued products of approximately $4,806,000.

   On June 21, 1993, the Company entered into a plea agreement with the DOJ to
   resolve the government'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
   recordkeeping violations.  The plea agreement also requires the Company to
   pay a fine of $2,500,000 over five years in quarterly installments of
   $125,000 beginning September 15, 1993.  Accordingly, the Company has recorded
   a provision of $2,060,000 (net of imputed interest).  As of December 31,
   1995, the Company has only paid two quarterly installments and additional
   partial payments of $90,000.  The plea agreement stipulates that if the
   Company does not make timely payments, the entire fine becomes due and
   payable.  As a result, the entire DOJ settlement has been 

                                      F-30






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE M (continued)

   reclassified as a current liability in the 1995 and 1994 consolidated balance
   sheets.  At the present time, no action has been initiated by the DOJ to
   require immediate payment of the entire amount.  Should the DOJ require
   immediate payment, it could result in a material adverse impact on the
   financial condition of the Company.

   On March 31, 1993, and April 1, 1993, five lawsuits were filed by
   shareholders against the Company and three or more of the Company's
   directors.  Each of the actions alleged that the Company and its directors
   made misleading statements and omissions relating to the prospects of the
   Company's business and products, including products under development, as
   well as relating to the status of the Department of Justice and FDA
   investigations.  Each of the actions purported to be brought on behalf of a
   class of the Company's shareholders.  Also, on May 20, 1993 and October 14,
   1993, two separate shareholders derivative lawsuits were filed against the
   Company and three or more of the Company's directors.  Each of these lawsuits
   alleged that the Company and its directors concealed certain government
   investigations by the FDA and the Department of Justice.  These actions also
   alleged that the directors breached their fiduciary duty in connection with
   their dispositions of their share of the Company's common stock on the basis
   of material information which was not publicly known.  In June 1994, the
   plaintiffs of the five lawsuits and the two shareholder-derivative lawsuits
   and the Company agreed to a settlement of these lawsuits.  The Company agreed
   to pay to the plaintiffs $1,000,000 in cash, which has been paid by the
   Company's insurance carrier and, at the Company's option, either (i) the
   issuance of shares of the Company's common stock having a value, as of the
   date of distribution, of $3,000,000 or (ii) the payment by the Company of
   $3,000,000 in cash or (iii) any combination of issuance of shares or payment
   of cash by the Company having a combined value as of the date of distribution
   of $3,000,000.  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 November 12, 1993, the Securities and Exchange Commission ("SEC")
   requested that the Company provide to the SEC, on a voluntary basis,
   information and documents regarding the ingredients and filings relating to
   the following drugs:  quinidine gluconate, propylthiourical, acetaminophen
   and codeine phosphate, metronidazole, quinidine sulfate, and hydraliazine
   hydrochloride.  The SEC advised the Company that the inquiry relates to
   public information disseminated by the Company and trading in the Company's
   securities during the period August 1987 through July 1993.  The Company is
   cooperating with the SEC and has made available various 


                                      F-31






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993


NOTE M (continued)



   documents.  These documents relate to the testing, formulations and sale of
   these drugs which were maintained by the Company at the offices of its
   counsel in Maryland.  In April 1994, the SEC requested additional
   documentation regarding these matters.  The Company has complied with the
   additional request.  On July 5, 1994, the Company made a formal submission to
   the SEC and outlined the parameters of a proposed settlement.  An additional
   submission was made on January 31, 1995 to bring additional information to
   the SEC.  In May 1995, a formal Order of Investigation was issued by the SEC
   covering the foregoing matters.  In June 1995, additional documents were
   submitted.  Officers and directors of the Company have also testified before
   the SEC.  On October 24, 1995, the SEC staff informed the Company that it
   would recommend that the Commission authorize the institution of an
   administrative proceeding pursuant to Section 21C of the Securities Exchange
   Act of 1934 (the "Exchange Act") against the Company.  Specifically the staff
   indicated it would seek an Order after filing 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 proposed action would allege 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 Form 10-Q were
   materially false and misleading.  The SEC staff proposal conforms in large
   part to the settlement proposal submitted by the Company.  Under this
   proposal, the Company, without admitting the allegations would then enter
   into a Consent Decree not to violate the law in the future.  The Company is
   unable to predict the ultimate outcome of the SEC adopting the staff proposal
   although the SEC has indicated that it anticipates such action.  An adverse
   determination in this regard could have a material adverse effect on the
   Company's financial condition.  The Company is unable to predict the
   likelihood of an unfavorable outcome as a result of this inquiry and,
   accordingly, no provision has been made for any potential costs.

   A lawsuit has been 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 alleges 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 seeks unspecified compensatory damages, as
   well as punitive damages, rescission, specific performance, reformation and a
   declaration as to what amount, if any, is owed to plaintiff.  Because of the
   early stage of this action, it is not possible at this time to predict with
   reasonable certainty the ultimate outcome of this matter and, accordingly, no
   provision has been made for any potential costs relating to this matter.



                                      F-32






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







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 1993.  In July
   1995, the Company repurchased the 500,000 shares from Ranbaxy for $1,100,000.





NOTE O - SIGNIFICANT CUSTOMERS AND SUPPLIERS 



   The Company sells its products to a large number of customers who are
   primarily drug distributors, drug store 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 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. 
   During 1994, the Company had net sales to three customers in excess of 10% of
   total sales, each aggregating 12% of total sales.  During 1993, the Company
   had net sales to two customers in excess of 10% of total sales, each
   aggregating               12% of total sales.  Balances due from these
   customers were approximately 25% and 7% of total accounts receivable at
   December 31, 1995 and 1994, respectively.  The loss of any of these customers
   could have a material adverse effect on the Company.






                                      F-33






<PAGE>

                     Halsey Drug Co., Inc. and Subsidiaries



             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



                        December 31, 1995, 1994 and 1993







NOTE O (continued)



   During 1995, the Company purchased approximately $2,741,000 of its raw
   materials from Mallinckrodt and amounts due this supplier represented
   approximately 29.7% of accounts payable as of December 31, 1995.  The federal
   drug application process requires specification of raw materials suppliers. 
   If raw materials from a supplier specified in a drug application were to
   become unavailable on commercially acceptable credit terms, FDA supplemental
   approval of any new supplier would be required.  In view of the FDA consent
   decree and the suspension of review of the Company's ANDA by the FDA, the
   Company would be unable to obtain FDA supplemental approval at the Brooklyn
   plant for a new supplier except in very limited circumstances.  The Drug
   Enforcement Administration limits the quantity of the Company's inventories
   of certain raw materials used in the production of controlled substances
   based on historical sales data.  These limitations could increase the
   likelihood of raw material shortages and of manufacturing delays in the event
   the Company was required to find new suppliers of these raw materials.  There
   can be no assurance that the Company will not face difficulties in obtaining
   raw materials on commercially acceptable terms, which could have a material
   adverse effect on the Company.



NOTE P - TEMPORARY CLOSING COSTS OF FACILITY



   As a result of irregularities identified in the manufacturing operations of
   its 51%-owned subsidiary, H.R. Cenci Laboratories, Inc. ("LABS"), the
   Company,in July 1994, ceased all manufacturing and sales activities at LABS. 
   The Company, upon completion of its review and modifications at the facility,
   reopened LABS in January 1996.  In connection with this temporary closure,
   the Company recorded costs of $615,000 and $427,000 for the years ending
   December 31, 1995 and 1994, respectively.  These costs consist of inventory
   write-offs, utilities, security and rent.





                                      F-34






<PAGE>


 
               EXHIBIT INDEX

Exhibit                                                                 Page
Number       Description                                                No.
- ------       -------------------------------------------------          ------
   3.1       Certificate of Incorporation and
   3.2       Restated Bylaws (incorporated by reference to

   10.1      Credit Agreement, dated as of December 22,

   10.2      Amendment Two, dated as of January 12, 1994,
   10.3      Amendment Three, dated as of May 31, 1994, to

   10.4      Amendment Four, dated as of July 1994, to

   10.5      Amendment Five, dated as of March 21, 1995,
   10.5(i)   Form of Warrants issued to The Bank of New

   10.5(ii)  Letter Agreement, dated July 10, 1995, among

   10.6      Agreement Regarding Release of Security 

   10.7      Consulting Agreement dated as of September,
   10.8      Employment Agreement, dated as of January 1,

   10.9      Employment Agreement, dated as of July 1,

   10.10(i)  Halsey Drug Co., Inc. 1984 Stock Option Plan,
   10.10(ii) Halsey Drug Co., Inc. 1995 Stock Option and

   10.11     Leases, effective February 13, 1989 and

   10.12     Lease, effective as of April 15, 1988, among
   10.12(i)  Lease, as of October 31, 1994, among

   10.13     Asset Purchase Agreement dated as of March

   10.14     Toll Manufacturing Agreement for
   10.15     Capsule ANDA Option Agreement dated as of

   10.16     Tablets ANDA Noncompetition Agreement dated

   10.17     Subordinated Non-Negotiable Promissory Term
   10.18     Term Note Security Agreement dated as of

   10.19     Amendment dated March 21, 1995 to

   10.20     Agreement dated as of March 30, 1995 between
   10.21     Waiver and Termination Agreement dated as of

   10.22     Convertible Subordinated Note of the

   10.23     Agreement dated as of March 30, 1995 among
   10.24     Supply Agreement dated as of March 30, 1995


                                      


<PAGE>

   10.25(i)  Form of 10% Convertible Subordinated

   10.25(ii) Form of Redeemable Common Stock Purchase
   10.25(iii)Form of 10% Convertible Subordinated

   10.25(iv) Form of Redeemable Common Stock Purchase

   10.25(v)  Letter Agreement dated November 16, 1995
   22        Subsidiaries of the Registrant (incorporated

   24        Consent of Grant Thornton LLP, independent

  *27        Financial Data Schedule




                                      










<TABLE> <S> <C>



<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheets at December 31, 1995 and the Consolidated Statements
of Operations for the Year Ended December 31, 1995 and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
       
<S>                             <C>
<PERIOD-TYPE>                   12-MOS
<FISCAL-YEAR-END>                          DEC-31-1995
<PERIOD-END>                               DEC-31-1995
<CASH>                                             353
<SECURITIES>                                         0
<RECEIVABLES>                                    1,969
<ALLOWANCES>                                       280
<INVENTORY>                                      7,716
<CURRENT-ASSETS>                                10,414
<PP&E>                                          18,471
<DEPRECIATION>                                  11,077
<TOTAL-ASSETS>                                  18,862
<CURRENT-LIABILITIES>                           17,807
<BONDS>                                              0
<PREFERRED-MANDATORY>                                0
<PREFERRED>                                          0
<COMMON>                                            90
<OTHER-SE>                                      13,359
<TOTAL-LIABILITY-AND-EQUITY>                    18,862
<SALES>                                         20,225
<TOTAL-REVENUES>                                     0
<CGS>                                           17,774
<TOTAL-COSTS>                                        0
<OTHER-EXPENSES>                                     0
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                               1,307
<INCOME-PRETAX>                                (3,807)
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                                  0
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                   (4,103)
<EPS-PRIMARY>                                   (0.52)
<EPS-DILUTED>                                        0
        

</TABLE>